Uncertainty and the Institutional Structure of Capitalist Economies
Hyman P. Minsky
Levy Economics Institute WP #155
In this working paper Distinguished Scholar Hyman P. Minsky explores the theoretical and practical causes of today's rising economic uncertainty and insecurity. He begins by noting views of uncertainty held by Keynes and adherents of the new classical economics by comparing Keynes' The Treatise on Probability and Sargent's Bounded Rationality in Macroeconomics. According to both views, decisions are made by agents based on varying degrees of ignorance and supposition; the agents have a more or less limited amount of knowledge and base their judgements on their own idea of how the economy works (their "model of the model"). In addition, agents are not homogeneous but have differing abilities and histories. Thus the internal models used to guide decisions are not consistent from agent to agent. Minsky notes that although according to Sargent's concept of bounded rationality all agents at any one time need not be acting according to mutually consistent models, Sargent ignores a point stressed by Keynes about the decision-making process: Economic events at any one time are the result of past mental models (and corresponding actions and expectations), and those past models are different from current models (and correspondingly different actions and expectations); therefore, factors that might determine long-term expectations are in a continuous state of flux. Despite this difference, the gap between the ideas of the two schools of thought have narrowed. Minsky points out that capitalism in the United States is an ever-evolving construct that recently entered a new stage: money manager capitalism. In this form of capitalism, nearly all businesses are organized as corporations; pension and mutual funds are the predominant owners of financial assets; and managers of these funds are judged solely on the total return on fund assets (dividends and interest plus appreciation in share value). One consequence of the money manager structure is predominance of short-run considerations in decision making.Historically, the public has had limited tolerance for uncertainty. During the New Deal era this intolerance led to the creation of institutions and arrangements to reduce uncertainty and create transparency in both financial markets and corporate governance. For example, crop insurance set floors to farmers' incomes, and deficits run by the federal government set floors to aggregate profit flows. However, the focus of money manager capitalism on short-run returns and uncompromised profit margins has increased economic uncertainty at the firm and plant levels through the chronic need to reduce overhead and variable costs. These activities have unraveled the traditional relationships between firms and workers and increased economic insecurity among employees. Minsky asserts that since existing institutions and arrangements cannot contain this uncertainty, new institutions and arrangements must be created to offset the effects felt by the "losers" in the gamble imposed by uncertainty. Such measures are necessary to prevent these individuals from becoming alienated and hence recruits for an alternative to democracy. Accepting the view of Henry Simons that the focus of economic policy is not narrowly the economy but rather to "assure that the economic prerequisites for sustaining the civil and civilized standards of an open liberal society exist," Minsky suggests that full employment programs analogous to certain New Deal programs (the Works Progress Administration, the Civilian Conservation Corps, and the National Youth Administration, for example) should be considered to meet these goals.How would such programs be financed? According to Minsky, the U.S. economy has ample resources, but the question is one of how willing we are to mobilize these resources, that is, to tax and borrow for such projects. For example, welfare in its current form (AFDC and food stamps) exists because it is the cheapest way (short of a policy of doing nothing at all) to take that ratio care of the population in need. Full employment policies are more humane but more expensive and require a larger and more innovative public sector. For government to institute programs to offset the uncertainties of money manager capitalism, it must validate government debt with government revenues. The current high rate of government debt to gross domestic product (GDP) is the result of the irresponsible fiscal policies of the 1980s; a responsible program would assure the decline of the ratio of federal debt to GDP over time from its current 65 percent to about 50 percent. The reduction could be accomplished by transforming the tax structure to a value-added revenue system in which, for example, the individual income tax is replaced by a progressive consumption tax with broad bands and a high per person deduction and value-added taxes are levied on production or distribution and on imports. Imposing such a revenue system would allow the United States to transform its economy from one based on transfer payments to a full employment economy, from one that generates resentment to one that maintains commitment to democracy.
JEL Classification: B22, E19, E20
Date posted: July 28, 1997