Risk in capitalism

One thing this crisis is demonstrating is that in modern capitalism it is workers and small businesses that bear risk to a greater extent that does larger capital.

As Paul Evans points out, some of the biggest losers are freelance workers who are ineligible for furlough schemes. And Charles Gascon at the St Louis Fed adds that it is low-paid workers who are most at risk of losing their jobs:

The occupations at the highest risk of unemployment also tend to be lower-paid occupations. The average annual earnings of the low-risk occupations is $64,600, about 75% higher than earnings in the high-risk occupations, at $36,600. This indicates the economic burden from this health crisis will most directly affect those workers who are likely in the most vulnerable financial situation.

The UK is unlikely to be much different.

By contrast, most asset-owners could with only moderate care have avoided big losses; in the IC, I’ve shown that simple diversified portfolios have lost only tiny sums.

This contrast is the culmination of several long-term trends which have seen capital de-risk in recent years at the expense of workers. For example:

 - The shift to a two-tier workforce with a core of staff and periphery of gig workers and freelancers means that companies can more easily shift cyclical risk onto workers. As Paul says, firms have “managed to shovel all of the risk related to their industry down the pipe to freelancers.”

 - Some workers are now in fact capitalists in the sense that they supply capital – for example freelance sound mixers supply their own expensive kit; Uber drivers take on debt to supply cabs; and some delivery drivers must supply their own vans and uniform. This exposes them not just to ordinary job risks, but also to the dangers of losing a capital investment.

 - Some capitalists make themselves secured creditors which means they lose little when “their” business fails, whilst the cost falls upon workers and subcontractors – as we saw, for example, with the collapse of Carillion.

 - As Rene Stulz and Kathleen Kahle have shown, stock market listed companies have become older, bigger and more cash-rich in recent years: this is true of the UK as well as US. This means the typical equity investment is less risky than it used to be.

 - The closure of final salary schemes means that the investment risk involved in saving for retirement has been transferred from firms to workers, even though they are unable to carry such risk efficiently.

 - UK companies generally have derisked their balance sheets since the financial crisis. Bank of England data show that their (sterling) cash holdings have doubled since then, and that non-financial firms now hold more cash than debt. (This is partly a reflection of the growing importance of intangible assets, though whether these are any riskier than tangible assets such as machinery is moot.)

 - The shift towards monetary activism and fiscal conservatism tends to benefit asset holders (especially leveraged ones) more than workers, as asset prices benefit from low interest rates and QE.

Now, this is not to pretend that there was a golden era in which workers had security whilst capitalists did not. As Judy Stephenson reminds us, piece-work is as old as capitalism and was one way in which capital transferred risk to labour. Nevertheless, it is the case that recent trends have been for larger capital to transfer risk to workers, subcontractors and smaller firms. The idea that the boss of a large firm is a swashbuckling risk-taker is a fiction as great as any portrayed in Hollywood, as Olivier Fournout has shown.

This raises two questions. One is: what function, then, do capitalists fulfil?

It is certainly not the provision of finance capital. Governments can do this cheaper and in greater abundance, as Rishi Sunak implicitly acknowledged this week with his plan to support innovative businesses. Nor is it clear that they effectively finance smaller firms. The stock of UK bank lending to manufacturing SMEs is a mere 9.4bn. That means that for every pound banks have lent to small manufacturers they have lent £155 in mortgages on houses.

Instead, increasingly, capitalists simply supply platforms. They act as middlemen connecting workers to other workers and to customers.

A second question this poses is: who should own firms? Common sense says that owners should be those with the most skin in the game. If you have most to lose from a firm going bust you have the biggest incentive to ensure that it doesn’t. This points to a case for subcontractors, freelancers and workers to have equity stakes – especially to the extent that they supply firm-specific capital and skills. As it is, current ownership structures give big capital exposure to upside risk whilst its workers and freelancers who face the most downside risk.

What we have here might yet another example of how ideas can outlive their evidence base. We still think of capitalists as like Victorian mill-owners who face the risk of ruin if their investments fail, and so are entitled to ownership and rewards on that account. But this is no longer the case. We must ask: what exactly is it that capitalists do and does this justify – even on narrow grounds of efficiency – their ownership?

Comments

[Ralph Musgrave]

“…small businesses that bear risk to a greater extent that does larger capital”. Then how come Virgin Airlines is in trouble? Actually it’s businesses (large or small) that are funded largely by debt that are in trouble, or businesses which have high fixed overheads that are in trouble (e.g. Greggs, which chose to rent properties, rather than buy them).

“Freelance workers who are ineligible for furlough schemes”. Actually there’s a scheme for the self-employed.

[Paulc156]

Branson has little skin in the game (not withstanding his offer of the odd flood ridden island as collateral) whilst typically sole proprietors, self employed/freelancers risk the roof over their heads. Try getting a business loanfloan from any bank without putting your house up as collateral.

[phoenix_rising]

"This points to a case for subcontractors, freelancers and workers to have equity stakes"

They can easily do that by buying shares in the market with a portion of their wages.

[phoenix_rising]

"what function, then, do capitalists fulfil?"

Allocate capital to its "highest and best use (HABU)".

The alternative is to have a command economy where the government makes the allocation decisions. Historically, that hasn't worked out well.

[DaveLevy]

The Banks are platform providers, their customers have more risk involved than their shareholders. Time for a new ownership model, or at least a return to an old one.

The alternative to equity markets is not a command economy, capital can be provided via bonds, which do not obtain or warrant a primary fiduciary duty.

[Paulc156]

@phoenix_rising
So an army of marginally head above water self employed and PAYE can buy 0.005% of available share capital with their surplus. Cushty.
As for efficiently allocating capital you are presumably referring to toy model capitalism. Rather than the teal world type which sees the vast majority of capital allocated to land speculation. (see article 're 95% bank loans for residential mortgages)

[Robert Mitchell]

> Allocate capital to its "highest and best use (HABU)".

Historically, that has not worked out well for me.

[phoenix_rising]

@Paulc156,

Workers earn their marginal product. If a company gives them equity, it would reduce their other compensation by the same amount.

"bank loans for residential mortgages"

Bank loans for residential mortgages are typically not an allocation of capital, but rather a change in the ownership of the housing stock. Only new residential building is an allocation of capital.

There are rules in place to prevent speculation in real estate, like making sure that people can afford their mortgage payments, but the government did not enforce them, i.e., NINJA loans.

[Paulc156]

@phoenix_rising
...workers earn their marginal product...
Toy models make for bad predictions and even lousier outcomes.
If workers were homogeneous ergo interchangeable...if they had comprehensive knowledge of the labour market...and were employers able to measure productivity accurately and compete freely in the labour market etc etc etc then maybe such a theory would stand scrutiny. Meanwhile back in the real world, workers do not earn 100% of GDP minus depreciation.
As for NINJA loans and that ilk, it is precisely because governments and regulators are captured by the power of big finance that such activities are tolerated and even encouraged.How so?
Capital is not allocated according to HABU but rather it's diverted toward land speculation and real estate more generally. The preserve of the modern capitalist/banker or general rentier.

[KG]

The poor always gain least in booms and suffer most in slumps. Talking about different modes of production is as much use to them as a chocolate teapot. There is only one viable model, "modern" or not, and it works for more people than we like to acknowledge. We can of course tax it and correct its failures, when we win an election.