Traditional Economics Can’t Help. We Need to Rethink Growth and Capitalism

Economics and policy for inclusive and sustainable growth

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By Mariana Mazzucato

In 2008, Queen Elizabeth II went to the London School of Economics to open a new academic building. The British Monarch has made it a life’s work to avoid saying anything contentious in public, but this time she had a question for the economists: Why had they not seen the financial crash coming?

Her question went to the heart of two huge failures of modern economics: the near collapse of some of the world’s major economies; and the faith in an orthodox economic framework that offered no explanation for what was happening. The thesis of my new book Rethinking Capitalism: Economics and Policy for Inclusive and Sustainable Growth, co-edited with Michael Jacobs, is that these two failures are intimately related. The failure by policy-makers to fully understand the dynamics of the capitalist system not only leads to periodic crises; it also leads to the wrong remedies, such as the pro-cyclical austerity that has only deepened and prolonged the crisis in many countries.

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Eight years on from the global financial crisis, the IMF is still describing the global recovery as “weak and precarious”. It points to modest recoveries experienced in most advanced economies characterised by “weak productivity, low investment, and low inflation”, which in turn reflect “subdued demand, diminished growth expectations, and declining output growth” (IMF, WEO, Oct 2016). Indeed, in most advanced economies investment remains below pre-financial crisis levels.

If future growth is to take a different path, it will require more than the usual mantra about taking advantage of low interest rates to fund infrastructure. Instead, we need to rethink the fundamental precepts that govern our understanding of how and why capitalist economies grow—both in terms of the ‘rate’ and the ‘direction’ of change.  Key to this is a better understanding of what drives business investment, and the effect that public investment can have—not just ‘crowding-in’ investments that businesses may already have been considering, but actively stimulating the desire to make new investments they hadn’t yet considered. It is this ability of bold, strategic public investments to rouse what Keynes called the ‘animal spirits’ of business investors that is key.

Looking at the economy through an investment lens is indeed instructive. Weakness in investment in part explains the persistence of output gaps across advanced economies, but also the slowing in growth of the volume of international trade. But the key question is, what kind of investment is needed? Would simply digging ditches and constructing bridges and roads suffice?

There are two key issues here. The first is that it has historically been ‘mission-oriented’ public investments that have increased business-investor expectations about future areas of growth. Indeed, in biotech, nanotech and IT, bold strategic public investments created new landscapes that then crowded in business. The second is that the grand societal challenges of the future—from climate change to the demographic crisis affecting much of the West—requires visionary thinking about future growth possibilities and a broad array of public investments to make those opportunities emerge. ‘Market failure’ theory is not adequate to understand this approach.

Those who advocate the inevitability of secular stagnation miss both these points. Stagnation is not caused by the deterministic forces of an ageing population, high savings, and exhausted tech opportunities. Rather, it is a result of falling private and public investment that has prevented the emergence of new investment opportunities. In other words, it is the result of choices made by public and private actors: opportunities are endogenous to investment, and when there is a crisis on both the public and private sides, stagnation sets in.

Let’s look at each in turn.

On both sides of the Atlantic, public companies are sitting on record piles of cash—around $2 trillion in the U.S. and a similar amount in Europe—which they are choosing to hold rather than to invest. At the same time, over the last decade, more than $3 trillion has been returned to shareholders in the form of buy-backs, in some cases, like Pfizer and Exxon, exceeding their net earnings over the period. This reflects the extent to which the so-called ‘real’ economy has become financialized in the name of shareholder value, where it has been easier to boost share prices (and with it executive remuneration) through buy-backs, than through investment in the company’s future.

This failure of corporate leadership has been matched by an equal failure of public policy. After the crisis, public debate focused narrowly on the size of public deficits, rather than on how to raise long-term growth. But the size of the deficit, year to year, matters far less than the question of what it is spent on, and how that spending affects the debt-to-GDP ratio in the medium to long term. Many of the countries across Europe that have the highest debt-GDP ratios are also those that have had moderate deficits. Their problem was not the size of their deficits, but the slow rate of their GPD growth.  Italy’s deficit, for example, has been lower than Germany’s for a decade. The problem for Italy, as elsewhere, was the lack of investments in areas like human capital and R&D that increase long run growth.

In mainstream theory, Keynes’ ‘animal spirits’ are assumed: firms are naturally inclined to invest, but will do so if only they receive the right incentive signals in the form of barriers being removed and competitive prices. In reality, however,  business tends to invest only when it sees a growth opportunity. Cutting the cost of investment – through tax reliefs or other indirect mechanisms – will not be effective in stimulating investment if businesses do not see opportunities for growth. Historically, generating such opportunities has been closely tied to mission-oriented public investments that have created and shaped new markets through direct strategic investments: market making, not market fixing.

In Silicon Valley, for example, the public investments have not been limited to solving ‘public good’ problems such as the positive spill-overs from basic research. The breadth and depth of public investments were present across the whole innovation chain: basic research, applied research, and even early stage high risk funding for companies (through organisations like SBIR) providing the patient strategic finance not forthcoming from the private market.  Despite all the talk about reforming finance after the crisis, too little attention has been given to the quality of finance. The long-term nature of innovation, and the extreme uncertainty which underlies it, means that it requires strategic, long-term, patient finance rather than venture capital seeking a quick return and exit. But today’s emphasis on cutting government budgets, and/or the need to show quick returns from such investments puts the public side at risk.

The investment lens is also missing from the debate about the effect on jobs of new technologies, especially Artificial Intelligence.  Economists tend to discuss the ‘skill bias’ of technological change—how technological revolutions leave behind workers not able to adapt—but miss the key point that skills have always been an endogenous function of investment. The real problem is the lack of public and private investments in R&D, human capital formation (skills and training), and fixed capital. As early as 1821, David Ricardo worried about the effect of mechanization on labor displacement. What was important then, and should inform our thinking now, was that profits (from mechanization) be reinvested into production, meaning that, in Ricardo’s time, while some jobs fell away, others were created. Our focus today should also be on that kind of reinvestment, which can also help to tackle inequality.

This brings us to a key point: What economies need, today, is not only a new approach to investment, but also a New Deal in terms of reinvestment: a new compact between the public and private sectors that can lead to more inclusive growth. This should be part of a broader approach to market shaping to ensure social returns reflect the public investments that have been made including, for example, reforms to patenting (keeping them narrow and downstream) and conditions that profits generated from publicly supported innovation are reinvested back into innovation and not hoarded or used mainly for share buybacks.  Indeed, it was precisely this type of healthy deal making that led to AT&T being asked to set up Bell Labs in exchange for its monopoly status.

The Queen’s 2008 question touched a nerve. Eight years on, it is pertinent to ask what we have really learned, given the continuing problems of public and private investment. We should be willing to question core assumptions about how economies grow and what inhibits growth. It means understanding why inequality must become a central concern of economic policy, for economic reasons. It means re-evaluating the role of public and private actors in generating growth; what drives investment; and how far the direction of growth can be shaped to benefit society. It means rethinking the role of government, understanding how an entrepreneurial state can actively stimulate new private sector investment. It means bringing back the notion of public value to economics—beyond the narrow way that the public good has been used to create a small slice of activity for the public to invest in. It means, in short, rethinking capitalism.

Originally published at the Institute for New Economic Thinking.

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  • Peter Mersch

    An interesting article and I agree with most of its points. What seems to be missing is the evolutionary perspective.

    The second is that the grand societal challenges of the future—from climate change to the demographic crisis affecting much of the West—requires visionary thinking about future growth possibilities and a broad array of public investments to make those opportunities emerge. ‘Market failure’ theory is not adequate to understand this approach.

    The demographic crisis has a lot to do with missing investments into the future, especially with missing investments into “human capital”. Unfortunately in social sciences there dominates the opinion, that it does not matter whether John Doe or Prof. Dr. Dr. Sheldon Lee Cooper have children. With the right education all children of John Doe could achieve exactly the same competences as Sheldon’s children would have gained.

    Well, evolutionary theory contradicts. There is much evidence that a lot of psychological human characteristics are at least partially genetically controlled (intelligence, creativity, energy, discipline, endurance, frustration tolerance, willingness to cooperate, initiative, …). E.g. some people have fast brains, while other’s are slow. It is similar to computers which run the same software but have different fast processors. You can update the software (= education) all the time, but for a faster processor you usually have to buy a new computer (= other person).

    One of the strongest supports for such a view comes from Clark, Gregory (2014): The Son Also Rises. Surnames and the History of Social Mobility. Princeton, NJ: Princeton University Press. On page 126 the author summarizes:

    The preceding Chapters explain why social mobility is lower than traditionally measured. But why are mobility rates seemingly constant across very different social regimes? Here I conjecture that this is because status inheritance is indistinguishable in form from the inheritance of genetically controlled attributes. This is not to say that social status is determined genetically. But whatever drives it is, on the tests performed here, indistinguishable from genetic inheritance. Status may or may not be genetically inherited, but for all practical purposes, nature dominates nurture.

    And on page 128:

    However, suppose that even half of the variation in this generation’s income is caused directly by the variations in income in the parent generation and the effects of those family-income variations on investments in training and education. That is, assume that parent income matters as much as children’s abilities in determining outcomes. Those conditions preclude the pattern of correlations of measures of status across multiple generations that researchers are now finding. The correlations in measures like income should decline quickly over multiple generations. To get slow long-run mobility at the same time as fast short-run mobility, the great majority of outcomes must be attributed to underlying abilities. Income can play only a very modest direct role in producing outcomes if the process is to describe the low long-run mobility we observe.

    If family characteristics are to account for observed dynastic connections in status across as many as ten generations, they must be much more persistent between generations. The persistent element cannot be earnings, income or wealth, because these have been demonstrated to be fluid across generations within individual families. This is not to imply that resource investments in children have no effect on the outcomes of the next generation, but that effect must be modest.

    In Germany fertility rates are very low since more than 40 years. Even worse: The percentage of all children which are born into families with low income, low employment, low education and low skills is rising from year to year. A very large percentage of all families with 4 or more children belongs to this class.

    Most sociologists believe that the low fertility of the middle class is an opportunity for poor families, because their children can later take over the jobs of the childless middle class people. But as Gregory Clark found out the opposite is true: The missing investments into human reproduction lead to increasing inequality. One symptom of this process is the erosion of the middle class.

    I believe that the main reason for the destructive process is gender equality in combination with patriarchal family structure.

    First of all: If both men and women usually go to work there are – compared to patriarchal societies – more people competing for well-paid and demanding work. This results in a fall in wages.

    In western societies parents usually have to provide the resources for their own children (which is a key attribute of the “patriarchal family structure”). This may have been fair for families in patriarchal societies where men usually went to work (to provide the resources) while women raised their children (see: Betzig, Laura L. (1986): Despotism and Differential Reproduction. A Darwinian View of History. New York, NY: Aldine Publishing Company). Under this paradigm families did not have significant opportunity costs for children. This changed dramatically with gender equality. Now it is especially difficult for middle class people to raise children. They usually have a medium to good income but very high opportunity costs for children, especially as their jobs often require a lot of knowledge, flexibility and overtime working. On the other hand the resources for the children of poor families are provided by the welfare state (this is at least in Europe the case). This has led to a general shift of human reproduction from middle class to lower classes. Especially larger families now exist predominantly in lower classes (poor, low employment, low education, low skills, migration background).

    In “The Selfish Gene” Richard Dawkins explains the phenomenon in the following way (p. 117; paperback 1989):

    What has happened in modern civilized man is that family sizes are no longer limited by the finite resources that the individual can provide. If a husband and wife have more children than they can feed, the state, which means the rest of the population, simply steps in and keeps the surplus children alive and healthy. There is, in fact, nothing to stop a couple with no material resources at all having and rearing precisely as many children as the woman can physically bear. But the welfare state is a very unnatural thing. In nature, parents who have more children than they can support do not have many grandchildren, and their genes are not passed on to future generations. There is no need for altruistic restraint in the birth-rate, because there is no welfare state in nature.

    It is interesting that Richard Dawkins did not treat this case as a contradiction to his Selfish gene paradigm. Instead he declared the welfare state as “unnatural” (with the same argument he could declare honey bee colonies as unnatural too).

    Unfortunately feminism has always fought against alternative solutions for the dilemma. Europe’s probably most influential feminist Simone de Beauvoir (“The Second Sex”, ) once argued strongly against any paid family work (Friedan, Betty (1998): It Changed My Life: Writings on the Women’s Movement. Boston: Harvard University Press, p. 397):

    No, we don’t believe that any woman should have this choice. No woman should be authorized to stay at home to raise her children. Society should be totally different. Women should not have that choice, precisely because if there is such a choice, too many women will make that one. It is a way of forcing women in a certain direction.

    Any prominent European feminist I know supports this view until today.

    As I mentioned in some other comments, all life is – from a physicist’s point of view – comparative competency loss prevention (for me this seems to be not the best English, better English terms are welcome). In ancient societies women were primarily selected for their biological competencies (beauty, health, youth, sometimes intelligence). But in modern societies with gender equality they achieve a lot of cultural competencies (especially from education). With these cultural competencies they are able to gain their own resources (independently of men or the state). Bearing and raising children would prevent them in reproducing (and preserving) their cultural competencies (which allow them to gain their own resources). That makes it very unlikely that well educated modern middle class women will have more than one or two children. Not infrequently, they remain childless. In the long term this erodes the middle class and increases inequality. In Germany (and many other countries) it has led to the extremely unsocial result, that the proportion of poor children (though total fertility is very low) under all births is increasing from year to year.

    So what to do? One obvious solution would be to create a new paid profession (primarily) for women to raise their own children (essentially financed by childless people). This does not mean that every woman with children would be paid, but only those, who make the mandatory education for the job, apply for the job and get hired. All other families would have to raise their children under the current conditions. I am convinced that as long as there is no such job, equal rights for men and women are an illusion. Regarding human reproduction modern human societies currently behave like corporations which pay all staff members with the exception of the research & development department, because these members produce no immediate profit but a lot of costs. In the long run the missing investments into human capital lead to increased social inequality and social stagnation.

    Currently a qualified young woman can try to become a successful stock trader at Wall Street, a teacher for children of other families or even “the next Sasha Grey” to earn a good income. But she cannot say: “Our society needs more well educated, well-behaved children? Well, I am willing to do the job. But only if I am sufficiently paid for this extremely important task.” As long as she cannot say something like this there is no real gender equality. I am convinced that the current “patriarchal” family structure is not compatible with gender equality.

    I would call the proposed new job an investment into human capital. There are alternative proposals like to pay every citizen a basic income, but you really can’t name this an investment into the future.

  • anotherneighborhoodactivist

    We should be willing to question core assumptions about how economies grow and what inhibits growth.

    How about the fact that there are limits to growth? The concept of limits appears to be missing from the author’s world view let alone her economic analysis.

  • GaryReber

    The key to growing the economy and creating new owners of new income-producing wealth is thedemocratization of access to productive capital credit. The Capital Homestead Act would employ the Fed’s existing powers under Section 13 of the Federal Reserve Act and make the Fed’s money power accessible directly to every American.
    By reorganizing the Federal Reserve System and its twelve regional banks into a “fourth branch of government,” every citizen can become a shareholder of this basic institution of money creation. Why “End the Fed,” as some are calling for, when we as citizens should “Own the Fed”?
    No longer should the Federal Reserve and our tax system merely serve the special interests of a financial elite or become the tool of the Federal government for financing war and deficit spending. “We the People” must be empowered to hold the Fed accountable and to return it to its true social purpose. With changes in our tax and monetary policies, as embodied in the comprehensive economic plan called “the Capital Homestead Act,” we could create sound, asset-backed money for sustainable private sector growth, and liberate every child, woman and man as a direct owner of new productive wealth.

  • GaryReber

    Below is a scenario that will accomplish broadened ownership of productive capital simultaneously with the growth of the economy.

    The common belief is that you can’t get money for investment––to buy capital (productive assets)––except by saving it yourself or borrowing it or just taking it away from somebody who has managed to save, is true. But this belief has a critical error, it assumes that the only way to save is to cut consumption and accumulate cash. And this therefore is what Louis Kelso and Mortimer Adler called “the slavery of past savings,” which was written about in the book “The New Capitalist.”

    Beyond conventional thinking there is another way: Let the capital pay for itself out of its “own” future earnings. Anybody can “create money” by promising to pay for something he or she receives now or in the future and having the promise accepted. It’s called “credit.” When it’s used to purchase food, clothing and shelter (consumer goods) now and pay later, it’s called “consumer credit,” and it’s pretty much the worst form of credit possible. When it’s used to purchase productive capital that pays for itself out of future earnings, it’s called “capital credit,” and can be the very best form of credit––and of creating money and help finance future growth, which this economy sorely needs.

    This is called “future savings.” Instead of reducing consumption in the past or now to finance new capital, increase future production from new capital that you’ve promised to pay for, out of future profits. You don’t save to save now, produce later. You can produce now, and save later. In other words, get “capital credit” now. Credit is nothing more than a promise to repay a loan out of future profits. You can use the promise itself as money to buy capital, then use what the capital produces to repay the loan. It’s a lot easier and faster than saving now and then producing later, and is much broader and larger in scale. It is the same basic architectural model of financing used by every 100 percent leveraged Employee Stock Ownership Plan (ESOP).

    Here is how, it could work. You would get a notice in the mail from the federal government that the Congress passed the Capital Homestead Act of 201_. A government survey of the capital growth needs of the economy has been determined that in the coming year, new and existing small and large “for-profit” companies want to sell $2.31 trillion (with a capital ‘T’) worth of newly-issued, full dividend payout, full voting shares to meet their growth and modernization needs in response to the demands of their U.S. and global customers. The Act gives all financially sound companies a way to invest in new capital and create new jobs to meet new customer demand for new and better products and services and even begin to construct and modernize new infrastructure through citizen-owned for-profit corporations. The obvious keywords, is new and citizen owned.

    The notice informs you that, as a new right of citizenship under the Act, like the political ballot, you have the right, if you choose, to receive a free government-issued Capital Credit Card that for the coming year will entitle you to receive free of charge capital credit to purchase $7,000 worth of the newly-issued shares of “qualified” companies with interest-free “new money.” The Capital Credit Card isn’t money, but it allows you to get productive credit, another form of money, to buy capital (productive assets) that can pay for itself.
    You will not be at risk if the loan cannot be paid off, because the loan will be insured by one of several “qualified” private capital credit insurance companies and/or reinsured by a for-profit Capital Credit Reinsurance Company established by many capital credit insurers, and not government insurance. Your loan is to be entirely backed by the anticipated profits in the form of dividends on each of the “qualified” shares that you, with your advisors, decide you wish to buy, with added backup from the capital insurance pool if the shares fail to earn a dividend. After the Capital Credit loan on each of the shares is repaid, you will receive outright all future dividends directly as “supplemental income” over and above income received from your work (job) and all other sources.

    The notice would also inform you (and your family members) that you should go down to your local commercial bank that is a member of the Federal Reserve System to set up in your own name a “Capital Homestead Account” (CHA). Like an Individual Retirement Account or “Super-IRA,” a CHA would be a “tax-shelter” for you to build up a growing accumulation of income-producing investments to meet your future consumption needs. Your CHA is designed to distribute dividend incomes during your working career as well as when you retire or become disabled.
    Like · Reply · 1 min

    Gary Reber Your Capital Credit Card would authorize your CHA “tax shelter” to be the legal vehicle for receiving each year’s loan to purchase “qualified” shares that you want to buy from the market––and would allow you to defer taxes on the income used to purchase the shares until you take the assets out of the CHA or die––at which point the assets become income to your heirs, not to the estate. The heirs, not the estate, pays taxes, unless the heirs put the assets into their own CHAs, in which case taxes are again deferred.

    Each annual loan for buying additional shares would take the form of a promissory note backed with a “bill of exchange” that you “draw” or “issue.” Your bill (which, like any bill, has to be paid) is backed in turn by the full stream of future profits paid out to your CHA. These anticipated (but obviously uncertain) future profits would in turn be backed by the “future savings.” These future savings take the form of the future capital products and future consumer products and services that the company issuing the new shares expects to produce with the money the companies receive from the sale of shares to your CHA.

    The local commercial bank “discounts” your bill of exchange (gives you less than the face value of the bill), issuing a promissory note in return. The discount covers the cost of the bank’s own services and the risk premiums to be paid out of future dividends expected on the shares purchased by your CHA. Each bank’s promissory note is thus a form of asset-backed (non-fractional) “money” over and above money issued by the government in the form of coins and official currency. Bills of exchange discounted by member banks of the Fed can be rediscounted in the financial markets or directly at the (re)discount window of the regional Federal Reserve Bank to be backed by the Fed’s promissory notes: newly-issued currency or Fed demand deposit accounts under Section 13, paragraph 2 of the Federal Reserve Act. In other words, “money” is anything that can be used in settlement of a debt, and new capital credit can be created in ways that it can be repaid entirely with “future savings,” making it possible for today’s propertyless to own future productive capital. Maybe your entire family could open their Capital Homestead Accounts at the same time.

    And that is how we will finance the future and help pay down the national debt.

    Help Pass Capital Homesteading Now! Support the Capital Homestead Act (aka Economic Democracy Act) at,…/capital-homestead-act-a-plan-for…/,…/capital-homestead-act-summary/ and

  • noergler

    Growth, growth, growth… the cure for every economic ailment.

    “Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist”, Kenneth Boulding,

    • anotherneighborhoodactivist

      I posted basically the same point “a month ago.” Note how much response it got. We as a society/species appear to be psychologically incapable of dealing with the fact that there are limits. Here’s a good essay on the subject: Wendell Berry’s “Faustian Economics”.