From today’s New York Times story about the new crop of billion-dollar internet startups:
Most of these chief executives are also veterans of the Internet bubble of the late ’90s, and confess to worries that maybe things are not so different this time. Mr. Tinker… said, “The reality is, I’ve taken $94 million in investors’ money, and we haven’t gone public yet. I feel that responsibility every day.” …
The nagging fear is that valuations, which are turned into profits only if the company goes public successfully or is bought for a high price, could still plunge.
The cheap pleasure here is gawking at the next stupid Pets.com. (The NYC subway right now is plastered with ads for some company that, wait for it, lets you order pet food online.) But maybe all of this lot will thrive, I have no idea. What I’m interested in is that bolded phrase.
You might naively think that whether a business makes profits is independent of who happens to own it. Profits appear as soon as a commodity is sold for more than the cost of its inputs. So the bolded sentence really only makes sense with the implied addition, profits for venture capitalists or for finance. But in the disgorge-the-cash era, that’s taken as read.
Capitalism is still about M-C-C’-M’, same as it ever as. But C-C’ now includes not just the immediate process of production, but everything related to the firm as a distinct entity. Profits aren’t really profits, under the current regime, as long as the claim on them is tied to a specific business or industry. And the only real capitalists are owners of financial assets.
(Of course what is interesting about the internet economy is the extent to which this logic has not held there. Functionally, profitability for internet companies has meant a relationship of sales to costs that allows them to grow, regardless of the level of payouts to financial claimants. Whether articles like this are a sign of a convergence of Silicon Valley to the dominant culture, or just an example of the bondholder’s-eye view reflexively adopted by the Times, I don’t know.)
EDIT: From the Grundrisse:
It is important to note that wealth as such, i.e. bourgeois wealth, is always expressed to the highest power as exchange value, where it is posited as mediator, as the mediation of the extremes of exchange value and use value themselves. … Within capital itself, one form of it in turn takes up the position of use value against the other as exchange value…: the wholesaler as mediator between manufacturer and retailer, or between manufacturer and agriculturalist, or between different manufacturers; he is the same mediator at a higher level. And in turn, in the same way, the commodity brokers as against the wholesalers. Then the banker as against the industrialists and merchants; the joint-stock company as against simple production; the financier as mediator between the state and bourgeois society, on the highest level. Wealth as such presents itself more distinctly and broadly the further it is removed from direct production and is itself mediated between poles, each of which, considered for itself, is already posited as economic form. Money becomes an end rather than a means; and the higher form of mediation, as capital, everywhere posits the lower as … labour, as merely a source of surplus value. For example, the bill-broker, banker etc. as against the manufacturers and farmers, which are posited in relation to him in the role of labour (of use value); while he posits himself toward them as capital, extraction of surplus value; the wildest form of this, the financier.
Finance stands with respect to productive enterprises as capitalists in general stand with respect to labor (and raw material). So it makes sense that, from finance’s point of view, profit is not realized with the sale of the commodity, but only with the sale of the enterprise itself.
Nice.
Capitalist investment is sunk cost investment, and returns on sunk cost investments are economic rents. Having, or creating, the political power sufficient to secure an economic-rent return from a sunk-cost investment is the major uncertainty surrounding a start-up. Most capitalist investment, seeking new sources of economic rent, is funded out of cash flow from economic rents, from "mature" investments, and carried out, or acquired soon after a demonstration of feasibility, by a firm already in possession of sufficient market/political power that the prospect of being able to secure an economic-rent return is a low-risk proposition.
The naive notion, as you put it, that profit arises from the difference between price and cost, or that the return on a capitalist investment — the net present value of the expected cash flow — is independent of ownership, requires a studied refusal (in neoclassical formulations among others) to see that capitalist investment is inherently and necessarily political. The "risk" that financial capitalists are constantly prattling on about is primarily a political risk: the risk that the political power to shape the bargaining over exchange values will be insufficient, after the sunk-cost investment has been made, to earn a return, which is to say, to generate an economic rent (on the invested capital or on some other, related asset — this last, the possibility of a return on owning or possessing some related asset is often of supreme, practical importance).
The contradiction at the core of the matter is that sunk cost investments do not necessarily earn any return at all. The owner of a sunk cost investment ought to take no account whatsoever of its cost in his subsequent bargaining. A capitalist's sunk cost investment would not even enter into your "naive" accounting of profit, as a cost of production. Strategically, though, the capitalist anticipates that the sunk cost investment will affect the subsequent bargaining, will affect the "naive" accounting that follows from the bargain struck, though indirectly, altering the terms of trade, the distribution of risk or the market value of related assets or competing businesses.
The acquisition of political power, through strategic investment in organization, is the prize. This can be a matter of subverting existing power, or attaching one's enterprise to existing power, or a bit of both in turn. But, there's no "profit" in the capitalist financier's sense, until economic power has been created and demonstrated in a "viable business model" as they say.
Do you think that's about the size and shape of it?
Bruce,
I think that's a lot of it, but not all. I don't disagree — I think — with what you're saying. But I don't think it conflicts with what I'm saying. Capitalism has many contradictions.
On the one hand, there's the relationship between fixed costs and monopoly power. For a business to recoup its fixed costs, it needs to be able to charge a price higher than average variable costs. Mainstream theory manages this with rising marginal costs, but in the real world, as you say, it's really about quasi-rents. In a world of constant or falling marginal costs — the world we live in — fixed costs can be recovered only if a business is able to charge a positive markup over marginal costs, that is, if it has some monopoly power. (Schumpeter made this point a long time ago. So did Joan Robinson.) The problem is, there is no economic mechanism to align the degree of monopoly with the share of fixed costs. Only by sheer luck will the markup over marginal costs be just enough to recover fixed costs. In general, you'll end up with either fratricidal competition with firms playing price-war chicken into bankruptcy; or a regime of excess profits where the problem is the piling-up of unreinvestable surpluses. (Baran and Sweezy land.) The general logic of capitalism is to find itself in one of those unbalanced states.
Now, one solution, as you say, is to regulate profits politically. This is obviously important, especially when you're more worried about tipping into the first kind of imbalance, excess competition. And social norms help on both sides — the network rents collected by traditional newspapers via advertising (classified mainly) were both stabilized and usefully dissipated by being institutionally linked with intrinsically-motivated newsgathering. (I had sort of imagined something similar would happen with Google, with cross-subsidized search replacing cross-subsidized journalism, but it doesn't seem to be working that way.)
This lack of a mechanism to match the degree of monopoly to the share of fixed costs is a profound problem for capitalism. But it isn't the only problem. Another is to get the profits of existing capital reinvested as new capital. You suggest this isn't a big deal, but I disagree, I think it's often a real sticking point. In particular, it's a problem because there is a distinct set of people/institutions allocating the surplus among potential new investments. In other words, we have banks — the Gosplan of capitalist economies, as Schumpeter called them. One particular implication of this is that acts of fixed investment generally are accompanied by the creation of new financial claims. (I.e. we also live in Minsky world.) This is why sunk costs can't be ignored.
Which brings us to my disgorge-the-cash argument, which this post is part of, and which I think is complementary to the points you are making here.
Apart from the question of the proportion of fixed costs to rents, there is a political question about the relationship between the production-moments and money-moments of the circuit of capital. Regardless of the source of economic rents, there's still the question of whether claims on those rents take the form of ownership of financial assets, or are more integrally tied up with some firm or production process. My point is that there's been a distinct shift from the latter to the former. This has happened at the same time as a shift from what Jim Crotty calls corespective to fratricidal competition in many industries, but the two are logically independent and on a larger scale the shifts between C-C' and M-M' epochs, and between excess-profit and excess-competition epochs, probably don't coincide all that much.
I didn't imagine that I was contradicting you. I am seeking clarity.
I view the phenomena you have identified with your disgorge the cash thesis as reflecting a process of massive disinvestment, which is shrinking the "real" capital stock, even as financial claims continue to multiply. So, I'm with you there, I think.
You speak of a relationship of "fixed costs" to "monopoly power", which I don't necessarily recognize. The key, I think, is the concept of economic rent. Capitalist entrepreneurs and capitalist firms are rent-seekers. The organization of the economy — and particularly the erection of bureaucratic hierarchies and investments in dedicated capital and expertise (is that what we are referring to as "fixed costs"?) — depends on successfully securing a source of economic rents, as a means of attenuating risk and variability. Secure rents are the foundation for investment in organization.
I think economic rents and money/finance in its extended forms are logically independent. As a first cut, it is tempting to imagine them as parallel, or with money forming a shadow. But, I certainly do not imagine them as functionally independent. Both economic rents and finance capital function as insurance, dampening variability and risk.
In Stiglitz land, leverage is a way for the manager/controllers of a firm to forfeit the cushion of rents, and bind themselves by debt commitments, to perform as managers. So, the tie is intimate.
I don't know that I much like the excess-competition label, either. The neoliberal program of deregulation was a program of knocking away institutional sources of rent, which supported competition in the sense of opposed parties in the industrial structure: savings and loans v. banks, or unions v. transportation and manufacturing giants, or municipal regulators v. utility companies. Is the free-for-all that resulted accurately called "excess competition"? Did you see competition knocking down credit card interest rates in banking? I saw the banking hierarchies that regulated the issuing mortgages deteriorate, with the disappearance of rents.
I think financialization has a lot to do with the campaign to institute intellectual property as an extractive regime.
Finance, left to its own devices, both provides "insurance" and then creates a need for that insurance. It becomes what Michael Pettis called, a volatility machine. Instituting rent structures can compete with that — I think a lot of New Deal reforms were aimed squarely at undermining the volatility machine both by direct repression, and by giving lots of people and firms direct claims on economic rents, through free public education, professions and unions and local government (financed by property taxes and empowered to regulate public utilities).
Anyway, I don't want to get too long-winded.
@JWM
You say that this "disgorge the cash" phenomenon is due to a sort of cultural revolution, that you call the managerial revolution.
I think that a big part of this phenomenon can be explained in terms of an increasingly speculative economy, that in turn is caused by a (cyclical?) fall in the rate of profit. This is my reasoning:
Let's assume that there is a group of people, the capital owners (capitalists for short), who buy stuff (capital assets) not in order to consume them but in order to have a gain from it.
This gain can come either from "profits" or from capital appreciation.
For example, suppose that I buy a house:
a) If I buy it because I like it and I want to live in it, im' a consumer, not a "capitalist", and I'm out of this story;
b) If I buy it to rent it to someone else, and pocket the rent, I'm trying to gain from "profits" (rent is a form of profit in this example), I'm a "normal" capitalist;
c) If I buy it because I expect that, in 10 years, it's price will skyrocket, I'm betting on capital appreciation, I'm a "speculative" capitalist.
In the real world, behaviurs a), b) and c) ere really mixed and it is hard to tell what someone is thinking to when he/she/it[corporatins are people] is buying a capital asset.
I assume that "healthy capitalism" is a situation where most capitalists behave as per (b). In this situation, capitalists will try to invest in those assets that have the best P/E ratio (the rate of profit), and this will lead to some sort of equalization of the P/E ratio and some sort of positive invisible hand effect. For example, Apple starts to produce smartphones; people want smartphones and pay high prices for them, so the P/E ratio for Apple goes up. On the other hand people buy less laptops and thus the P/E ratio of, say, Asus goes down. Capitalists will try to invest in smartphones and disinvest from laptops, which will lead to an increased production of s.s and a decreased production of l.s, until the market for s.s is saturated and the market for l.s becomes less competitive, so that the P/E ratio of Apple and of Asus returns the same. In other words, there is a balancing of the quantities of stuff produced (which is the whole idea of the invisible hand).
In pratice, this balance will happen this way: s.assets and l.assets will each have their distinct (but somehow fixed) cost of production, and each will have some potential profit, that decreases as more capital assets will produce more stuff for the same market niche. Hence the P/E ratio of l.assets and s.assets will vary inversely to their quantity, with fixed "P" for each.
However, some capital assets have a very unelastic supply curve, as land or, today, as immaterial stuff like brand names such as "Google", "Apple" or "Facebook".
[segue…]
[…segue]
The cost of production of such assets doesn't really exist, so their value is determined from their earnings and the "normal" P/E ratio: for example if the Apple logo can give me 100$ of earnings/year, and the normal rate of profit is 5%, the value of the Apple logo will be (100$ / 5% =) 2000$.
Given a fixed normal P/E ratio, the value of such assets will change proportionally to the change in earnings, so that some capitalists will buy stuff on the expectation non only of higer profit, but of capital appreciation – a speculative behaviour.
Now, I have honestly no real idea about what determines the "normal" rate of profit, but let's suppose that, for some reason, this rate falls from 5% to 4%. In this situation the value of the Apple logo will rise to 2500%: a fall in the average rate of profit will cause an inversely proportional appreciation of unelastic assets.
Capital assets are eterogeneous stuff, so we can compare the quantity of such assets only in terms of value. But if the value of unelastic assets rises when the normal P/E ratio falls, then the quantity (in terms of value) of unelastic assets will rise in proportion to the quantity of elastic assets; thus the lower the normal P/E ratio, the more speculative the economy.
Plus, unelastic assets can be used as collateral for lending, so that a fall in the normal P/E ratio will cause an increase in the total collateral for lending and an increased financialisation of the economy.
In such an environment, it seems obvious to me that capitalist will look to capital appreciation as a major source of gains, while profits become less important; from this point of view, the idea that a business is profitable only if its capital market value rises makes sense not only in terms of "disgorge the cash", but mostly in terms of "casinò capitalism" where owners mostly bet on the appreciation of their assets as a source of gains.
I also think that the "managerial revolution" was a consequence of this dinamic, and not the cause (or maybe was part consequence and part cause).
Josh – you really need to read Bryan and Rafferty (Capitalism with Derivatives). I think they have some pretty important insights into this subject with the interaction between derivatives, finance and business. Their argument is that derivatives (though more accurately finance in general) creates a means of constant comparison and commensuration of the value of assets both within and among corporations, so that each asset and each component of the process of production gets constantly revalued.
To quote: "With financial derivatives, the boundaries between individual capitals have been blurred, the differences between different forms of capital (debt and equity) made less important, locational differences in activities made easier to compare, and the nature of assets with different time horizons made less incompatible. . . Derivatives are now continually deployed in re-calculating the monitary value of capital throughout the circuit and in this way financial derivatives have intensified competition and drawn notions of capital together." They argue that the result is that many of the traditional sources of monopoly profits end up being traded away through financial markets.
I don't think I have enough of a grasp of their argument to synthesize it with what you are arguing here (and I don't think their argument is perfect – they miss some of the managerial aspects and the shareholder revolution, but that might be because they are Australian and those impacts are felt differently). But it strikes me that the connection they make is part of the puzzle.
RL-
Very interesting comments. I agree with some of it, but not all.
You say that this "disgorge the cash" phenomenon is due to a sort of cultural revolution, that you call the managerial revolution. I think that a big part of this phenomenon can be explained in terms of an increasingly speculative economy, that in turn is caused by a (cyclical?) fall in the rate of profit.
Yes, agree.
suppose that I buy a house:
a) If I buy it because I like it and I want to live in it, im' a consumer, not a "capitalist", and I'm out of this story;
b) If I buy it to rent it to someone else, and pocket the rent, I'm trying to gain from "profits" (rent is a form of profit in this example), I'm a "normal" capitalist;
c) If I buy it because I expect that, in 10 years, it's price will skyrocket, I'm betting on capital appreciation, I'm a "speculative" capitalist.
In the real world, behaviurs a), b) and c) ere really mixed and it is hard to tell what someone is thinking to when he/she/it[corporatins are people] is buying a capital asset.
OK. But it's important here that there are two levels where this decision takes place, the acquisition of assets by a firm, and the acquisition of (claims on) the firm itself. i think there are lots of cases — arguably even the dominant case in some times and places — where assets are acquired BY firms for motivations (b) and (c) and but claims ON firms are acquired for reasons more like (a) — business is pursued "as a way of life," etc.
I assume that "healthy capitalism" is a situation where most capitalists behave as per (b). In this situation, capitalists will try to invest in those assets that have the best P/E ratio (the rate of profit), and this will lead to some sort of equalization of the P/E ratio and some sort of positive invisible hand effect. For example, Apple starts to produce smartphones; people want smartphones and pay high prices for them, so the P/E ratio for Apple goes up. On the other hand people buy less laptops and thus the P/E ratio of, say, Asus goes down. Capitalists will try to invest in smartphones and disinvest from laptops, which will lead to an increased production of s.s and a decreased production of l.s, until the market for s.s is saturated and the market for l.s becomes less competitive, so that the P/E ratio of Apple and of Asus returns the same. In other words, there is a balancing of the quantities of stuff produced (which is the whole idea of the invisible hand).
I agree that is is important whether capitalists — whether located in firms or in financial markets — are pursuing profits from production or from capital gains. That's a somewhat different (tho related) question however. Concretely, in your example here you are abstracting from the other factors that affect the price of stocks, particularly the payout ratio and liquidity. mainstream economic theory tends to treat the value of a firm's equity as just equal to the present value of its future profits. I'm rejecting that, and focusing specifically on the changing relationship between profits in the firm and profits received by owners of financial assets.
(continued)
let's suppose that, for some reason, this rate falls from 5% to 4%. In this situation the value of the Apple logo will rise to 2500%: a fall in the average rate of profit will cause an inversely proportional appreciation of unelastic assets.
You are assuming that whatever causes the change in the general rate of profit leaves the flow of dollars from ownership of Apple IP unchanged. Why assume that?
I agree that there is a greater focus on capital gains relative to profits from production, but I think this has more to do with bigger revaluations of assets in the light of unstable expectations, than the kind of direct mechanical effect of falling profit rates that you describe here. I also think that when capitalists, or some subset of them, are committed in various ways to returns at a certain level, if returns available from productive enterprises falls below that they will be more vulnerable to speculative bubbles.
More generally, I do think a fall in profits contributed to the shareholder revolution, but in a more straightforward way — a fall in the total pool of surplus helped spur efforts by financial capital to claim a greater share of it.
Also, one point of terminology — what I'm discussing here is the shareholder revolution. The term "managerial revolution" refers to the transition in the opposite direction, toward more autonomous professional managers, that took place early in the 20th century.