A Return to Corporate Investment
Financialization is a blight on capitalism. In that system, the corporate sector is supposed to provide the large-scale capital investment that drives economic growth. Financialization inverts the corporate sector’s role, diverting resources away from capital intensive projects and toward financial assets instead. And it empowers agents outside of corporations, whether Wall Street financial managers or ESG political activists, to control the nation’s vital economic resources.
Capitalism’s free enterprise system assumes a traditional flow of funds: Workers earn income to provide for their necessities, and save the rest. Their savings—in banks, retirement accounts, and many other vehicles—are invested in businesses. Businesses, in turn, invest these savings productively in their operations. As Adam Smith describes it in The Wealth of Nations, “[b]y what the frugal man annually saves,” he is “like the founder of a public workhouse” because those savings serve as “a perpetual fund” for reinvestment in the economy.
For most of modern American history, the corporate sector was the principal net borrower of savers’ resources. The corporate sector, as a whole, continually raised capital from the rest of the economy and spent it on non-financial assets: property, plants, and equipment, creating jobs and driving innovation.
Financialization (whether as cause or effect) disorders this cycle. Capital is supposed to flow from households, which are net savers, into businesses, which are net borrowers from the rest of the economy. But in a financialized economy, non-financial corporations begin to fail in their role as the borrowers and builders. They instead become savers themselves by acquiring financial assets, effectively deferring the earthy and material work of productive capital investment to others. Corporations do this in a variety of ways, from focusing their business activities on financial services and buying up other companies, to returning capital back to shareholders faster than they raise and invest it.
Statistically, this transition began in the 1980s, as the share of corporate investment in tangible assets declined and the acquisition of financial assets climbed. By the start of the 21st century, the corporate sector’s role had flipped; it was no longer the economy’s net borrower, but a net lender—like banks and investment funds. But that is not all that happened, because not all sectors of an economy can be net lenders. Someone must absorb and ultimately deploy society’s savings. In this transition, the net borrower and thus “investor” has become the United States government. As federal deficits have soared, the government has issued trillions of dollars in Treasury bonds. In net terms, the American economy’s savings are now no longer channeled to fund corporate investment, but government spending.
Whatever system that is, it is not traditional capitalism. As the parable of the talents instructs: For one entrusted with investing another’s capital, saving is no virtue. Preserving the free enterprise system requires reestablishing the business sector as the net investor of the economy’s resources.
While there are a variety of policies that might encourage corporations to increase capital investment, financial incentives can only go so far. Ideas and ideologies that operate internally within corporations play a primary role in setting business investment decisions. In this sense, “financialization” is also a useful shorthand for the predominance of financial considerations in business management. Effective policy reform must focus on corporate governance, with the goal of reforming both how corporations invest, and who decides it.
Milton Friedman’s dictum that corporate directors should act exclusively to maximize profits can lead to suboptimal capital investment. An approach to business management that focuses exclusively on maximizing profits will tend to prefer quantifiable investment opportunities, which can be shorter-term and lower in capital intensity. It will also tend to increase the influence of financial managers in investment decisions at the expense of more closely affiliated owners and managers whose histories and skills are bound up in the corporation’s long-term future.
The purported opposite of the Friedman doctrine, so-called “stakeholder” governance and the Environmental, Social, and Governance (ESG) movement, contributes to financialization in its own way. Only by the dominance of large investment managers in corporate governance could a minority, elite political movement like ESG attain the level of influence it currently has over corporations. Whereas financial managers might cut capital investments by imposing a kind of spreadsheet logic, ESG seeks to even more relentlessly discipline corporate behavior toward its abstract ends through the forced quantification of concepts, such as disclosures of “diversity matrices” or “Scope 3” emissions.
ESG opposes corporate investment in a more fundamental way, too. While ESG as a corporate governance methodology might have the theoretical capacity to promote riskier long-term capital investments, its substantive environmental and social commitments undercut any chance of that. For one, capital investment is often energy intensive. Revealingly, ESG advocates opportunistically endorse “shareholder value” to support share buybacks by companies precisely because it comes at the expense of energy companies’ capital investments. In these ways, financialization also stands for the control of businesses by ideologically and physically distant managers who cut corporate investment in pursuit of agendas that are unrelated to the interests of the business or the nation.
Instead, public policy should promote flesh-and-blood corporate governance that drives real capital investment. Financial incentives certainly have a role to play. For example, reforms to corporate tax policy can reduce tax-motivated investment arbitrage, like how the current deductibility of business interest expenses encourages corporations to lever up on financial assets with excess corporate debt. Better regulation should restrict share buybacks to reestablish more strategic investment planning via long-term investment and dividends.
Public policy can also encourage corporate management to operate with better priorities. Bankruptcy reforms can improve corporate governance by ensuring workers and communities receive higher priority when it comes to preserving corporate assets. Labor laws can open up new forms of worker representation within the traditional corporate governance framework, consistent with fiduciary duties. And public pension governance can be improved by increasing transparency, so that lawmakers and the public can see how public resources are being used to advance different visions of corporate governance in the market.
Public policy can help to draw limits that encourage the corporate sector to better perform its role in the market and ensure the system’s healthy functioning.