Crony Capitalism and Stagnation, Connecting the Dots

Ashwin Parameswaran has an excellent piece up over at Macroeconomic Resilience on the intersection of  economic innovation and technological progress, crony capitalism, complex system dynamics, and unemployment. To quote from the post’s conclusion:
Ashwin Parameswaran. Macroeconomic Resilience. 24 November 2010.

Due to insufficient exploratory innovation, a crony capitalist economy is not diverse enough. But this does not imply that the system is fragile either at firm/micro level or at the level of the macroeconomy. In the absence of any risk of being displaced by new entrants, incumbent firms can simply maintain significant financial slack. If incumbents do maintain significant financial slack, sustainable full employment is impossible almost by definition. However, full employment can be achieved temporarily in two ways: Either incumbent corporates can gradually give up their financial slack and lever up as the period of stability extends as Minsky’s Financial Instability Hypothesis (FIH) would predict, or the household or government sector can lever up to compensate for the slack held by the corporate sector.

Whatever the chosen solution, full employment is unsustainable in the long run unless the core problem of cronyism is tackled. The current over-leveraged state of the consumer in the developed world can be papered over by increased government spending but in the face of increased cronyism, it only kicks the can further down the road. Restoring corporate animal spirits depends upon corporate slack being utilised in exploratory investment, which as discussed above is inconsistent with a cronyist economy….

At the appropriate mix of exploration and exploitation, individual incumbent and new entrant firms are both incredibly vulnerable. Most exploratory investments are destined to fail as are most firms, sooner or later. Yet due to the diversity of firm-level strategies, the macroeconomy of vulnerable firms is incredibly resilient. At the same time, the transfer of wealth from incumbent corporates to the household sector via reduced corporate slack and increased investment means that sustainable full employment can be achieved without undue leverage. The only question is whether we can break out of the Olsonian special interest trap without having to suffer a systemic collapse in the process.

Mr. Parameswaran’s post is on the denser side, but time taken to understand his argument is time well spent. I recommend that all those concerned with the danger posed by an entrenched and exploitative elite or those generally interested in economics and system dynamics read his post in full

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