Sunday, May 19, 2013
Financialization and the Incredible Shrinking Time Horizon
Reading this excerpt from an interview with UNCTAD economist Heiner Flassbeck posted at Naked Capitalism prompts these thoughts on how financialization has altered the way capitalism functions.
Consider two ways an enterprise can be privately owned and managed. (For simplicity I will talk about two discrete models, but of course there is a continuum between them.) In the first way, which I’ll call institutional, a set of residual claimants are tied to the enterprise: there are substantial exit costs to their ownership, and thus they are forced to accept less diversification of their wealth portfolio than would otherwise be optimal—for them. They could be family members with longstanding ties to the enterprise, perhaps dating from some ancestral founding, top executives whose career paths do not easily extend horizontally to other enterprises, perhaps because of a perception that firm-specific knowledge is critical in executive competence, or investment banks or other intermediaries who hold long-term equity positions. It has to be emphasized that, from a purely risk-weighted wealth maximization point of view, such tied asset positions are unfavorable.
The second way, which can be called financial, takes the form of possession of paper claims on the enterprise tradeable in liquid markets or executive positions also tradeable for comparable positions in other enterprises. Exit costs, in other words, are much lower. This greatly reduces the risk of those in positions of transitory ownership and control: the owners can maintain a diversified and shifting portfolio of equity positions, while the executives can preserve outside employment options that substantially reduce the variability of expected permanent income.
In a world of perfect foresight or unitary ("rational") expectations it could be shown that these two models converge. In the real world of fundamental uncertainty, asymmetric information and conflicting expectations they don’t. Rather, the institutional approach compels owners and managers to extend their time horizons and lower their discount rates when forecasting future performance of the enterprise to which they are tied. The availability of low-cost exit reduces this incentive for comparable parties under the financial approach.
One consequence of a longer-term orientation is an incentive for greater investment, and an important venue for this investment is the enterprise’s workforce. A high-investment personnel strategy is one in which more resources are devoted to cultivating human capital and worker attachment to the firm. The latter is fostered through internal labor markets, rent-sharing and a more favorable, or at least less resistant, attitude toward worker voice. (This also depends, of course, on the production regime; under a technologically regimented regime such as one finds in commodity mass production like apparel, the drive system can coexist with a long-term orientation.) Financialization is linked to inequality and greater precariousness of work because there is little incentive to expend resources in the present to capture the return to investments in the workforce that materialize (uncertainly) well into the future.
There is also a political economic dimension to financialization. Those who are wealthy or hold positions at the top of organizational pyramids have disproportionate influence over public policy everywhere. If personal interests play a central role, directly or indirectly via ideology, in the kinds of policies economic elites favor, one would expect systematic differences between these two varieties of capitalism. Perhaps the most important is that the sort of sectoral jockeying one associates with institutionalized capitalism will give way to policies that are favorable to wealth-holders in general. Such policies will be those that promote capital mobility, reduce effective taxes on financial income, limit inflation or intensify disinflation, and backstop credit market positions. Again, I am not claiming that economic elites necessarily operate from a stance of naked self-interest; in fact, it is more likely that they will base their claims on sophisticated arguments that these things are in the public interest, as developed, for example, by like-minded economists.
So why the wave of financialization? The key, in my opinion, is to recognize that tying one’s fortune to any particular enterprise is always costly. Active entrepreneurs do this because their commitment to the enterprise, during this stage, is irreplaceable: there is simply no option for them to diversify their investments. Beyond this, elites seek diversification if they can get it. One reason institutional capitalism has prevailed in certain times and places is that rules were put in place to require it; labor laws, for instance, have served this function in many countries. Capital market regulations have also sheltered tied investors, in effect subsidizing their commitment to particular enterprises. This suggests that one reason we have seen the shift toward financialization is the dismantling, in most countries, of such rules. (The European Union has been explicit in opposing any national regulation that sheltered tied investors in the name of the single capital market.) Another factor is globalization, which is both a consequence of capital liberalization but also an inducement to it: as geographically dispersed markets with radically different economic opportunities and price structures are integrated, the costs of inhibiting capital mobility go up. At the same time, cultural shifts have taken place which devalue the kinds of commitment on which institutional capitalism depends and even celebrate the wealth of those who time their ship-jumping with exquisite accuracy. In the world we live in today, a radical lack of commitment to any specific enterprise is the default position, at least among those at the top of the hierarchy, and conscious social intervention is required to create countervailing pressures.
Two political observations to conclude:
1. Elites recognize as a fundamental conceptual point that a short-term orientation is dangerous. Of course, the point of financialization is that they dare not point this gun at themselves. Thus they project their concerns onto the public sector: it is government’s short-sightedness in fiscal matters alone that causes financial instability. This is a nice option, enabling them to adopt the posture of one who is wise and thinks in the long run while resisting any proposal that would cause them to forego their own private short-run orientation.
2. It is truly unfortunate that the rise of financialization and its political economic fallout has coincided with the emergence of a drastic problem whose solution depends on governments’ adopting much longer time frames than ever before, climate change.