Human geography and financialisation: A complex systems theory response

The long-running debate about the spatial implications of financialisation has given rise to a gap in the literature, between the standard (or convergence view) on the one hand, and the orthodox (or divergence) view on the other. This paper seeks to contribute to this debate by charting a middle course, differentiated from the current literature in both methodological and conceptual scope, with the main proposition being that: while financialisation has brought geographies into question, its spatial legacy lies not in any organised deterritorialisation of economy, but rather, in its structural, compositional and computational arrow of time (i.e. historical, irreversible time). The essay begins by reviewing the standard view, before presenting evidence to the contrary. Drawn from case studies in CIP deviations, banking networks, and the international division of labour, the alternative ‘complexity’ view is then explored, followed by a critical analysis of its strengths and shortcomings, as well as a discussion about the need for a reorientation of assumptions. The essay concludes with an empirical evaluation of the new theory.

1. The standard (original) view

The standard view holds that the mobility of capital presents unprecedented changes to the geography of money and finance (French et al. 2011: 810). Strange (2016 [1998]: 24) argues that, emboldened by innovations accruing from ‘computers, chips, and satellites’, the financial sector laid the groundwork for run-away capital. Citing the burgeoning market for finance and capital, she predicts that a convergence in CIP (covered interest rate parity)—a key spatial result of her theory—should prevail. For Frieden (1991: 442) the dawn of the international mobility of capital bears ‘striking’ implications upon the policy arsenal of states, restricting the ‘degree of exchange rate flexibility and the level of the exchange rate itself’. As the influence of finance grows by making it easier for capital to find the best rate of return, it exacerbates the whipsawing of states. In the developed world, this process has ‘drive[n] a wedge between two camps’: the “integrationists”, consisting of the financial sector and relevant stakeholders; and the “anti-integrationists”, the firms specific to particular geographies. These ideas find their logical conclusion in O’Brien’s 1992 pamphlet, Global Financial Integration: The End of Geography, where the ‘regulatory revolution’ is cast in the light of ascendant financial and derivatives markets. While clarifying that persistent differences among countries and markets continue to shape the landscape, ‘there is a case’, argues O’Brien, ‘for trying to establish an overarching authority that can act as lead supervisor and regulator’ (1992: 108).

2(a). Empirical analysis of the standard/original view

Counter-evidence, however, abounds. The developed countries of Europe and the Americas dominate international holdings of bonds, equities and bank assets relative to GDP, exceeding low-cost countries in Latin America and the Asia Pacific (Figure 1). Deviations have also been observed in covered interest rate parity figures, a key litmus test identified by Strange. These rates should, according to the theory, deviate by no more or less than zero cross-currency basis points. But differentials between GBP and USD have been known to exceed 300 points (Figure 2). Large, persistent, and systematic arbitrage opportunities have precluded a stable convergence, pointing to a post-GFC interaction between ‘costly financial intermediation’ and ‘international imbalances in funding supply and investment demand across currencies’ (Du et al. 2018: 952), a testament to enduring spatial disparities.

Screen Shot 2018-07-24 at 7.17.45 pm.png
Figure 1 / Bonds, equities, and bank assets (% of GDP). Source: IMF (2015).
Figure 2 / Persistent CIP deviations. Source: Jauregui & Natraj (2017: 02).

Defending homogeneity was never meant to be easy. Proponents of the standard view cannot be necessarily blamed for failing to anticipate such anomalies, in large part because it is not clear what they meant: there is no commonly agreed upon interpretation of the evidence. This makes the school theoretically, not to mention empirically, unsound. At times Frieden draws upon a tripartite model consisting in the ‘political significance of the short-run’, the ‘relative specificity of most people and investments to their current activity’, and the ‘possibility that some factors are more mobile than others’ (1991: 438). But at other times, this interpretative grid is superseded by another, characterised by friction between BCM, the time before capital mobility, and ACM, after capital mobility, bereft of an historico-political account of the demarcation. There is a further methodological distinction made between sectoral- and class-based approaches, the spatial implications of which are atomically conceived. The problem with Frieden’s account, and the standard view as whole, consists in this attempt to show that the multi-scalar compressions of space-time and abstract macroeconomic industrial organisation are commensurable. A new account of this correspondence, between the microscopes and macroscopes of space, is required.

2. The complexity view: introduction to structural, compositional, and computational forces

Three main forces driving spatial transformation which cannot be accounted for in the current literature are implied by the evidence. They are: structural, compositional, and computational. The sum total of these transformations imply a broader logic of fractal development and evolution within which the ‘schizophrenia’ (Harvey 1990: 240) of finance unfolds. This assessment can be conceived of as the ‘complexity’ view, differentiated from the standard (or ‘the world is flat’) view on the one hand, associated with Strange (2016 [1998]) O’Brien (1992), Frieden (1991), and Friedman (2007 [2005]), and the orthodox (or ‘variegation’) view on the other, associated with Dunn (2004), Toporowski (2012), Brenner (1997), and Clark (2003). Firstly, structural complexity has reinforced networks of hierarchy and organisation (Arrighi & Drangel 1986: 56), weighted by the relative size and location of nodes, privileging financial activity over non-financial activity, and so entrenching spatial divergence. Secondly, compositional complexity has tilted the content of financialisation toward increased risk and liability (Battellino 2007: 81). Spatially, this implies greater instability through heightened interconnectivity and therefore interdependence. Thirdly, computational complexity has improved the speed and precision of financialisation, accelerating the productivity of those spaces with access relative to those without (Bryan & Rafferty 2006: 164). This model coheres because each force is dependent on the process analytically prior to it, from structure down to computation, evolving abstractly rather than iteratively. Heuristically, these transformations correspond to the level of the nation state, firm, and individual respectively.

2(a). A change in the underlying assumptions

On the methodological level, such a change in the way we think about spatial transformations implies a fundamental shift in the underlying assumptions.

Structurally, the dichotomy conceived through the lens of ACM and BCM dissolves and is transposed onto the centrifugal tendencies of hierarchy and organisation, leaving higher-order emergent phenomena intact. This is desirable because it allows for comparisons across space (Dymski & Li 2004: 214). It also entails a change from static linear equilibrium underscored by exogenous injection, to open non-linear chaos underscored by endogenous projection.

Compositionally, the progress of some firms over others, driven by the centripetal tendencies of competition and accumulation at the microeconomic level, fragments financial geographies—a key intuition shared by O’Brien, and an enduring strength of his otherwise radical analysis. These outcomes accentuate the reflexivity of the system and its capacity for self-organisation (Mauboussin 2002: 51).

Computationally, the fundamental unpredictability of the atomic level, differentiated from Knightian uncertainty (1921), feeds into the non-ergodicity of financial geography by the arrow of time. Simon (2005 [1962]: 146) and Haldane (2015: 02) have shown this platform plays a crucial role in the evolution of the system via amplifying feedback mechanisms because it accounts for the path dependency of the system.

This discussion relating the atomic and systemic levels leads us finally into the key insight of the complexity view: that the multi-scalar compressions of space-time and abstract macroeconomic industrial organisation are mediated by a hitherto unexplored level of analysis, the meso-structure.

2(b). Empirical analysis of the complexity view

With conceptual and methodological preliminaries out of the way, an empirical evaluation of the complexity view is now in order.

At the systemic level, figures show global manufacturing firms in the UK and USA, for instance, have allocated their revenues ‘according to a corporate governance principle that we call “retain and reinvest”’, writes Epstein (2005: 86): ‘These corporations tended to retain both the money that they earned and the people whom they employed’, and then ‘reinvest the funds into non-productive financialised activities’, rather than R&D or training, entrenching spatial unevenness.

Screen Shot 2018-07-24 at 7.15.22 pm.png
Figure 3 / UK interbank network (exposures). Source: Langfield et al. (2014: 290).
Figure 4 / UK interbank network (funding). Source: Langfield et al. (2014: 291).

Compositionally, research on the UK interbank network also provides insight into the self-organised core-periphery structure of financialisation. In  Figures 3 and 4, each node represents a bank, the size of which represents the total value of exposures or funding received and provided by the bank.[1] Broken down by instrument, derivatives are the most substantial (see Jobst 2008), comprising 44% of all interbank exposures, followed by unsecured loans (25%), marketable securities (16%) and securities financing transactions (11%). By contrast, repos (66%) dominate the funding network, followed by unsecured loans (29%). The majority of lending instruments (exposures) have an outstanding maturity of less than 3 months (45%), compared to those of more than a year (14%). In the funding (marketable securities) network, maturities regularly exceed one year (33%), suggesting banks borrow long and lend short, a result that highlights the increased risk, speed, precision, and concomitant interconnectivity, of the contemporary financial system. Financialised geographies are therefore not as resilient as the standard view has it, but nor are they as vulnerable as orthodox geographers suggest. When targeted shocks affect core nodes—the “super-spreaders”—their hyper-connectivity risks generating a systemic cascade (Albert et al. 2000: 379). However, these networks are scale-free: random shocks are more likely to impact peripheral nodes unconnected with, and therefore unlikely to cascade through, the topology as a whole.

Screen Shot 2018-07-24 at 7.14.07 pm.png
Figure 5 / Regional unemployment rates with search frictions in both sectors. The red dashed lines indicate the value of the variables for the agriculture sector, while the continuous blue lines represent the variables in the manufacturing sector. The red and blue dot dashed lines denote the regional variables in the long-run unstable equilibrium. Source: Yang (2014: 510).

Linking the meso-structure, Yang (2013) has shown that at the computational level, when labour market frictions are introduced, interdependency between agglomeration and unemployment obtains. As trade freeness, , rises beyond a certain threshold, break, the spatial equilibrium experiences a discontinuous shock into full agglomeration (that is, the economy collapses into one spatial/regional sector). In this way, Yang’s decomposition accounts for the embeddedness of spatial vareigation: the amplifying feedback effects prevailing at this atomic level directly underpin the centripetal, agglomerative tendencies of the compositional level of analysis. In panels (c) and (d) of Figure 5, the blue dot dashed line rises as trade openness increases, corresponding to worsening (manufacturing) unemployment, until the loss is matched by a fall in the agriculture sector’s rate of unemployment. The pitchfork bifurcations from which these models derive exhibit fundamental uncertainty, irregularity, and non-normal probability behaviour that cannot be divined by stochastic calculus distributions, reinforcing financialisation’s non-ergodicity.

3. Conclusion and insights

The three main spatial implications of financialisation are that: system-wide, centrifugal tendencies have embedded spatial unevenness through emergent structures of hierarchy and organisation; firm-wide, centripetal tendencies have exacerbated spatial disparities through self-organised networks of financial interdependence and connectivity; and that non-ergodic, path dependent computational processes have undermined financialised geographies through amplifying feedback effects. Because the methodological constitution of this approach coheres, it is equipped—through the meso-economy of structural, compositional, and computational complexity—to deal with the central shortcoming of the standard view: its idea that the multi-scalar compressions of space-time and abstract macroeconomic industrial organisation are commensurable.

Notes


[1] Widths denote value of exposures/funding (£). Arrows point away from exposed/lending banks. Circles’ diameters are proportional to log{banks’ total interbank exposures, received interbank funding}. UK banks (orange), investment banks (green), overseas banks (blue), and building societies (red).

 

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