Keynes famously said that in the long-run we are all dead. What he was counseling against was the tendency on the part of economists to discuss economic processes in terms of the so-called ‘long-run’. This idea, which I have written about more extensively here, often leads economists to think in the most metaphysical of terms, concocting imaginary worlds in which logical processes work themselves out with ease and then conflating an confusing these imaginary worlds with reality. Keynes’ implicit advice was that economists should largely concern themselves with the short-run.
Yesterday I attended a conference at which a number of economists considered the long-run at length but in a way that, I think, Keynes would have approved. The conference was entitled Financial Governance for Innovation and Social Inclusion and it was largely concerned with the fact that capital markets are very poor at financing long-term investments — particularly those that have to do with basic research. Centered around the excellent work of Marianna Mazzucato, who organised the conference, a variety of economists tried to trash out the implications of what this empirical fact has for the future developments of the capital infrastructure of our economies.
Long ago Keynes recognised that long-term investments carried with them an enormous amount of uncertainty. In chapter 12 of the General Theory Keynes wrote,
The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made. Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing; or even five years hence. In fact, those who seriously attempt to make any such estimate are often so much in the minority that their behaviour does not govern the market.
These considerations led Keynes to conclude that there was a major role for the state in making investments that carried with them a very high degree of uncertainty.
Here, however, I think it might be interesting to highlight and emphasise the last sentence in that quote as it resonates very loudly today in our modern world of risk-modelling that is used to channel resources in our economies. Such risk-modelling is geared, quite organically, to the short-term. In order to understand why consider the CAPM, a financial model that is often used to price assets in capital markets. (I have written extensively on and criticised the CAPM here).
The CAPM tries to estimate the price of an asset based on how risky it is vis-a-vis the rest of the market. This effectively comes down to how much volatility the asset has relative to the overall volatility of the market. The reasons that this favours short-termism should be obvious; first of all, it requires data to be inputted and since data is unavailable for a new innovation or an asset that will have a very long life running into the future it is clear that the CAPM is completely unsuitable for such investments; secondly, it requires a measure of probabilistic risk that will only likely hold (if it holds at all) into the very near term.
Of course, CAPM is not the only means to mathematically estimate the return on investments, but other methods face similar difficulties. When we discuss a market for an asset that has long been in existence and our position in that asset is only fairly short-term, using probability estimates may be somewhat functional. If, however, we are talking about a new innovation or a very long-term investment that we will have to carry far into the future such models are quite literally meaningless.
And yet the capital markets are becoming increasingly dominated by such techniques by the day. Why? Because, despite the mythic figure of the private sector entrepreneur that our press and politicians present to us, the reality is that private sector investors are usually extremely risk averse. They are usually looking for a great deal of certainty that their investment will make an x% return of a set period.
We should not blame private investors for this, indeed it is their savings that we are talking about here, but the fact of the matter is that they then employ legions of managers to try as best they can to reduce uncertainty and make the returns that they require. This, in turn, results in a massive proliferation of financial bureaucrats that seek desperately and as best they can to meet portfolio targets in a manner not unlike how a government bureaucrat tries to meet their set targets. The result is an industry that is irreducibly conservative, grey, dull and boring.
This truth — which is so obvious to anyone who has even ventured onto a website of a modern day financial firm — tends to turn the myths that we are fed every day on their heads. Private sector capital tends to be extremely conservative in its uses. Such capital is channeled to rather dull people who try desperately to control the world based on probability estimates and who resemble less a rugged entrepreneur and more a Soviet bureaucrat trying to meet production targets.
But now that we are coming more and more to rely on these bureaucrats to manage the capital structure of our economies we can be sure that innovation will gradually slow to a crawl and short-termism will increasingly come to the fore. Unless states act to the contrary more and more people who should be doing real scientific research will be channeled into the Politburos that we call ‘financial districts’ in our major cities in order to try to control the future in the tragi-comic way that brainy bureaucrat-types tend to try to control things over which they have no grasp.
Such a future is nothing short of bleak. Where the planners in the Soviet Union tore that economic system apart with their misguided attempts to steer a vehicle over which they had no command, our modern planners have gained control over the money needed to channel resources in such a way that the capital infrastructure of the economy develops in an innovative manner.