In this post, I apply the framework outlined previously to some empirical patterns in the financial markets and the broader economy. The objective is not to posit crony capitalism as the sole explanation of the below patterns, but merely to argue that the below patterns are consistent with an increasingly crony capitalist economy.

The Paradox of Low Volatility and High Correlation

As many commentators have pointed out [1,2,3], the spike in volatility experienced during the depths of the financial crisis has largely reversed itself but correlation within equities and between various risky asset classes has kept on moving higher. The combination of high volatility and high correlation is associated with the process of collapse and typical of the Minsky moment when the system undergoes a rapid delevering. However the combination of high correlation and low volatility post the Minsky moment is unusual. In the absence of bailouts or protectionism, the economy should undergo a process of creative destruction and intense exploratory activity which by its diffuse nature results in low correlation. The combination of high correlation and low volatility instead signifies stasis and the absence of sufficient exploration in the economy, alongwith the presence of significant slack at firm level (micro-resilience).

As I mentioned in a previous post, financing constraints faced by small businesses hinder new firm entry across industries. Expanding lending to new firms is an act of exploration and incumbent banks are almost certainly content with exploiting their known and low-risk sources of income instead.

The Paradox of High Corporate Profitability, Rising Productivity and High Unemployment and The Paradox of High Cash Balances and High Debt Issuance

Although corporate profitability is not at an all-time high, it has recovered at an unusually rapid pace compared to the nonexistent recovery in employment and wages. The recovery in corporate profits has been driven by a rise in worker productivity and increased efficiency but the lag between an output recovery and an employment recovery seems to have increased dramatically. So far, this increased profitability has led not to increased business investment but to increased cash holdings by corporates. Big corporates with easy access to debt markets have even chosen to tap the debt markets simply for the purpose of increasing cash holdings.

Again, incumbent corporates are eager to squeeze efficiencies out of their current operations including downsizing the labour force but instead of channeling the savings from this increased efficiency into exploratory investment, they choose to increase holdings of liquid assets. In an environment where incumbents are under limited threat of being superceded by exploratory new entrants, holding cash is an extremely effective way to retain optionality (a strategy that is much less effective if the pace of exploratory innovation is high as an extended period of standing on the sidelines of exploratory activity can degrade the ability of the incumbent to rejoin the fray). Old jobs are being destroyed by the optimising activities of incumbents but the exploration required to create new jobs does not take place.

This discussion of profitability and unemployment echoes many of the common concerns of the far left. This is not a coincidence - one of the most damaging effects of Olsonian cronyism is its malformation of the economy from a positive-sum game into an increasingly zero-sum game. The dynamics of a predominantly crony capitalist economy are closer to a Marxian class struggle than they are to a competitive free-market economy. However, where I differ significantly from the left is in the proposed cure for the disease. For example, incumbent investment can be triggered by an increase in leverage by another sector - given the indebted state of the consumer, the government is the most likely candidate. But such a policy does nothing to tackle the reduced evolvability of the economy or the dominance of the incumbent special interest groups. Moreover, increased taxation and transfers of wealth to other organised groups such as labour only aggravate the ossification of the economic system into an increasingly zero-sum game. A sustainable solution must restore the positive-sum dynamics that are the essence of Schumpeterian capitalism. Such a solution involves reducing the power of the incumbent corporates and transferring wealth from incumbent corporates towards households not by taxation or protectionism but by restoring the invisible foot of new firm entry.


Stefan Stackhouse

Exactly right. I have always thought that bailing out the big dinosaurs was a huge mistake with very unfortunate long-term consequences for the US economy. By keeping the dinosaurs on life support, we have denied the little guys scurrying around in the underbrush the opportunity to grow and become the new big guys. This does indeed convert one of the world's most dynamic economies into just another static, slowly dying one. Of course, it is quite obvious that this happened because the big dinosaurs paid very well to assure it would happen. We do indeed have the best government that money can buy. I don't know if anything short of torches, pitchforks, and nooses slung over lamp posts can effect change for the better, but I still hope something more peaceful and less catastrophic can still bring about needed changes. Thanks so much for this article.


Stefan - Thanks for the comment. We all hope that the changes can come about via something less traumatic than a systemic collapse!

Mick Costigan

I discovered your blog today and have read everything you've written. I want to extended my sincerest congratulations for the whole blog but particularly for this tour de force double post. I've been exploring many of the same thinkers on uncertainty, ecology and heterodox economics and finance for several years but until now had not found anyone who linked the disparate ideas together as clearly and compellingly. I am a little bowled over right now (having read everything) but will be in touch soon with some more structured thoughts. Well done!


Mick - Thanks! Look forward to hearing your thoughts.

Bruce Wilder

Reading through your essays provokes in me a jumble of thoughts: as you make connections, I make connections. I do think macroeconomics, in the era of ratex, representative agents and DSGE models is extremely impoverished, and certainly not just because the economists threw Keynes overboard. I liked the big cycles within cycles theories of the business cycle, and think the connections between the financial economy and the so-called "real" economy are not touched by the fantasists doing RBC. Honestly, I don't know much about macro, after ~1970 intermediate college macro reading The General Theory, though I have heard Minsky, but I loved James March and Mancur Olson, when I read some their classic essays many years ago, so these connections you are making really delighted me. I may leave some comments reacting to your ideas, in part just to sort out my own jumble. If I structure these around demurrals, and, in defining terms, spell things out in simple, fundamental terms, please don't think I'm being hostile in my critique. I really admire your effort, here. And, if I reveal deficiencies in my reading comprehension, well, it won't be the first time.


Bruce - Thanks for reading. Most of my essays get posted when I get tired of self-critiquing them so please don't hold back on the critique!


Hi Ashwin, Great post, very good synthesis. I wanted to check if you were aware of Henry George's idea of the single tax on land. By having a tax on land, capturing a substantial portion of the ground rent, one can eliminate a number of barriers to new entry of firms. Lower tax rate on incomes and corporates, resulting in more firms, more potential customers and suppliers. Lower wastage of valuable city space, forcing an initial densification, which reduces search costs for new firms and increases potential for local products and services. Lower initial cost of land leading to lower capital cost. Entrepreneurs who don't own land today anyway end up paying a regular amount spread over multiple years, either as rent or as repayment of mortgage. In the land tax system, most of this would be given as a tax.


Prakash - Thanks. I'm aware of the idea but don't have much of an informed opinion on it.

Operation Twist and the Limits of Monetary Policy in a Credit Economy at Macroeconomic Resilience

[...] The ability of incumbent firms to hold their powder dry and hold cash as a defence against disruptively innovative threats is in fact enhanced by policies like ‘Operation Twist’ that flatten the yield curve. Firms find it worthwhile to issue bonds and hold cash due to the low negative carry of doing so when the yield curve is flat, a phenomenon that is responsible for the paradox of high corporate cash balances combined with simultaneous debt issuance. [...]