resilience, not stability

Macroeconomic Stabilisation and Financialisation in The Real Economy

with 35 comments

The argument against stabilisation is akin to a broader, more profound form of the moral hazard argument. But the ecological ‘systems’ approach is much more widely applicable than the conventional moral hazard argument for a couple of reasons:

  • The essence of the Minskyian explanation is not that economic agents get fooled by the period of stability or that they are irrational. It is that there are sufficient selective forces (especially amongst principal-agent relationships) in the modern economy that the moral hazard outcome can be achieved even without any active intentionality on the part of economic agents to game the system.
  • The micro-prudential consequences of stabilisation and moral hazard are dwarfed by their macro-prudential systemic consequences. The composition of agents changes and becomes less diverse as those firms and agents that try to follow more resilient or less leveraged strategies will be outcompeted and weeded out – this loss of diversity is exacerbated by banks’ adaptation to the intervention strategies preferred by central banks in order to minimise their losses. And most critically, the suppression of disturbances increases the connectivity and reduces the ‘patchiness’ and modularity of the macroeconomic system. In the absence of disturbances, connectivity builds up within the network, both within and between scales. Increased within-scale connectivity increases the severity of disturbances and increased between-scale connectivity increases the probability that a disturbance at a lower level will propagate up to higher levels and cause systemic collapse.

Macro-stabilisation therefore breeds fragility in the financial sector. But what about the real economy? One could argue that in the long run, it is creative destruction in the real economy that drives economic growth and surely macro-stabilisation does not impede the pace of long-run innovation? Moreover, even if non-financial economic agents were ‘Ponzi borrowers’, wouldn’t real economic shocks be sufficient to deliver the “disturbances” consistent with macroeconomic resilience? Unfortunately, the assumption that nominal income stabilisation has no real impact is too simplistic. Macroeconomic stabilisation is one of the key drivers of the process of financialisation through which it transmits financial fragility throughout the real economy and hampers the process of exploratory innovation and creative destruction.

Financialisation is a term with many definitions. Since my focus is on financialisation in the corporate domain (rather than in the household sector), Greta Krippner’s definition of financialisation as a ““pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production” is closest to the mark. But from a resilience perspective, it is more accurate to define financialisation as a “pattern of accumulation in which risk-taking occurs increasingly through financial channels rather than through trade and commodity production”.

In the long run, creating any source of stability in a capitalist economy incentivises economic agents to realign themselves to exploit that source of security and thereby reduce risk. Similar to how banks adaptation to the intervention strategies preferred by central banks by taking on more “macro” risks, macro-stabilisation incentivises real economy firms to shed idiosyncratic micro-risks and take on financial risks instead. Suppressing nominal volatility encourages economic agents to shed real risks and take on nominal risks. In the presence of the Greenspan/Bernanke put, a strategy focused on “macro” asset price risks and leverage outcompetes strategies focused on “risky” innovation.  Just as banks that exploit the guarantees offered by central banks outcompete those that don’t, real economy firms that realign themselves to become more bank-like outcompete those that choose not to.

The poster child for this dynamic is the transformation of General Electric during the Jack Welch Era, when “GE’s no-growth, blue-chip industrial businesses were run for profits and to maintain the AAA credit rating which was then used to expand GE Capital.” Again, the financialised strategy outcompetes all others and drives out “real economy” firms. As Doug Rushkoff observed, “the closer to the creation of value you get under this scheme, the farther you are from the money”. General Electric’s strategy is an excellent example of how financialisation is not just a matter of levering up the balance sheet. It could just as easily be focused on aggressively extending leverage to one’s clients, a strategy that is just as adept at delivering low-risk profits in an environment where the central bank is focused on avoiding even the smallest snap-back in an elastic, over-extended monetary system. When central bankers are focused on preventing significant pullbacks in equity prices (the Greenspan/Bernanke put), then real-economy firms are incentivised to take on more systematic risk and reduce their idiosyncratic risk exposure.

Some Post-Keynesian and Marxian economists also claim that this process of financialisation is responsible for the reluctance of corporates to invest in innovation. As Bill Lazonick puts it, “the financialization of corporate resource allocation undermines investment in innovation”. This ‘investment deficit’ has in turn led to the secular downturn in productivity growth across the Western world since the 1970s, a phenomenon that Tyler Cowen has coined as ‘The Great Stagnation’. This thesis, appealing though it is, is too simplistic. The increased market-sensitivity combined with the macro-stabilisation commitment encourages low-risk process innovation and discourages uncertain and exploratory product innovation. The collapse in high-risk, exploratory innovation is exacerbated by the rise in the influence of special interests that accompanies any extended period of stability, a dynamic that I discussed in an earlier post.

The easiest way to explain the above dynamic is to take a slightly provocative example. Let us assume that the Fed decides to make the ‘Bernanke Put’ more explicit by either managing a floor on equity prices or buying a significant amoubt of equities outright. The initial result may be positive but in the long run, firms will simply align their risk profile to that of the broader market. The end result will be a homogenous corporate sector free of any disruptive innovation – a state of perfect equilibrium but also a state of rigor mortis.

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Written by Ashwin Parameswaran

October 3rd, 2011 at 4:16 pm

35 Responses to 'Macroeconomic Stabilisation and Financialisation in The Real Economy'

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  1. When I compare your work with that of almost any other economist writing on these topics, I feel as if you are playing at a completely different level. Your perspective seems above and oblique to most of the debate going on elsewhere, and thereby it conveys a very special insight that is generally absent.

    I would love to see a conference convened devoted to discussing your work, with leading economists invited, and you there to clarify and dispute interpretations. Still plotting and scheming on how to get more attention focused on your work . . .

    Michael Strong

    3 Oct 11 at 6:46 pm

  2. Well said. We need real risk in the financial economy to produce good behavior without the Fed behind as a safety net. As it is, the Fed encourages bad behavior by its implicit protection of the speculative culture.



    David Merkel

    4 Oct 11 at 1:57 am

  3. Michael – Thank you! I have a half-written post on how my thoughts tie in with academic macro which I hope to post soon. My dynamic, disequilibrium way of looking at things doesn’t fit in very well with modern macro but it’s not that dissimilar to the way some classical economists looked at things.

    David – Exactly. The implications of protecting financial claims also corrupt the incentive structure in the real economy. Thank you!


    4 Oct 11 at 2:38 am

  4. While I agree with your thoughts ashwin I don’t think macro stabilisation is simply a policy ‘choice’. Let us assume that real growth in a capitalist economy after population growth is factored out comes about as a result of productivity gains. Productivity gains are basically due to an increase in specialisation.

    From the perspective of labour, increased specialisation is a big risk because in the kind of creatively destructive, micro-unstable environment you advocate, specialists are much more vulnerable to exogenous shocks (whether due to technology demographics, finance etc) than generalists are. What appears a moderate shock from an economy wide perspective would end millions of careers which matters not one jot to an economist interested in macro stability but it sure as hell will make individuals think twice about whether it makes more sense to learn how to design wind turbines for example, or stick with something safe like being a doctor or banker.

    Once given specialisms become sufficiently technologically complex such that switching between them is not practical for the typical individual in their working life, the whole foundation of the Shumpeter-ian view of the benefits of creative destruction is called into question. In fact he foresaw this himself, in his famous description of how capitalism must be hoist by its own petard as a result.


    4 Oct 11 at 5:44 am

  5. In fact it’s amongst the big generalist sectors like health, finance, education and local government (which also tend to be reliant in various structural ways on state support) that one finds most if not all of the deeply entrenched cronyism.

    Because creative destruction doesn’t impact them like it does the sectors which are actually at the sharp end of driving productivity growth, we get the kind of stagnation you are talking about.

    So until the playing field here is levelled, don’t expect chip designers and biotechnologists to be rallying to your cause!


    4 Oct 11 at 6:02 am

  6. scepticus – on the assertion that macro stabilisation is not a choice but is driven by political interests, I agree. I’ve discussed Mancur Olson’s work before. It can even be argued that the human desire for order has something to do with all this. But in the process of writing about all this, I’d have to write a book instead of a blog post! :-)

    Your point about micro-instability is spot on and hence why I support intervention via direct transfers to affected individuals in times of generalised distress. I also think that in a less stable environment, individuals will choose to be less specialised or more multi-skilled. Part of the problem is that the amount of efficiency-seeking and specialisation itself increases in response to the artificially stabilised environment.

    Just another point – many parts of finance, esp. investment banking are in fact way more super-specialised than most other jobs.


    4 Oct 11 at 6:50 am

  7. No, you missed my point I think. I’m saying that the need for macroeconomic stabilisation may be dictated by the moving parts of advanced human technological civilisation. It may be that there was no other policy choice that is compatible with increasing specialisation and hence with real growth.

    If in a less stable environment individuals opt for less specialisation then we shall have less (or more likely negative) productivity gain and less growth. To make the modern IT infrastructure work we **need** individuals who spend 10 years in education learning the basics of semiconductor design, and who then spend another 10 or 15 years specialising in spending signals across 10cm of copper track at 5gbit/second. What’s more, to have a competitive environment in this specific area, we need perhaps 4-10 times as many such people, of whom perhaps one half will end up working for unprofitable companies. Then, when the technology is successful, it gets commoditised and transferred to low wage manufacturing zones, the design work falls off and this poor bum has to pick a new spin-off area of technical expertise and hope he picks the right one.

    If these individuals opt out of this process early on, we simply shan’t have the technology, period, let alone healthy competition in that sector.

    The same argument applies to financial specialists – who presumably have driven much of the much maligned recent “innovation”. But in a micro-unstable environment, we’ll need that innovation (hopefully directed toward more useful models and techniques) to allow financial intermediaries to have a chance to survive and hence to offer their risk bearing services. We’ll need experts in options pricing and so on, not just loan salesmen and risk management executives.

    If I’m a specialist I don’t want to have to rely on government policy largesse such as transfers to put me on a level playing field with a family doctor or dentist or lawyer, because I can’t rely on government policy holding steady for my working life.

    Sorry to go on at length about this, but what you are proposing is deeply unfair to those sectors we most rely on for growth, unless the creative destruction applies equally throughout the workforce.

    Another issue related to increasing specialisation is it requires increasing population size.

    There is also the notion that shumpeterian competition may actually be less efficient than some form of ‘ikea socialism’ in a situation in which output is energy or land constrained rather than constrained by human or financial capital.


    4 Oct 11 at 7:28 am

  8. On creative destruction applying equally to all, I absolutely think that this is necessary. Maximum micro-disorder for both capital and labour and all its sub-groups. I am opposed to all the myriad barriers to entry such as occupational licensing as I am to macro-stabilisation.


    4 Oct 11 at 8:14 am

  9. If anything, the problem during the “neo-liberal” era has been the fact that we have the marketing slogan of free markets and deregulation combined with an explicit and implicit stabilisation policy that only a few can exploit.


    4 Oct 11 at 8:16 am

  10. In which case, I think this situation (fairly distributed micro-disorder) needs time to propagate prior to countenancing any collapse, otherwise we’ll just end up with family doctors, dentists and all the other beneficiaries of “baumol’s disease” buying up asset at fire sale prices from all those who have done the most to create very significant the productivity gains of the last 40 years.

    Which would be the final indignity of moral hazard, IMO.


    4 Oct 11 at 8:26 am

  11. I see what you mean. But preserving stability is itself the source of continuing rents to those in finance and the corporate sector.


    4 Oct 11 at 8:47 am

  12. Seems to me that the flat yield curve is not doing anything to increase rents to the finance sector – in fact their profits are plummeting and stocks are now under performing the non financial sector.

    And even if that were not the case, simply diverting that flow of rents to the sectors I have outlined is not useful from a macro-stability perspective.


    4 Oct 11 at 9:44 am

  13. We don’t really need to do anything – we need to simply not prevent the bank failures via monetary action, bailouts etc.

    And failure of banks and financialised corporates will reduce rents extracted from the taxpayer and the firms’ consumer. Preventing a deflationary collapse via transfers will mitigate the possibility of a fire-sale.


    4 Oct 11 at 11:23 am

  14. Hi Scepticus,

    A lot of the advantage of modern economies relies on specialization, completely agree. But please also note that newer forms of specialisation happen only at the edge of development.

    Within the interior, where patterns are well established, most people will be making a living out of doing something that is public knowledge. What they definitely will be doing is accumulating capital, mostly in the currency of the realm. As more and more capital fights it out for fewer ideas (as you yourself have mentioned, the no. of people taking risks specializing is seriously reduced in the new micro-volatile scenario), the balance tilts in the favour of the entrepreneur. It’s all played out at the margin.

    Overall, growth is slower, but more sure. More people are generalists for longer. I can’t say for sure that that would be a bad thing. Maybe there is no team that can design the pentium chip in 2011, but there could be a vast army of electronics enthusiasts who are aware of the basics of electronics, of logic gates, etc.

    The only downside, in a cosmic sense, due to the slower growth might be the number of people who die waiting for a cure for aging, but that is just my personal transhumanist preferences talking.


    4 Oct 11 at 1:09 pm

  15. Ashwin

    While the broader point about the resilience vs stability tradeoff is certainly correct, you may be overstating the case by saying that macroeconomic stability leads to a low innovation economy. ‘Let’s give up this idea because it doesn’t provide the opportunity (or is one-period dominated) for regulatory arb’ is a thought process that may afflict some large organisations, but it’s hard to think of that as applicable to the broader set of business managers and entrepreneurs across the world economy. Could it simply be the Jack Welch and GE saw that large parts of the world economy were under-financed, saw that as the big global opportunity and simply did that in the most financially efficient way possible given the then present scenarios?

    But more fundamentally, is the resultant lack of resilience is in itself argument enough to give up the pursuit of stability. Is the fact that most pathogens eventually become resistant a good reason to ditch trying to make superior anti-biotics?


    4 Oct 11 at 1:35 pm

  16. Prakash, a quick google for ‘top 10 paying jobs’ ought to convince one that specialists on the margin of technology don’t regularly feature in the top 10. For example:

    the above list takes training time, cost, number of jobs available etc to generate the list.

    When I am talking about specialists we can consider two kinds, those at your margin and those in the core. I don’t for example consider airline pilots specialists because they perform routine social roles that don’t change much over time.

    A specialist that contributes to creative destruction of the mould ashwin is advocating is someone who’s role must change over time, and that brings dangers.

    The next generation of microprocessors can only be designed by a wide range of experts in perhaps 8 vast technical fields working together.

    Its not a co-incidence I feel, that the most rapid period of technological progress ever has co-incided with a regime (rightly or wrongly) of macro-stabilisation.


    4 Oct 11 at 2:16 pm

  17. Ritwik – my point is that macro-stabilisation reduces the incentive for firms to invest in high-risk exploratory innovation. This is especially true for incumbent firms who are primarily motivated to protect their competitive rents (historically, disruptive innovation comes mainly from new entrants). Stability also accelerates the influence of Olsonian special interests and makes new firm entry, a point which I analysed in this earlier post .

    It’s not the invention of antibiotics that is the problem – its the persistent use of antibiotics for even the smallest infections that reduces the body’s immunity in the long run. Which is the reason why, in the UK, doctors prescribe antibiotics only when the infection is severe enough that the body cannot fight it on its own.

    There are many more medical analogies – hopefully the subject of a future post.


    4 Oct 11 at 2:24 pm

  18. Plus, your point about the core workers accumulating capital which overflows thus favouring the entrepreneur makes my point for me. You have forgotten to mention the marginal specialists the entrepreneur has to employ to realise his innovation. It is these people that get stuffed by creative destruction.

    The shumperterian notion focusses always on the more glamorous roles and main beneficiaries of this process, forgetting who does the actual work.

    As you say, all the interesting/critical stuff happens at the margin.


    4 Oct 11 at 2:30 pm

  19. Gem of a comment summarizing the problem of the neo-liberal era, Ashwin. That message needs to be drilled into politicians’ minds before they utter more platitudes about deregulation and now re-regulation.


    4 Oct 11 at 3:16 pm

  20. Ashwin, this paper is worth a look:

    It suggests that productivity is mainly governed by transaction costs. Well managed high density populations will have lower transaction costs and that is what supports beneficial division of labour. However high activity-learning costs also increase division of labour, but to the *detriment* of per capita income. The paper notes that transaction costs are lowered by merging of populations and markets.

    Therefore it might be argued that macro-stabilisation which lowers transaction costs increases productivity and I think there is much evidence for this increase the last 3 decades. Therefore a micro-chaotic economy will increase transaction costs (it must do so) and will retard the possibility of productivity increases.

    I have also kind of argued that the innovations at the margin which will in future deliver marginal increase in productivity will create activities with high learning cost. Combined with micro-chaos the result will not be an acceleration of innovation.

    That’s not to say that micro-chaos isn’t preferable overall due to the minimising of catastrophic outcomes, but there must be a price to be paid and the bill will arrive in the form of reduced productivity.

    I also think that there are options for retaining macro-stabilisation but with a different intermediation structure that would not deliver creative destruction but would deliver resilience.


    4 Oct 11 at 4:15 pm

  21. Scepticus,

    You’ve given me something to think about. As of now, I see a few patterns.

    First about the well paying jobs – When surveys are taken, they are taken of a large number of people. Large numbers, almost by definition, are present in the core. Plus, there are a lot of medical and construction related activities there – heavily regulated and possibly not valid examples. Regulatory changes favouring medical tourism and ready to assemble buildings might change the picture.

    You agree that growth might be slower in a micro-chaotic environment. I say the same. But this will be a more resilient environment, I believe and an environment in which people will try to be flexible and try really hard to learn different things. I don’t see this as a bad thing.

    Dedicated effort to perfecting an art will be done in those arts that are relatively well-established and possibly by people who are passionate about the art itself, irrespective of its commercial value. That is not necessarily a bad thing. The horizon will continue to expand, but slower.

    One of the few sure shots as you mentioned in a later post is to try to brute force specialisation by bringing together people and markets. Have more cities and connect them better. I totally agree. Nice way of having our cake and eating it too, but this strategy will also be subject to limits.

    About the options to retain resilience without the micro-chaos of creative destruction, I’m not able to visualise anything like that. Please feel free to elaborate.


    4 Oct 11 at 10:19 pm

  22. Scepticus – My perspective on innovation and productivity is essentially similar to the exploration-exploitation tradeoff a la James March. ref

    IMO, all the points you make are valid in increasing exploitative efficiency and productivity but in terms of exploration, the ‘destruction’ in creative destruction is unavoidable.

    As for micro-chaos and macro-resilience, we’re getting deep into systems analysis here. I wrote a geeky post on this a while ago

    But there’s more to this – in complex adaptive systems across domains, intermittent periods of stability and efficiency/homogeneity winning out over slack/diversity are unavoidable. But the system somehow maintains resilience in a near-optimal state through a few mechanisms – constant stream of new entrants (even if most of them fail) in economic systems, degeneracy in biological systems, “weak links” in ecological systems. In all these, some level of disturbance is necessary but the response to an absence of disturbances is not linear. Keep stabilising and things get worse slowly in the beginning and then they suddenly become incredibly fragile.

    Anyway, I’ve been planning to write more on the work done in systems biology/ecology on this topic but my own thoughts on it are nowhere near as coherent as they should be on the matter. Apologies to both you and Prakash for foisting all this half-baked systems theory on you guys. In a nutshell, there are ways to preserve resilience by giving up a small amount of efficiency.


    5 Oct 11 at 2:49 am

  23. John – Thanks. I hope to write something longer on the topic of neoliberalism soon.


    5 Oct 11 at 4:01 am

  24. Ashwin, if we take the period 1250-1700, how much exploration do we think is taking place versus exploitation optimisation?

    The modern period, roughly since say 1750, clearly exhibits periods of alternating focus on exploration and exploitation.

    What I’m saying is that the future (and the dominant constraints in the future) may not be like the recent past.

    Also what works depends on what the cultural imperative is – for the egyptians who had decided that huge monuments were a key output, I presume exploitation would be more critical than exploration – since one can only afford one pyramid per few generations.

    How does this question fit into the biological systems analogy?


    5 Oct 11 at 4:58 am

  25. IMO, without sufficient exploration, a capitalist economy cannot sustain full employment and will therefore not be socially resilient. This will be even more of a problem in the future as AI takes over more and more of the exploitation domain.

    The implicit assumption in any resilience argument is that the broader system is one worth preserving. If that doesn’t hold, then even systemic collapse is no bad thing.

    I don’t really know any good analogies in biology but there are a few in ecology. Some ecologists go much further than me in that they argue that even the catastrophic fires that lead to regime change are a natural phenomenon. And even in social systems, the empirical historical evidence can support a similar argument – that the observed path is closer to a combination of large periods of stabilisation/equilibrium followed by regime change. But there’s no way that long periods of stabilisation can be achieved without an almost certain collapse at the end of the road.


    5 Oct 11 at 5:56 am

  26. “The implicit assumption in any resilience argument is that the broader system is one worth preserving. If that doesn’t hold, then even systemic collapse is no bad thing. ”

    Agreed. But I would not characterise the ‘broader system’ as capitalism, I’d characterise the broader system as a “socially stable technological planetary-scale human civilisation”.

    It makes no sense to consider capitalism as the thing to be preserved -frankly I couldn’t care less about capitalism as an end in itself (in any case we can define it how we like), what matters is saving an advanced tool using society such that it can continue to perpetuate itself reliably. No other starting point makes sense.

    I think this implied assumption vis-a-vis the broader system on your part is what has given rise to the main thrust of my objections.


    5 Oct 11 at 6:20 am

  27. Fair enough – to me, constant exploratory innovation is a characteristic worth preserving. But I have nothing against those for whom it’s not.


    5 Oct 11 at 6:44 am

  28. I’m not denying the usefulness of innovation. The manorial system of the middle ages managed a good deal of innovation that resulted in population growth to levels that wasn’t matched again until the mid C18th. Shumperterian capitalism isn’t the only way of skinning that cat.

    1350-1750, there may not have been much innovation in industrial/primary extraction terms, but what did arise during this time was nation states and money.

    I think it all depends which of the various societal development vectors one considers as innovation, which is a matter of terminology and interpretation.


    from the intro:

    “Briefly stated, innovation has become the emblem of the modern society, a panacea for resolving many problems, and a phenomenon to be studied. As H. Nowotny defines our epoch: it is a fascination and quest for innovation …”

    “This suggests three questions. First, why has innovation acquired such a central place in our society or, put differently, where precisely does the idea of innovation come from? To many, innovation is a relatively recent phenomenon and its study more recent yet: innovation has acquired real importance in the twentieth century. In point of fact, however, innovation has always existed. The concept itself emerged centuries ago. This suggests a second question: why did innovation come to be defined as technological innovation? Many people spontaneously understand innovation to be technological innovation.”

    it goes on in that vein.


    5 Oct 11 at 10:13 am

  29. […] Failure: Allow insolvent banks and financialised corporations to […]

  30. […] this increasingly financialised economy, “the increased market-sensitivity combined with the macro-stabilisation commitment […]

  31. […] JW Mason reminds us that the neo-liberal transition also coincided with a dramatically increased financialisation of the real economy. Throughout my series of posts on crony capitalism, I have argued that the […]

  32. […] I elaborated upon in an earlier post: creating any source of stability in a capitalist economy incentivises economic agents to realign […]

  33. […] access to the programs used to implement this macroeconomic stability, such as banks and financialised corporates, were the big winners – a process that is largely responsible for the rise in […]

  34. […] to include private sector assets, it will exacerbate the descent into an unequal, crony capitalist, financialised and innovatively stagnant economy that started during the Greenspan/Bernanke put […]

  35. […] In order to meet their stabilisation mandate, central banks have implicitly taken on a mandate to backstop and stabilise the entire spectrum of liquid asset markets. If the central banks influence anything that could be termed as money supply in the modern credit economy, they do so via their influence on asset price levels (influenced in turn through the central bank’s actions on present interest rates, future interest rate path and liquidity). In a collateral-dependent credit economy, the Greenspan Put is the logical end-point of the stabilisation processes, the modern motto of which could be summarised as: ‘Focus on collateral values and the money supply will take care of itself’. Successive stabilisation leaves the economy in a condition where all economic actors have moved away from the idiosyncratic, illiquid economic risks that are the essence of an innovative, entrepreneurial economy towards the homogeneous liquid risks of a stagnant economy (detailed argument here). […]

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