The Class Struggle on Wall Street: A Footnote

Remember back at the beginning of February when the stock markets were all crashing? Feels like ages ago now, I know. Anyway, Seth Ackerman and I had an interesting conversation about it over at Jacobin.

My rather boring view is that short-term movements in stock markets can’t be explained by any kind of objective factors, because in the short run prices are dominated by conventional expectations — investors’ beliefs about investors’ beliefs… [1] But over longer periods, the value of shares is going to depend on the fraction of output claimed as profits and that, in general, is going to move inversely with the share claimed as wages. So if working people are getting raises — and they are, at least more than they were in 2010-2014 — then shareholders are right to worry about their own claim on the product.

One thing I say in the interview that a couple people have been surprised at, is that

there has been an upturn in business investment. In the corporate sector, at least, business investment, after being very weak for a number of years, is now near the high end of its historical range as a fraction of output.

Really, near the high end? Isn’t investment supposed to be weak?

As with a lot of things, whether investment is weak or strong depends on exactly what you measure. The figure below shows investment as a share of total output for the economy as a whole and for the nonfinancial corporate sector since 1960. The dotted lines show the 10th and 90th percentiles.

Gross capital formation as a percent of output


As you can see, while invesment for the economy as a whole is near the low end of its historic range, nonfinancial corporate investment is indeed near the high end.

What explains the difference? First, investment by households collapsed during the recession and has not significantly recovered since.  This includes purchases of new houses but also improvements of owner-occupied houses, and brokers’ fees and other transactions costs of home sales (that last item accounts for as much as a quarter of residential investment historically; many people don’t realize it’s counted at all). Second, the investment rate of noncorporate businesses is about half what it was in the 1970s and 80s. This second factor is exacerbated by the increased weight of noncorporate businesses relative to corproate businesses over the past 20 years. I’m not sure what concrete developments are being described by these last two changes, but mechanically, they explain a big part of the divergence in the figure above. Finally, the secular increase in the share of output produced by the public sector obviously implies a decline in the share of private investment in GDP.

I think that for the issues Seth and I were talking about, the corporate sector is the most relevant. It’s only there that we can more or less directly observe quantities corresponding to our concepts of “the economy.” In the public (and nonprofit) sector we can’t observe output, in the noncorproate sector we can’t observe profits and wages (they’re mixed up in proprietors income), and in the household sector we can’t observe either. And financial sector has its own issues.

Anyway, you should read the interview, it’s much more interesting than this digression. I just thought it was worth explaining that one line, which otherwise might provoke doubts.


[1] While this is a truism, it’s worth thinking through under what conditions this kind of random walk behavior applies. The asset needs to be and liquid and long-lived relative to the relevant investment horizon, and price changes over the investment horizon have to be much larger than income or holding costs. An asset that is normally held to maturity is never going to have these sort of price dynamics.

12 thoughts on “The Class Struggle on Wall Street: A Footnote”

  1. Aren’t there significant differences between investment and gross capital formation? This is not something I know much about but it’s my impression that the latter includes “Intellectual Property” and thus can be affected by changes in value (for accounting or tax purposes?) of IP. In short, is gross capital formation a good measure of the flow of funds from businesses into investment activities?

    1. No, the terms are equivalent. Both describe expenditure on long-lived means of production; neither is affected by valuation changes. What is true is that since 2013 the US nastional accounts include IP in both measures, while private accounts — with certain exceptions — do not count IP spending as investment.

  2. A bit OT but, since you wrote about Goodwin’s model:

    While I’m a big fan of the Goodwin cycle model, some time ago I read the original paper:

    and, as far as I can understand, it’s not actually a model of business cycles, but rather a model about the effects of demographic growth.

    The problem is this: Goodwin famously used the “predator-prey” equations in his models, but the predator is the wage share (not workers) and the prey the profit rate (not capital).

    In practice Goodwin assumes that there is constant population growth (workers reproduce like rabbits), but capital creation is faster or slower depending on the profit rate, so in some case capital grows faster than workers reproduce, causing unemployment and a low wage share/high profits, at which point capital reproduces more slowly causing more unemployment.

    From Goodwin’s article:
    “The following assumptions are made for convenience:
    (2) steady growth in the labour force;

    The problem is that unemployment actually goes up because of population growth, not because businesses are closing, which is obviously wildly unrealistic.

    What happens in the real world is that, with a more or less fixed population, at some point businesses start to close down, thus creating unemployment. This also implies negative net investment, that also doesn’t exist in Goodwin’s model but evidently exists in reality.
    Negative net investment in turn has a negative effect on profits, so that even if the wage share falls profits stay low, which IMHO is what causes underconsumption in the strict sense, so IMHO even if capitalists consume more the dynamics of underconsumption during a crisis don’t change.

    To put it in another way, I think that if we use G’s model as a model for the business cycle (and not as a model for demographics), then it becomes a model where there is primary demand (consumption goods) and secondary demand (net investments) that can swing positive or negative, but in the upswing investment demand is limited by the rising wage share, whereas in the downswing profits are limited part by the wage share but mostly by the underconsumption due to negative net investment.

    Another point about Goodwin’s model: it assumes that the wage share is determined by wages, in the labor market. But the profit share can be seen as the markup that business places on profits above wages, so if the wage share rises it means that for some reason capitalists can’t increase the markup on sales, otherwise there would be inflation but not an increase of the wage share.
    But, from the point of view of the business owner, it means that he or she at some point sees no good investment outlet.

  3. “Negative net investment in turn has a negative effect on profits”

    Can you spell that out a bit further, please. When you say “negative effect on profits”, are you saying it reduces the total, absolutely sum-total of profits? Does ‘negative net investment’ ‘restore’ the profit-RATE though?

  4. What I mean (and please note that I’m not an economist) is this:

    a) suppose an economy where there is a net investment of 0. This means that there is a gross output of, say, 150, but 50 of this is used for capital and raw material consumption so that the net output is 100 of consumption goods, of which 70 goes to the workers and 30 to the employers (wage share of 70%). This implies that the employers are consuming all the 30 as consumption goods.

    b) suppose that in the same economy of A there is a net investment of 10. This means that the workers are consuming 70 and employers are consuming 20 as personal consumption and “consuming” 10 as additional investment.

    c) suppose that in the same economy of b) employers immediately stop investing: this gives an economy that produces 100 but consumes only 90 (70+20 consumption goods), with 10 going unsold.
    Now, the unsold 10 does not count as “profit” for the employers, so we have an economy with a wage share of 70%, a profit share of 20%, and a “loss” that generally isn’t contabilised, but still the profit share fell.
    In case we have a negative net investiment we have a situation where the economy has a gross output of 150, of which 50 would be needed just to mantain capital but, because of the negative net investment of, say 5, only 45 are used, plus 70 in wages, plus 20 in employer’s consumption = 135/150 gross output = profit share of 15%, wage share of 70%, and lost production of 15% (note with negative investment the profit share is actually lower than the share of employer consumption).

    In theory it’s also possible that the employers increase their consumption when they go into negative investiment, but this means that they would be actively eating their capital so I don’t think it’s likely, I think that the hig consumption level on the profit share depends on the fact that negative investiment lowers the profit share (and replaces it with an “unsold goods” share).

  5. It’s sort-of well known in academic finance that short-term stock price movements aren’t driven by expectations, though this is phrased in a carefully technocratic way that does not lend itself to any conclusions (even the obvious ones). The term of art is “stock prices respond more to discount rate news rather than cash flow news”.

  6. It’s basically what they gave Shiller the Nobel Prize for. Stock prices are more volatile than can be explained by volatility in the underlying cash flows (dividends/earnings). If cash flows aren’t changing, then what must be changing is the rate at which we discount those cash flows. Campbell-Shiller (1988) or Campbell (1991) are the standard citations.

    1. Now I see what you are saying. We are using the term expectations differently. Shiller starts from the assumption that stock prices do in fact represent investors’ best estimate of the present value of future dividends or earnings. So changes in stock prices must then reflect some combination of changed expectations about future dividends/earnings, and/or the discount rate applied to them. But Keynes and Post Keynesians reject that assumption, for two reasons. First, liqudidity concerns can’t be reduced to the discount rate. Second, for investors who are not planning to hold the stock forever, valuation changes can be an independent factor in returns. If I plan to sell a share a year from now, what matters to me is what I expect the price to be a year from now. That’s the form of expectations I’m referring to in the interview. You might of course argue that the price a year from now will simply be the present value of the future dividends/earnings from that point. But then you’re just arguing in a circle.

      (Sorry for very late reply.)

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