On Tuesday, August 16, President Biden signed the Inflation Reduction Act (IRA) into law. The bill, passed by both houses as of last week, has allocated $369 billion for investments in “Energy Security and Climate Change.” The IRA, as well as the CHIPS Act, are a sign of changing times. Since the 1970s, developed economies have become extraordinarily capital-lite. Firms optimize for the minimum amount of fixed assets and inventory rather than for resilience. This has had extraordinary results: for consumers in the developed world, it has meant relatively low prices, while for developing economies, it has meant the proliferation of jobs as companies offshored expensive capital production to affiliates in new locations. The past two years have been a lesson in the expected and unexpected fragilities of a capital-lite economy. The COVID pandemic and the war in Ukraine have both wreaked havoc on the delivery of goods and services. Both these events were extraordinary shocks; however, they have taught us valuable lessons about what kind of economy we need in the coming decades. Climate change will accelerate and geopolitical tensions with it. Neither COVID nor the Russian invasion of Ukraine are likely to be the last shocks to a global system. These factors will change what firms and governments must optimize. First and foremost, the process of investment and optimal capital structure will have to be rethought. Whereas once we emphasized flexibility and lightness, we will have to begin to also focus on redundancy and resilience. We will need to start building again and that means doing the complicated work of financing fixed capital.
Managing a capital-intensive economy is no easy task. When economist Hyman Minsky wrote his classic Stabilizing an Unstable Economy in 1985, he was contending with the end of the post-war period, a capital-heavy, industrial economy, and a transition to what we now call our own capital-lite “neoliberal” economy. Minsky understood that the problems faced by the economy of the 1970s were of profits validating new capital investment. A new piece of capital is like a bond. It has an upfront cost and a corresponding stream of returns. These returns are formed from the profits of a capitalist firm. If these returns are increasingly hard to find, firms, especially ones with large market shares, will increase prices. This happens first in capital-intensive industries and then ripples through an economy. Moreover, it forces competition between workers in the rapidly expanding high-investment industries and those in less high-growth industries, leading to labor pressures.
The neoliberal economy addressed these pressures in two ways. First, it detached heavy capital investment from the core of the firm. The doctrine of shareholder value meant that firms would have to optimize their use of capital and move the risk associated with investment into new fixed capital to specific counterparties, for example, through offshoring. Second, it moved inflation pressures from goods to assets. Profits allowed for high returns to financial instruments. The “middle class” was often given some insured version of such an asset via the financialization of homeownership. Homes became assets that would continuously appreciate and form the basis of retirement savings. Pensions could thus be shorn from the balance sheets of the firm and risk transferred onto the household.
What Minsky observed in 1985 is that these shifts would create instability in financial markets as the previous system created instability in price. Minsky’s theory has been proven right all through the late-20th and twenty-first centuries. Starting from 1997 to a culmination in 2008, the global economy has witnessed a rolling cycle of financial shocks. To solve this problem, most developed countries actually leaned further into the model that was built in the 1980s. They lowered expenditure on capital, leading to what economists call hysteresis – the long-term effects on the productive capacity of economies from underinvestment. The cost of this was borne by workers with precarious employment prospects. This strategy continued to stabilize the economy in the wake of catastrophic losses, but it created even more long-term weaknesses. Like a gymgoer who has to exercise consistently at increasingly higher weights to see more benefits, a system of production has to work consistently and not skip gym days if it wants to be strong. A strong economy can function under the extremes of shocks, but a lazy economy fearing injury will inadvertently only hurt itself more under extreme exhaustion. And that is where we are. Worse still, to prevent pain we are pursuing the only policy we know – slowing growth. Of course, this will be borne by those who find themselves unemployed.
Slowing growth for the sake of price stability is a short-term solution to a long-term problem. Our system is just not built for investment into fixed capital. But we need exactly such investment if we are to both operate at our full potential and build resilience to decades that will likely be full of shocks. This requires strategic thinking around coordination. In my work with Berggruen Fellow Michael McCarthy, we have argued that a stable socio-economic system must reconcile coordination problems in political, productive, investment, welfare, and consumption spheres.
Each of these spheres will need to be recalibrated to get to a stable and resilient high-investment economy. Politically, we will have to expand democracy in a manner that allows the public to broadly understand tradeoffs in economic policy and make choices regarding its direction. The Berggruen Institute has called this “participation without populism.” Financing and production must become more designed to facilitate redundancy. This might mean the return of industrial policy. The term “industrial policy” may evoke past fears from the middle of the 20th century, but a modern industrial policy should not be about pure protectionism – it should be about allowing firms to build spare capacity to run an economy at full employment. Finally, we need to explore new ways of managing public welfare and facilitating consumption. Nathan Gardels and Nicolas Berggruen have argued that we need to pursue a “pre-distribution” agenda wherein the public can reap the surplus of investment directly through public ownership structures. Such public institutions can help workers get returns from greater technical progress while restraining direct pressure on wages. These are just some of the possible institutional fixes that we can introduce to create a resilient, stable capitalism.
For years, our capitalism has looked like a sports car. It was light, low to the ground, and emitted high amounts of greenhouse gases. Sports cars are fun to drive when you have straight, smooth roads. However, we have not invested enough in keeping our roads straight or smooth. Financial globalization is going to pave way for rougher terrain full of potholes and gravel. To get through this, we will need an economy that is designed like an electric vehicle with low emissions, one built for resiliency.