Capitalism and the state

Greg Smith and Dehenna Davison write:

For many in left behind parts of the country, the reality is that the private sector is stifled by a bloated public sector that is almost Soviet-sized in some areas of the North.

This seems to me to be a case of confusing correlation and causality. The reason why the public sector accounts for such a big share of economic activity in some areas is that the private sector in those places is so weak.

In fact, I’d suggest that – for the economy as a whole – a bigger state can work to the benefit of capitalism.

My story here is not about the several mechanisms through which the rich (pdf) disproportionately influence government policy, nor about crony capitalism, corporate welfare, bank bailouts and implicit subsidies, important as all these are.

Instead, let’s start in a less likely place - with a paper (pdf) written by Robert Merton in 1969. He showed that the proportion of wealth an investor should devote to risky assets rather than safe ones such as cash or bonds could be described by a simple equation. This says the proportion should be equal to the expected annual return on risky assets over safe ones, divided by the product of the variance of risky returns and a coefficient of risk aversion.

Let’s put some numbers into this. One bit of standard theory (p20 of this pdf) predicts that the expected risk premium should be only two percentage points or even less. The standard deviation of a well-diversified equity portfolio is around 15% giving us a variance of 0.0225. And a reasonable estimate of the coefficient of risk aversion is around three. This give us a solution to Merton’s equation of 0.02/(0.0225x3) = 0.296. Less than a third of one’s wealth should therefore be in risky assets.

For many people, the weighting of equities should be even less. If you could lose your job in a recession, equities are especially risky for you because they too would fall when your earnings disappear. And if you regard housing as an asset (say because you are planning on trading down) it too could fall in a recession, when shares fall. Both risks point to a low equity weight.

What’s more, for many people the opportunity cost of holding equities is not cash or bond yields but rather paying off the mortgage or credit card bills, the interest rate on which is higher than that on cash. Yulia Merkoulova and Chris Veld point out that, for these people, the personal equity risk premium is very low or even negative. That can justify holding no equities at all.

Some standard economics therefore predicts that demand for equities should be very low indeed. Which suggests that stock market capitalization should be paltry.

So why isn’t it?

Enter the welfare state. The wealth in Merton’s equation means your total wealth. Wealth is merely capitalized income*. And income includes pension income. The state pension is therefore a big part of your wealth. At current annuity rates, the basic state pension is worth over £170,000 for a 70-year-old. This means that, following the maths above, somebody with £100,000 of other wealth should have not £30,000 in equities but £80,000.

The state pension thus boosts demand for equities. In giving us a safe income, it allows us to take financial risks we otherwise would not.

Of course, this is not the only way the welfare state supports the stock market. It acts as an automatic stabilizer, helping to mitigate recessions; this is especially important as policy-makers cannot predict recessions and so cannot always use monetary and fiscal policy to stabilize the economy. Such stabilization policy reduces the cyclicality of corporate earnings and also our background risks such as the cyclicality of or jobs and small businesses. On both counts, it raises demand for equities.

We often talk of tax incidence, the fact that taxes aren’t necessarily paid by the people they directly fall upon. But there is also benefit incidence: welfare benefits don’t benefit only those who receive them, but also those who own the businesses where those benefits get spent.

In fact, there’s a third historic benefit of the welfare state. In buying off discontent, it has reduced the threat of revolution which has also supported shares.

All of this explains a big fact – that stock markets in developed economies did best whilst the role of government in the economy was expanding. The UK market made no capital gains on average during the free market era of the 19^th and early 20^th century, but soared in the post-war era.

One reason for the famous equity premium puzzle (pdf) of Mehra and Prescott is that the riskiness of equities fell in the latter part of the 20^th century and so share prices rose – as the threat of depression and political unrest fell. The larger welfare state is a big part of that story.

What Marx said in 1848 is therefore still valid: “the executive of the modern state is nothing but a committee for managing the common affairs of the whole bourgeoisie.” The state functions to support capitalism.

Of course, this is not to say that the current boundaries of the state are exactly those which are optimum for capitalism. Reasonable people can disagree on what these are: they might include a lot of social democracy.

Instead, my point is merely that there are many channels through which a big state can – and should! – sustain capitalism. Which is why few intelligent capitalists are minimal state purists, and perhaps why so many rightists have very comfortably abandoned the small state thinking of the 1980s.

* This is why wealth taxes should be redundant. If we’re measuring income properly (which the tax system does not), wealth taxes are just capitalised income taxes.

Comments

[Scurra]

perhaps why so many rightists have very comfortably abandoned the small state thinking of the 1980s.
...whilst also spending their time lying about this position.
And, of course, very few rightists oppose increased spending on "defence" which is the very epitome of big government; if they were really so keen on the small state, you'd think they would be advocating an entirely private system?

[ltr]

For many in left behind parts of the country, the reality is that the private sector is stifled by a bloated public sector that is almost Soviet-sized in some areas of the North.

[ The point of course is that the public sector provides the base and support for the private sector to grow. I am uninterested in Conservative thinking, but do enough Labour folks still understand this? Obviously Keir Starmer wants Labour to be Conservative, but are there still sufficient Labour folks who understand what Jeremy Corbyn was trying to teach? ]

[ltr]

https://fred.stlouisfed.org/graph/?g=F7ZN

August 4, 2014

Real per capita Gross Domestic Product for China and United Kingdom, 1977-2020

(Percent change)

https://fred.stlouisfed.org/graph/?g=F801

August 4, 2014

Real per capita Gross Domestic Product for China and United Kingdom, 1977-2020

(Indexed to 1977)

[ltr]

I am likely foolishly trying to understand how a British government has come to undermining its relations with most of Europe, especially France, showing disdain for relations with China and cultivating a nuclear arms race in the Pacific or about a thoroughly peaceful China.

Has the British government become the Rupert Murdoch media empire? I am completely lost and deeply saddened for Britain, but I fail to understand what has been happening.

[rsm]

Don't both capitalists and statists owe us a basic income for enclosing all the commons such that we have no legal way of nonviolently not cooperating with either?

[ltr]

Fine, related essay at Mainly Macro:

September 21, 2021

Neoliberalism, Corporations and Wealth Inequality

Neoliberalism and Corporations

If I had to offer one piece of evidence to those who are sceptical about the concept of neoliberalism, I would look at Investor State Dispute Settlement (ISDS). These entities are set up as part of trade or investment deals, and essentially allow a corporation to sue governments if governments do something to disadvantage the corporation. For some examples of cases brought by companies against governments see here. These actions are often used against smaller states, but companies have also sued Germany (for ending nuclear power) and Canada (for banning a dangerous chemical)....

-- Simon Wren-Lewis

[LJC]

ISDS was intended to stop countries expropriating property belonging to non-citizens of that country (companies have a legal personhood too).

Quoting Wikipedia 'The majority of the treaties provides foreign investors with substantive legal protection (including the right to "fair and equitable treatment", "full protection and security", "free transfer of means" and the right not to be directly or indirectly expropriated without full compensation) and access to ISDS for redress against host states for breaches of such protection.'

So, while there is no doubt that ISDS is being abused, there is still a need to protect companies against abusive States.

[ltr]

September 22, 2021

Coronavirus

United Kingdom

Cases ( 7,530,103)
Deaths ( 135,621)

Deaths per million ( 1,985)

China

Cases ( 95,851)
Deaths ( 4,636)

Deaths per million ( 3)

[ The UK needed to be working with China on controlling the epidemic from early in 2020. ]

[Blissex]

Our blogger's points are often interesting, but sometimes tiresome in his endorsing of neoliberal framing, as in here: the framing between "left" (actually the tory right) and "right" (actually the whig far right) as between big and small state is accepted here without the slightest hesitation.

But the right, whether whig or tory, do not care about principles except as a means to bamboozle the gullible, they care about outcomes, and that means mostly power and distribution of income, not even maximizing immediate income; given their already high incomes, protecting their power is more important than increasing them.

Where they benefit from "the markets", they want big markets and small state, when they benefit from the state, big state is fine too and never mind the markets, "Which is why few intelligent capitalists are minimal state purists".

That I guess is pretty obvious to most people.

Never mind talking of "the capitalists" as one group, when instead they have several factions with interests better protected by the state or the markets or different combinations of both. For example the whig right is all about heavy handed state intervention in the markets when it comes to refilling the bonus pools of City bankers, but totally opposed when it comes to providing a social safety net for everybody else.

[Blissex]

«So, while there is no doubt that ISDS is being abused, there is still a need to protect companies against abusive States.»

Don't those states have courts? Don't their people deserved protection from state abuses too?

In practice international treaties are often designed to overlay special rights for business and property rentiers on top of domestic legislation, creating two different categories of protection, a "gold" level of protection for those who matter and a "plywood" level for "hoi polloi".

BTW the idea that ISDSes and other tricks apply only to foreign investors is ridiculous: any investor can register a company in many foreign jurisdictions and become a "foreign" investor.

[ltr]

So, while there is no doubt that ISDS * is being abused, there is still a need to protect companies against abusive States.

* Investor State Dispute Settlement

[ This is in essence a way of exercising control over developing states and is intolerable. Absolutely intolerable surrender of state sovereignty. ]

[ltr]

September 23, 2021

Coronavirus

United Kingdom

Cases ( 7,565,867)
Deaths ( 135,803)

Deaths per million ( 1,988)

China

Cases ( 95,894)
Deaths ( 4,636)

Deaths per million ( 3)

[ The UK has needed to be working with China on issue after issue, but the UK would rather be sadly antagonistic. ]