17/02/2021
We live in an advanced form of what the US economist Hyman Minsky had termed ‘money manager capitalism’ 25 years ago. Today, the dominant role played by the captains of industry in the area of industrial capitalism falls to the money managers in charge of hedge funds and pension funds. By identifying this new incarnation of capitalism, Minsky drew attention to the concentration of financial power in the hands of institutional investors and to the dysfunctionalities this engenders.
Today’s economic system: ‘small-buffers’ capitalism
In the past quarter of a century, however, capitalism has evolved further into a system that drains money away from productive uses and prudent buffers. Funds are funnelled towards the accumulation of financial and real estate assets, controlled by money managers via layers of ownership titles. This ever more lopsided distribution of financial and real estate assets creates inequality – income from capital, rather than from wages, is the main driver of rising income inequality – and it breeds instability and fragility. It chokes off the financial flows that should support investment and innovations. And it weakens the incentives for work and for entrepreneurship, as Thomas Piketty had warned in Capital in the Twenty-First Century.
The flip side of the concentration of money and power with institutional investors is the exhaustion of disposable money resources in many households, in the face of wage stagnation and failing social security systems. Cash buffers are also small in many firms, where, despite healthy profits (thanks in part to those low wages and falling employer contributions), the Covid-19 calamity found many unprepared. And productive investment is low: much profit had been squandered on dividends and stock buybacks, mergers and acquisitions, real estate speculation and other financial transactions. Furthermore, borrowing is also mostly for asset investment rather than the formation of productive capabilities. I therefore refer to today’s money manager capitalism as ‘small-buffers’, low-investment capitalism.
Buffers, capital, and wealth
The rise of managed money and other forms of unproductive wealth is one symptom of what is wrong in this kind of capitalism. The lack of adequate buffers is another. And a third feature is under-investment in capital. Seen this way, today’s capitalism is about three alternative uses of money – for speculation and rent seeking; for buffers; and for investment. Speculation has little if any societal value, and yet this is where most of the money goes that is circulating in today’s financial and real estate markets. We need to maintain buffers to cushion shocks, and we need to make productive investments for our long-term flourishing. ‘Productive’ investment should be taken in a broad, encompassing manner. Investment, for example, in:
- capital in the traditional (not the financial) sense: machines, robots, structures and infrastructure;
- societal capital (a healthy public sector, a vibrant community life);
- human capital (good and accessible education systems, the fostering of talent regardless of gender, age and ethnicity, labour market accessibility for all);
- natural capital (from public parks, green cities, pollution reduction and decarbonisation to sustainable water management, circular agriculture and protection of natural habitats).
What we see nowadays is a ‘small-buffers’ capitalism system that, in a myriad of ways, leads financial flows away from tangible, human, societal and natural capital, away from prudent financial buffers in households and firms, and towards financial and real estate markets. This is not just a trend in the private sector; unfortunately, it is equally present in the public sector. A list of some of those myriad ways is below.
- A ‘debt shift’ in the allocation of credit and other lending and of investment, away from supporting productive resource and towards asset markets, above all real estate asset markets. Much of our financial resources are locked up in real estate, bond, and stock markets, driving up prices of housing and securities. Rising debt with rising asset prices is a financial loss to the real sector – not just as interest, but as fees and repayment. And the costs are not just financial. In my research I have shown that this leads to income growth slowdown and polarisation and higher costs of crises. This ‘debt shift’ is increasing the cost of business, blocking access to affordable housing to the young and creating windfall gains and rents for the already wealthy as well as for the real estate-financial services complex that lives off the loans and the transaction fees.
- A shareholder-oriented mindset in corporate business, government and academia has fostered short-termism and underinvestment. Profit is given away, via dividends and share buybacks, to shareholders. Being investors, they typically use it not for investment or consumption, but for other financial and real estate investments. Productive investment out of profit suffers, aggregate demand falls, and income inequality widens as a result.
- Widespread labour market flexibility has pushed down wage growth, increasing profit and shareholder value. As much as through falling unionisation, the hollowing out of job security occurred through the spread of zero-hours contracts and the use of spurious ‘one-person businesses’ – that is, workers who are entrepreneurs in name only, and who bear all the risks that their employers used to shoulder, without proper insurance. The social costs of businesses shedding this immense ‘flexible skin’ of disposable workers during the Covid-19 crisis will demonstrate the precariousness of this way of organising labour markets. Again, it is the logic of small-buffers capitalism: efficiency, hence profit and hence shareholder value, has been increased, at the cost of workers’ financial buffers.
- Central banks’ policy during (and before) the Covid crisis has simply mimicked and supported shareholders and rentiers, supporting investment in real estate and financial assets, by buying up those assets and accepting them as collateral in repo transactions. The result was a boom in stock and bond markets in 2020 even as the real economy went into the strongest contraction in living memory. This has been true for each of the major central banks in the world (the US Fed, the European Central Bank, the Bank of England, and the Bank of Japan).
- Fiscal policies and public financial architectures have served to increase governments’ wealth (low sovereign debt) at the expense of societal capital, but benefitting bondholders. Constraints on net government spending and investment – such as those defined by the European Stability and Growth Pact (SGP) and the Fiscal Compact – have come at the cost of well-functioning public sectors, public-sector wage growth, municipal finances, and public initiatives and the coordination of much-needed innovations in sustainability. Instead of acting as entrepreneurial states, as Mariana Mazzucato calls them, states have often behaved as rentier states or even, as James K. Galbraith says, as “predator states”. In the Netherlands, the government went far beyond the call of duty of the Stability and Growth Pact: the four pre-Covid years saw budget surpluses and therefore mounting shortages in the care system, in education, even in courts and in the police force. There were gaping holes in municipal finances, even before the Covid-crisis surge in social spending.
Clearly, these trends and practices are among the principal causes of the fact that we now have “too much finance” – the title of a famous research paper by Jean-Louis Arcand, Enrico Berkes and Ugo Panizza that showed that on average a larger financial sector, functioning in this way, creates less, not more economic development. The problem of asset-oriented behaviour (rather than production-oriented) goes beyond the financial sector. Labour markets and public finances have been shaped in conformity with this orientation. Schumpeter’s vision of a financial sector and structure that would be a driver of innovation and entrepreneurship has been turned on its head.
From problems to solutions: update research, theories and economic models
Current research practice in macroeconomics tends to obfuscate the dominance of speculation and of money managers, as well as the precariousness of household finances, in several ways. To begin with, in many macroeconomic models, there is no financial sector at all. The underlying assumption is that the financial sector only intermediates between savers and borrowers, which nets out. Although this is true ex-post (and abstracting from capital gains), it ignores the reality of credit creation, which animates the financial process and who’s dynamic cannot be reduced to real-sector decisions about saving and borrowing.
And even if there is a financial sector, in many models there is no conceptual distinction between investment and speculation, or between productive capital on the one hand and financial and real estate assets on the other. The underlying assumption is that all investment is productive, by definition, or it would not occur in a market economy. As a consequence, precisely those processes that need correcting are ruled out of the equation, and therefore made conceptually invisible.
Third, macroeconomic models typically do not feature asset values and capital gains. Any increase in wealth is thought to be the accumulation of savings. In reality, the larger part of it is capital gains. Market actors realise this, and they engage in speculative actions in pursuit of capital gains. These motivations and actions are simply ruled out in the typical macroeconomic model.
Fourth, wealth itself is thought to be irrelevant to income (perhaps apart from stock dividends and bond yields). All behaviour is construed as income-maximising. In reality, financial market actors pursue ‘total returns’ (returns plus capital gains) on their assets, with behavioural outcomes that are very different from the income-optimising model world of macroeconomics. Over 2000–19, the US household sector’s net saving was $14 trillion, while its net worth increased by $75 trillion, as Roth and Oncü report in The Wealth of Corporations.
A fifth and final obfuscation is that macroeconomic models typically do not make financial flows explicit. Some, such as interest, are treated as if they were transfers between real-sector agents, with zero macroeconomic impact. In reality, interest boosts profit and equity in the banking sector. Other flows, such as loan repayment, are treated as payment to oneself. In reality, with rising asset prices, loan repayment imposes a rising drain off real-sector income into banks. And in general, not tracing financial flows leads to inconsistencies – for instance, repayment is a drain on spending, but it is typically absent in macroeconomic models. All money comes from somewhere and goes somewhere, but this basic identity is often violated in macroeconomic models.
To even begin to understand small-buffers capitalism, we need a change in research practice – away from real-sector equilibrium models, and towards stock-flow consistent models that specify both a financial sector and a real sector, and where all changes in stocks and financial flows are traced. Such models can be formalised as in the tradition advocated by Wynne Godley and Marc Lavoie in Monetary Economics. But formalisation is not the key. This is a way of thinking more than a technique. Stock-flow consistent thinking, recognising the impact of financial and real estate wealth, and the real-world effects of financial flows, is what we need.
From problems to solutions: three policy suggestions
Capitalism is financial capitalism, as Minsky (following Keynes) recognised. And to reform small-buffers capitalism, we must reform its financial structure. This is because money is a claim on resources, and small-buffers capitalism entails a misallocation of money so that resources are misdirected – at the cost of household financial security and detracting from innovations and investment, including investment for a sustainable society.
Governments must intervene at the points where money-flows in the system are directed away from productive uses and into speculation and rent seeking. The three places in the ‘circular flow’ of the economic system where this happens are:
- at the point of income formation (flows are directed towards profit and rents, away from wages);
- at the point of income use (flows are directed towards assets, away from investment and consumption);
- at the point of credit creation (idem);
- at the point of savings allocation.
This analysis gives us a handle on which actionable policy initiatives are needed. Fortunately, there is no need to develop these from scratch. There are detailed, well thought-through policy proposals on the shelf. It is ‘just’ a question of political will. I will now illustrate this in three areas for the case of the Netherlands.
Labour market regulation and wage growth
A reform of labour markets is necessary so that basic worker labour rights are reinstated everywhere (including for migrant workers), spurious ‘one-person business’ contracts are outlawed, minimum wages are increased, and the use of zero-hour and other flexible contracts is more tightly regulated. Pay in the public sector needs to be increased, and Covid-support programmes need to come with conditions attached so that the private sector follows suit. The resulting increase in employment, wages and job security will put a floor under aggregate demand, and so speed up the recovery. It will also give employees a stronger basis to negotiate. An actionable proposal for higher minimum wages is the voor14.nl initiative. In November 2019, a majority in the Dutch Parliament voted for higher minimum wages. The German experience with minimum wages confirms that there is no negative correlation with employment levels.
Credit guidance
Private credit allocation, and, more generally, liberalised financial markets, suffer from a bias towards riskier, more leveraged projects (as Minsky has argued), and they lack the necessary coordination mechanisms to bring about public-good types of innovation and investment. Four decades of financial market liberalisation have made this abundantly clear. There is a strong case for public involvement in the allocation of financial resources, both directly – for instance through development banks – and indirectly, by regulating the private credit supply towards socially desirable and democratically endorsed ends. The ECB now recognises, for instance, that Quantitative Easing (QE) is not neutral if ‘the market’ does not account for climate costs and misses the benefits of climate cost mitigation and carbon emissions reduction (a ‘market failure’). Credit guidance is central bank regulation with respect to capital weights, costs of liquidity. The design of collateral and asset purchase programmes can harness a society’s financial power towards these and other goals. It can counteract the destabilising and polarising tendencies of private credit allocation towards asset markets. Credit guidance was normal practice before the decades of liberalisation from the 1980s onwards. We need contemporary forms of credit guidance to address today’s policy challenges.
Taxation
Revenues from consumption taxes in the EU amounted to 11.2 per cent of GDP in 2018 – significantly above the 2009 level. The level of wage taxation revenues was 20.8 per cent of GDP and capital taxation revenues were 8.2 per cent of GDP, both roughly stable since 2009 (taxation of wage incomes in the European Union has been constant since 2010 at an average of 45 per cent ‘real tax rate’ for typical workers, while VAT has risen in 20 of the 28 member states). Debt is subsidised almost everywhere, and capital gains taxes are typically low or absent (in the Netherlands, but also in most other countries). Numerous tax loopholes exist for capital income – above all, international capital income – but almost none for wage income. This has created a gap between the growth of rentier incomes and profit on one hand and wage growth and household disposable incomes on the other hand, with the largest burden falling on the lower middle incomes. The result is rising inequality, rising fragility of household finances, and a system of incentives away from work and entrepreneurship and towards accumulation of financial wealth.
Conceptually, the solution is straightforward: scale down, then stop debt subsidisation; close (international) tax loopholes and stop the (many) tax exemptions that multinationals and wealthy individuals enjoy; and introduce higher taxation of capital gains and income from capital, which can finance a large decrease in wage taxation and VAT. In particular, a ground rent tax on real estate (the land, not the structures) has already been advocated by Richard Arnott and Joseph E. Stiglitz in 1979 (in Aggregate Land Rents, Expenditure on Public Goods, and Optimal City Size) as an efficient, effective and progressive tax, and a solution to housing market instability and rising housing rents. Another option could be to move towards a common European withholding tax on dividend, interest and royalties, as Arjan Lejour, Maarten van ‘t Riet have recommended in a recent FEPS policy brief, in order to minimise profit shifting within the European Union.
There is always more that can be done. But if we implement these few changes, small-buffers capitalism will be on its way out. Mixed-economy capitalisms, with a large role for government involvement in the economy and a strong public sector, have historically the best track record in delivering growth with equality. We can already begin to build back better during the Covid-19 pandemic!
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