disgorge the cash – J. W. Mason

What Is the Stock Market For?

Elon Musk’s pending purchase of Twitter is an occasion for thinking, again, about what function stock markets perform in modern capitalism.

The original form of wealth in a capitalist society is control over some production process. If you become a wealthy capitalist, what this means at the outset is that you have authority over people engaged in some particular form of productive activity. Let’s say a group of people want to get together to make steel, or write some computer code, or serve a meal, or put on a play: The armed authority of the state says they cannot do it without your ok.

That property rights are fundamentally a legally enforceable veto over the activity of others is one of the first points you get from legal analysis of property. “The essence of private property is always the right to exclude.” What makes capitalist property distinct is that it is a right to exclude people specifically from carrying out some productive activity, and is linked in some way to the concrete means of production employed.

As a capitalist, you are attached to the production process you have property rights over.¹ Now, you may be happy with this situation. You are a human person as well as a holder of property rights, and you may feel various kinds of personal affinity with this particular process. You may have some knowledge, or social ties, or other property claims that make this process a particularly suitable form for your wealth; or you may simply regard this as a more promising source of money income than the alternatives.

Then again, you may not be happy; you may not want to be attached to this particular process. There are risks associated with both an enterprise as a social organism, and with the kind of activity it is engaged in. (The steel mill may burn down, or be taken over by the workers; steel may be replaced by alternative materials or cheaper imports.) Ensuring that the process remains oriented both to its own particular ends and to producing an income for you requires active engagement on your part; you may be unsuited to carry this out, or just get tired of it. And even if your ownership rights generate a steady flow of income for you, the rights themselves cannot be easily converted into claims on some other part of the social product or process. (You can’t eat steel.) So you may wish to convert your claim on this particular production process into a claim on social production in general.

In the US context, this is especially likely at the point where the owner dies or retires. For Schumpeter, the ultimate ambition of business owners was “the foundation of an industrial dynasty”, “the most glamorous of .. bourgeois aims”. But in the US, at least, the glamor seems to have faded.² Heirs may not be interested in running the business, or competent to do so. There may be several of them, or none. And a curiously persistent monarchical principle generally precludes looking outside the immediate family for a successor.

At some point, in any case, the holder of ownership rights over an enterprise will no longer be in a position to exercise them. At this point, the business might shut down. Before the modern corporation, this was the normal outcome: In early-modern England, “The death of the master baker … ordinarily meant the end of the bakery.” This will often still happen in the case of small businesses, where the value of the enterprise is tightly linked to the activity of the owner themself. This is fine when the productive capacity of the economy is widely dispersed in the brains of the individuals carrying out, and in tools that can be owned by them. But once production involves large organizations with an extensive division of labor, and means of production that are too lumpy for personal ownership, some means has to be found for the organization to continue existing when the individual who has held ownership rights over it is no longer willing or able to.

The stock market exists in order to allow ownership rights over particular production process to be converted into rights to the social product in general.

This is true historically. In the great wave of mergers in the 1890s that established the publicly-owned corporation as the dominant legal form for large industrial enterprises in the US, raising funds for investment was not a factor. As Naomi Lamoreaux notes, in a passage I’ve quoted before, “access to capital is not mentioned” in contemporary accounts of the merger wave. And in the hearings by the U.S. Industrial Commission on the mergers, “None of the manufacturers mentioned access to capital markets as a reason for consolidation.” The firms involved in the first mergers were normally ones where the founder had died or retired, leaving it to heirs “who often were interested only in receiving income.” The problem the creation of the publicly-traded corporation was meant to solve was not how to turn widely dispersed claims not he social product in general into claims on means of production to be used in this particular enterprise, but just the opposite: How to turn claims on these particular means of production into claims on the social product in general.

The same goes for today. We already have institutions that allow claims on the social product to be exercised by entrepreneurs on the basis of their plans for generating profits in the future. These include banks and, in favored sectors, venture capitalist funds, but not the stock market. The stock market isn’t there for the enterprise, but those with ownership claims on it.

The purpose of a stock offering is to allow those who already hold claims against the enterprise (early investors, and perhaps also favored employees) to swap them out for general financial wealth. This is why IPO “pops” — immediate price rises from the offering price — are considered a good thing, even though, logically, they mean the company raised less money than it could have. The pop makes the stock more attractive to the investors who will be buying out the insiders’ stakes down the road. The IPO is for the owners, not for the company. Or as Matt Levine puts it, “the price of the IPO is less important than the insiders’ ability to sell stock at good prices in the future.”

As I’ve argued before, converting the surplus generated within the firm into claims on the social product in general is fundamental to the capitalist process as production itself. It’s also an integral part of capitalist common sense. As any guide for budding entrepreneurs will remind you, “It’s not enough to build a business worth a fortune. You also need a way to get your money back.”

Now, in principle this goal could be achieved in other ways. Money itself is a claim on general social product — that is one definition of it. When Antonio’s ships are safely come to road, his venture is concluded and his whole estate is available to meet his obligations. This is sufficient for merchant capital in early-modern Venice – its self-liquidating character means that no additional mechanisms are needed to turn claims on concrete commodities back into money.

Ongoing enterprises cannot be liquidated so easily. And money is liable to delink from productive economy over longer periods – what one wants is something with the safety, liquidity and non-need for management of money, but which maintains a proportionate claim on the overall surplus. Government bonds are an obvious choice here. They offer a claim on productive activity in general, or at least that part of it which is subject to taxation.

This possibility is worth pausing over. Historically, this was one of the most important ways for holders of claims against particular production processes to turn them into claims against society in general. The “rent” in rentier refers originally to the interest on a government bond. Government bonds as alternative to stock ownership also calls attention to the fundamentally political character of this transaction. For the capitalist to be able to give up their direct control over a production process in return for a proportionate share of the overall social product, someone else needs to oversee the collection of the surplus. And that someone needs to be accountable to wealth owners in general. There is an important affinity between finance and the state here.

Alternatively, partnership structures allow for the human owners to turn over while ownership as such remains tied to the particular enterprise. ³ Universal owners are another route. If Morningstar or Blackstone owns all the corporations, it’s redundant for them to do so in the form of stock. They could just own them directly. Many startups today have their liquidity moment not by issuing stock but being bought by a larger competitor. One could imagine a world where a startup that is successful enough is bought up by a universal index-slash-private equity fund, without the intermediate step of issuing stock.

Another possibility, of course, would be for the founder to give up their ownership rights and the company then just not to have owners. Wikipedia is a thing that exists; Twitter could, in principle, have a similar structure. I admit, I can’t think of many similar examples. When Keynes talked about corporations “socializing themselves”, this didn’t entail a change in legal structure; the shareholders continued to exist, but just were increasingly irrelevant. Plenty of rich people do leave some fraction of their wealth to self-governing charities of one sort or another, but this is their financial wealth, not the businesses themselves. The closest one gets, I suppose, is when someone leaves real estate to a conservation or community land trust.

Back in the real world, these other models of transition out of personal ownership are either nonexistent, or else confined to narrow niches. What we have is the stock market. Fundamentally, this is a way for owners of claims against production processes to pool them — to trade in their full ownership of a particular enterprise for a proportionate share of ownership in a broad group of enterprises. This was more transparent in the trust structures that preceded the development of publicly traded corporations, which were explicitly structured as a trade of direct ownership of a business for a share in a trust that would own all the participating businesses.⁴ But the logic of the public corporation is the same.

This is why shareholder protections are so critical. They’re often framed as protections for small retail investors. But the real problem they are addressing is mutual trust among owners. The pooling of claims works only if their holders can be reasonably confident that they’ll continue receiving their income even as they surrender control over production.

You’ll have noted that I keep using obtuse terms like “holders of property claims against the corporation” instead of the more straightforward “owners”. This is necessary when we are discussing shareholders. It is not the case, as more familiar language might imply, that shareholders “own” the corporation. One of my favorite discussions of this is an article by David Ciepley, which observes that many of the features of the corporation are impossible to create on the basis of private contracts. Limited liability, for example — there is no private contract a group of property owners can sign among themselves that will eliminate their liability to third parties for misuse of their property.

If we take a step back, it is obvious that the relationship of shareholders to the corporation is something other than ownership. Just think about the familiar phrase, separation of ownership from control — it is an oxymoron. What, after all, is ownership? The old books will tell you that it is a set of control rights — jus utendi, jus disponendi, and so on. Ownership without control is ownership without ownership.

The vacuity of shareholder “ownership” can be glossed over most of the time, but becomes salient in takeovers and governance questions in general.⁵ Dividends and other payments can be subdivided arbitrarily, but decisions are discrete and control over them is unitary. Either Elon Musk buys Twitter, or he does not. Yes, there are votes, but someone still sets the terms of the vote, and 51% is as good as 100%.⁶ This is the contradiction that shareholder protections are meant to paper over. The publicly owned corporation allows business owners to pool their claims on the income of their respective companies. But it is not possible to share control over the businesses themselves. So the board – which actually does controls them — is instructed to act “as if” the shareholders did.

All of this is visible by contrast in Elon Musk’s purchase of Twitter, which reverses the usual logic of shareholding. He is trading in a claim on the general social product (or on Tesla, but it has to be cashed in first) into a claim on the specific activity organized via Twitter. He wants Twitter itself, not the stream of income it generates. He wants to turn his share of Twitter’s (so far nonexistent) profits into control over the substantive production process it is engaged in. Twitter for him is a source of use-value, not exchange-value. In this specific transaction, he is acting not as a capitalist but as a feudal lord. (Italics for a reason. One of the many mistakes we can make on these tricky questions is to treat terms like “capitalist” as if they described the essential nature of a person or organization, something that one either is or isn’t. Whereas they are ways of organizing human activity, which one can participate in in one context but not in another.)

The tension between the social production processes over which property claims are exercised, and the specific people who exercise them and the means by which they do so, is easy to lose sight of. It’s natural to abstract from these questions when you’re focused on other questions, like the conflict between capital — whoever exactly that may be — and the human beings who more directly embody labor. In Volume 1 of Capital, the capitalist is simply the personification of capital, and there are good exposition reasons for this.⁷

It’s in Volume 3 — truly the essential reading on this topic — that Marx directly takes on the conflation of social relations with concrete things. In a blistering passage in chapter 48 he attacks the identification of the real conditions of production with the incomes that are received from them, as if for example land — the natural world — existed only insofar as it is a source of rent for the landlord. This is “the complete mystification of the capitalist mode of production, the conversion of social relations into things, … It is an enchanted, perverted, topsy-turvy world, in which Monsieur le Capital and Madame la Terre do their ghost-walking as social characters and at the same time directly as mere things.” This mystification is alive and well in modern discussions of economics, where ownership of claims against a thing are constantly confused with being the thing. The ubiquitous language of payments to capital (or factor payments) is an obvious example, in which a payoffs to whatever private rights-holder you need permission from to use a machine, are imagined as payments to the machine itself.

This is not just a matter of verbal ambiguity. It leads to completely wrong conclusions when transactions involving ownership claims on something are confused with transactions involving the use of the thing. For example, you sometimes hear housing activists say that investor purchases will drive up the cost of housing. This sounds reasonable – but only because the word “housing” is being used in two different senses. Ownership of a house, and living in a house, are not competing uses, they exist on entirely separate levels. We may object for various reasons to ownership of homes by large investors rather than owner-occupiers or small landlords (or we may not). But this shift in ownership claims has no effect on the amount of space available for people to live in.

Coming back to the stock market, the confusion comes from mixing up transactions and institutions intended to shift ownership rights over the enterprise with solutions to the financing needs of the enterprise itself. The terms of the twitter deal seem to be: The bankers will get $2 billion per year, half from Musk, half from Twitter. Current Twitter shareholders get a one-time payment of $54 per share, which they may or may not be happy with.⁸ Twitter as an enterprise — and its employees and users — get nothing from the transaction at all. The company ends up owing $13 billion in additional debt, which finances nothing.

On one level, this is just what the stock market, and finance more generally, do: They change asset and liability positions around, without necessarily implying any changes in the substantive activities that those positions give rights over and which generate the incomes that go with them. As Perry Mehrling likes to point out, the biggest single transaction for most families is the purchase of a home, which doesn’t even show up in the national income and product accounts. But on another level, again, in the specific trade here — away from liquidity and general financial claims toward a more direct relationship with a particular production process — is the opposite of what the stock market usually facilities. Musks’s purchase of Twitter is, precisely, a form of de-financialization.

On some level I suppose all this is obvious. Everyone understands that this a transaction between various groups of holders of financial claims against Twitter — Musk, the board on behalf of the existing shareholders, the banks— to which Twitter-the-enterprise is not a party at all. But coverage tends to treat this as a problem only insofar as Twitter is special, the “digital town square”. In weighing the deal, the Times sniffs, the board “might as well have been talking about a tool-and-die manufacturer.” Any conflict between relations of production and relations of ownership is, evidently, only a problem when what is being produced are 280-character messages.

At this point, I suppose, I should denounce Elon Musk’s purchase of Twitter. But honestly, I’m not convinced it will make much difference one way or another.

For me personally, Twitter has been a good outlet. It connects me with journalists, political people, potential students, and other folks I want to communicate with more effectively than any other platform. It’s a gratifyingly horizontal — anyone who has something to say is on the same level. I’d be sorry if it no longer existed in its current form. But I’m not sure any of its good qualities come from who exactly exercises a claim on whatever profits it may generate.

Do you think that any of Twitter’s positive qualities emanate from the particular individuals who’ve owned it, or “owned” it? Jack Dorsey seems like kind of a nut; if the platform works, it’s in spite of him, not because of him. The current gaggle of suits on the board don’t see to have much hands-on involvement one way or another. The people who do the actual work of maintaining the platform obviously take their jobs seriously. I have no idea who exactly they are, but I have a lot of respect for them. I expect they’ll continue doing their job, whoever is appropriating the surplus.

To say that having Elon Musk own a company is a central, transformative fact about it – for good or for ill — is to buy into the narcissistic worldview of the masters of the universe. I would rather not do that. Indeed, the idea that who owns a business and how it operates are inseparable, is more or less exactly the position I’m arguing against in this post.

The question of who owns a company is a distinct question from what it does or how it is run. Not entirely unrelated, to be sure — but to think about how they are connected, we first have to recognize that they are not the same.

“Has Finance Capitalism Destroyed Industrial Capitalism?”

(At the big economics conference earlier in January, I spoke on a virtual panel in response to Michael Hudon’s talk on the this topic. HIs paper isn’t yet available, but he has made similar arguments here and here. My comments were in part addressed to his specific paper, but were also a response to the broader discussion around financialization. A version of this post will appear in a forthcoming issue of the Review of Radical Political Economics.)

Michael Hudson argues that the industrial capitalism of a previous era has given way to a new form of financial capitalism. Unlike capitalists in Marx’s day, he argues, today’s financial capitalists claim their share of the surplus by passively extracting interest or economic rents broadly. They resemble landlords and other non-capitalist elites, whose pursuit of private wealth does not do anything to develop the forces of production, broaden the social division of labor, or prepare the ground for socialism.

Historically, the progressive character of capitalism comes from three dimensions on which capitalists differ from most elites. First, they do not merely claim the surplus from production, but control the production process itself; second, they do not use the surplus directly but must realize it by selling it on a market; and third, unlike most elites who acquire their status by inheritance or some similar political process, a capitalist’s continued existence as a capitalist depends on their ability to generate a large enough money income to acquire new means of production. This means that capitalists are under constant pressure to reduce the costs through technical improvements to the production process. In some cases the pressure to reduce costs may also lead to support for measures to socialize the reproduction costs of labor power via programs like public education, or for public provision of infrastructure and other public services.

In Hudson’s telling, financial claims on the surplus are essentially extractive; the pursuit of profit by finance generates pressure neither for technical improvements in the production process, nor for cost-reducing public investment. The transition from one to the other as the dominant form of surplus appropriation is associated with a great many negative social and political developments — lower wages, privatization of public goods, anti-democratic political reforms, tax favoritism and so on. (The timing of this transition is not entirely clear.)

Other writers have told versions of this story, but Hudson’s is one of the more compelling I have seen. I am impressed by the breadth of his analysis, and agree with him on almost everything he finds objectionable in contemporary capitalism.

I am not, however, convinced. I do not think that “financial” and “industrial” capital can be separated in the way he proposes. I think it is better to consider them two moments of a single process. Connected with this, I am skeptical of the simple before and after periodization he proposes. Looking at the relationship between finance and production historically, we can see movements in both directions, with different rhythms in different places and sectors. Often, the growth of industrial capitalism in one industry or area has gone hand in hand with a move toward more financial or extractive capitalism somewhere else. I also think the paper gives a somewhat one-sided account of developments in the contemporary United States. Finally, I have concerns about the political program the analysis points to.

Let’s start with idea that industrial capitalists support public investments in areas like education, health care or transportation because they lower the reproduction costs of labor. This is less important for owners of land, natural resources or money, whose claim on the social surplus doesn’t mainly come through employing labor.

I wouldn’t say this argument is wrong, exactly, but I was struck by the absence of any discussion of the other ways in which industrial capitalists can reduce the costs of labor — by lowering the subsistence level of workers, or reducing their bargaining power, or extracting more work effort, or shifting employment to lower-wage regions or populations. The idea that the normal or usual result of industrial capitalists’ pursuit of lower labor costs is public investment seems rather optimistic.

Conversely, public spending on social reproduction only reduces costs for capitalist class insofar as the subsistence level is fixed. As soon as we allow for some degree of conflict or bargaining over workers share of the social product, we introduce possibility that socializing reproduction costs does not lower the price of labor, but instead raises the living standards of the human beings who embody that labor. Indeed, that’s why many people support such public spending in the first place!

On the flip side, the case against landlords as a force for capitalist progress is not as straightforward as the paper suggests.

Ellen Meiksins Wood argues, convincingly, that the origins of what Hudson calls industrial capitalism should really be placed in the British countryside, where competition among tenants spurred productivity-boosting improvements in agricultural land. It may be true that these gains were mostly captured by landlords in the form of higher rents, but that does not mean they did not take place. Similarly, Gavin Wright argues that one of the key reasons for greater public investment in the ante-bellum North compared with the South was precisely the fact that the main form of wealth in the North was urban land. Land speculators had a strong interest in promoting canals, roads and other forms of public investment, because they could expect to capture gains from them in the form of land value appreciation.

In New York City, the first subways were built by a company controlled by August Belmont, who was also a major land speculator. In a number of cases, Belmont — and later the builders of the competing BMT system — would extend transit service into areas where they or their partners had assembled large landholdings, to be able to develop or sell off the land at a premium after transit made it more valuable. The possibility of these gains was probably a big factor in spurring private investment in transit service early in the 20th century.

Belmont can stand as synecdoche for the relationship of industrial and financial capital in general. As the organizer of the labor engaged in subway construction, as the one who used the authority acquired through control of money to direct social resources to the creation of new means of transportation, he appears as an industrial capitalist, contributing to the development of the forces of production as well as reducing reproduction costs by giving workers access to better, lower-cost housing in outlying areas. As the real estate speculator profiting by selling off land in those areas at inflated prices, he appears as a parasitic financial capitalist. But it’s the same person sitting in both chairs. And he only engaged in the first activity in the expectation of the second one.

None of this is to defend landlords. But it is to make the point that the private capture of the gains from the development of the forces of production is, under capitalism, a condition of that development occurring in the first place, as is the coercive control over labor in the production process. If we can acknowledge the contributions of a representative industrial capitalist like Henry Frick, author of the Homestead massacre, to the development of society’s productive forces, I think we can do the same for a swindler like August Belmont.

More broadly, it seems to me that the two modes of profit-seeking that Hudson calls industrial and financial are not the distinct activities they appear as at first glance.

It might seem obvious that profiting from a new, more efficient production process is very different from profiting by using the power of the state to get some legal monopoly or just compel people to pay you. It is true that the first involves real gains for society while the second does not. But how do those social gains come to be claimed as profit by the capitalist? First, by the exclusive access they have to the means of production that allows them to claim the product, to the exclusion of everyone else who helped produce it. And second, by their ability to sell it at a price above its cost of production that allows them to profit, rather than everyone who consumes the product. In that sense, the features that Hudson points to as defining financial capitalism are just as fundamental to industrial capitalism. Under capitalism, making a product is not a distinct goal from extracting a rent. Capturing rents is the whole point.

The development of industry may be socially progressive in a way that the development of finance is not. But that doesn’t mean that the income and authority of the industrial capitalist is different from that of the financial capitalist, or even that they are distinct people.

Hudson is aware of this, of course, and mentions that from a Marxist standpoint the capitalist is also a rentier. If he followed this thought further I think he would find it creates problems for the dichotomy he is arguing for.

Let’s take a step back.

Capital is a process, a circuit: M – C – P – C’ – M’. Money is laid out to gain control of commodities and labor power, which are the combined in a production process. The results of this process are then converted back into money through sale on the market.

At some points in this circuit, capital is embodied in money, at other points in labor power and means of production. We often think of this circuit as happening at the level of an individual commodity, but it applies just as much at larger scales. We can think of the growth of an industrial firm as the earlier part of the circuit where value comes to be embodied in a concrete production process, and payouts to shareholders as the last part where value returns to the money form.

This return to money form just as essential to the circuit of capital as production is. It’s true that payouts to shareholders absorb large fraction of profits, much larger than what they put in. We might see this as a sign that finance is a kind of parasite. But we could also see shareholder payouts as where the M movement is happening. Industrial production doesn’t require that its results be eventually realized as money. But industrial capitalism does. From that point of view, the financial engineers who optimize the movement of profits out of the firm are as integral a part of industrial capital as the engineer-engineers who optimize the production process.

My second concern is with the historical dimension of the story. The sense one gets from the paper is that there used to be industrial capitalism, and now there is financial capitalism. But I don’t think history works like that.

It is certainly true that the forms in which a surplus is realized as money have changed over time. And it is also true that while capital is a single process, there are often different human beings and institutions embodying it at different points in the circuit.

In a small business, the same person may have legal ownership of the enterprise, directly manage the production process, and receive the profits it generates. Hudson is certainly right that this form of enterprise was more common in the 19th century, which among other things allowed Marx to write in Volume One about “the capitalist” without having to worry too much about exactly where this person was located within the circuit. In a modern corporation, by contrast, production is normally in the hands of professional managers, while the surplus flows out to owners of stock or other financial claims. This creates the possibility for the contradiction between the conditions of generating a surplus and of realizing it, which always exists under capitalism, to now appear as a conflict between distinct social actors.

The conversion of most large enterprises to publicly traded corporations took place in the US in a relatively short period starting in the 1890s. The exact timing is of course different elsewhere, but this separation of ownership and control is a fairly universal phenomenon. Even at the time this was perceived as a momentous change, and if we are looking for a historical break that I think this is where to locate it. Already by the early 20th century, the majority of great fortunes took the form of financial assets, rather than direct ownership of businesses. And we can find contemporary observers like Veblen describing “sabotage” of productive enterprises by finance (in The Price System and the Engineers) in terms very similar to the ones that someone like Michael Hudson uses today.

It’s not unreasonable to describe this change as financialization. But important to realize it’s not a one-way or uniform transition.

In 1930s, Keynes famously described American capital development as byproduct of a casino, again in terms similar to Hudson’s. In The General Theory, an important part of the argument is that stock markets have a decisive influence on real investment decisions. But the funny thing is that at that moment the trend was clearly in the opposite direction. The influence of financial markets on corporate managers diminished after the 1920s, and reached its low point a generation or so after Keynes wrote.

If we think of financialization as the influence of financial markets over the organization of production, what we see historically is an oscillation, a back and forth or push and pull, rather than a well-defined before and after. Again, the timing differs, but the general phenomenon of a back and forth movement between more and less financialized capitalism seems to be a general phenomenon. Postwar Japan is often pointed to, with reason, as an example of a capitalist economy with a greatly reduced role for financial markets. But this was not a survival from some earlier era of industrial capitalism, but rather the result of wartime economic management, which displaced financial markets from their earlier central role.

Historically, we also find that moves in one direction in one place can coexist with or even reinforce moves the other way elsewhere. For example, the paper talks about the 19th-century alliance of English bankers and proto-industrialists against landlords in the fight to overturn the corn laws. Marx of course agreed that this was an example of the progressive side of capitalist development. But we should add that the flip side of Britain specializing in industry within the global division of labor was that other places came to specialize more in primary production, with a concomitant increase in the power of landlords and reliance on bound labor. Something we should all have learned from the new historians of capitalism like Sven Beckert is how intimately linked were the development of wage labor and industry in Britain and the US North with he development of slavery and cotton production in the US South; indeed they were two sides of the same process. Similar arguments have been made linking the development of English industry to slave-produced sugar (Williams), and to the second serfdom and de-urbanization in Eastern Europe (Braudel).

Meanwhile, as theorists of underdevelopment like Raul Prebisch have pointed out, it’s precisely the greater market power enjoyed by industry relative to primary products that allows productivity gains in industry to be captured by the producers, while productivity gains in primary production are largely captured by the consumers. We could point to the same thing within the US, where tremendous productivity advances in agriculture have led to cheap food, not rich farmers. Here again, the relationship between the land-industry binary and the monopoly-competition binary is the opposite as Hudson’s story. This doesn’t mean that they always line up that way, either, but it does suggest that the relationship is at least historically contingent.

Let’s turn now to the present. As we all know, since 1980 the holders of financial assets have reasserted their claims against productive enterprises, in the US and in much of the rest of the world. But I do not think this implies, as Hudson suggests, that today’s leading capitalists are the equivalent of feudal landowners. While pure rentiers do exist, the greatest accumulations of capital remain tied to control over the production process.

Even within the financial sector, extraction is only part of the story. A major development in finance over the past generation has been the growth of specialized venture capital and private equity funds. Though quite different in some ways — private equity specializing in acquisition of existing firms, venture capital in financing new ones — both can be seen as a kind of de-financialization, in the sense that both function to re-unite management and ownership. It is true of course, that private equity ownership is often quite destructive to the concrete production activities and social existence of a firm. But private equity looting happens not through the sort of arm’s length tribute collection of al landlord, but through direct control over the firm’s activity. The need for specialized venture capital funds to invest in money-losing startups, on the other hand, is certainly consistent with the view that strict imposition of financial criteria is inconsistent with development of production. But it runs against a simple story in which industry has been replaced by finance. (Instead, the growth of these sectors looks like an example of the way the capital looks different at different moments in its circuit. Venture capitalists willing to throw money at even far-fetched money-losing enterprises, are specialists in the M-C moment, while the vampires of private equity are specialists in C-M.)

It is true, of course, that finance as an industry has grown relative to the economy over the past 50 years, as have the payments made by corporations to shareholders. Hudson describes these trends as a “relapse back toward feudalism and debt peonage”, but I don’t think that’s right. The creditor and the landlord stand outside the production process. A debt peon has direct access to means of production, but is forced to hand over part of the product to the creditor or landlord. Capitalists by contrast get their authority and claim on surplus from control over the production process. This is as true today as when Marx wrote.

There is a widespread view that gains from ownership of financial assets have displaced profits from production even more many nonfinancial corporations, and that household debt service is a form of exploitation that now rivals the work place as a source of surplus, as households are forced to take on more debt to meet their subsistence needs. But these claims are mistaken — they confuse the temporary rise in interest rates after 1980 for a deeper structural shift.

As Joel Rabinovich convincingly shows, the increased financial holdings of nonfinancial corporations mostly represent goodwill from mergers and stakes in subsidiaries, not financial assets in the usual sense, while the apparent rise in their financial income of in the 1980s is explained by the higher interest on their cash holdings. With respect to household debt, it continues to overwhelmingly finance home ownership, not consumption; is concentrated in the upper part of the income distribution; and rose as a result of the high interest rates after 1980, not any increase in household borrowing. (See my discussion here.) With the more recent decline in interest rates, much of this supposed finacialization has reversed. Contrary to Hudson’s picture of an ever-rising share of income going to debt service, interest payments in the US now total about 17 percent of GDP, the same as in 1975.

On the other side, the transformation of the production process remains the source of the biggest concentrations of wealth. Looking at the Forbes 400 list of richest Americans, it is striking how rare generalized financial wealth is, as opposed to claims on particular firms. Jeff Bezos (#1), Bill Gates (#2) and Mark Zuckerberg (#3) all gained their wealth through control over newly created production processes, not via financial claims on existing ones. Indeed, of the top 20 names on the list, all but one are founders and active managers of companies or their immediate families. (The lone exception is Warren Buffet.) Finance and real estate are the source of a somewhat greater share of the fortunes found further down the list, but nowhere near a majority.

Companies like Wal Mart and Google and Amazon are clearly examples of industrial capitalism. They sell products, they lower prices, they put strong downward pressure on costs. Cheap consumer goods at Wal Mart lower the costs of subsistence for workers today just as cheap imported food did for British workers in the 19th century.

Does this mean Amazon and Wal Mart are good? No, of course not. (Tho we shouldn’t deny that their logistical systems are genuine technological accomplishments that a socialist society could build on.) My point is that the greatest concentrations of wealth today still arise from the competition to sell more desirable goods at lower prices. This runs against the idea of dominance by rentiers or passive rent-extractors.

Finally, I have some concerns about the political implications of this analysis. If we take Hudson’s story seriously, we may see a political divide between industrial capital and finance capital, and the possibility of a popular movement seeking alliance with the former. I am doubtful about this. While finance is a distinct social actor, I do not think it is useful to think of it as a distinct type of capital, one that is antagonistic to productive capital. As I’ve written elsewhere, it’s better to see finance as weapon by which the claims of wealth holders are asserted against the rest of society.

Certainly I don’t think the human embodiments of industrial capital would agree that they are victims of finance. Many of the features of contemporary capitalism he objects would appear to them as positive developments. Low wages, weak labor and light taxes are desired by capitalists in general, not just landlords and bankers. The examples Hudson points to of industrial capitalists and their political representatives supporting measures to socialize the costs of reproduction are real and worth learning from, but as products of specific historical circumstances rather than as generic features of industrial capitalism. We would need a better account of the specific conditions under which capital turns to programs for reducing labor costs in this way — rather than, for example, simply forcing down wages — to assess to what extent, and in which areas, they exist today.

Even if it were feasible, I am not sure this kind of program does much to support a more transformative political project. Hudson quotes Simon Patten’s turn-of-the-last-century description of public services like education as a “fourth factor of production” that is necessary to boost industrial competitiveness, with the implication that similar arguments might be successful today. Frankly, this kind of language strikes me as more characteristic of our neoliberal era than a basis for an alternative to it. As a public university teacher, I reject the idea that my job is to raise the productive capacity of workers, or reduce the overhead costs of American capital. Nor do I think we will be successful in defending education and other public goods from defunding and austerity using this language. And of course, it is not the only language available to us. As Mike Konczal notes in his new book Freedom from the Market, historically the case for public provision has often been made in terms of removing certain areas of life from the market, as well as the kinds of arguments Hudson describes.

More fundamentally, the framing here suggests that the objectionable features of capitalism stem from it not being capitalist enough. The focus on monopolies and rents suggests that what is wanted is more vigorous market competition. It is a strikingly Proudhonian position to say that the injustice and waste of existing capitalism stem from the failure of prices to track costs of production. Surely from a Marxist perspective it is precisely the pressure to compete on the basis of lower costs that is the source of that injustice and waste.

There is a great deal that is interesting and insightful in this paper, as there always is in Michael Hudson’s work. But I remain unconvinced that financial and industrial capitalism can be usefully thought of as two opposed systems, or that we can tell a meaningful historical story about a transition between them. Industry and finance are better thought of, in my view, as two different sides of the same system, or two moments in the same circuit of capital. Capitalism is a system in which human creative activity is subordinated to the endless accumulation of money. In this sense, finance is as integral to it as production. A focus on on the industrial-financial divide risks attributing the objectionable effects of accumulation to someone else — a rentier or landlord — leaving a one-sided and idealized picture of productive capital as the residual.

This being URPE, many people here will have at one time or another sung “is there aught we have in common with the greedy parasites?” Do we think those words refer to the banker only, or to the boss?

UPDATE: My colleague Julio Huato made similar arguments in response to an earlier version of Hudson’s paper a few years ago, here.

Now Playing Everywhere

This Businessweek story on the Sears bankruptcy is like the perfect business action-adventure story for our times.

First act: Brash young(ish) hedge fund guy takes over iconic American business, forces through closures and layoffs, makes lots of money for his friends.

From the moment he bought into what was then called Sears, Roebuck & Co., he also maneuvered to protect his financial interests. At times, he even made money. He closed stores, fired employees and … carved out some choice assets for himself.

All seems to be going well. But now the second act: He gets too attached, and instead of passing the drained but still functioning business onto some other sucker, imagines he can run it himself. But managing a giant retailer is harder than it looks. Getting on a videoconference a couple times a week and telling the executives that they’re idiots isn’t enough to turn things around.

But the big mistake was even trying to. Poor Eddie Lampert has forgotten “the investors’ commandment: Get out in time.” That’s always the danger for money and its human embodiments — to get drawn into some business, some concrete human activity, instead of returning to its native immaterial form. Once the wasp larva has sucked the caterpillar dry, it needs to get out and turn back into a wasp, not go shambling around in the husk. This one waited too long.

Not even Lampert’s friends could understand why the hedge-fund manager, once hailed as a young Warren Buffett, clung to his spectacularly bad investment in Sears, a dying department store chain. … After 13 years under Lampert’s stewardship, Sears finally seems to be hurtling toward bankruptcy, if not outright liquidation. And, once again, Wall Street is wondering what Eddie Lampert will salvage for himself and his $1.3 billion fund, ESL Investments Inc., whose future may now be in doubt.

Oh no! Will the fund survive? Don’t worry, there’s a third act. Sears may have crashed and burned, but it turns out Lampert had a parachute – he set himself up as the senior creditor in the bankruptcy, and presciently spun off the best assets for himself.

Under the filing the company is said to be preparing for as soon as this weekend, he and ESL — together they hold almost 50 percent of the shares — would be at the head of the line when the remnants are dispersed. As secured creditors, Lampert and the fund could get 100 cents on the dollar… And Lampert carved out what looked like — and in some cases might yet be — saves for himself, with spinoffs that gave him chunks of equity in new companies. One was Seritage Growth Properties, the real estate investment trust that counts Sears as its biggest tenant and of which Lampert is the largest shareholder; he created it in 2015 to hold stores that were leased back to Sears — cordoning those off from any bankruptcy proceeding. He and ESL got a majority stake in Land’s End Inc., the apparel and accessories maker he split from Sears in 2014.

The fund is saved. The business crashes but the money escapes. The billionaire is still a billionaire, battered but upright, dramatically backlit by the flames from the wreckage behind him. Credits roll.

Acquisitions as Corporate Money Hose

Among the small group of heterodox economics people interested in corporate finance, it is common knowledge that the stock market is a tool for moving money out of the corporate sector, not into it. Textbooks may talk about stock markets as a tool for raising funds for investment, but this kind of financing is dwarfed by the payments each year from the corporations to shareholders.

The classic statement, as is often the case, is in Doug Henwood’s Wall Street:

Instead of promoting investment, the U.S. financial system seems to do quite the opposite… Take, for example, the stock market, which is probably the centerpiece of the whole enterprise. What does it do? Both civilians and professional apologists would probably answer by saying that it raises capital for investment. In fact it doesn’t. Between 1981 and 1997, U.S. nonfinancial corporations retired $813 billion more in stock than they issued, thanks to takeovers and buybacks. Of course, some individual firms did issue stock to raise money, but surprisingly little of that went to investment either. A Wall Street Journal article on 1996’s dizzying pace of stock issuance (McGeehan 1996) named overseas privatizations (some of which, like Deutsche Telekom, spilled into U.S. markets) “and the continuing restructuring of U.S. corporations” as the driving forces behind the torrent of new paper. In other words, even the new-issues market has more to do with the arrangement and rearrangement of ownership patterns than it does with raising fresh capital.

The pattern of negative net share issues has if anything only gotten stronger in the 20 years since then, with net equity issued by US corporations averaging around negative 2 percent of GDP. That’s the lower line in the figure below:

Note that in the passage I quote, Doug correctly writes “takeovers and buybacks.” But a lot of other people writing in this area — definitely including me — have focused on just the buyback part. We’ve focused on a story in which corporate managers choose — are compelled or pressured or incentivized — to deliver more of the firm’s surplus funds to shareholders, rather than retaining them for real investment. And these payouts have increasingly taken the form of share repurchases rather than dividends.

In telling this story, we’ve often used the negative net issue of equity as a measure of buybacks. At the level of the individual corporation, this is perfectly reasonable: A firm’s net issue of stocks is simply its new issues less repurchases. So the net issue is a measure of the total funds raised from shareholders — or if it is negative, as it generally is, of the payments made to them.

It’s natural to extend this to the aggregate level, and assume that the net change in equities outstanding similarly reflects the balance between new issues and repurchases. William Lazonick, for instance, states as a simple matter of fact that “buybacks are largely responsible for negative net equity issues.” ¹ But are they really?

If we are looking at a given corporation over time, the only way the shares outstanding can decline is via repurchases.² But at the aggregate level, lots of other things can be responsible — bankruptcies, other changes in legal organization, acquisitions. Quantitatively the last of these is especially important. Of course when acquisitions are paid in stock, the total volume of shares doesn’t change. But when they are paid in cash, it does. ³ In the aggregate, when publicly trade company A pays $1 billion to acquire publicly traded company B, that is just a payment from the corproate sector to the household sector of $1 billion, just as if the corporation were buying back its own stock. But if we want to situate the payment in any kind of behavioral or institutional or historical story, the two cases may be quite different.

Until recently, there was no way to tell how much of the aggregate share retirements were due to repurchases and how much were due to acquisitions or other causes.⁴ The financial accounts reported only a single number, net equity issues. (So even the figure above couldn’t be produced with aggregate data, only the lower line in it.) Under these circumstances the assumption that that buybacks were the main factor was reasonable, or at least as reasonable as any other.

Recently, though, the Fed has begun reporting more detailed equity-finance flows, which break out the net issue figure into gross issues, repurchases, and retirements by acquisition. And it turns out that while buybacks are substantial, acquisitions are actually a bigger factor in negative net stock issues. Over the past 20 years, gross equity issues have averaged 1.9 percent of GDP, repurchases have averaged 1.7 percent of GDP, and retirements via acquisitions just over 2 percent of GDP. So if we look only at corporations’ transactions in their own stock, it seems that that the stock market still is — barely — a net source of funds. For the corproate sector as a whole, of course, it is still the case that the stock market is, in Jeff Spross’ memorable phrase, a giant money hose to nowhere.

The figure below shows dividends, gross equity issues, repurchases and M&A retirements, all as a percent of GDP.

What do we see here? First, the volume of shares retired through acquisitions is consistently, and often substantially, greater than the volume retired through repurchases. If you look just at the aggregate net equity issue you would think that share repurchases were now comparable to dividends as a means of distributing profits to shareholders; but it’s clear here that that’s not the case. Share repurchases plus acquisitions are about equal to dividends, but repurchases by themselves are half the size of dividends — that is, they account for only around a third of shareholder payouts.

One particular period the new data changes the picture is the tech boom period around 2000. Net equity issues were significantly negative in that period, on the order of 1 percent of GDP. But as we can now see, that was entirely due to an increased volume of acquisitions. Repurchases were flat and, by the standard of more recent periods, relatively low. So the apparent paradox that even during an investment boom businesses were paying out far more to shareholders than they were taking in, is not quite such a puzzle. If you were writing a macroeconomic history of the 1990s-2000s, this would be something to know.

It’s important data. I think it clarifies a lot and I hope people will make more use of it in the future.

We do have to be careful here. Some fraction of the M&A retirements are stock transactions, where the acquiring company issues new stock as a kind of currency to pay for the stock of the company it is acquiring.⁵ In these cases, it’s misleading to treat the stock issuance and the stock retirement as two separate transactions — as independent sources and uses of funds. It would be better to net those transactions out earlier before reporting the gross figures here. Unfortunately, the Fed doesn’t give a historical series of cash vs. stock acquisition spending. But in recent years, at least, it seems that no more than a quarter or so of acquisitions are paid in stock, so the figure above is at least qualitatively correct. Removing the stock acquisitions — where there is arguably no meaningful issue or retirement of stock, jsut a swap of one company’s for another’s — would move the M&A Retirements and Gross Equity Issues lines down somewhat. But the basic picture would remain the same.

It’s also the case that a large fraction of equity issues are the result of exercise of employee stock options. I suspect — tho again I haven’t seen definite data — that stock options accout for a large fraction, maybe a majority, of stock issues in recent decades. But this doesn’t change the picture as far as sectoral flows goes — it just means that what is being financed is labor costs rather than investment.

The bottom line here is, I don’t think we heterodox corporate finance people have thought enough about acquisitions. A major part of payments from corporations to shareholders are not distribution of profits in the usual sense, but payments by managers for control rights over a production process that some other shareholders have claims on. I don’t think our current models handle this well — we either think implicitly of a single unitary corporate sector, or we follow the mainstream in imagining production as a bouillabaisse in where you just throw in a certain amount of labor and a certain amount of capital, so it doesn’t matter who is in charge.

Of course we know that the exit, the liquidity moment, for many tech startups today is not an IPO — let alone reaching profitability under the management of early investors — but acquisition by an established company. But this familiar fact hasn’t really made it into macro analysis.

I think we need to take more seriously the role of Wall Street in rearranging ownership claims. Both because who is in charge of particular production processes is important. And because we can’t understand the money flows between corporations and households without it.

“The financialization of the nonfinancial corporation”

One common narrative attached to the murky term financialization is that nonfinancial corporations have, in effect, turned themselves into banks or hedge funds — they have replaced investment in means of production with ownership of financial assets. Financial profits, in this story, have increasingly substituted for profits from making and selling stuff. I’m not sure where this idea originates — the epidemiology points toward my own homeland of UMass-Amherst — but it’s become almost accepted wisdom in left economics.

I’ve been skeptical of this story for a while, partly because it conflicts with my own vision of financialization as something done to nonfinancial corporations rather than by them — a point I’ll return to at the end of the post — and partly because I’ve never seen good evidence for it. On the cashflow side, it’s true there is a rise in interest income from the 1960s through the 1980s. But, as discussed in the previous post, this is outweighed by a rise in interest payments; it reflects a general rise in interest rates rather than a reorientation of corporate activity; and has subsequently been reversed. On the balance sheet side, there is indeed a secular rise in “financial” assets, but this is all in what the financial accounts call “unidentified” assets, which I’ve always suspected is mostly goodwill and equity in subsidiaries rather than anything we would normally think of as financial assets.

Now courtesy of Nathan Tankus, here is an excellent paper by Joel Rabinovitch that makes this case much more thoroughly than I’d been able to.

The paper starts by distinguishing two broad stories of financialization: shareholder value orientation and acquisition of financial assets. In the first story, financialization means that corporations are increasingly oriented toward the wishes or interests of shareholders and other financial claimants. The second story is the one we are interested in here. Rabinovitch’s paper doesn’t directly engage with the shareholder-value story, but it implicitly strengthens it by criticizing the financial-assets one.

The targets of the paper include some of my smartest friends. So I’ll be interested to see what they say in response to it.

The critical questions are: Have nonfinancial corporations’ holdings of financial assets really increased, relative to total assets? And, has their financial income risen relative to total income?

The answers in turn depend on two subsidiary issues. On the first question, we need to decide what is represented by the “other unidentified assets” category in the Financial Accounts, which is responsible for essentially all of the apparent rise in financial assets. And on the income side, we need to consistently compare the full set of financial flows to their nonfinancial equivalents. Rabinovitch argues, convincingly in my view, that looking at financial income in isolation is not give a meaningful picture.

On the face of it, the asset and income pictures look quite different. In the official accounts, financial assets of nonfinancial corporations have increased from 40% of nonfinancial assets to 120% between 1946 and 2015. Financial income, on the other hand, is only 2.5% of total income and shows no long-term increase. This should already make us skeptical that the increase in “financial” assets represents income-generating assets in the usual sense.

Rabinovitch then explores this is detail by combining the financial accounts with the IRS statistics of income (SOI) and the Compustat database. Each of these has strengths and weaknesses — Compustat provides firm-level data, but is limited to large, publicly-traded corporations and consolidates domestic and overseas operations; SOI gives detailed breakdowns of income sources for all forms of legal organization broken down by size, but it doesn’t include any balance-sheet variables, so it can’t be used to answer the asset questions.

iI the financial accounts, the majority of the increase in identified financial assets is FDI stock. As Rabinovitch notes, “it’s dubious to directly consider FDI as a financial asset if we take into account that it implies lasting interest with the intention to exercise control over the enterprise.” The largest part of the overall increase in financial assets, however, is in the residual “other unidentified assets” line of the financial accounts. The fact that there is no increase in income associated with these assets is already a reason to doubt that they are financial assets in the usual sense. Compustat data, while not strictly comparable, suggests that the majority of this is intangibles. The most important intangible is goodwill, which is simply the accounting term of the excess of an acquisition price over the book value of the acquired company. Importantly, goodwill is not depreciated but only written off through impairment. Another large portion is equity in unconsolidated subsidiaries; this accounts for a disproportionate share of the increase thanks to a change in accounting rules that required corporations to begin accounting for it explicitly. Other important intangibles include patents, copyrights, licenses, etc. These are not financial assets; rather they are assets or pseudo-assets acquired, like real investment, in order to carry out a company’s productive activities on an extended scale.

These are all aggregate numbers; perhaps the financialization story holds up better for the biggest firms? Rabinovich discusses this too. Both Compustat and SOI allow us to separate firms by size. As it turns out, the largest firms do have a greater proportion of financial income than the smaller ones. But even for the largest 0.05% of corporations, financial income is still only 3.5% or total income, and net financial income is still negative. As he reasonably concludes, “even for the biggest nonfinancial corporations, financialization must not be understood as mimicking financial corporations.”

What do we make of all this?

First, the view of financialization as nonfinancial businesses acquiring financial assets for income in placer of real investment, is widely held on the left. After my Jacobin interview came out, for example, several people promptly informed me that I was missing this important fact. So if the evidence does not in fact support it, that is worth knowing. Or at least, future statements of the hypothesis will be stronger if they respond to the points made here.

Second, the fact that “financial” assets in fact mostly consist of goodwill, interest in unconsolidated subsidiaries, and foreign investment is interesting in its own right, not just as negative criticism of the financialization story. It a sign of the importance of ownership claims as a means of control over production— both as the substantive content of balance sheet positions and as a core part of corporate activity.

Third, the larger importance of the story is to the question of whether nonfinancial corporations and their managers should be seen mainly as participants in, or victims of, financialization. Conversely, is finance itself a distinct social actor? In a world in which the largest nonfinancial corporations have effectively turned themselves into hedge funds, it would not make much sense to talk about a conflict between productive capital and financial capital, or to imagine them as two distinct sets of people. But in a world like the one described here, or in my previous post, where the main nexus between nonfinancial corporations and finance is payments from the former to the latter, it may indeed make sense to think of them as distinct actors, of conflicts between them, and of intervening politically on one side or the other.

Finally, to me, this paper is a model of how to do empirical work in economics. Through some historical process I’d like to understand better, economists have become obsessed with regression, to the point that in academic economics it’s become synonymous with empirics. Regression analysis starts from the idea that the data we observe is a random draw from some underlying data generating process in which a variable of interest is a function of one or more other variables. The goal of the regression is to recover the parameters of that function by observing independent or exogenous variation in the variables. But for most macroeconomic questions, we are dealing with historical processes where our goal is to understand what actually happened, and where the hypothesis of some underlying data-generating process from which historical data is drawn randomly, is neither realistic nor useful. On the other hand, the economy is not a black box; we always have some idea of the mechanism linking macroeconomic variables. So we don’t need to evaluate our hypotheses by asking how probable the it would be to draw the distribution we observe from some hypothetical random process; we can, and generally should, ask instead whether the historical pattern is consistent with the mechanism. Furthermore, regression analysis is generally focused on the qualitative question of whether variation in one variable can be said to cause variation in a second one; but in historical macroeconomics we are generally interested in how much of the variation in some outcome is due to various causes. So a regression approach, it seems to me, is basically unsuited to the questions addressed here. This paper, it seems to me, is a model of what one should do instead.

Corporate cashflows, 1960-2016

Here is some background on the investment question from the previous post, and related topics.

I’ve been fooling around recently with assembling a comprehensive account of sources and uses of funds for the US corporate sector from the Integrated Macroeconomic Accounts (IMA). (It’s much easier to do this with the IMAs than by combining the NIPAs with the financial accounts from the Fed.) The goal is a comprehensive account of flows of money into and out of the corporate sector, grouped in a sensible way.

My goal here is not to make any specific argument, but to provide context for a bunch of different arguments about the finances of US businesses. I think this an important thing to do – both mainstream and heterodox people tend to make claims about specific sets of flows in specific periods, but it’s important to start from the overall picture. Otherwise you don’t know what questions it makes sense to ask. It’s also important to give a complete set of flows, for the same reasons and also to check that one’s claims are logically coherent. Needless to say, you also have to measure everything consistently.

Some people do do this, of course — the social accounting matrices of Lance Taylor and company are the best versions I know of. But it’s relatively rare.

The IMAs are a fairly new set of national accounts, motivated by two goals. First, to combine the “real” flows tracked by the BEA with the financial flows and balance-sheet positions tracked by the Fed into a single, consistent set of accounts; and second, to produce a set of US accounts that conform to the System of National Accounts (SNA) followed by most of the rest of the world. (The SNAs are sort of the metric system of national accounts.) The first goal is more completely realized than the second – there are some important differences between the IMAs and SNAs. For our purposes, the most important one is the definition of the corporate sector. In the SNAs corporate businesses include, broadly, any enterprise staffed mainly by wage workers that produces goods and services for sale; this includes closely-held firms, government-owned enterprises, and many nonprofits. In the IMAs, the corporate sector is based on tax status, and so excludes partnerships and small family businesses, nonprofits, and government enterprises.

The nonfinancial corporate sector on the IMA definition accounts for roughly 50 percent of US value-added. [1] I think there are good reasons to focus on this 50 percent. This is where most important productive activity takes place, and where essentially all the profit that economic life is organized around is generated. It’s also the sector where the conceptual categories of economics best correspond to observables. We don’t directly see output in public sector or nonprofits, don’t directly see wages and profits in noncorporate sector, we don’t see either in the household sector. Finance of course has its own issues.

In any case! Figure 1 shows the corporate sector’s share of value added since 1960.

I am not sure what substantive significance, if any, most of the movements in this figure have. Some large part, perhaps most, of them reflect definitional or measurement factors rather than any change in concrete economic activity. That said, the secular rise in finance as well as government does, I think, reflect changes in what people do all day. The only one of these lines that definitely means what it seems, is the long-run rise in government – given the way the accounts are constructed, there must be a corresponding rise in the share of public sector employment. The household sector line basically reflects changes in the weight of spending associated with owner-occupied housing – the nonprofit piece of this is fairly stable over time. The fall and rise in the noncorporate business sector may also reflect the changing weight of real estate – where noncorporate forms are common – and independent-contractor arrangements. But it may also reflect shifts in legal forms and/or BEA imputations, that don’t involve any substantive change in productive activity.

Nonetheless this figure is important — less for what it tells us about economic substance than for what it tells us about economic data. Any series that exclusively or disproportionately draws from the corporate sector (nonresidential investment is an obvious and important case) will be scaled by that top line. And any discussion of factor shares needs to take into account the change in the shares of sectors where wages and/or profits are not directly observed.

Figure 2 is the real point of this post. It’s my broadest summary of sources and uses of funds in the corporate sector. All are measured as a share of total corporate value added. The same data is shown in the table at the end.

I’ve organized this in a somewhat nonstandard way, but which I think is appropriate for the questions we are most interested in. The vertical scale is fraction of corporate value-added, or output. The heavy black line shows the share of output available to corporate managers. Above the line are three deductions from value-added: first, wages and other compensation of labor; second, in gray, taxes, including both taxes on production and corporate income taxes; and third, the narrow white band, net payments to the financial system. This last is interest and other property payments, less interest, dividends and other property payments received. These are the three categories of payments that are effectively imposed on corporations from outside. [2] The area below this line is the internal funds at the disposal of management – what’s often referred to as corporate cashflow.

In red are two main uses of funds by corporate managers. The bottom red area is investment. Above this is payouts — first dividends, and then the top red area, net share repurchases. This latter includes both repurchases in the strict sense and shares retired through cash mergers and acquisitions – aggregate data combines them. The difference between the black line and the red line is net financial saving by the corporate sector. Where the heavy black line is above the top red line, the corporate sector is a net lender in financial markets – its acquisitions of financial assets are greater than the new debt it is incurring. Where the red line is above the black line, as it usually is, the corporate sector is a net borrower – its new debt is greater than its acquisition of financial assets.

Finally, the dotted black line shows reported depreciation. (Consumption of fixed capital in the jargon of the accounts.) This is not actually a source or use of funds. And there are serious conceptual and measurement issues with defining it – so much so that, in my view, it’s probably not a usable category for describing real world economies. Nonetheless, it is necessary to define some other terms that play a big part in these discussions. Most importantly, profits can be regarded as the difference between cashflow and depreciation. [3] And net investment is the difference between investment and depreciation.

The same items are presented in the table at the end of the post, for three periods and for the most recent full year available.

As I discuss below, some terms are grouped here differently from the way they are presented in the IMAs. Obviously, how exactly we aggregate is open to debate, and the pros and cons of different choices will depend on the questions we are trying to answer. But I think some picture like this has to be the starting point for any kind of historical discussion of the US economy.

So what do we see?

First, the labor share (i.e. labor costs as a percent of value added) is quite stable around 63-64 percent of value added between 1960 and 2000. It only begins falling in 2002 or so, dropping about 4 points in the early 2000s and another 3 points in the wake of the Great Recession, with a modest recovery in the past couple years. This timing is quite different from the impression most people have — what you’d get from straightforwardly looking at the wage share of GDP — of a steady long-term decline from the 1970s.

There are two reasons for this difference. First, during the 1970s and 1980s, the non-wage share of labor costs (mainly health benefits) rose quite a bit, from around 5 percent to around 10 percent of total compensation. This explains why labor cost growth did not slow during this period, even though wage growth did slow. Since healthcare prices were rising quite a bit faster than overall prices during this period, the rising share of health benefits in compensation also meant that the cost of labor to employers was also rising faster than the value of compensation to workers. [4] This factor becomes less important after the early 1990s, when the non-wage share of labor compensation flatted out.

Second, the labor share in the corporate sector is quite a bit higher than the labor share in finance and noncorporate businesses — the two sectors whose share of GDP has increased in recent decades. This means that even if there were no change in factor shares within each sector, the labor share for the economy as a whole would fall. Again, I don’t know how much of the difference in factor shares between sectors is a measurement issue, how much it reflects shifting legal forms of organization of the same kinds of activities, and how much it reflects real differences in how claims on the social product are exercised. But either way, it’s important to understand that a large part of the observed fall in the labor share over the past generation is explained, at least in an accounting sense, by this shift between sectors.

Moving on to taxes, there is also a substantial fall in this claim on corporate value-added, from 16 percent in 1960 to around 11 percent today. But here, the decrease comes earlier, in the 1960s and 1970s – the tax share has hardly changed since 1980. (I suspect that if this figure were extended to earlier dates, there would be a large fall in the tax share in the 1950s as well.) This means that after-tax profits show a more steady long-term rise than do pre-tax profits.

I should note that “taxes” here combines two items from the IMAs — taxes on production, and taxes on profits. In the national accounts, there are good reasons to separate these — taxes on production enter into the cost of output and so have to be treated as a factor payment, while taxes on profits are not part of costs and so are treated as a transfer. This distinction is critical if we are going to calculate GDP in a consistent way, but for substantive questions it’s not so important. To government, managers and other economic actors, taxes are all mandatory payments from the corporation to the state, however they are assessed.

After taxes comes net financial payments. As defined here, this is interest, rent and net current transfers, less interest, rent and dividends received. In other words, it is net payments on the corporate sector’s existing financial assets and liabilities. It’s represented on the figure by the white space between the thin black line and the thick black line. The first thing to notice about these net payments by corporations is that they are almost always positive and never significantly negative. In other words, over the past 56 years the corporate sector as a whole has never received more income from its financial assets than it has paid on its financial liabilities. You can see that the largest share of corporate value-added going to financial payments came in the high-interest 1980s; in most other periods the balance has been close to zero.

I’ll come back to this in a later post – a next step in this project should be precisely to unpack that white section. But the fact that the net financial income of the corporate sector is small, never positive, and shows no significant trend over time, is already enough to reject one popular story about financialization, at least in its most straightforward form. It is simply not the case that nonfinancial corporations in the aggregate have turned themselves into hedge funds – have replaced profits from operations with income from financial assets. The Greta Krippner article that seems to be the most influential version of this claim is a perfect example of the dangers of focusing on one piece of the cashflow picture in isolation. [5] She looks at financial income received by corporations but ignores financial payments made by corporations (mostly interest in both cases). So as shown in Figure 3, she mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses.

Figure 3. Because she focuses on the heavy black segment in isolation, Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits.

Returning to Figure 2: After subtracting labor costs, taxes and interest and other financial claims, we are left with the heavy red line — the share of value added available as cashflow to corporate managers. This rises from 20 percent in the 1960s to as high as 25 percent in the 1990s, to around 30 percent today. This increase in the corporate profit share (gross of depreciation, net of taxes) is one of the central facts of modern US macroeconomic history.

In the broadest terms, corporations can use cashflow in three ways. They can invest it in order to maintain or grow the business; they can distribute it to shareholders; or they can retain it for later use in some financial form. This last use can be, and often is, negative, if investment and payouts are together greater than cashflow.

Investment here includes gross capital formation, defined in the national accounts as spending on durable equipment, structures, software, research and development, and the creation of intellectual property. (The last two items have been included in the national-accounts measure of investment only since 2013.) It also includes the change in private inventories and spending on nonproduced durable assets, which I assume is almost all land. This item is listed separately in the IMAs, and it’s not obvious how to handle it: Corporate purchases of land have different macroeconomic implications than spending on new means of production, but from the point of view of the people making the investment decision there’s no major difference between money spent on a building and money spent for the land it sits on. This item is generally very small — well below 1 percent of total investment — but, like inventories, it’s highly cyclical and so plays a disproportionate role in short-run fluctuations. About a tenth of the fall in investment between 2008 and 2010, for example, was in nonproduced assets.

Somewhat surprisingly, there is no downward trend in the investment share. It was 17 percent of value added in the 1960s and 1970s, versus over 18 percent in this decade, and 19 percent in the third quarter of 2017 (the most recent available).

If investment today is, if anything, historically high as a share of corporate output, why have so many people (including me!) been arguing that weak investment is a problem? There are several reasons, though perhaps none are entirely convincing.

First, as I pointed out in the previous post, in recent years there has been an unusual divergence between investment in the corporate sector and investment in the economy as a whole. Residential investment by households remains very low by historical standards; nonresidential investment by noncorporate businesses is also low. At the same time, financial and especially noncoporate businesses always invest at lower rates than nonfinancial corporations, so the rising share of these sectors leads to lower overall investment. Second, the recovery in corporate investment is relatively recent – things looked different a few years ago. Nonfinancial corporations’ investment share fell extremely sharply in 2009, to its lowest level in 45 years, and took several years to bounce back. So when we were discussing this stuff three or four years ago, the picture looked more like a secular decline. Third — and probably most relevant for my work — while investment is relatively high as a share of corporate value added, it is quite low as a share of profits or cashflow. There is a genuine puzzle of weak investment, as long as we don’t ask “why are corporations investing less?”, but instead ask “why haven’t high profits led corporations to invest more?” Fourth, there has been a large increase in reported depreciation — from around 10 percent of value added in the 1960s to around 15 percent today. While I think for a number of reasons that this number is not really meaningful, if you take it seriously, it means that while gross investment has risen slightly, net investment has fallen a lot, to about half its level in the 1960s and 70s. Finally, if you take a strong Keynesian or Kaleckian view that it’s business investment that drives shifts in demand, then the ratios shown here are not informative about the strength or weakness of investment. The ratio of investment to output, in this view, only tells us about the size of the multiplier. To assess the strength or weakness of investment, we should instead look at the absolute increase in investment over the business cycle, which — while it’s picked up a bit in the past year — is still quite low by historical standards. I’ve made this argument myself, but I wouldn’t want to push it too far — investment is not the only source of autonomous demand.

Moving on in Figure 2: Above investment is payouts – first dividends, then net share repurchases. Here we see what you’d expect: These flows have gone up a lot. Dividends have doubled from 4.5 percent of value added in the 1960s and 1970s to 9 percent today, while net repurchases have gone from less than nothing to 6 percent (and as high as 10 percent in the 2000s.) Measured as a share of corporate cashflow rather than value added, dividends have remained stable at around 50 percent. Retained earnings as conventionally defined — profits minus dividends — have also been roughly stable as a share of value added.

Including net share repurchases with dividends is the biggest way my presentation here departs from the format of the IMAs. There, net share issuance is classed as an addition to liabilities, just like issuance of new debt. Net repurchases are the same as negative issuance — the equivalent, in the IMA framework, of paying back loans. The difference, of course, is that share repurchases have no effect on the balance sheet. This is the fundamental reason I think it makes sense to group repurchases with dividends. The flow of dividend payments is not affected by the number of shares outstanding. [6] It’s also important that market participants clearly perceive share repurchases as equivalent to dividend payments. If you read the financial press, dividends and buybacks are always treated as two forms of shareholder payouts.

Personally, I don’t have any doubts that this is the right way to look at it — today. But this is a good example of how the relations between economic and accounting categories are always somewhat slippery and can change over time. Whether net share issuance should be classed with dividends (and interest payments, etc.) as a current transfer, as I do, or whether it should be considered a financing transaction, where the standard IMA presentation puts it, depends on the way these transactions are actually used – it can’t be answered a priori. Again, I think it’s reasonably clear that, given their use today, net stock repurchases should be grouped with dividends. But in the 1950s or 1960s, treating them as financing made more sense. Also, this adjustment needs to be made consistently. If we are going to count repurchases as dividends, we have to subtract them from the headline measures of retained earnings and corporate saving. We will probably want to make an equivalent adjustment to the accounts of other sectors as well, though this poses its own set of challenges.

Another thing to consider is that we see negative issuance not only when corporations repurchase their own shares, but when shares are purchased for cash as part of mergers and acquisitions. This is not necessarily a problem. If we are just adding up payments for the sector as a whole, the two sets of flows are equivalent. On a more concrete behavioral or policy level there are important differences, but we’ll pass over those for now.

If we look at dividends alone, 2016 saw them at their highest share of corporate value-added, of profits and of cashflow since the IMAs begin in 1960; and almost certainly since the 1920s. If we measure payouts as dividends plus net share repurchases, then 2016 levels were still a bit short of the peak in the mid-2000s. Share repurchases have been a bit lower (around 5 percent of value added) in 2017 than 2016; unfortunately, the quarterly IMAs don’t have dividend data, but the financial accounts suggest that dividends have declined somewhat as well. It seems that the 2-point decline in the profit share since its 2014 peak is now beginning to be reflected in payouts to shareholders. By comparison with any period before the mid-2000s, payouts are still very high. Still, their decline over the past year seems significant – though maybe the tax bill will give them a second wind.

The final item in Figure 2 is the space between the heavy red line and heavy black line. This shows the financing gap – the net financial borrowing (if positive, with the red line above the black line) or lending (if negative) by the corporate sector. In my opinion this is a much more relevant number than corporate saving as conventionally defined. As the figure shows, nonfinancial corporations are normally net borrowers in financial markets; the brief periods of net lending are all associated with deep recessions. As the figure also makes clear, however, this specific interpretation is quite sensitive to counting share repurchases as payouts. If net equity issuance is treated as a form of financing, then the aggregate corporate sector has been mostly close to a zero balance in financial markets and has more recently been a substantial net lender. On the other hand, if we think of this gap as showing the net credit-market borrowing by the nonfinancial corporate sector — as it more or less is — then the conclusion holds regardless of how you treat stock buybacks. Either way, by this measure the recent expansion is not exceptional: As of 2016 credit-market borrowing by the corporate sector was still smaller, as a share of value-added, than it was at the high points of the 1980s, 1990s or 2000s.

The same results are shown below for three periods and for the most recent year. I won’t recap the table, it’s the same stories as above. Just to be clear, the values are the averages for the periods shown for the flows listed in the second column. So for instance labor costs accounted for an average of 63 percent of corporate value-added during 1960-1979. The first column just shows the accounting relationships between the flows.

	Flow	1960-1979	1980-1999	2000-2015	2016
100 –	(A) Labor costs	63	64	60	59
–	(B) Taxes	15	12	12	12
–	(C) Net financial payments	1	2	1	1
=	(D) Internal funds (cashflow)	21	22	27	29
	(E) Dividends	5	5	7	9
+	(F) Net share repurchases	-1	2	4	6
=	(G) Payouts	4	7	11	15
	(H) Investment	17	18	18	18
–	(J) Depreciation	10	13	15	15
=	(K) Net investment	7	5	4	3
(G) + (H) – (D) =	(I) Financing gap	0	3	2	5
(D) – (J) =	(L) Profits	11	9	13	14

What do we take from all this? Again, my goal here was not to make any particular substantive claim, but to lay out some essential context for more specific arguments about corporate finances that I’ll make in the future. But it is interesting, isn’t it?

[1] Value-added is the difference between sales and the cost of material inputs. It’s the best way to measure the output of various sectors. For the economy as a whole, total value-added is identically equal to GDP.

[2] Of course corporations have some control over their wage, tax and debt-service payments. But these are not mainly decision variables for corporate management in the same way that investment and shareholder payouts are. Or at least I think it’s reasonable to so regard them.

[3] Whether they are exactly this value or only approximately depends on the profits concept being used. In any case, it’s important to keep in mind that the values of depreciation used by corporations for reporting profits to financial markets and to the tax authorities, may be quite different from the depreciation reported in the national accounts.

[4] The different behavior of prices of workers’ consumption basket and of output in general was the subject of the first substantive post on this blog, seven years ago. It’s an important topic!

[5] While I don’t agree with the claims in this article, I’m a big admirer of Krippner’s other work.

[6] The big exceptions, of course, are cases that involve all of a given corporation’s shares — IPOs and transactions that take a company private. These do respectively create and extinguish dividend flows. For this reason, when using micro data, it may make sense to use gross rather than net repurchases; but this isn’t possible with the IMA data. IPOs however are a quite small part of the overall net issuance/repurchase of shares, and I am pretty sure that firms going private are as well. Private equity might create some more serious issues here — this is something I’d like to understand better. On the other hand, the advantage of using net rather than gross repurchases is that it eliminates repurchases that are simply compensating for stock issued as part of compensation packages.

Thoughts and Links for December 21, 2016

Aviation in the 21st century. I’m typing this sitting on a plane, en route to LA. The plane is a Boeing 737-800. The 737 is the best-selling commercial airliner on earth; reading its Wikipedia page should raise some serious doubts about the idea that we live in an era of accelerating technological change. I’m not sure how old the plane I’m sitting on is, but it could be 15 years; the 800-series was introduced in its present form in the late 1990s. With airplanes, unlike smartphones, a 20-year old machine is not dramatically — is not even noticeably — different from the latest version. The basic 737 model was first introduced in 1967. There have been upgrades since then, but to my far from expert eyes it’s striking how little changed tin 50 years. The original 737 carried 120 passengers, at speeds of 800 km/h on trips of up to 3,000 km, using 6 liters of fuel per kilometer; this model carries 160 passengers (it’s longer) at speeds of 840 km/h on trips of 5,500 km, using 5 liters of fuel per kilometer. Better, sure, but probably the main difference you’d actually notice from a flight 50 years ago is purely social: no smoking. In any case it’s pretty meager compared that with the change from 50 years earlier, when commercial air travel didn’t exist. The singularity is over; it happened on or about December 1910.

Unnatural rates. Here’s an interesting post on the New York Fed’s Liberty Street blog challenging the ideas of “natural rates” of interest and unemployment. good: These ideas, it seems to me, are among the biggest obstacles to thinking constructively about macroeconomic policy. Obviously it’s example of, well, naturalizing economic outcomes, and in particular it’s the key ideological element in presenting the planning by the central bank as simply reproducing the natural state of the economy. But more specifically, it’s one of the most important ways that economists paper over the disconnect between the the economic-theory world of rational exchange, and the real world of monetary production. Without the natural rate, it would be much hard to pretend that the sort of models academic economists develop at their day jobs, have any connection to the real-world problems the rest of the world expects economists to solve. Good to see, then, some economists at the Fed acknowledging that the natural rate concepts (and its relatives like the natural rate of unemployment) is vacuous, for two related reasons. First, the interest rate that will bring output to potential depends on a whole range of contingent factors, including other policy choices and the current level of output; and second, that potential output itself depends on the path of demand. Neither potential output nor the natural rate reflects some deep, structural parameters. They conclude:

the risks associated with monetary easing are asymmetric. That is, excessive easing can be reversed, but excessive tightening may cause irreversible damage to the economy’s potential output.

In the research described in this blog, we focus on the effect of recessions on human capital. Recessions may affect potential output through other channels as well, such as lower capital accumulation, lower labor force participation, slow productivity growth, and so forth. Our research would suggest that to the extent that these mechanisms are operative, a monetary policy that seeks to track measured natural rates—of unemployment, interest rates, and so forth—might be insufficiently accommodative to engineer a full and quick recovery after a large recession. Such policies fall short because in a world with hysteresis, “natural” rates are endogenous. Policy should set these rates, not track them.

Also on a personal level, it’s nice to see that the phrases “potential output,” “other channels,” “lower labor force particiaption,” and “slow productivity growth” all link back to posts on this very blog. Maybe someone is listening.

More me being listened to: Here is a short interview I did with KCBS radio in the Bay area, on what’s wrong with economics. And here is a nice writeup by Cory Doctorow at BoingBoing of “Disgorge the Cash,” my Roosevelt paper on shareholder payouts and investment.

Still disgorging. Speaking of that: There were two new working papers out from the NBER last week on corporate finance, governance and investment. I’ve only glanced at them (end of semester crunch) but they both look like important steps forward for the larger disgorge the cash/short-termism argument. Here are the abstracts:

Lee, Shin and Stultz – Why Does Capital No Longer Flow More to the Industries with the Best Growth Opportunities?

With functionally efficient capital markets, we expect capital to flow more to the industries with the best growth opportunities. As a result, these industries should invest more and see their assets grow more relative to industries with the worst growth opportunities. We find that industries that receive more funds have a higher industry Tobin’s q until the mid-1990s, but not since then. Since industries with a higher funding rate grow more, there is a negative correlation not only between an industry’s funding rate and industry q but also between capital expenditures and industry q since the mid-1990s. We show that capital no longer flows more to the industries with the best growth opportunities because, since the middle of the 1990s, firms in high q industries increasingly repurchase shares rather than raise more funding from the capital markets.

And:

Gutierrez and Philippon – Investment-less Growth: An Empirical Investigation

We analyze private fixed investment in the U.S. over the past 30 years. We show that investment is weak relative to measures of profitability and valuation… We use industry-level and firm-level data to test whether under-investment relative to Q is driven by (i) financial frictions, (ii) measurement error (due to the rise of intangibles, globalization, etc), (iii) decreased competition (due to technology or regulation), or (iv) tightened governance and/or increased short-termism. We do not find support for theories based on risk premia, financial constraints, or safe asset scarcity, and only weak support for regulatory constraints. Globalization and intangibles explain some of the trends at the industry level, but their explanatory power is quantitatively limited. On the other hand, we find fairly strong support for the competition and short-termism/governance hypotheses. Industries with less entry and more concentration invest less, even after controlling for current market conditions. Within each industry-year, the investment gap is driven by firms that are owned by quasi-indexers and located in industries with less entry/more concentration. These firms spend a disproportionate amount of free cash flows buying back their shares.

I’m especially glad to see Philippon taking this question up. His Has Finance Become Less Efficient is kind of a classic, and in general he somehow seems to manages to be both a big-time mainstream finance guy and closely attuned to observable reality. A full post on the two NBER papers soon, hopefully, once I’ve had time to read them properly.

“Sets” how, exactly? Here’s a super helpful piece from the Bank of France on the changing mechanisms through which central banks — the Fed in particular — conduct monetary policy. It’s the first one in this collection — “Exiting low interest rates in a situation of excess liquidity: the experience of the Fed.” Textbooks tell us blandly that “the central bank sets the interest rate.” This ignores the fact that there are many interest rates in the economy, not all of which move with the central bank’s policy rate. It also ignores the concrete tools the central bank uses to set the policy rate, which are not trivial or transparent, and which periodically have to adapt to changes in the financial system. Post-2008 we’ve seen another of these adaptations. The BoF piece is one of the clearest guides I’ve seen to the new dispensation; I found it especially clarifying on the role of reverse repos. You could probably use it with advanced undergraduates.

Zoltan Pozsar’s discussion of the same issues is also very good — it adds more context but is a bit harder to follow than the BdF piece.

When he’s right, he’s right. I have my disagreements with Brad DeLong (doesn’t everyone?), but a lot of his recent stuff has been very good. Here are a couple of his recent posts that I’ve particularly liked. First, on “structural reform”:

The worst possible “structural reform” program is one that moves a worker from a low productivity job into unemployment, where they then lose their weak tie social network that allows them to get new jobs. … “Structural reforms” are extremely dangerous unless you have a high-pressure economy to pull resources out of low productivity into high productivity sectors.

The view in the high councils of Europe is that, when there is a high-pressure economy, politicians will not press for “structural reform”: there is no obvious need, and so why rock the boat? Politicians kick every can they can down the road, and you can only try “structural reform” when unemployment is high–and thus when it is likely to be ineffective if not destructive.

This gets both the substance and the politics right, I think. Although one might add that structural reform also often means reducing wages and worker power in high productivity sectors as well.

Second, criticizing Yellen’s opposition to more expansionary policy,which she says is no longer needed to get the economy back to full employment.

If the Federal Reserve wants to have the ammunition to fight the next recession when it happens, it needs the short-term safe nominal interest rate to be 5% or more when the recession hits. I believe that is very unlikely to happen without substantial fiscal expansion. … In the world that Janet Yellen sees, “fiscal policy is not needed to provide stimulus to get us back to full employment.” But fiscal stimulus is needed to create a situation in which full employment can be maintained…. if we do not shift to a more expansionary fiscal policy–and the higher neutral rate of interest that it brings–now, what do we envision will happen when the next recession arrives?

This is the central point of my WCEG working paper — that output is jointly determined by the interest rate and the fiscal balance, so the “natural rate” depends on the current stance of fiscal policy. Plus the argument that, in a world where the zero lower bound is a potential constraint — or more broadly, where the expansionary effects of monetary policy are limited — what is sometimes called “crowding out” is a feature, not a bug. Totally right, but there’s one more step I wish DeLong would take. He writes a lot, and it’s quite possible I’ve missed it, but has he ever followed this argument to its next logical step and concluded that the fiscal surpluses of the 1990s were, in retrospect, a bad idea?

Farmer on government debt. Also on government budgets, here are some sensible observations on the UK’s, from Roger Farmer. First, the British public deficit is not especially high by historical standards; second, past reductions in debt-GDP ratios were achieved by growth raising the denominator, not surpluses reducing the numerator; and third, there is nothing particularly desirable about balanced budgets or lower debt ratios in principle. Anyone reading this blog has probably heard these arguments a thousand times, but it’s nice to get them from someone other than the usual suspects.

Deviation and trend. I was struck by this slide from the BIS. The content is familiar; what’s interesting is that they take the deviation of GDP from the pre-criss trend as straightforward evidence of the costs of the crisis, and not a demographic-technological inevitability.

Cap and dividend. In Jacobin, James Boyce and Mark Paul make the case for carbon permits. I used to take the conventional view on carbon pricing — that taxes and permits were equivalent in principle, and that taxes were likely to work better in practice. But Boyce’s work on this has convinced me that there’s a strong case for preferring dividends. A critical part of his argument is that the permits don’t have to be tradable — short-term, non transferrable permits avoid a lot of the problems with “cap and trade” schemes.

Why teach the worst? In a post at Developing Economics, New School grad student Ingrid Harvold Kvangraven forthrightly makes the case for teaching “the worst of mainstream economics” to non-economists. As it happens, I don’t agree with her arguments here. I don’t think there’s a hard tradeoff between teaching heterodox material we think is true, and teaching orthodox material students will need in future classes or work. I think that with some effort, it is possible to teach material that is both genuinely useful and meaningful, and that will serve students well in future economics class. And except for students getting a PhD in economics themselves — and maybe not even them — I don’t think “learning to critique mainstream theories” is a very pressing need. But I like the post anyway. The important thing is that all of us — especially on the heterodox side — need to think more of teaching not as an unfortunate distraction, but as a core part of our work as economists. She takes teaching seriously, that’s the important thing.

Apple in the balance of payments. From Brad Setser, here’s a very nice example of critical reading of the national accounts. Perhaps even more than in other areas of accounts, the classification of different payments in the balance of payments is more or less arbitrary, contested, and frequently changed. It’s also shaped more directly by private interests — capital flight, tax avoidance and so on often involve moving cross-border payments from one part of the BoP to another. So we need to be even more scrupulously attentive with BoP statistics than with others to how concrete social reality gets reflected in the official numbers. The particular reality Setser is interested in is Apple’s research and development spending in the US, which ought to show up in the BoP as US service exports. But hardly any of it does, because — as he shows — Apple arranges for almost all its IP income to show up in low-tax Ireland instead. To me, the fundamental lesson here is about the relation between statistical map and economic territory. But as Setser notes, there’s also a more immediate policy implication:

Trade theory says that if the winners from globalization compensate the losers from globalization, everyone is better off. But I am not quite sure how that is supposed to happen if the winners are in some significant part able to structure their affairs so that a large share of their income is globally (almost) untaxed.

Links for October 6

More methodenstreit. I finally read the Romer piece on the trouble with macro. Some good stuff in there. I’m glad to see someone of his stature making the point that the Solow residual is simply the part of output growth that is not explained by a production function. It has no business being dressed up as “total factor productivity” and treated as a real thing in the world. Probably the most interesting part of the piece was the discussion of identification, though I’m not sure how much it supports his larger argument about macro. The impossibility of extracting causal relationships from statistical data would seem to strengthen the argument for sticking with strong theoretical priors. And I found it a bit odd that his modus ponens for reality-based macro was accepting that the Fed brought down output and (eventually) inflation in the early 1980s by reducing the money supply — the mechanisms and efficacy of conventional monetary policy are not exactly settled questions. (Funnily enough, Krugman’s companion piece makes just the opposite accusation of orthodoxy — that they assumed an increase in the money supply would raise inflation.) Unlike Brian Romanchuk, I think Romer has some real insights into the methodology of economics. There’s also of course some broadsides against the policy views of various rightwing economists. I’m sympathetic to both parts but not sure they don’t add up to less than their sum.

David Glasner’s interesting comment on Romer makes in passing a point that’s bugged me for years — that you can’t talk about transitions from one intertemporal equilibrium to another, there’s only the one. Or equivalently, you can’t have a model with rational expectations and then talk about what happens if there’s a “shock.” To say there is a shock in one period, is just to say that expectations in the previous period were wrong. Glasner:

the Lucas Critique applies even to micro-founded models, those models being strictly valid only in equilibrium settings and being unable to predict the adjustment of economies in the transition between equilibrium states. All models are subject to the Lucas Critique.

Here’s another take on the state of macro, from the estimable Marc Lavoie. I have to admit, I don’t care for way it’s framed around “the crisis”. It’s not like DSGE models were any more useful before 2008.

Steve Keen has his own view of where macro should go. I almost gave up on reading this piece, given Forbes’ decision to ban on adblockers (Ghostery reports 48 different trackers in their “ad-light” site) and to split the article up over six pages. But I persevered and … I’m afraid I don’t see any value in what Keen proposes. Perhaps I’ll leave it at that. Roger Farmer doesn’t see the value either.

In my opinion, the way forward, certainly for people like me — or, dear reader, like you — who have zero influence on the direction of the economics profession, is to forget about finding the right model for “the economy” in the abstract, and focus more on quantitative description of concrete historical developments. I expressed this opinion in a bunch of tweets, storified here.

The Gosplan of capitalism. Schumpeter described banks as capitalism’s equivalent of the Soviet planning agency — a bank loan can be thought of as an order allocating part of society’s collective resources to a particular project. This applies even more to the central banks that set the overall terms of bank lending, but this conscious direction of the economy has been hidden behind layers of ideological obfuscation about the natural rate, policy rules and so on. As DeLong says, central banks are central planners that dare not speak their name. This silence is getting harder to maintain, though. Every day there seems to be a new news story about central banks intervening in some new credit market or administering some new price. Via Ben Bernanke, here is the Bank of Japan announcing it will start targeting the yield of 10-year Japanese government bonds, instead of limiting itself to the very short end where central banks have traditionally operated. (Although as he notes, they “muddle the message somewhat” by also announcing quantities of bonds to be purchased.) Bernanke adds:

there is a U.S. precedent for the BOJ’s new strategy: The Federal Reserve targeted long-term yields during and immediately after World War II, in an effort to hold down the costs of war finance.

And in the FT, here is the Bank of England announcing it will begin buying corporate bonds, an unambiguous step toward direct allocation of credit:

The bank will conduct three “reverse auctions” this week, each aimed at buying the bonds from particular sectors. Tuesday’s auction focuses on utilities and industries. Individual companies include automaker Rolls-Royce, oil major Royal Dutch Shell and utilities such as Thames Water.

Inflation or socialism. That interventions taken in the heat of a crisis to stabilize financial markets can end up being steps toward “a more or less comprehensive socialization of investment,” may be more visible to libertarians, who are inclined to see central banks as a kind of socialism already. At any rate, Scott Sumner has been making some provocative posts lately about a choice between “inflation or socialism”. Personally I don’t have much use for NGDP targeting — Sumner’s idée fixe — or the analysis that underlies it, but I do think he is onto something important here. To translate the argument into Keynes’ terms, the problem is that the minimum return acceptable to wealth owners may be, under current conditions, too high to justify the level of investment consistent with the minimum level of growth and employment acceptable to the rest of society. Bridging this gap requires the state to increasingly take responsibility for investment, either directly or via credit policy. That’s the socialism horn of the dilemma. Or you can get inflation, which, in effect, forces wealthholders to accept a lower return; or put it more positively, as Sumner does, makes it more attractive to hold wealth in forms that finance productive investment. The only hitch is that the wealthy — or at least their political representatives — seem to hate inflation even more than they hate socialism.

The corporate superorganism. One more for the “finance-as-socialism” files. Here’s an interesting working paper from Jose Azar on the rise of cross-ownership of US corporations, thanks in part to index funds and other passive investment vehicles.

The probability that two randomly selected firms in the same industry from the S&P 1500 have a common shareholder with at least 5% stakes in both firms increased from less than 20% in 1999Q4 to around 90% in 2014Q4 (Figure 1).1 Thus, while there has been some degree of overlap for many decades, and overlap started increasing around 2000, the ubiquity of common ownership of large blocks of stock is a relatively recent phenomenon. The increase in common ownership coincided with the period of fastest growth in corporate profits and the fastest decline in the labor share since the end of World War II…

A common element of theories of the firm boundaries is that … either firms are separately owned, or they combine. In stock market economies, however, the forces of portfolio diversification lead to … blurring firm boundaries… In the limit, when all shareholders hold market portfolios, the ownership of the firms becomes exactly identical. From the point of view of the shareholders, these firms should act “in unison” to maximize the same objective function… In this situation the firms have in some sense become branches of a larger corporate superorganism.

The same assumptions that generate the “efficiency” of market outcomes imply that public ownership could be just as efficient — or more so in the case of monopolies.

The present paper provides a precise efficiency rationale for … consumer and employee representation at firms… Consumer and employee representation can reduce the markdown of wages relative to the marginal product of labor and therefore bring the economy closer to a competitive outcome. Moreover, this provides an efficiency rationale for wealth inequality reduction –reducing inequality makes control, ownership, consumption, and labor supply more aligned… In the limit, when agents are homogeneous and all firms are commonly owned, … stakeholder representation leads to a Pareto efficient outcome … even though there is no competition in the economy.

As Azar notes, cross-ownership of firms was a major concern for progressives in the early 20th century, expressed through things like the Pujo committee. But cross-ownership also has been a central theme of Marxists like Hilferding and Lenin. Azar’s “corporate superorganism” is basically Hilferding’s finance capital, with index funds playing the role of big banks. The logic runs the same way today as 100 years ago. If production is already organized as a collective enterprise run by professional managers in the interest of the capitalist class as a whole, why can’t it just as easily be managed in a broader social interest?

Global pivot? Gavyn Davies suggests that there has been a global turn toward more expansionary fiscal policy, with the average rich country fiscal balances shifting about 1.5 points toward deficit between 2013 and 2016. As he says,

This seems an obvious path at a time when governments can finance public investment programmes at less than zero real rates of interest. Even those who believe that government programmes tend to be inefficient and wasteful would have a hard time arguing that the real returns on public transport, housing, health and education are actually negative.

I don’t know about that last bit, though — they don’t seem to find it that hard.

Taylor rule toy. The Atlanta Fed has a cool new gadget that lets you calculate the interest rate under various versions of the Taylor Rule. It will definitely be useful in the classroom. Besides the obvious pedagogical value, it also dramatizes a larger point — that macroeconomic variables like “inflation” aren’t objects simply existing in the world, but depend on all kinds of non-obvious choices about measurement and definition.

The new royalists. DeLong summarizes the current debates about monetary policy:

1. Do we accept economic performance that all of our predecessors would have characterized as grossly subpar—having assigned the Federal Reserve and other independent central banks a mission and then kept from them the policy tools they need to successfully accomplish it?

2. Do we return the task of managing the business cycle to the political branches of government—so that they don’t just occasionally joggle the elbows of the technocratic professionals but actually take on a co-leading or a leading role?

3. Or do we extend the Federal Reserve’s toolkit in a structured way to give it the tools it needs?

This is a useful framework, as is the discussion that precedes it. But what jumped out to me is how he reflexively rejects option two. When it comes to the core questions of economic policy — growth, employment, the competing claims of labor and capital — the democratically accountable, branches of government must play no role. This is all the more striking given his frank assessment of the performance of the technocrats who have been running the show for the past 30 years: “they—or, rather, we, for I am certainly one of the mainstream economists in the roughly consensus—were very, tragically, dismally and grossly wrong.”

I think the idea that monetary policy is a matter of neutral, technical expertise was always a dodge, a cover for class interests. The cover has gotten threadbare in the past decade, as the range and visibility of central bank interventions has grown. But it’s striking how many people still seem to believe in a kind of constitutional monarchy when it comes to central banks. They can see people who call for epistocracy — rule by knowers — rather than democracy as slightly sinister clowns (which they are). And they can simultaneously see central bank independence as essential to good government, without feeling any cognitive dissonance.

Did extending unemployment insurance reduce employment? Arin Dube, Ethan Kaplan, Chris Boone and Lucas Goodman have a new paper on “Unemployment Insurance Generosity and Aggregate Employment.” From the abstract:

We estimate the impact of unemployment insurance (UI) extensions on aggregate employment during the Great Recession. Using a border discontinuity design, we compare employment dynamics in border counties of states with longer maximum UI benefit duration to contiguous counties in states with shorter durations between 2007 and 2014. … We find no statistically significant impact of increasing unemployment insurance generosity on aggregate employment. … Our point estimates vary in sign, but are uniformly small in magnitude and most are estimated with sufficient precision to rule out substantial impacts of the policy…. We can reject negative impacts on the employment-to-population ratio … in excess of 0.5 percentage points from the policy expansion.

Media advisory with synopsis is here.

On other blogs, other wonders

Larry Summers: Low laborforce participation is mainly about weak demand, not demographics or other supply-side factors.

Nancy Folbre on Greg Mankiw’s claims that the one percent deserves whatever it gets.

At Crooked Timber, John Quiggin makes some familiar — but correct and important! — points about privatization of public services.

In the Baffler, Sam Kriss has some fun with the new atheists. I hadn’t encountered Kierkegaard’s parable of the madman who tells everyone who will listen “the world is round!” but it fits perfectly.

A valuable article in the Washington Post on cobalt mining in Africa. Tracing out commodity chains is something we really need more of.

Buzzfeed on Blue Apron. The reality of the robot future is often, as here, just that production has been reorganized to make workers less visible.

At Vox, Rachelle Sampson has a piece on corporate short-termism. Supports my sense that this is an area where there may be space to move left in a Clinton administration.

Sven Beckert has edited a new collection of essays on the relationship between slavery and the development of American capitalism. Should be worth looking at — his Empire of Cotton is magnificent.

At Dissent, here’s an interesting review of Jefferson Cowie’s and Robert Gordon’s very different but complementary books on the decline of American growth.

Links for April 12

Maybe I should aspire to do a links post like this once a week. Today is Tuesday; is Tuesday a good day? Or would it be better to break a post like this into half a dozen short ones, and put them up one at a time?

Anyway, some links and thoughts:

Public debt in the 21st century. Here is a very nice piece by DeLong, arguing that over the next 50 years, rich countries should see a higher level of public expenditure, and a higher level of public debt, and that even much higher debt ratios don’t have any important economic costs. There’s no shortage of people making this general case, but this is one of the better versions I’ve seen.

The point that the “sustainability” of a given deficit depends on the relation between interest rates and growth rates has of course been made plenty of times, by people like Jamie Galbraith and Scott Fullwiler. But there’s another important point in the DeLong piece, which is that technological developments — the prevalence of increasing returns, the importance of information and other non-rival goods, and in general the development of what Marx called the “cooperative form of the labour process” — makes the commodity form less and less suitable for organizing productive activity. DeLong sees this as an argument for a secular shift toward government as opposed to markets as our central “societal coordinating mechanism” (and he says “Smithian market” rather than commodity form). But fundamentally this is the same argument that Marx makes for the ultimate supercession of capitalism in the penultimate chapter of Capital.

Short-termism at the BIS. Via Enno Schroeder, here’s a speech by Hyun Song Shin of the BIS, on the importance of bank capital. The most interesting thing for my purposes is how he describes the short-termism problem for banks:

Let me now come back to the question as to why banks have been so reluctant to plough back their profits into their own funds. … we may ask whether there are possible tensions between the private interests of some bank stakeholders versus the wider public interest of maintaining a soundly functioning banking system… shareholders may feel they can unlock some value from their shareholding by paying themselves a cash dividend, even at the expense of eroding the bank’s lending base.

As many of the shareholders are asset managers who place great weight on short-term relative performance in competition against their peers, the temptation to raid the bank’s seed corn may become too strong to resist. … These private motives are reasonable and readily understandable, but if the outcome is to erode capital that serves as the bank’s foundation for lending for the real economy, then a gap may open up between the private interests of some bank stakeholders and the broader public interest.

Obviously, this is very similar to the argument I’ve been making for the corporate sector in general. I especially like the focus on asset managers — this is an aspect of the short-termism story that hasn’t gotten enough attention so far. People talk about principal-agent problems here in terms of management as agents and shareholders as principals; but only a trivial fraction of shares are directly controlled by the ultimate owners, so there are plenty of principal-agent problems in the financial sector itself. When asset managers’ performance is evaluated every year or two — not to mention the performance of the individual employees — the effective investment horizon is going to be short, and the discount rate correspondingly high, regardless of the preferences of the ultimate owners.

I also like his diplomatic rejection of a loanable-funds framework as a useful way of thinking about bank lending, and his suggestion that the monetary-policy and supervisory functions of a central bank are not really distinct in practice. (I touched on this idea here.) The obligatory editorializing against negative rates not so much, but I guess it comes with the territory.

Market failure and government failure in the euro crisis. This piece by Peter Bofinger gets at some of the contradictions in mainstream debates around the euro crisis, and in particular in the idea that financial markets can or should “discipline” national governments. My favorite bit is this quote from the German Council of Economic Experts:

Since flows of capital as well as goods and services are market outcomes, we would not implicate the ‘intra-Eurozone capital flows that emerged in the decade before the crisis’ as the ‘real culprits’ …Hence, it is the government failures and the failures in regulation … that should take centre-stage in the Crisis narrative.

Well ok then!

Visualizing the yield curve. This is a very nice visualization of the yield curve for Treasury bonds since 1999. Two key Keynesian points come through clearly: First, that the short-term rate set by policy has quite limited purchase on the longer term market rates. This is especially striking in the 2000s as the 20- and 30-year rates barely budget from 5% even as the short end swings wildly. But second, that if policy rates are held low enough long enough, they can eventually pull down market rates. The key Keynes texts are here and here; I have some thoughts here, developed further here.

Trade myths. Jim Tankersley has a useful rundown in the Washington Post on myths about trade and tariffs. I’m basically on board with it: You don’t have to buy into the idolatry of “free trade” to think that the economic benefits of tariffs for the US today would be minimal, especially compared with the costs they would impose elsewhere. But I wish he had not bought into another myth, that China is “manipulating” its exchange rate. Pegged exchange rates are in general accepted by orthodoxy; for much of modern history they were the norm. And even where exchange rates are not officially pegged or targeted, they are still influenced by all kinds of macroeconomic policy choices. It’s not controversial, for instance, to say that low interest rates in the US tend to reduce the value of the dollar, and thereby boost US net exports. Why isn’t that a form of currency manipulation? (To be fair, people occasionally suggest that it is.) I heard Joe Stiglitz put it well, at an event a year or two ago: There is no such thing as a free-market exchange rate, it’s just a question of whether our central bank sets it, or theirs does. And in any case, the Bank of China’s purchase of dollars has to be considered alongside China’s capital controls, which — given the demand of wealthy Chinese for dollar assets — tend to raise the value of the renminbi. On net, the effect of Chinese government interventions has probably been to keep the renminbi “artificially” high, not low. (As I’ve been saying for years.)

The politics of the minimum wage. Here is a nice piece by Stephanie Luce on the significance of New York’s decision to raise the minimum wage to $15. Also in Jacobin, here’s Ted Fertik on why our horrible governor signed onto this and the arguably even more radical paid family leave bill.

It would be a great project for some journalist — I don’t think it’s been done — to explore how, concretely, this was won — the way the target was decided, what the strategy was, who was mobilized, and how. In mainstream press accounts these kinds of reforms seem to spring fully formed from the desks of executives and legislators, midwifed by some suitably credentialed experts. But when you dig beneath the surface there’s almost always been years of grassroots organizing before something like this bears fruit. The groups that do that work tend to avoid the press, I think for good reasons; but at some point it’s important to share with a wider public how the sausage got made. My impression in this case is that the key organizing work was done by Make the Road, but I’d love to see the story told properly. I haven’t yet read my friend Mark Engler’s new book, This Is an Uprising, but I think it has some good analysis of other similar campaigns.

Links for March 25

Some links, on short-termism, trade, the Fed and other things.

Senators Tammy Baldwin and Jeff Merkley have introduced a bill to limit activist investors’ ability to push for higher payouts. The bill, which is cosponsored by Bernie Sanders and Elizabeth Warren, would strengthen the 13D disclosure requirements for hedge funds and others acquiring large positions in a corporation. This is obviously just one piece of a larger agenda, but it’s good to see the “short-termism’ conversation leading to concrete proposals.

I’m pleased to be listed as one of the supporters of the bill, but I think the strongest endorsement is this furious reaction from a couple of hedge fund dudes. It’s funny how they take it for granted that shareholder democracy is on the same plane as democracy democracy, but my favorite bit is, “Shareholders do not cause bad management, just as voters do not cause bad politicians.” This sounds to me like an admission that shareholders are functionless parasites — if they aren’t responsible for the quality of management, what are we paying them all those dividends for?

I wrote a twitter essay on why the US shouldn’t seek a more favorable trade balance.

Jordan Weissman thinks I was “a bit ungenerous” to Trump.

My Roosevelt Institute colleague Carola Blinder testified recently on reform of the Fed, making the critical point that we need to take monetary policy seriously as a political question. “Contrary to conventional thinking, the rules of central banking are not neutral: Both monetary policy and financial supervision have profound effects on income and wealth inequality … [and] are the product of political contestation and compromise.” Relatedly, Mark Thoma suggests that the Fed “cares more about the interests of the rich and powerful than it does the working class”; his solution, as far as I can tell, is to hope that it doesn’t.

Matt Bruenig has a useful post on employment by age group in the US v the Nordic countries. As he shows, the fraction of people 25-60 working there is much higher than the fraction here (though workers here put in more hours). This has obvious relevance for the arguments of the No We Can’t caucus that there’s no room for more stimulus, because demographics.

A reminder: “Ricardian equivalence” (debt and tax finance of government spending have identical effects on private behavior) was explicitly denied by David Ricardo, and the “Fisher effect” (persistent changes in inflation lead to equal movements of nominal interest rates, leaving real rates unchanged) was explicitly denied by Irving Fisher. One nice thing about this piece is it looks at how textbooks describe the relationship between the idea and its namesake. Interesting, Mankiw gets Fisher right, while Delong and Olney get him wrong: They falsely attribute to him the orthodox view that nominal interest rates track inflation one for one, when in fact he argued that even persistent changes in inflation are mostly not passed on to nominal rates.

Here is a fascinating review of some recent books on the Cold War conflicts in Angola. One thing the review brings out was how critical the support of Cuba was to South Africa’s defeat there, and how critical that defeat in turn was to the end of apartheid. We tend to take it for granted that history had to turn out as it did, but it’s worth asking if, in the absence of Castro’s commitment to Angola, white rule in South Africa might have ended much later, or not at all.