resilience, not stability

The Great Recession, Business Investment and Crony Capitalism

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Paul Krugman points out that since 1985, business investment has been purely a demand story i.e. “a depressed economy led to low business investment” and vice versa. As he explains “The Great Recession, in particular, was led by housing and consumption, with business investment clearly responding rather than leading”. But this does not imply that low business investment does not have a causal role to play in the conditions that led to the Great Recession, or that increased business investment does not have a role to play in the recovery.

As Steve Roth notes, business investment has been anaemic throughout the neo-liberal era. 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 structural and cyclical problems of the developed world are inextricably intertwined. The anaemic trend in business investment is the reason why the developed world has been in a ‘great stagnation’ for so long. This ‘investment deficit’ manifests itself as the ‘corporate savings glut’ and an increasingly financialised economy. The cause of the investment deficit is an increasingly financialised, cronyist, demosclerotic system where incumbent corporates do not face competitive pressure to engage in risky exploratory investment.

Business investments can typically either operate upon the scale of operations (e.g. capacity,product mix) or they can change the fundamental character of operations (e.g. changes in process, product). Investments in scaling up operations are most easily influenced by monetary policy initiatives which reduce interest rates and raise asset prices or direct fiscal policy initiatives which operate via the multiplier effect. Investments in process innovation require the presence of price competition within the industry. Investments in exploratory product innovation require not only competition amongst incumbent firms but competition from a constant and robust stream of new entrants into the industry.

In an economy where new entrants are stymied by an ever-growing ‘License Raj’ that costs the US economy an estimated $100 billion per year, a web of regulations that exist primarily to protect incumbent large corporates and a dysfunctional patent regime, it is not surprising that exploratory business investment has fallen so dramatically. A less cronyist and more dynamically competitive economy without the implicit asset-price protection of the Greenpan/Bernanke put will have lesser profits in aggregate but more investment. Incumbents need to be compelled to take on risky ventures by the threat of extinction and obsolescence. Increased investments in risky exploratory ventures will not only drag the economy out of the ‘Great Stagnation’ but it will result in a reduced share of GDP flowing to corporate profits and an increased proportion of GDP flowing towards wages. In turn, this enables the economy to achieve a sustainable state of full employment and even a higher level of sustainable consumption without households having to resort to increased leverage as they had to during the Great Moderation.

Alexander Field has illustrated how even the growth of the Golden Age of the 50s and the 60s was built upon the foundations of Pre-WW2 innovation. If this thesis is correct, the ‘Great Stagnation’ was inevitable and in fact understates how long ago the innovation deficit started. The Great Moderation far from being the cure was simply a palliative that postponed the inevitable end-point of the evolution of the macroeconomy through successive cycles of Minskyian stabilisation. As I noted in a previous post:

The neoliberal transition unshackled the invisible hand (the carrot of the profit motive) without ensuring that all key sectors of the economy were equally subject to the invisible foot (the stick of failure and losses and new firm entry)….“Order for all” became “order for the classes and disorder for the masses”….In this increasingly financialised economy, the increased market-sensitivity combined with the macro-stabilisation commitment encourages low-risk process innovation and discourages uncertain and exploratory product innovation. This tilt towards exploitation/cost-reduction without exploration kept inflation in check but it also implied a prolonged period of sub-par wage growth and a constant inability to maintain full employment unless the consumer or the government levered up. For the neo-liberal revolution to sustain a ‘corporate welfare state’ in a democratic system, the absence of wage growth necessitated an increase in household leverage for consumption growth to be maintained. 

When commentators such as James Livingston claim that tax cuts for businesses will not solve our problems and that we need a redistribution of income away from profits towards wages to trigger increased aggregate demand via aggregate consumption, I agree with them. But I disagree with the conclusion that the secular decline in business investment is inevitable, acceptable and unrelated to the current cyclical downturn. The fact that business investment during the Great Moderation only increased when consumption demand went up is a symptom of the corporatist nature of the economy. When the household sector has reached a state of peak debt and the financial system has reached its point of peak elasticity, simply running increased fiscal deficits without permitting the corporatist superstructure to collapse simply takes us to the end-state that Minsky himself envisioned: an economy that attempts to achieve full employment will yo-yo uncontrollably between a state of debt-deflation and high,variable inflation – somewhat similar to a broken shower that only runs either too hot or too cold. The only way in which the corporatist status quo can postpone collapse is to abandon the goal of full employment which is exactly the path that the developed world has taken.  This only substitutes an economic fragility with a deeper social fragility.

Stability for all is synonymous with an environment of permanent innovative stagnation. The Schumpeterian solution is to transform the system into one of instability for all. Micro-fragility is the key to macro-resilience but this fragility must be felt by all economic agents, labour and capital alike. In order to end the stagnation and achieve sustainable full employment, we need to allow incumbent banks and financialised corporations to collapse and dismantle the barriers to entry of new firms that pervade the economy. The risk of a deflationary contraction from allowing such a collapse be prevented in a simple and effective manner with a system of direct transfers to individuals as Steve Waldman has outlined. This solution also reverses the flow of rents that have exacerbated inequality over the past few decades.

Note: I went through a much longer version of the same argument with an emphasis on the relationship between employment and technology adapted to US economic history in a previous post. The above logic explains my disagreements with conventional Keynesian theory and my affinity with Post-Keynesian theory. Minsky viewed his theory as a  ‘investment theory of the cycle and a financial theory of investment’ and my views are simply a neo-Schumpeterian take on the same underlying framework.

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Written by Ashwin Parameswaran

December 7th, 2011 at 5:44 pm

Posted in Cronyism,Resilience

8 Responses to 'The Great Recession, Business Investment and Crony Capitalism'

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  1. For a different part of the answer to the question ‘why stagnation’, you might also want to read David Harvey’s The Enigma of Capital. (A quirky/quick summary of his main points can be found here:


    7 Dec 11 at 6:35 pm

  2. I have read David Harvey’s work and I tend to agree with a lot of the descriptive criticism of the neo-Marxists like Harvey, Dumenil and Levy, Paul Sweezy etc. But what they see as some sort of fundamental irredeemable flaw in capitalism I tend to see as a result of crony capitalism and the absence of creative destruction and dynamic competition. When Harvey refers to capitalism as a speculative system, I view it as a feature and not as a bug. Schumpeter saw it the same way. The key is that the level of “speculation” on disruptive innovations must be intense enough that capitalists as a class do not make supranormal profits.


    7 Dec 11 at 7:02 pm

  3. Yes, I agree that Harvey’s macro accounts largely ignore the question what role is played by rentierism in ‘mature’ economies. (Though he seems to have been clued in to the importance of this of late, at least when it comes to land rent etc.)
    Michael Hudson is better on that score, though I find reading him frustrating for other reasons.

    (PS. I apologize for never engaging with the content of your posts directly; I do enjoy reading them.)


    7 Dec 11 at 7:55 pm

  4. Harvey sometimes mentions the role of rents but as a bit of a afterthought. He’s even noted how rents blur the usual class conflict lines and Dumenil-Levy have noted the need to separate the managerial class out of labour. But once you incorporate these two factors, we’re a long way from a conventional Marxian analysis.

    To be fair, I far prefer reading the radical left than the centre-left. The centre-right may be incoherent but they’re winning! The centre-left just keeps arguing for more taxes and deficits without any perception that our problems may be structural. And they’re not even winning this argument!

    No need to apologise! Thanks for reading.


    7 Dec 11 at 8:46 pm

  5. The two reasons I like Harvey are first because of the work he’s done to show Marx was into process philosophy (think Whitehead) rather than the (technological) determinism he’s usually charged with, and secondly because of his book Cosmopolitanism and the Geographies of Freedom, which, among other things, has a very lucid discussion on the different conceptions of space-time and how those shape our thinking.
    Will have a look at the authors you’ve mentioned here soon — wasn’t familiar with them yet.
    As for the failures of the radical left: David Graeber has just recently published a nice and very short book on that topic, called Revolutions in Reverse.


    8 Dec 11 at 12:44 am

  6. Thanks for the Graeber tip – He’s always worth reading.

    Dumenil and Levy’s ‘Crisis of Neoliberalism’ is not bad. Paul Sweezy was a student of Schumpeter’s and his book ‘Monopoly Capital’ written in the 60s anticipates a lot of what is wrong with the economy today even if some of it is also borderline unreadable and dated.


    8 Dec 11 at 1:17 am

  7. (I’m guessing you’ve already read Debt?)


    9 Dec 11 at 12:57 am

  8. I have – TBH I never bought the entire “gold as emergent currency outcome” argument but it still added a lot of good anthropological detail.


    9 Dec 11 at 11:56 am

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