The problem of distribution

In a comment here, Nuno Ornelas Martins says: "the central problem of economics is the distribution of the surplus rather than the allocation of scarce resources."

This, of course, flatly contradicts the standard view that scarcity is the problem of economics. However, in one context at least, he is right. J.W. Mason points out that, in the US, companies have (net) long ceased to raise money from financial markets. A similar thing is true in the UK; for years, companies' retained profits have exceeded capital spending - something which the OBR expects to continue.

It used to be the case that finance was scarce. The purpose of the joint-stock company was to overcome this problem, by allowing firms to raise small amounts of money from many dispersed investors.

But this is no longer so. From the point of view of existing companies, finance is abundant. Their problem is no longer one of the scarcity of finance, but instead of the distribution of surplus.

Sure, shareholder-owned firms raise cash. But they do so either through borrowing to buy back shares, or as a way for owners to cash out through IPOs. Such cash raisings aren't a means of raising investment funds.

This brings into question the nature of the firm. If external shareholders aren't necessary for raising investment funds, what use are they?

They don't provide effective oversight of managers; we know this from the theory of collective action and from the bitter experience of the banking crisis.

Nor is it that share prices signal which firms should invest and which shouldn't. Charles Lee and Salman Arif point out that, around the world, high investment leads to falling share prices, more earnings disappointments and weaker macroeconomic growth. This suggests that capitalism does a bad job of investment appraisal, with investment being driven by sentiment rather than by an accurate assessment of genuine profit opportunities. (Though this might tell us more about humans' bounded rationality than about the failure of capitalism.)

All this raises the question: if the problem is now the distribution of surplus, are capitalist institutions the best solution? It's tempting to think not. A natural alternative would be a more equal distribution of ownership, perhaps through a form of Roemerian market socialism, such that dividends would, in effect, be part of a citizens' basic income.

The obvious objection to this is simply that such a reallocation of property rights would be unjust; why should someone who owns lots of shares be expropriated more than one who is (say) long of housing?

And this raises a possibility which is counter-intuitive but I think at least reasonable - that the case for capitalism (in the narrow sense I intend here) lies more in justice than efficiency.  

A clarification. You might object that the fact that corporate spending fell sharply after the banking crisis shows that finance matters hugely for businesses - that it isn't scarce at all.  I'm not sure. The fact that businesses in aggregate are/were self-financing suggests that what happened in the crisis was a loss of intermediation services, not of finance per se; finance could not be transferred so easily from cash-rich to credit-constrained firms. To tweak Larry Summers' metaphor, it was as if electricty transmission failed, rather than electricity generation.

Note for the hard of thinking: I am not saying here that the central problem of economics is always distribution rather than scarcity. I'm just saying that, in this context and now, it is. Most interesting facts in the social sciences are local and particular.

Comments

[Dave Timoney]

Or, to put it another way, the current problem of economics is political, not technical.

[ed]

I'm confused by this.

Isn't it valuable to allow someone who has built a business to sell it? This is true even if the new owners ("shareholders") don't add any value themselves.

[chris]

@ Ed - yes. I suspect a big virtue of the stock market is that it incentivizes entrepreneurship by offering owners a way of selling their business, often at an inflated price.

[Metatone]

One subtlety at work here is investment criteria for pension funds, insurance companies etc.

This has meant that there are classes of assets where prices and returns are linked to demography as much as anything else.

Demography of the post-WW2 era was a growing (working age) population and so asset classes that fit the criteria grew. (e.g. FTSE?)

Perhaps along the way we got to a point that for firms that are in the right asset class are not finance constrained?

[rogerh]

Diminishing returns? The world is stuffed with big TV sets, washing machines, Ipads etc. They are all very good and pretty cheap, anyone who wants one and lives in a semi-capable country can buy one. The rich consumers seem sated and harder to sell to so less profits. So the question is to make even flashier products (and have them copied in a trice) or sell into new markets (and face barriers and lower profits) hence diminishing returns.

Perhaps the idea that the entire world can lounge around developing 'apps' whilst sipping skinny lattes will not come true after all.

[Ben]

Sorry for hijacking but I guess this would be a good place to ask for help. I enjoy reading blogs like these and have read some applied economics on the recent crisis such as Stiglitz, Krugman etc. However, I am ready to tackle some more technical economics and would appreciate some advice.

Is Keynes/Marx/neoclassical a reasonable triad that forms the basis of the field? Or would I be better reading original texts from these people and Smith/Ricardo. etc

[Christiaan Hofman]

In a sense, economics is always about scarcity. In this case its just not resources but rather scarcity of investment opportunities, or scarcity of demand. So the core question is not whether it's scarcity, but what is scarce at the moment. The answer to that question should also determine what type of policy is needed, and what type of model should be used. Because when different things are scarce, different mechanisms become important and others become irrelevant, and this must be reflected in the models (because models can never be complex enough to cover all cases.) Essentially, the model should be driven by whatever is scarce, not by what's abundant. That's also why Keynesian models are more relevant today and during the Great Depression. And that's why the free market models fail, because they are driven by what's abundant today. Oh, and I could and a lot about your subversion of justice.

[Thornton Hall]

You wrote:
"Most interesting facts in the social sciences are local and particular."

If this is true, and I think it is, why (to this untrained eye) would anyone think that mathematical models would be useful in a social science?

There have been debates in the econoblogosphere about the value of models, but to the untrained eye these debates resemble nothing so much as continental philosophy, i.e., brilliant abstract reasoning that had no reference to the corporeal world.

[Kaleberg]

We've been awash in capital since the 1970s. Surely I'm not the only one to remember all the inflation back then. Every one had all sorts of money to invest. The resolution to the crisis was to take the money from the smaller investors and give it to the larger ones. This led to a declining return on investment overall and stagnant living standards.

[Dave Timoney]

@Thornton Hall, because abstraction to the plane of pure maths allows policy-makers to ignore the social ramifications of policy.

Just as the most pervasive ideology is the one that thinks it is "common sense", so the most pernicious politics is the strain that considers itself to be apolitical.

[joe]

As an engineering educated businessman I find it strange that business strategy decisions are classed as having much to do with economics. We have to deal with reality. There may be economics input but there will be dozens of other inputs with competing and complex issues.

rogerh has nailed it. Since increased globalisation and computerisation there has been a rapid reduction in things that are viable to invest in. Undercutting, patent law costs, lack of consumer spend, counterfeiting, in-out EU, Scotland leaving, mafia states who don't pay for goods and services etc etc.

The irony of UK stuffed with "vital" investment banks who will not invest a penny in a new idea but willingly lend $B's to failing states who will struggle to pay the interest let alone the original loan.
UK having to go to China to fund a single but highly needed nuclear power plant that had such a poor investment case that the payback had to be Government guaranteed and inflated over 2 decades.