Why have investment rates declined since the 1960s
By: Jonathan Kush
Why have investment rates declined since the 1960s? Explore atleast two competing arguments, assessing their theoretical basis
Following the turbulent and economic turmoil of the 2007/8 financial crisis whose effects are still felt to date, various economists have come up with explanations of what caused the crisis, by examining various historical underpinnings and paradigms such as heterodox economics and mainstream economics. Heterodox economists base their argument on the financialization and stagnation concept while mainstream economists focus on fiscal policies, capital accumulation, and output affects concepts. This essay assesses the decline of investment rates since the 1960s, based on these two competing ideologies, exploring their theoretical basis. This includes exploring which arguement (s) is/are most convincing and why? We will summarise by discusing which of the two best explains why investment rates have decreased since the 1960s.
1.0 Heterodox economics approach
Financialization and stagnation form a critical construct of the heterodox economics that attempts to justify the capitalist production mode and economic developments. Essentially, according to Serfati (2008), financialization is perceived to be at the core of neoliberalism, an aspect that depicts the existence of a predatory capitalism version that is apparently inclined towards crisis. The concept of Financialization has widely been used to explain the idea of stagnation with regard to various economic constructs. The definition of “Financialization” is variant across different researchers. Nevertheless, it can be defined as “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of domestic and international economies” (Epstein, 2005, p. 3).
To understand the impact of financialization and stagnation, it is crucial to understand the meaning of finance too. From an economic perspective, “finance” entails purchasing power movement across different economic actors; this may take the form of ownership rights, assumptions or extension of credit with regard to an asset that is surmised to accrue some financial benefits In a given period. According to Orhangazi (2008), following the aftermath of the World War II, capitalism attained its corporate stage, with securities achieving both creditor status and ownership representation. Owing to this, the financial markets boomed as the securities became tradable since the states of a creditor or owner could be traded (sold or bought).
Over the decades since its emergence, the institutional paradigm of capitalism has gone through significant changes. According to Orhangazi (2008), neoliberalism can be perceived to be the most recent institutional capitalism form. McDonough, Reich, and Kotz (2010) assert that the capitalist institutional structure changes can be analysed via the social structure of accumulation theory. Following the great economic depression of the late 1920s, the perception that unregulated finance access was a major contributor towards the depression became clearer. Such a perception greatly impacted financial regulations, which in turn influenced the post-world war social structure of accumulation. For instance in the United Sates, interest rates controls were imposed by the federal government; financial organizations were categorized based on their permitted business, close regulation of the financial industry entry was effected, and states imposed policies to protect the banks against failure. Such an aspect greatly fostered the non-financial sector capital accumulation.
In the late 1960s and 1970s, the financial institutions profits and the financial markets activity started up trending as compared to the profits and activity of the nonfinancial sector. According to Bhaduri (1998), the foreign exchange transactions escalated from $15 to $80 billion per day from 1973 to 1980 respectively, with 1995 hitting a $1,260 billion mark. From a Heterodox perspective, there was a significant shift to neoliberal capitalism from state-regulated capitalism in the 1980s. Apparently, there exist different notions on the rise of financialization. Owing to this, Sweezy (1994) held it that following the declining investment opportunities in the real estate sector in the 1970s due to the development of stagnation; there was a significant shift to the financial sector. This is well supported by Dumenil and Dominique (2005) who assert that though financial institutions and intermediaries have historically been subject to vast economic limits and needs, the 1970s saw a noticeable shift with regard to policy making and economics, in response to the economic depression. This is well supported by scholars like Caverzasi and Godin (2014) who posit that the dramatic growth of financial markets from the 1980s that was greatly triggered by their deregulation, impacted different economic constructs differently, and significantly influenced the capitalist structure, especially in the United States.
Such an aspect resulted in decreased real capital rate of accumulation, which was in favour of financial investment. Essentially, the deregulation of the financial markets paved the way for the heightened financial practices dominance and business organizations fusion with financial engineering concept. All these capitalist dynamics can be linked to the Keynesian problematic; the latter builds on the notion that possession and ownership separation towards the closure of the 19th century, resulted in a new social class that challenged the earnings and business class with reference to tripartite class segmentation
In a study on the sub-prime crisis with reference to financialization, Caverzasi and Godin (2014) established that financialization bears a depressive impact on the economy and can thus be associated with a decline in the investment interest rates from the late 19th century to date. However, this adverse effect could be counterbalanced through the establishment of a channel for realizing capital gains (Caverzasi and Godin, 2014). This is supported by Bernardo, Stockhammer and Martinez’s (2015) study on Tobin’s q in a Stock-Flow, whereby the authors argued that “post-Keynesian q theory stands against the main predictions of mainstream finance and constitutes an alternative to developing a macroeconomic theory for equity markets.” Critically, this clearly implies that there exists a negative long-run relationship between growth rates and q, as well as propensities to consume and q as articulated in the 1966 "Kaldorian q theory.”
2.0 Mainstream economics approach
Mainstream economic theories, considered to be orthodox, are built on neoclassical economics and usually emphasize rational choice theory. Under this model, proponents argue that the production function encompasses decreasing marginal returns of labour and capital. Owing to this model, any policy that results in long-term increase in the capital/labour ratio cannot result in long-term growth in per-capita income unless physical capital is continuously increasing. Just like the Heterodox perspective, the mainstream economic perception has evolved over time, with various scholars such as Uzawa (1965) and Arrow (1962) modifying the traditional neoclassical model through the addition of the human capital aspect. Essentially, the mainstream perspective regarding economic instability and the decline in the investment rates is Keynesian based. Specifically, this model stresses that changes in investment spending that results in changes in aggregate demand may result in adverse supply shocks that have the potentiality of negatively impacting the supply function.
From an analytical perspective, investment spending is associated with a broad range of variations and therefore, any "multiplier effect” has the potentiality of widening such changes, which in turn results in greater changes in aggregate demand which may trigger demand-pull inflation or even an economic recession, should spending on investments fail (Elgar, 1998). On the same note, neoclassical economists believe that in various circumstances, whenever the substitution between labour and capital takes place, the rate of growth depicted in the Harrod-Domar framework tends towards natural growth rate (Karras, 1994). Based on this argument, if a given economy is in a long-run growth equilibrium and a sudden increase in the savings ratio emanating from fiscal policy occurs, income growth rate will rise but decline afterwards and downwards towards growth rate equilibrium.
On the same note, fiscal policies are believed to have a significant impact on transition, developing and developed economies. Shah (1995) suggests that discretionary fiscal and monetary policies can be applied to reduce the business cycle duration and intensity. Owing to the aftermath of the of the 2008 financial crisis, it has become vital to focus on different economic constructs such as syncing public debt burdens, excessive budget deficits, inadequate national savings, and high unemployment.
With regard to the decline in the investment rates, mainstream economists envision the paradigm that budget deficits result in increased total lifetime consumption via transfer of taxes to succeeding generations. This implies that full employment of the economy results in increased consumption which ultimately leads to a mean decrease in savings. Therefore, In order to balance the capital markets, the rise in interest rates must be encouraged and vice versa. This explains the reduced investment rates since the 1960's especially in OECD countries, whereby economic deficits “crowd out” accumulation of the private capital. Essentially, interests’ rates usually rise whenever the federal government decides to finance a deficit in a country’s economy when operating near capacity (Engen and Jonathan,1992). Consequently, higher interest rates result in reduced investment rates. This model suggests that the rise in the interest rates has been the main cause of falling investment rates, an aspect that has been detrimental to both local and the global economy.
With respect to the post-Keynesian perspective on mainstream economics, a substantial percentage of the general population are considered to be liquidity or myopic constrained. With consideration of the available disposable income, such people have a relatively higher propensity to consume. From an economic perspective, since economic deficits foster both national income and consumption, capital accumulation and savings do not have to be negatively impacted. A study by Dean, Durand, Fallon and Hoeller (n.d), in OECD countries showed that national investment rates and national savings were higher in the 1960s and 1970s compared to the 1980s, while the interstate variation has been extremely large. Further, the authors further argue that reduced government spending as from 1960 has been a significant contribution towards declines in national investment and savings. Conversely, the savings rate of the private sector has seen significant stability over time compared to business rates and the component household. Additionally, business savings have been significantly boosted by rapid recovery as from the 1980s and consequently led to enhanced business investment and self-financing. Nevertheless, research by Dean, Durand, Fallon and Hoeller (n.d) suggests that the investment and savings rate have varied significantly across OECD states, though one trend has been common; the declining investment and savings shares in Gross National Product from 1960.
Barkbu, Berkman. Lukyantsau, Saksonovs and Schoelermann (2015) consider the investment decline to be lower in the core economies as compared to stressed economies. On the same note, they also argue that SME conditions have worsened compared to those faced by bigger companies. Such an aspect may depict numerous factors posing a combined effect, such as structural differences across countries, policy uncertainties, corporate debt, financial fragmentation and bank-sovereign links.
From a mainstream perspective, the declining investment since the 1960s, especially in European countries is associated with different factors such as output dynamics, which can be employed to explain the wide investment trends including the global financial crisis. On the same note, Karras (1994) suggests that financial constraints also played an integral role in limiting investment in various countries.
Essentially, there is no right or wrong theory as each is based on substantially credible material facts about consumer behavior. Nevertheless, the neoclassical perspective is more practical, analytical, and highly intriguing for economic and consumer behavior scholars who wish to understand the concept of consumer behavior and decision-making when presented with different commodities.