Making Finance Serve the Real Economy

Thomas I. Palley

In the wake of the financial crisis of 2008, financial sector reform has been a major policy focus around the world. However, that focus has been almost exclusively on the issue of “stability” and preventing a repeat of the crisis. There has been little debate about the broader role of finance in shaping economic developments over the past 30 years, and inadequate attention is given to the challenges of how to remedy the massive economic inequities and problems relating to unemployment and growing indebtedness of many households.

This silence on the broader role of finance has economic and political consequences. The framing of the reform debate in terms of the narrow issue of stability shuts down the case for deeper systemic reform. Financial markets have a broader social purpose than just the efficient allocation of capital on behalf of shareholders. That broader purpose is to contribute to the delivery of “shared prosperity,” which can be defined as full employment with rising incomes and contained income inequality. Today, we clearly do not have shared prosperity, and a big reason for that is the economic and political power of finance.

The structure of the economy affects whether the economy meets the needs of people, and in a broader sense, it influences the way that societies are governed. The rising influence of finance has distorted the public discourse and narrowed the range of those who are able to make themselves heard. This not only affects decision making in the economic and political realms, it also means that the growing urgency of reconciling the economy with environmental limits—creating the conditions for a shared and sustainable prosperity—has been largely neglected. For more than three decades, financialization has been an engine of an economy that gobbles up growing amounts of scarce resources even as it distributes the product in ever more unequal ways. In the future, the finance sector will need to be governed in ways that facilitate the transition to a more equal and sustainable economy.

In the United States, as around the world, the process of “financialization”—by which the financial sector has become the new master of the broader economy—needs to be tamed so that finance once again serves the economy and people's needs. Subjecting runaway financial institutions to rules and regulations driven by the public interest forms a critical part of overhauling governance processes.