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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

Ashwin Parameswaran on the Downsides of Stability



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I urge you to read Ashwin’s thoughts on the rise of crony capitalism in advanced market democracies, and how it relates to the financialization of vanguard economies:

Due to insufficient exploratory innovation, a crony capitalist economy is not diverse enough. But this does not imply that the system is fragile either at firm/micro level or at the level of the macroeconomy. In the absence of any risk of being displaced by new entrants, incumbent firms can simply maintain significant financial slack. If incumbents do maintain significant financial slack, sustainable full employment is impossible almost by definition.  However, full employment can be achieved temporarily in two ways: Either incumbent corporates can gradually give up their financial slack and lever up as the period of stability extends as Minsky’s Financial Instability Hypothesis (FIH) would predict, or the household or government sector can lever up to compensate for the slack held by the corporate sector.

Most developed economies went down the route of increased household and corporate leverage with the process aided and abetted by monetary and regulatory policy. But it is instructive that developing economies such as India faced exactly the same problem in their “crony socialist” days. In keeping with its ideological leanings pre-1990, India tackled the unemployment problem via increased government spending. Whatever the chosen solution, full employment is unsustainable in the long run unless the core problem of cronyism is tackled. The current over-leveraged state of the consumer in the developed world can be papered over by increased government spending but in the face of increased cronyism, it only kicks the can further down the road. Restoring corporate animal spirits depends upon corporate slack being utilised in exploratory investment, which as discussed above is inconsistent with a cronyist economy.

There are many potential implications of Ashwin’s synthesis of Mancur Olson and Hyman Minsky, and I imagine I disagree with him on many of the particulars. But I do think that the developing economies of midcentury, particularly Brazil under military rule, offer a glimpse at where the world might be heading if we really have entered — and I hope we haven’t — a post-neoliberal era. The notion that the financialization of the economy has driven a “silent coup” in which major financial institutions exercise outsized power over our political system, often indirectly through the socialization of elites, is an interesting one that shouldn’t be dismissed lightly. But many of those who are most exercised by the “silent coup” propose giving the administrative state more power over the economy, exacerbating the danger of regulatory capture and strengthening the hand of politically influential incumbents. 

Achieving a stable state of micro-fragility, or a macroeconomy of vulnerable firms, strikes me as a worthy goal. 

At the appropriate mix of exploration and exploitation, individual incumbent and new entrant firms are both incredibly vulnerable. Most exploratory investments are destined to fail as are most firms, sooner or later. Yet due to the diversity of firm-level strategies, the macroeconomy of vulnerable firms is incredibly resilient. At the same time, the transfer of wealth from incumbent corporates to the household sector viareduced corporate slack and increased investment means that sustainable full employment can be achieved without undue leverage. The only question is whether we can break out of the Olsonian special interest trap without having to suffer a systemic collapse in the process.

Yet it’s not clear to me how policy shifts can get us there. We’ve recently seen many arguments for “inefficiency,” i.e., a more resilient, less tightly centralized global economy that doesn’t rely so heavily on brittle supply chains, etc. And we’ve also seen louder calls for aggressive antitrust enforcement. I’m skeptical about this approach, though I do think that cartels built around intellectual property should be challenged through aggressive copyright reform, the elimination of software patents and at the very least a rationalization of business-method patents, and other measures of that kind.

And there are other smart reforms we can and should pursue as part of a “de-cartelization” agenda, including, perhaps, taxing leverage or at least tightening leverage requirements, improving transparency in public purchasing, decentralizing the provision of public sector goods, etc. But there are no silver bullets. As Jonathan Rauch argued in Government’s End, the right analogy for fighting rent-seeking behavior is fighting cancer: open markets and transparency can help at the margin, but some aggressive interventions, like too much chemotherapy, risk killing the patient. 

When I think about the shape of the post-neoliberal world, and I still think the best guide is Brad DeLong and Stephen S. Cohen’s The End of Influence, the irony is hard to miss: the end of the Soviet bloc and the economic opening of China and India has made the world safer and more stable, yet stability and global growth has contributed to an unease in what had been the core market economies that, cannily exploited by populist political entrepreneurs, has in a variety of ways undermined the growth machine while strengthening political and financial elites. The main way the U.S. has tackled this unease has been through a dramatic expansion of public and quasi-public employment during the Bush years, at the state and local level and in the health sector, financed by debt and the tax take from high-end workers. And now many on the left are convinced that we need an even more ambitious public sector expansion. We badly need a more balanced growth model, and I think Ashwin’s thinking might help us get there. 

That’s enough abstraction for now. 



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