Many contemporary economic debates remain grounded in older models of firm competition. But today’s economy is largely characterized by market-feedback-induced consensus among firms that reflects the priorities of asset managers and the interests of asset owners. Recognition of this fact is the first step toward a better understanding of today’s capitalism and toward policies that address its key weaknesses, particularly incentives against competitive investment in many industries.
Science, as well as technology, will in the near and in the farther future increasingly turn from problems of intensity, substance, and energy, to problems of structure, organization, information, and control.
—John von Neumann, 1949
Mathematician John von Neumann foresaw how increasingly sophisticated economic modeling and automated machine intelligence would lead to the primacy of information games. Indeed, von Neumann invented one of the first electronic computers, worked on the Manhattan Project, and developed the field of economic game theory, which he would use in developing the theory of “Mutually Assured Destruction” as an adviser to the United States on its nuclear strategy. In doing so, he saw firsthand how the economic logic of game theory was able to account for behavior involving the most destructive weapons invented by mankind.
A less apocalyptic problem of “structure, organization, information, and control”—yet one that is central to the twenty-first-century sociopolitical order—is faced by capital allocators and firm managers who aim to maximize value for shareholders. The growing share of resources and range of strategies—particularly those that seek to increase share values while relying on no or only incidental changes to the underlying productivity of firms’ operations—employed in asset management and governance exemplifies the secular trend von Neumann predicted.
What are the consequences of the rise of an industry that seeks to maximize the value of asset portfolios more efficiently? At the most superficial level, the financial sector has captured a growing share of GDP, profits, and human capital. The influence of a sophisticated investor base on the nature of corporate capital allocation, however, has been of greater consequence than the rents it extracts. Critics of financialization have compellingly illustrated how an asset governance paradigm designed to maximize shareholder value has driven a wedge between asset value growth and productivity, net investment, and wage growth. Corporate profits have increasingly concentrated within asset-light, high-margin superstar firms, and excess profits that were once invested in physical capital and used to produce broader prosperity have been diverted toward buying up existing assets in public and private markets.
Politicians like Elizabeth Warren may blame simple greed for this extractive approach to capital allocation, but without a structural account of the relationship between financialization and competition, arguments decrying buybacks, leveraged buyouts, asset-stripping, industry concentration, and other forms of financial engineering can be dismissed on the grounds that there is no reason to believe the social efficiency of markets has been impaired. The dislocation between asset values and productivity growth may simply be the result of more dynamic capital allocation that will enhance prosperity in the long term.
An examination of the way that today’s markets and management incentives shape capital allocation, however, reveals that the most powerful economic force financialization has unleashed to benefit shareholders is not greed, but consensus. By creating incentives to maximize overall industry profit pools and minimize competitive investment, a shareholder-centric asset governance model has undermined the competitiveness of markets and encouraged a de facto coordination among firms that benefits asset owners at the expense of broader prosperity.