Rentier Capitalism: Great for Stocks, Lousy for Growth

As fans of Michael Hudson and/or students of economic history know, one of the strongly-held policy views of classic economists was that constraining rentier activities was essential to promoting growth. They understood that rentier-ism could often produce more profits than investment in productive activities. For instance, they favored usury ceilings because lenders would otherwise lend to the most desperate borrowers who still could eventually be compelled to satisfy most of their obligations, which in their day would be gamblers from aristocratic families. They would pay very high interest rates to satisfy gaming debts, far more than commercial borrowers could afford. Usury ceilings would result in lenders not being able to charge enough to compensate for the risk of lending to compulsive punters, and so the most attractive debtors would be industrialists and other businessmen.

We’re embedding an oddly neglected paper at the end of this post, which offers empirical support for these long-standing warnings about the economic costs of rentier activity. Admittedly, authors Daniel L. Greenwald, Martin LettauUC Berkeley, and Sydney C. Ludvigson settled on a not-terribly revealing title: How the Wealth Was Won: Factor Shares as Market Fundamentals. I’m not in a position to assess their methodology, but they claim that their assessment of the source of stock market returns shows a marked shift, starting in 1989. Before that, stock price gains came almost entirely from economic growth. After that, they find that the biggest driver was shareholders deriving the benefits of economic rents. From the abstract:

We provide novel evidence on the driving forces behind the sharp increase in equity valuesover the post-war era. From the beginning of 1989 to the end of 2017, 23 trillion dollars of real equity wealth was created by the nonÖnancial corporate sector. We estimate that 54% of this increase was attributable to a reallocation of rents to shareholders in a decelerating economy. Economic growth accounts for just 24%, followed by lower interest rates (11%) anda lower risk premium (11%). From 1952 to 1988 less than half as much wealth was created,but economic growth accounted for 92% of it.

Now readers might wonder why 1989 was the inflection point. After all, the neoliberal era arguably started in 1976, when workers started getting short-changed on sharing in productivity gains, or perhaps with the Reagan era. After all, by the mid 1980s, Michael Milken and his raider allies were striking fear in Corporate America and forcing lots of companies to defensively shrink bloated corporate centers and reverse not-sufficiently-related acquisitions.

However, it appears that simple circling of wagons to forestall hostile takeovers, as much as they were the regular fodder of headlines, was not the big driver of changed corporate behavior. It was instead the spectacle of CEOs like Michael Eisner at Disney and top execs become egregiously rich when they took an equity cut in deals that worked out. The business press in the 1980s touted the idea that corporate chieftans needed to be paid like entrepreneurs despite not taking entrepreneurial risk. Harvard Business School’s Michael Jensen and USC’s Kevin Murphy, in a seminal 1990 Harvard Business Review article, CEO Incentives: It’s Not How Much You Pay, But How, argued forcefully for the heavy use of equity options in executive compensation. That turbo-charged the trend towards stock-linked pay. Executives indeed set about to goose the prices of their companies since that was what they were paid to do, irrespective of whether their actions were good for the business.

Jensen later repudiated that view in a 2005 article, How Stock Options Reward Managers for Destroying Value and What to Do About it, but by then, that horse was out the gate and in the next county.

I hope you’ll circulate this article. It deserves to be more widely read.

00 How the Wealth Was Won
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21 comments

  1. Fazal Majid

    Well, rentier is a French word and in France “rente” was the interest on government bonds, as opposed to “rente de situation” which was the profit from government positions that were bought and sold like goods under the cash-strapped Ancien Régime.

    I’d argue the kleptocratic CEO class has proven adept at capturing most profits at the expense of shareholders, including pension funds. I’m sure their control over how their employees’ pension funds discharge their fiduciary responsibilities is purely coincidence.

    Reply
  2. KYrocky

    One other thing to note about the timing in 1989. This is also when the tech boom was really lifting off, making billionaires of dirty kids, people who founded those companies for whom, via stock prices, had IPO’s and stock values that defied the economic gravity of the past.

    Bricks and mortar CEO’s wanted in on that gravy train, despite as you mention, not being the people who actually created or invented anything.

    The movie Wall Street was also released in in 1987, and by 1989, Greed, as the say, had become good.

    Reply
  3. Michael Fiorillo

    The NYC Banker’s coup of ’75-’76, with its deep attacks on the public sector, and appropriation of budgeting power by business, was the start of the Neoliberal era, shortly followed by the passage of Proposition 13 in California.

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  4. The Rev Kev

    Probably the worse thing about rentier economies is that resources are spent in securing their ‘rent’ rather than innovation and new designs. You see that with John Deere tractors which try to lock in farmers with only that company forever more. Or Microsoft shifting to a model where you pay rent for software instead of buying and owning it direct. But once a corporation feels that they have their customers locked in a rentier model, then instead of spending their money in research and development, they spend the money instead on stock buybacks and executive compensation. The operative principle for such corporations is that only corporations can own things – people can at best only license them.

    Reply
    1. flora

      Or Boeing borrowing money to prop up its stock price with stock buybacks (inflating the value of stock options – boardroom rentier?) , while loading the company with debt that will have to be paid back, and little R&D or innovation in the company itself.

      Reply
      1. John Wright

        One could suggest that the debt holders will eventually rebel when they understand that they have a high risk of not being repaid.

        This may eventually come about via covenants that companies MUST maintain a minimum debt to liquidation value ratio before more debt can be piled on.

        But who is funding the new share buyback corporate debt?

        Is it banks that are backstopped by the FED such that they are less concerned about repayment risk?

        Reply
        1. stowers_joe@yahoo.com

          The ‘who’ is funding share buy-backs is a good question.

          I suspect your other questions are rhetorical — but as for the risks, I thought the loans were secured against the income streams a firm generates — though I believe the interest paid often does not fully compensate for the risks. Once all the income streams have been sold — leveraged — and there is a drop in a firm’s income … the firm may default on its loans. Smaller firms will be swallowed up by their larger ‘competitors’ furthering consolidation and wiping out any retirement fund money held for their workers — if they had a retirement fund. Very large firms will probably be bailed out — like General Motors was. The banks were bailed out the last time they blew up the economy why will the next time be different? [Maybe that is why Bernie causes so much angst.] Anyway that is what I think will happen.

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    2. Phil

      As far as the software for rent model goes, users will eventually get tired of paying rent and move on to other solutions. In general, the cloud has been used as a notion to forcefully herd users from distributed desktop computers back toward what amounts to terminal machines in order to sell rentier applications. Fortunately, there are plenty of options to avoid rentier software, but its unfortunate that some of the standard applications like Photoshop have been crapified this way. As far as I am concerned, these products are now damaged goods and I won’t use them anymore.

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    3. Jeremy Grimm

      I believe globalization and thinning of supply chains is another aspect of resources spent to secure rent. In the case of globalization the resources spent were the accumulated base of physical capital, skills, and know-how — built and accumulated over a couple of centuries and the resilience of a large supporting base of smaller manufacturers providing multiple suppliers in-country.

      Reply
  5. tegnost

    It might not be so bad if in 2008 they were required to suffer the same “free market” they’d been subjecting us all to. But no, socialism for what it could be argued are the worst people in the world is what we got, and now the ACRONYM funder is a vulture capitalist who holds distressed debt from hurricane ravaged puerto rico. How democratic…

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  6. Captain Spaulding

    It’s worth remembering that the classical political economists of the first half of the 19th century were operating before capitalism had achieved Its current hegemonic status. Today most people take it for granted not only as the default economic system, but as an ideological justification for anything it produces, including rentier capitalism. The classicals, on the other hand, were operating at a time when emergent industrial capitalism was fighting against the interests of aristocratic landowners in Europe who reaped economic rent from monopoly ownership of agricultural land. That gave the The classicals an ideological incentive to investigate the role of economic rent in the economy of their time as an aspect of their discipline.

    Today, economists operate under ideological incentives to Ignore or reward rentier behavior. That’s why whether you agree with them or not, engaging with emergent alternative paradigms like MMT is so important. It’s not just a technical economic challenge, it’s also an ideological challenge. Ultimately, winning the ideological battle is more important.

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  7. Matthew G. Saroff

    How can you not mention SEC Rule 10b-18, which legalized stock price manipulation through buy-backs, by name?

    This has had the effect of creating a huge avenue for control fraud by senior management.

    They buy-back stocks, their stock options are above water as a result, and they make out even as they their companies eat their own seed corn, paving the way for their eventual demise.

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  8. teacup

    Since there has been no democratization of the banking sector, contraction for the masses (and thus its inverse, exampled in this article) will inevitably follow. Keynes looked forward to the “euthanasia of the rentier.” Systemic change won’t begin until the science fiction of the derivative of neoliberalism, neoclassical economics, is cast out of the wild westernized university economic curricula.
    http://www.marketoracle.co.uk/Article38764.html

    Reply
  9. Jeremy Grimm

    I will have to mull over this paper for a while. There is a lot of Greek in the middle I am not sure I can muddle through. After a very quick shallow scan of the paper my first impression is that the technique used to obtain the paper’s results was originally developed in a field outside economics … system identification? The title of this paper obscures its content and the mathematics — while giving it Economist-weight — does the same, but much more impressively.

    Michael Hudson posted a paper on his website a while ago that offers a different and I believe more direct way to arrive at results similar to those stated in conclusion of the “Rentier Capitalism …” paper. Michael Hudson worked through the accounting that goes into calculating the GDP figures:
    [https://michael-hudson.com/2019/10/asset-price-inflation-and-rent-seeking/]
    Full Paper:
    “Asset-Price Inflation and Rent Seeking:A Total-Returns Profile of Economic Polarization in America”
    [https://michael-hudson.com/wp-content/uploads/2019/12/Hudson_FMM-Berlin-Conference-October2019__24september_FINAL.pdf]
    Michael Hudson describes how rents are added to the GDP. Items like “imputed rent for homeowners” and financial “services” are added to the GDP instead of subtracted from it to obtain a measure for economic growth. I think the extract from that paper below encapsulates a good synopsis of its content:
    “Today’s basic System of National Accounts was created in the 1930s to focus on the cost of production and how these costs – wages to labor, payments to suppliers, business profits and taxes paid to the government – are distributed and, in turn, spent on consumption, new capital investment and public programs. The resulting measure of economic activity is the Gross Domestic Product (GDP), defined as the sum of all earned incomes (wages and profit), juxtaposed to the output produced by labor and capital. This accounting format reflects a somewhat propagandistic post-classical view of how industrial capitalism is supposed to work efficiently. All returns are depicted as “earnings,” even including economic rents not earned by work, innovation or entrepreneurship in the production process.” [p. 13]

    Growth? What growth?

    Reply
  10. p. fitzsimon

    If I’m not mistaken Michael Jensen authored a paper in 1976 kicking off the “Shareholder Primacy” concept to solve the agency problem with corporate governance. I have serious concerns with how that evolved. Anyone know if this is the same guy?

    Reply
    1. Yves Smith Post author

      Milton Friedman’s incoherent 1971 op ed did more to get the shareholder capitalism movement going than that Jensen paper. Economists have kept trying to argue that directors have a legal duty to put shareholders first, when that is false.

      Reply
  11. Kaleberg

    I first noticed this after Black Monday, as they called it, back in 1987. The stock market plummeted. I didn’t worry figuring I had a lot of years ahead of me for recovering any losses. To the surprise of many, the market recovered quite quickly and continued rising. It wasn’t about improved economic conditions. It was about the rising glut of capital. However one parsed the situation, it was rather obvious that something had changed.

    In the old regime, in the 1950s through the 1970s, workers were in relatively good shape, and the way to make money was to provide them with goods and services. If the workers did well, then business did well, but this started to change in the 1970s. One problem was inflation, which was just fine if you were working. Prices went up, but so did your salary. A worker could borrow money and pay it back easily. This wasn’t fun for those who had lots of money. You actually had to compete providing goods and services, and lending money was just a holding action.

    The two energy crises took a while to ripple through the economy which was much more intensive than it is today. Then Volker came in and raised interest rates. He induced a depression so severe that it not only squeezed out inflation, but it did so by squeezing out the middle class. Interest rates stayed high through most of the 1980s while inflation stayed low. Despite the rhetoric, the 1980s were not a good decade for workers.

    Under Reagan the tax code was rewritten to further weaken the middle class and get more money flowing to the wealthy. That led to inflation of high end assets, the kind of things that rich people would buy like fungible debt, shares of corporations, pedigreed art and fancy real estate. When the market collapsed in the early 1990s, I didn’t bat an eye. I knew it would recover. It wasn’t as if anyone working for a living was getting paid more. There was nothing to invest in, so people with money would have no choice but the buy stocks.

    That’s been my investment mantra since the late 1980s. Maybe if Bernie Sanders or Elizabeth Warren win the election and the Democrats take the Senate and keep the House, things might change, but until then, the rule is that there is nothing to invest in, so the wealthy will have no choice but to keep market prices high and interest rates low. Look at Europe where the debate is whether to store cash in a safe at cost X or lend it to the government at cost Y. Maybe if someone invented a car that ran by burning cash – insert car joke here – that would add cost Z to the equation.

    If this paper argues that the inflection was in 1989, that’s pretty close to my analysis, though it was obvious where things were going in 1987.

    Reply
  12. Sound of the Suburbs

    How can you kill growth in an economy?
    By doing what Japan did in the 1980s.

    Japan led the way and everyone followed.
    At 25.30 mins you can see the super imposed private debt-to-GDP ratios.
    https://www.youtube.com/watch?v=vAStZJCKmbU&list=PLmtuEaMvhDZZQLxg24CAiFgZYldtoCR-R&index=6
    What Japan does in the 1980s; the US, the UK and Euro-zone do leading up to 2008 and China has done more recently.
    Global Japanification.

    Richard Koo had studied what had happened in Japan and knew the same would happen in the West after 2008. He explains the processes at work in the Japanese economy since the 1990s, which are at now at work throughout the global economy.
    https://www.youtube.com/watch?v=8YTyJzmiHGk
    Debt repayments to banks destroy money, this is the problem.
    https://www.bankofengland.co.uk/-/media/boe/files/quarterly-bulletin/2014/money-creation-in-the-modern-economy.pdf

    Reply
    1. Sound of the Suburbs

      The economics of globalisation has always had an Achilles’ heel.
      In the US, the 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.
      Not considering private debt is the Achilles’ heel of neoclassical economics.

      What could possibly go wrong?
      The same as the last time they used this debt blind economics.

      Economies fill up with debt until they crash in a Minsky Moment.
      1929 – US
      1991 – Japan
      2008 – US, UK and Euro-zone
      The PBoC know how to spot a Minsky Moment coming, unlike the FED, ECB, BoE and BoJ.

      How can you really kill an economy?
      Do what the US did in the 1920s, which is the same as Japan did in the 1980s.
      Japan saved the banks, but left all the debt in place, which causes the balance sheet recession rather than a Great Depression.

      Reply

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