Financialization and endogenous technological change: A post-Kaleckian perspective

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Highlights

  • In post-Keynesian literature, Hein (2012a) was the first to incorporate financialization as an influential positive determinant of the rate of technological change. However, financialization is more like a two-edged sword which can affect technological change negatively as well. We capture both the positive as well as the negative effect of financialization on technological change which encapsulates the possibility of multiple equilibria.

  • In analyzing the long run of the model, we endogenize the financialization parameter as well and get richer dynamics than Hein (2012a).

  • We show that under certain circumstances, a higher speed of diffusion of technolog- ical innovation, more regulated financial markets, and higher intra-class competition among firms are desirable for stabilizing the economy. Finally, we provide some policy prescriptions for the same.

Abstract

In post-Keynesian literature, Hein (2012b) was the first to incorporate financialization as an influential positive determinant of the rate of technological change. However, financialization is more like a two-edged sword which can affect technological change negatively as well. We capture both the positive as well as the negative effect of financialization on technological change which encapsulates the possibility of multiple equilibria. In analyzing the long run of the model, we endogenize the financialization parameter as well and get richer dynamics than Hein (2012b). We show that under certain circumstances, a higher speed of diffusion of technological innovation, more regulated financial markets, and higher intra-class competition among firms are desirable for stabilizing the economy. Finally, we provide some policy prescriptions for the same.

Introduction

The phenomenon of ‘financialization’ has an important role to play in explaining developments in the world economy (especially for developed countries) over the past four decades. Financial markets and agents play a prominent role in the modern economy. Enormous increases in the size of the financial sector on one hand and deregulation of the sector, on the other hand, are associated with significantly changed income distribution in this era of financialization. Financialization has transformed the functioning of the economic system at both the micro and macro levels. For the last four decades for the US economy, on the one hand, we observe continuous invention and innovation of new technologies and, on the other hand, an increasing engagement of non-financial businesses in financial markets. For the last few decades, financial fragility has increased enormously, and finally, there is a financial crisis of the US economy (2007-08).

The intention of this paper is, first, to focus on how technological change occurs through time, especially in the era of financialization in the context of the US economy. Second, to explain how financialization itself evolves. Third, to explain how the interaction between the dynamics of technological change and financialization leads to fragility and instability in the economy. Our analysis develops over Hein (2012b) in the sense that unlike Hein (2012b) (where, in the long run, the economy always achieves a stable steady-state) by introducing the financialization dynamics and allowing the possibility of the nonlinearity of the technological change dynamics we are able to open up the possibility of long-run instability in our model. While several economists and policymakers have tried to explain the recent financial crisis of the US economy, this paper provides an alternative way of looking into the problem. This paper seeks to explain whether intra-class conflict among firms has any role to play in ensuring stability in the economy, especially when the economy is in a prolonged stagnation. The paper also seeks to explain how government (or institutional) intervention weakening stringent intellectual property rights, more public expenditure on Research and Development (R&D), and more regulated financial markets help to ensure stability in the economy.

We focus on the concept of financialization and a thorough discussion of it first. After that, we briefly discuss the Keynesian and post-Keynesian literature regarding endogenous technological change. Then we explain the distinctive features and novelty of our analysis compared to the earlier literature. Finally, we discuss the outline for the rest of the paper.

‘Financialization’ has emerged as a concept like ‘globalization’ for which not only is a unique definition unavailable, but the precise form and usage of it is also unclear. As a result, we find several definitions and various uses of the term. The most cited definition of the term comes from Epstein (2005) to whom “Financialization means the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies”. The intention of this paper is mainly to focus on the long run interaction between the financialization level and technological change. Therefore, following Dumenil and Levy (2004), we define the concept of financialization as “the growth of financial enterprises, the rising involvement of non-financial enterprises in financial operations, the holding of large portfolios of shares and other securities by households, and so on”. We also assume financialization as associated with the notion of ‘shareholder value orientation’. Lazonick and O’Sullivan (2000) extensively discuss the concept of ‘shareholder value’ as a principle of corporate governance in the United States. As they point out, there is a massive “transformation of US corporate strategy from an orientation towards the retention of corporate earnings and reinvestment in corporate growth through the 1970s to one of downsizing of corporate labour forces and distribution of corporate earnings to shareholders”2 over the past few decades for satisfying shareholders’ demand for distributed profits and for maintaning high share prices. So, by the notion of ‘shareholder value orientation’, we emphasize this very change in the objective of firm management.3

There is a vast literature which discusses the effect of financialization on economic growth, income distribution, and fragility and instability caused by financialization. Boyer (2000) shows the possibility of a ‘finance-led growth’ regime, in which financialization has an overall positive effect on growth. Aglietta et al. (2001) point out that asset price inflation, financed by debt, is the driving force of capital accumulation. According to Panitch and Gindin (2005), financialization can help accumulation by closing unprofitable businesses and by encouraging mergers and acquisitions. Financialization disciplines firms to reorganize production and reallocates capital away from less profitable companies, and thereby helps the firms to get rid of the problem of over-accumulation.

On the one hand, financialization leads to a rise in gross profits (including retained profits, dividends and interest paymants) at the cost of a declining share of wages in national income (Boyer, 2000), and on the other hand, there is increasing income inequality of wages and top management salaries (Hein (2012c); Lavoie (2009); Palley, 2006, Palley, 2013). The increased role of shareholders in the firm and the ‘owner-manager conflict’ is highlighted by some authors (Boyer, 2000, Crotty, 1990, Dallery, 2009, Stockhammer, 2004, Stockhammer, 2006). Hein, 2008, Hein, 2010 and Hein and van Treeck (2010) have argued that at least in the medium run when rising dividend payments to rentiers have become a permanent feature, the mark-up in firms’ price-setting is likely to become dividend-elastic. According to Hein (2012c), decreasing price competition in the goods market, mergers and acquisitions and hostile takeovers in the corporate sector, weakened bargaining power of workers and increasing (threat of) unemployment caused by a policy of ‘downsize and distribute’4 will improve the conditions for a rising mark-up in the face of a rising dividend rate. Therefore, in the medium to long-run, increasing shareholder power favours redistribution at the expense of the labour income share.5

Financialization leads to higher dividend or interest payments that have a negative effect on investment. This phenomenon is incorporated in the theoretical post-Keynesian models by Hein, 2006, Hein, 2007, Hein, 2008, Hein, 2008, Lavoie (1995), Lavoie (2008), Lavoie and Godley (2002), vanTreeck (2009) and Skott and Ryoo (2008). As Hein (2012c) points out, increasing shareholder power vis--vis management and workers, on the one hand imposes short-termism on management and lowers managements’ animal spirits with respect to real investment in capital stock and long-run growth of the firm (preference channel). On the other hand, shareholders put pressure on firms for higher distribution of profits. As a consequence, there is a higher dividend payout ratio and hence a lower retention ratio. Also, a lower contribution of new equity issues to the financing of investment, or even share buybacks is possible now. All of these drain internal means of finance for real investment purposes (internal means of finance channel). Each of these channels (preference and internal means of finance) possesses a negative effect on firms’ real investment in capital-stock and hence long-run growth of the economy.

Palley (2007) points out that the era of financialization has been associated with tepid real economic growth. The rapid rise in household debt-income ratios and corporate debt-equity ratios for last few decades explain the system’ s growth as well as rise in fragility. However, this process is not sustainable as debt constraints must eventually bite. Palley (2007) argues that the economy would be jeopardized to debt-deflation and prolonged recession when this occurs. Hein, van Treeck (2010) argue that even an expansive finance-led economy may cause significant financial imbalance. A rise in debt-capital or debt-income ratio may make economies prone to financial instability.

Considering a stock-flow consistent Kaleckian growth model, Hein (2010) analyze the effect of financialization on investment in real capital stock. Depending on the set of parameters, Hein (2010)’s analysis provides three different macroeconomic regimes in the face of rising shareholder power: ‘finance-led growth’, ‘profits without investment’ and ‘contractive’ regimes.6 Among these, only the ‘finance-led growth’ regime yields a medium-run stable financial structure of the corporate sector, whereas the other two regimes are prone to financial instability.

Charles (2008) develops a simple post-Keynesian macro-model and shows the instability in the economy because of a change in interest rate. Charles endogenizes the interest rate which fluctuates due to the change in debt-capital ratio or due to change in the exogenous interest rate of the riskless assets. According to him higher the debt-capital ratio, the higher is the borrower’s risk and the rate of interest (of risky assets). While a rising interest rate can destabilize the economy, an easy monetary policy can prevent the economy from collapsing.

Rising indebtedness of worker households is also an important phenomena in the US economy for the last several decades. Onaran et al. (2011) point out how the reduction in investment demand, due to the change in income distribution in favour of capital (because of financialization), has been compensated by a rise in consumption demand through the wealth effect which has come from the redistribution of income because of financialization. The positive effects of higher wealth on consumption are taken into account in recent post-Keynesian theoretical models by Boyer (2000), Lavoie and Godley (2002), Bhaduri et al. (2006), Skott and Ryoo (2008), vanTreeck (2009), VanTreeck (2009) and Onaran et al. (2011) etc. Using Minsky’s financial cycle framework, Cynamon and Fazzari (2008) try to explain how spending and financial preferences of household evolve as social norms, and unprecedented household debt ultimately culminated in a financial crisis for the US economy. The impact of worker borrowing on the economy is captured by Kim et al. (2014), Cynamon and Fazzari (2015), Kapeller and Schütz (2015), Kim (2012), and Setterfield and Kim (2016a), Setterfield et al. (2016b), Dutt (2006b), Hein (2012), Parui (2020b) as well.

We will discuss now how post-Keynesian literature treats technological change. Most of the neoKeynesian and post-Keynesian literature which treats technological change as an endogenous phenomenon explains the technological change as positively dependent on the rate of capital accumulation (e.g. Dutt, 1990, Kaldor, 1957, Kaldor, 1961, Kaldor, 1966, Lavoie, 1992, Rowthorn, 1981, Taylor, 1991 etc.). However, a significant amount of post-Keynesian literature considers technological innovation as being determined by income distribution as well (e.g. Cassetti, 2003, Dutt, 2006, Dutt, 2013, Naastepad, 2006, Taylor, 1991). A basic argument of this literature is that as wage share rises, firms face higher labour costs,7 and this accelerates the innovation of new labour-saving technologies so that profit share can be prevented from falling further. According to Dutt, 2006, Dutt, 2013, technological change depends positively on the difference between the growth rate of labour demand and labour supply. A rise in aggregate demand leads to an enhancement of labour employment growth which in turn leads to a faster growth rate of technological (labour-augmenting) change so that the problem of a labour shortage is taken care of. This argument is consistent with the impact of distributional variables on technological change in the sense that a shortage of labour puts upward pressure on the wage share, and this leads to labour-saving changes in technology.8

Using a post-Kaleckian growth model, Hein, 2010, Hein, 2012, Hein, 2012, Hein, 2012, examines the effect of financialization (and an increase in shareholder power) on the demand regime9 and on the productivity regime separately and then on the overall regime of the model. Financialization and increasing shareholder power for the analysis of both the demand and productivity regimes is considered to be an exogenous variable in Hein’ s model. When the demand regime is analysed, productivity growth is assumed to be an exogenous variable which is endogenized later for the analysis of the productivity regime. In the analysis of the overall regime, the equilibrium growth rate and the productivity growth both are determined endogenously and finally, the effect of financialization10 (and a rise in shareholder power) on both the regimes are derived.

Tridico and Pariboni (2018) use empirical analysis to explain the leading causes of labour productivity slowdown in several developed countries. They first explain how financialization11 leads to higher income inequality and then considering an extended version of Sylos-Labini’s equation12 they find the labour productivity growth rate to be positively dependent on the growth rate of GDP and the wage share. In contrast, income inequality and financialization both have a negative impact on it.

Our work is most closely related to Hein (2012b). Therefore, we briefly discuss Hein (2012b). Hein (2012b) assumes a one-sector, closed economy post-Kaleckian growth model with no government intervention and no depreciation of capital stock. No overhead labour is there, and labour saving and capital embodied technical progress prevails in the economy. Technical progress is associated with an increasing labor productivity (a=Y/L). The capital-labor ratio at full capacity (k=K/L) grows at the same pace as labor productivity, and therefore the ratio of capital to potential output (v=K/Y*) remains constant. The rate of capacity utilization (u) is given by the ratio of actual real output to capital stock. As long as the potential output-capital ratio is fixed, the actual output-capital ratio can be used as a proxy for the degree of capacity utilization. The market is oligopolistic in nature where price (p) is determined by a mark-up on prime cost. The cost of raw materials and overhead costs are assumed away and labour cost is considered as the only cost of production. Therefore, price is determined by the following equation asp=[1+m(Ω)]WLYp=[1+m(Ω)]Wa;m>0,mΩ0m denotes the mark-up rate. Total wage share equals WLpY=ωa, where ω is real wage rate. Ω represents the degree of shareholder power vis--vis management and laborers or in other words, the level of financialization. So, profit share can be expressed as π=(1ωa). It can also be expressed as the ratio of total profit to the nominal level of income as well i.e.π=RpY=m1+m;πΩ0The markup and the profit share both may change with respect to a change in shareholder power vis--vis management and labourers.13A rise in shareholder power (because of mergers, acquisitions and hostile takeovers) can potentially reduce the degree of competition in the goods market and the ‘downsize and redistribute’ strategy of firms lowers the bargaining power of labour unions in the labour market. Thus an increase in the level of financialization (Ω) is associated with an increase in markup in firms’ pricing which is expressed in equation (1.1) and thus it is associated with a rise in the share of profit (equation (1.2)).14 Rate of profit is expressed as a product of share of profit and the degree of capacity utilization and is expressed in the following equation asr=RK=πuA fraction of total profit is retained by the firms (RF) and the rest is distributed as dividends (paid on equity held by rentiers (RDiv)) and as interest payment (paid on debt to the rentiers (RInt)). Thus total distributed profit (RR) consists of dividend and interest payment to the rentiers. This argument is captured in the next equation asR=RF+RInt+RDiv=RF+RRDividing both sides of the above equation with respect to the nominal value of capital stock we get rate of profit as a summation of firms’ retained profit rate (rF) and rentiers’ profit rate (rR) i.e.r=rF+rRrR=RRK;rRΩ>0rF=RFKWorkers spend all of their income (which is the wage income only) on consumption whereas a fraction (sr) of rentiers’ income is saved. So total savings of the economy consists of savings of the firms (which is essentially the retained profit) and the savings of the rentiers i.e.S=RF+srRR=RRR+srRR=R(1sr)RRNormalization of the above equation in terms of the existing capital stock yields,SK=σ=πu(1sr)rRHein (2012b) assumes investment decisions to be positively influenced by expected sales (i.e. by the degree of capacity utilization) and by the profit share as both positively affect the expected profit rate. Distributed profits, by reducing the available internal funds, negatively affects investment demand while at the same time imposing restrictions on the access to external funds la Kalecki (1937). Hein (2012b) assumes inventions of new technologies also positively influence the investment demand. Therefore, the investment function isIK=g=α0+α1u+α2πα3rR+α4λ;α0,α1,α2,α3,α4>0;α0Ω<0,rRΩ>0Here λ represents the rate of technological change or the growth rate of labour productivity. So λ=a˙a=a^. In the short run equilibrium,IK=SKu=(α0+α2π+α4λ)+(1srα3)rR(πα1)Using (1.11) to substitute for the degree of capacity utilization in (1.10) yields the short run equilibrium rate of capital accumulation asg=α0+α1u+α2πα3rR+α4λg=π(α0+α2π+α4λ)+[α1(1sr)α3π]rR(πα1)An increase in shareholder power, as Hein (2012b) points out, affects the accumulation rate through three channels. First, through the ‘preference channel’ which is negative. Second, through the ‘internal finance channel’, the overall effect of which is ambiguous.15 And third, the ‘distribution channel’16 which also has an ambiguous effect on the capital accumulation. So the overall effect of a rise in shareholder power on the equilibrium accumulation rate is ambiguous. It can be ‘expansive’ i.e. there is a positive impact of a rise in shareholder power on the accumulation rate or it can be ‘contractive’ i.e. an increase in shareholder power will negatively affect the accumulation rate.17

Hein (2012b) assumes the rate of growth in labour productivity positively depends on the rate of capital accumulation. He assumes a positive effect of increasing shareholder power on productivity growth. Profit share negatively affects the rate of growth in labour productivity. Since rising shareholder power may have a stimulating effect on the profit share, this may have an indirect negative effect on productivity growth. Thus, Hein (2012b) gets,λ=ξ0+ξ1g+ξ2Ωξ3π(Ω),ξ0,ξ1,ξ2,ξ3>0For a given capital accumulation rate, a change in shareholder power has a direct positive effect on productivity growth and a negative indirect effect via the profit share. So the overall effect of a rise in shareholder power on productivity growth is ambiguous.

If demand and productivity regime both are expansive, with a rise in shareholder power, an overall expansive regime can be achieved i.e. capital accumulation and productivity growth both increase in the face of rising shareholder power. Similarly, if both the regimes are contractive, the overall regime will be contractive too.

However, if the demand regime is contractive and the productivity regime is expansive and the contractive effect on the demand regime is relatively weak, we may obtain an overall expansive regime while if the contractive effect on the demand regime is relatively strong then we may obtain an overall contractive regime. If, however, the partial effects on demand regime and productivity regime are neither too strong nor too weak then an overall intermediate regime is possible i.e. a slow capital accumulation with fast productivity growth may co-exist. Exactly opposite of the above happens if the demand regime is expansive and the productivity regime is contractive.

Hein, 2010, Hein, 2012, Hein, 2012, Hein, 2014 is the first and to the best of our knowledge is the only contributor for the literature who focuses on the impact of financialization on productivity growth (or technological change) from a theoretical perspective. The basic structure of our model is based on Hein (2012b). However, compared to Hein (2010,2012b,2012c,2014), this paper has a few distinct features.

First, Hein (2012b) points out that if ‘shareholder value orientation’ goes too far, a potential negative impact of it on labour productivity growth is possible. Nonetheless, his basic analysis is based on a simple linear positive relationship between ‘shareholder value orientation’ and labour productivity which ensures the unique and stable steady state only. However, in this paper by incorporating both positive and negative effects of financialization on the rate of technological change, we get a non-linear relationship between those two that allows the existence of multiple equilibria and opens the possibility of instability in the economy. In our analysis of the long run, we provide the rationale for the assumed non-linear relation between the level of financialization and technological change. This, in our opinion, is more appropriate for explaining developments in the US economy, which has become more fragile and unstable for the last several decades.

Second, so far, most of the literature captures financialization as an exogenous parameter and explain its impact on the economy by the change in that very parameter. The novelty of our work lies in the fact that we try to explain how this financialization parameter itself evolves through time (in other words we are trying to endogenize this financialization parameter in the long run). We then show how the interaction between one stable and one unstable subsystem (represented by technological change and financialization dynamics respectively) can produce instability and cycles in the whole system. We show that a lower degree of restrictiveness enforced by various intellectual property rights, more public expenditure in R&D, more regulated financial markets, and more competition among firms are desirable for stabilizing the economy. We discuss some policy prescription for the same as well.

The outline of the rest of the paper is as follows. Section 2 sets up the model and presents a short run analysis. Section 3 discusses the long run where we endogenize the financialization parameter and technological change. Section 4 talks about possible cases which may arise due to the interaction between financialization and technological change. Depending on how financialization affects the rate of capital accumulation, four different cases are possible. These are (i) Case 1: where there is a strong contractionary effect of financialization on the rate of capital accumulation, (ii) Case 2: where the impact of financialization on the rate of capital accumulation is weakly contractionary, (iii) Case 3: where the impact of financialization on the rate of capital accumulation is weakly expansionary, and (iv) Case 4: where there is a strong expansionary effect of financialization on the rate of capital accumulation. We discuss the possible steady states and stability issues for each of these cases in this section. This is followed by the discussion of Hopf bifurcation in Section 5, where we analyze how the interaction between financialization and technological innovation can produce limit cycles. Section 6 discusses the comparative statics. Section 7 offers some concluding remarks.

Section snippets

the model

Our short run analysis is based on Hein (2012b). We assume a simple one-sector, closed economy, post-Kaleckian growth model in which the economy consists of workers, rentiers, and firms. There is no government intervention in the economy. For simplicity we assume lack of depreciation of capital and only labour saving and capital-embodied technological change prevails in the economy. Technological change thus implies an increment in output-labour ratio or labour productivity (a=Y/L).18

long run

In the long run we assume that the goods market clears, i.e. the short run equilibrium values (u*, and g*) are always attained.25 A multivariate dynamic model of financialization and the rate of technological change is developed in this section. We first discuss the dynamic evolution of technological change and financialization. This is followed by the discussion of the possible cases which may arise due to the interaction

possible cases

The assumption that (1ξ1gλ+ξ3πλ)>0 ensures J11 to be negative and the assumption that [η1+η2gλ+η3πλ]>0 ensures J21 to be positive. Depending on the value of gΩ four different cases are possible. These are (i) Case 1: where there is a strong contractionary effect of financialization on the rate of capital accumulation, (ii) Case 2: where the impact of financialization on the rate of capital accumulation is weakly contractionary, (iii) Case 3: where the impact of financialization on

hopf bifurcation

In this sub-section, we discuss the possibilities of emergence of cycle as a solution to the dynamical systems represented by equation (3.2) and (3.9). Consider the steady state F of Case 4.1 or 4.2. We get the following proposition.

Proposition 10

For an appropriate value of the speed of adjustment parameter, θ, the characteristic equations to (3.2) and (3.9) evaluated at the steady state F of the Case 4.1 or Case 4.2 has purely imaginary roots and for the same dynamical system, θ=θ^=ϕ[η2gΩ+η3πΩ1][ξ1gλ

comparative statics

In our model, ξ0 represents the intra-class competition among firms that leads to a positive desired rate of technological change. Therefore, the comparative static of a change in ξ0 deserves some discussion. For comparative statics analysis, we assume the economy is in a stable steady state. The effects of parametric change of ξ0 can be shown by totally differentiating equations (3.2) and (3.9), which imply[J11J12J21J22][dλdΩ]=[θ0]dξ0Therefore we get, dλdξ0=θJ22(J11J22J12J21) and dΩdξ0=θJ21(

conclusion

In this paper, we dealt with a post-Kaleckian growth model in which in the long run rate of technological change and the level of financialization evolve endogenously. While several economists and policymakers have tried to explain the recent financial crisis of the US economy, our paper provides an alternative way of looking into the problem in the sense that how the interaction between the dynamics of technological change and financialization leads to fragility and instability in the economy.

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    1

    This paper is part of the author’ s doctoral thesis submitted to Jawaharlal Nehru University, New Delhi, India. The author is indebted to Subrata Guha, Gogol Mitra Thakur, C. Saratchand, two anonymous referees, and the editor of this journal for their valuable comments and suggestions. However, the author is solely responsible for the remaining errors.

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