What role do banks play for the major imperialist powers? Everyone knows that the rich countries own the big banks, and that the big banks are in a powerful position in the global economy. Despite this, there has been little attempt to examine the relationship of finance to imperialism, still less to analyse the financial system as part of the every day operation of the imperialist world economy. Here I offer a framework for understanding this role of finance, which is part of a project that I am researching.
The points outlined are based on a paper I presented at the 5-7 July 2012 conference of the AHE/FAPE/IIPPE in Paris. Since that conference, I have revised and further developed the analysis, and here I present some of the results (I plan to get a full paper published). These summary points exclude the more detailed analysis, documentation and references. I welcome any comments.
I start with the standard formula used to represent the rate of profit on capital investment. By examining how this formula needs to be modified, if it is to reflect the workings of the capitalist economy, I show not only where the financial system fits into this formula, but also how the formula can be developed to highlight important aspects of the role of finance for imperialism.
First, a warning! Running through a series of definitions and equations can be a little dull. I have not yet figured out how to do this with witty literary allusions, nor by using cartoon characters, but I hope that the content of what is being explained is engaging enough to offset the dry form of presentation.
1. From the ‘basic’ rate of profit to a system rate of profit
The familiar expression for the rate of profit on capitalist investment that is taken from Volume 3 of Marx’s Capital is:
where S is the total surplus value produced, C is the constant capital advanced (on machinery, raw materials, etc) and V is the value of the variable capital advanced on living labour power.
However, strictly speaking this expression refers only to the rate of profit for productive capital, excluding any allowance for non-productive expenditures. Neither does it allow for the rate of turnover of the invested capital. Both these factors can have a big influence on the rate of profit for the capitalist system as a whole and below I will incorporate them into an expression for the system rate of profit.
Investment that is productive of value and surplus value extends beyond purely industrial activities and the production of physical goods. However, for simplicity I shall call productive capitalist operations those of ‘industrial’ capital. Expenditures that are not productive of value or surplus value may be broken down into expenditures made by the state or government and non-productive expenditures made by private capital. State expenditures have become very important for the capitalist economy, but are excluded from this analysis because I wish only to focus on the role of private capital. Private capital’s non-productive activity is in what Marx called the ‘sphere of circulation’. Here there is no production of any new value, but only a change of the form of value (the buying M-C, or selling C-M, of commodities), the borrowing or lending of money, or the trading of financial claims. For simplicity again, I shall call the buying and selling of commodities an operation performed by ‘commercial’ capital and the remaining functions those of ‘financial’ capital or ‘banks’.
The non-productive expenditures of private capital might indirectly boost productive capital. For example banks could provide funds for investment, or commercial capital could buy or sell commodities more quickly or in a less costly manner than the productive capitalist could do on its own. However, even if the total value and surplus value produced in a year increases as a result, this is a function of the value produced in the productive sphere only. The costs incurred by the non-productive sphere still have to be accounted for as a capital advance, and as an expense to be deducted from total surplus value produced.
On the second issue, the turnover time of capital investment, this describes how quickly the value of capital advanced returns back to the capitalist after the periods of circulation and production. Marx distinguishes for productive capital two types of capital employed when he analyses turnover: fixed and circulating capital. Fixed capital (machinery, tools, buildings, etc) lasts for more than one production process and gives up its value to the product in a piecemeal fashion; circulating capital (the value of labour-power employed, raw materials, etc) adds or transfers its value in full in one production process. Only a portion of fixed capital is used up in a year, but it all has to be advanced at once – you cannot work with half of a machine. Circulating capital will usually be turned over several times per year, so the total capital advanced to buy circulating capital at any one time will be less than the total used in a year.
These distinctions are used in what follows. A further note is that, for capital advanced by both commercial and financial capital, while only the depreciation of their ‘fixed assets’ needs to be set against the total surplus value produced, all of their ‘circulating costs’ in the year represent a deduction from surplus value.
2. The rate of profit including commercial capital
The rate of profit, taking into account both productive and commercial capital, can be derived by considering firstly the total value of the commodities produced in a year and the surplus value contained in them. Then this surplus value is measured against the total capital advanced in the year by both industrial and commercial capital.
In this expression for the rate of profit, the terms are defined as follows:
FC the total advance of fixed capital by productive capitalists, with β being the proportion that depreciates in one year
CC the advance of circulating capital for one period of production
V the advance of variable capital to hire productive workers for one production period
B the advance of money capital by commercial capitalists to buy commodities from and sell to industrial capital (this element of capital is not a cost that needs to be deducted from surplus value, because it is returned on the sale of the commodities)
K the advance of capital by commercial capitalists for fixed assets, with β being the proportion that depreciates in a year
L the total circulating capital costs of commercial capital in a year
S the surplus value produced in one period of production
n the number of turnovers of circulating capital employed by productive capital in a year
Using these terms, the formula for the rate of profit that includes both industrial and commercial capital is then:
Clearly, the system rate of profit now looks much lower than that implied by equation 1, since it has to allow both for a deduction from surplus value of the annual costs of commercial capital in the numerator and for the extra costs of capital advanced in the denominator. In Marx’s exposition in Capital Volume 3, these extra deductions and costs are not always evident, although it is noted that a faster rate of turnover (a higher value for n) will increase the mass of surplus value produced in a year.
3. The rate of profit allowing for financial capital
In order to show how financial capital can be included in our calculations of system profitability, it is necessary to define some additional variables. Let E be the value of bank equity capital, or ‘shareholders’ equity’ and let D be the value of customer deposits and other borrowings. It is important to note that these deposits include not only the surplus cash resources of industrial and commercial companies. They will also be boosted by the banking sector’s own creation of money.
The value of D plus E is used to fund the bank’s total assets, which I will designate as A. In standard accounting terminology, the bank’s total assets equal its liabilities plus its equity capital, so the next formula is:
A = D + E
I shall assume that, of the bank’s total assets, a value equivalent to E covers the bank’s fixed and circulating capital costs (buildings, technology, infrastructure and salary costs, etc) and its core reserve capital. This is a reasonable simplification, and it leaves a value equivalent to D to be lent out. The lending can be to industrial and commercial companies, or to other financial companies (including buying any financial assets in the secondary market). This value D can then be divided into D1, where it is lent ‘internally’ to other financial companies, and D2, where it is lent ‘externally’ to industrial and commercial companies (I exclude households and the government in this analysis).
If the average interest rate paid on deposits is iD, and the average return on bank loans is iA, the bank’s net interest income (before deducting other, non-interest costs) can be written as:
D(iA – iD)
The sum D2 represents the funds for investment that industrial and commercial companies have borrowed from banks. These funds are for their extra investments in constant capital, variable capital, plus a proportion of commercial money capital advanced and a proportion of the fixed and circulating costs of commercial capital. For the total constant fixed capital, FC, this can be broken down into FC1, advanced by the industrial capitalist directly, and FC2, that portion borrowed from the bank. Hence
FC = FC1 + FC2
CC = CC1 + CC2
V = V1 + V2
and likewise for the commercial capitalist,
B = B1 + B2 and so on
Since, by assumption, all the borrowed funds equal one portion of the total deposits of banks, then:
D2 = FC2 +CC2 + V2 + B2 + K2 + L2
The logic behind these formulations is straightforward and it can be developed to derive some interesting and intuitively reasonable results.
Firstly, total surplus value remains nS, as noted before, but the surplus value is not only shared between industrial and commercial capitalists and the financial sector. For both the latter two sectors, their depreciation costs of fixed capital outlay for buildings, technology, etc, and their personnel and other circulating costs are not transferred to the values of commodities. Hence these latter costs must be recovered from the total surplus value produced in society. If we assume that the depreciation of the fixed assets of financial capitalists in one year is equal to γE, and that the total circulating costs in a year (including wages paid) amount to M, then the total profit appropriated by the three sectors is lower still than in equation (iii) above. It is expressed as:
nS – L – βK – M – γE
The total capital advanced by all three sectors can be given as the sum of that belonging to the industrial and commercial capitalists, the funds they have borrowed from the financial sector plus the financial sector’s own equity (which here we assume also covers their circulating costs M). Hence the rate of profit on total social capital can now be written as:
While a little unwieldy, this result highlights the impact of the commercial and financial sectors on the total system rate of profit. It shows in particular how the rate of profit is much lower than suggested by simply looking at the ratio of the total S in one year to the C + V advances of productive capital. I believe this kind of formulation to be original. Although some elements of this type of formula have been discussed in the literature, it is notable that in Volume 3 of Capital Marx only discussed the division of the surplus value accruing to industrial and commercial capital between ‘profit of enterprise’ and interest. Marx did not discuss the rate of profit of the system as a whole once the costs of commerce and finance had been included, and neither did Hilferding in Finance Capital.
The methodology used here excludes financial assets from the calculation of the capitalist system’s rate of profit, except to the extent that the value of these assets reflects investments in the operations of industrial, commercial and financial companies. In those cases, the assets may be considered as capital advanced, whether or not the funding goes to productive or unproductive (commercial or financial) capitalist enterprises. Otherwise, the large volume of assets recorded by financial companies will simply reflect a potentially huge sum of value that is based on loans made (largely based on deposit creation by the banks), or financial securities and derivatives purchased. The only common element between the former invested assets and the latter assets is that they will, in general – except for derivatives – accrue interest or dividend payments. But while all such payments remain deductions from the total surplus value produced by the capitalist system, only the former assets can be considered as real capital advanced.
4. The profitability differences between banks and other companies
It can be shown (as explained in the main paper) that the system rate of profit described here drives the movement of some important profitability targets of industrial and commercial companies such as the ‘return on equity’. As the system rate of profit trends higher or lower, so will the industrial and commercial companies’ return on equity.
However, the relationship between the system rate of profit and the return on equity for banks is far more tenuous. This is because the banks can expand their assets dramatically through their ability to create deposits. These assets are multiplied by the interest rate differential (and fees) that they gain, boosting their profitability. Banks are at the centre of the capitalist financial system, able to gain access to far easier sources of funding than other companies, both from other private banks and from the central bank’s liquidity operations. As a result, it is considered ‘normal’ for them to have a leverage ratio of 20, whereby their borrowings are 20 times their equity base. Other types of company normally have leverage ratios of less than one. This creates a different dynamic for the return on equity for financial companies compared to that for industrial and commercial companies, and there is no clear mechanism for the equalisation of such a profit measure between banks and other companies.
Another issue arises from the fact that bank costs and profits are a deduction from the surplus value produced by the system as a whole. This should place a constraint on how far the banking sector can grow, but that constraint appears in a different way for different countries. If a country is an imperialist power with a strong financial system, then it can derive surplus value from other parts of the world, enabling its financial sector to grow dramatically and nevertheless remain a profitable area of business!
5. Imperialism and finance
The UK stands out in this respect. Not only is it a major imperialist power with a GDP in the top 10, but it has a banking sector that has liabilities more than five times national GDP. Surprisingly, this simple point receives no coverage in the Marxist literature. But this omission is consistent with that literature analysing neither why the UK financial sector is so big, nor how the financial sector operates as a functional part of imperialist economic power. It is not open to every country to establish a major international banking and financial network. The growth of the UK financial sector is based on its status and privileges in the world economy, one that has been promoted by successive UK governments, in particular from the late 1970s and in cooperation with the US.
There are three important ways in which the financial sector can play a key role for the economic livelihood of an imperialist power:
(a) By drawing on (relatively low cost) funds from abroad to lend to domestically based capital and to the state: this happens largely via the FX reserve role of the dollar in the US’s case, and via the London-based banking system in the UK’s case.
(b) By financing the foreign operations of domestic corporations, whether from domestic or from foreign funds, so that they can exploit foreign labour: this can happen via bank finance or via the stockmarket enabling the centralisation of capital. across national borders.
(c) By taking a share of globally produced surplus value: this takes place through the banking centres providing loans and other ‘financial services’ to foreign businesses and governments.
Each of these financially derived benefits for the imperialist power concerned depends on a privileged relationship with other countries, one that it is determined to protect. Hence the attitude of the UK and US governments to any measures to constrain the financial sector beyond what they might also agree is necessary to prevent further damaging excesses.
The article above first appeared on Tony’s Economics of Imperialism site, here.