Minsky’s Analysis of Capitalist Development

2.1. Minsky’s stages of capitalism

For a long time, Minsky’s work was limited to analyzing the mechanisms that lead to crises in capitalism. Better known as the financial instability hypothesis (FIH), this body of work fits within a short- and mid-term perspective. Not until the mid-1980s, when he realized that the U.S. economy had changed radically, did Minsky feel the need to analyze the structural evolution of American capitalism. In the Minskyan analysis of the evolution of capitalism, the challenge was threefold: propose an intertemporal comparison of the various phases of capitalism; place FIH in context; and last, provide an explanation for capitalism’s resilience. In this perspective, capitalism evolves through stages and this capacity to change and adopt different forms is the reason behind its resilience. In fact, Minsky used to say that capitalism comes in “as many varieties [. . .] as Heinz has pickles” (Minsky 1991b). Through a series of articles, Minsky considered that “[t]he task confronting economics today may be characterized as a need to integrate Schumpeter’s vision of a resilient intertemporal capitalist process with Keynes’s hard insights into the fragility introduced into the capitalist accumulation process by some inescapable properties of capitalist financial structures” (Minsky 1986b: 121). Keynes’s hard insights were already present in FIH; Schumpeter’s vision must be added.

In his articles focused on the evolution of capitalism, Minsky identified at least four stages, ranging from merchant capitalism to money manager capitalism (MMC), across the intermediary forms of financial capitalism and “managerial-welfare state” (or paternalistic) capitalism (Minsky 1989, 1990, 1992, 1993a). ³

In its earliest phase, merchant or commercial capitalism (1607-1813), “[. . .] only trade is financed by the banking system and organized financial markets” (Minsky 1990: 66). This form of capitalism, which emerged out of European feudal societies, gave a substantial place to merchants, who dominated the economic scene. The promissory note developed because “such a bill is drawn on a banker and asserts that the banker guarantees that the receiver of goods will pay the shipper” (Minsky 1993a: 107). This form of capitalism survived until the financing of productive activities was hampered by the high dependence of capital growth on external capital (Minsky and Whalen 1996).

Next came “financial capitalism,” an expression borrowed from Hilferding, whereby Minsky designates a new phase of capitalism dominated by financial relationships. This stage is characterized by the development of powerful banks and heavyweights of industrial production: it “[. . .] was the era of the houses of Rothschild and Morgan” (Minsky 1990: 67). Along with the rise of these major firms, the New York Stock Exchange was organized, and investment banks such as J. P. Morgan emerged, later to become the main institutions of financial markets, with the goal of “[. . .] acting as brokers when facilitating the trade of existing securities, and as operators when underwriting new securities” (Minsky 1993a: 108-109). This capitalism, which fell with the 1929 crisis, was one of small government with the central bank absent from its role as lender of last resort (LOLR).

Managerial-welfare state or paternalistic capitalism is characterized by the state’s growing importance in economic activity. This phase of capitalism, which began after World War II, is marked by big government. It ushered in a period of unheard-of economic prosperity that gradually lost momentum and ended with the first warning signs of the 1966 “credit crunch” and the oil shocks of the early 1970s. However, note that no period of debt deflation occurred. For Minsky, “[. . .] the absence of widespread depressions is a good side effect of the successful Welfare State” (Minsky 1990: 69). This era of big government gradually yielded in the 1970s to a new phase: money manager capitalism (MMC).

Following the postwar Keynesian period, a new era of capitalism took hold, which Minsky calls “money manager capitalism.” In this phase, markets and financial arrangements are dominated by money managers (Minsky and Whalen 1996). Born out of the ashes of the welfare state and an ideological shift that swept away the remnants of the capital accumulation regime of the postwar boom years, this new form of capitalism enabled the rise of major financial institutions such as pension funds, mutual funds, insurance companies, and large banking trusts (Minsky 1989, 1990, 1993a).

Regarding the conditions for the rise of MMC, we can say that the emergence of this last stage can be seen as the result, in part, of the changes described by the financial instability hypothesis. Indeed, the long period of stability after World War II deterred cautious agents from maintaining safety margins applied to loans and borrowing. But another explanation of this emergence is provided by institutional and ideological changes that transform the way American capitalism works. Thus, the end of managerial capitalism, which notably came about because productivity gains were exhausted, breaking the wage compromise and drying up domestic demand (Boyer and Orléan 1991; Boyer 2004; Lordon 2009). Faced with this lackluster domestic market, commercial strategies refocused on exports, gradually enabling the finance sector to be freed of national constraints and regulations. This is the beginning of autonomization of finance under the effect of its internationalization and the era of money managers: institutional investors (private equity funds, hedge funds, venture capital funds, and mutual and pension funds) that manage large amounts of funds and impose new forms of governance on firms and banks.

Moreover, if Minsky used the term money manager capitalism, he did so to refer to the omnipotence of money managers in this economic system. In fact, the main characteristic of the current stage is the sacrosanct status of shareholder value: “the sole criterion by which [the money managers] are judged – is the maximization of the value of the investments made by the fund holders. This is measured by the total return on assets: the combination of dividends and interest received and the appreciation in per share value” (Minsky and Whalen 1996: 158). This is a phase of capitalism in which a decisive role is given to the profitability of stock market assets, both in terms of value creation and distribution. Long-term objectives became a luxury that could not be reached by financial and industrial organizations.

Another main characteristic of this stage of capitalism is the decline in workers’ incomes. According to Minsky and Whalen, “[n]umerous explanations have been proposed to account for the falling worker incomes and rising instability, inequality and insecurity of the past two decades [. . .]. Despite the relevance of [those] factors, one crucial element has been left out – the evolution of financial structure” (ibid.: 156). Thus, Minsky’s works on contemporary capitalism include a dimension related to distributive conflict. In other words, there is already an analysis of wage deflation that will be decisive in the case of the subprime crisis.

This presentation of the various stages of capitalism that Minsky made toward the end of his life is a way to identify the structural evolution of economic systems over long periods of time. The characterization of the current phase is much more comprehensive than for the previous ones. This therefore could mean that the rise of the last stage of capitalism and the resulting new instability problems fueled Minsky’s need to theorize capitalism. ⁴ In the rest of this article, I will offer a critical interpretation of these works to show what separates them from a rationalization of capitalism.

2.2. Weaknesses in Minsky’s analysis of the evolution of capitalism

The descriptive nature of Minsky’s works on the evolution of capitalism opens it up to easy criticism for lacking an analytic dimension. The analytic shortfall can be seen on several levels. First, there is a lack of set criteria to differentiate the various stages of capitalism; while corporate governance structure and labor market characteristics are only present in the features mentioned by Minsky for the last two phases of capitalism, the role of finance and the size of government (big government ⁵ vs. small government) play a decisive role in distinguishing between the various phases of capitalism.

The second potential criticism looks at the role of finance, which Minsky also presents as a criterion for distinguishing between the various phases: “[t]hese stages are related to what is financed and who does the proximate finance” (Minsky 1993a: 107), as it does not easily explain the transition from one phase to the next either. Nor are the questions that Whalen (1999) proposes to answer in order to follow capitalism’s progression and to differentiate the stages of capitalism ⁶ impermeable to criticism regarding the factors of evolution. Moreover, an analysis based on the weight of finance also has the disadvantage of not showing that each phase has its own institutional arrangement that makes capitalism’s dynamic stability possible. Likewise, it does not show that the successive phases of capitalism are a series of institutional reconfigurations that lead to new stable regimes. This analysis is less focused on the reasons that explain why coherent growth models can be destabilized and give rise to crises, and more focused on identifying the role of finance in economic activity.

The third criticism involves the distinction between the different phases based on the size of government. This criticism emphasizes the fact that to distinguish between the last two phases of capitalism, the size of government is not a relevant criterion because in both postwar capitalism and money manager capitalism we were in an era of big government. ⁷ The only slight difference is that with MMC, we have seen a refocusing of government intervention, which has taken on a disciplinary nature in order to guarantee the proper functioning of markets. Indeed, after agreeing on the fact that the market at the center of the current phase of capitalism is not a natural entity but a construction, government presence is more than necessary to protect competition. The size of government is therefore not always a relevant distinguishing criterion. Minsky himself acknowledged that the Reagan era coincided with “[. . .] an explosion of the government debt relative to gross domestic product over the 12 years of Reagan-Bush [that] was largely due to an irresponsible fiscal policy, [an explosion which] undermined the revenue system even as it did not reign in government spending, mainly on defense but also on transfer payments” (Minsky 1996: 366). In the same vein, Wray uses the notion of “predator state” ⁸ to refer to a big government that acts in the interest of money managers under the cover of laissez-faire marketing, and this played a key role in the transition from paternalistic capitalism to money manager capitalism (Wray 2009: 815).

Thus, the size of government is not a sufficiently robust distinguishing criterion to understand the evolution of capitalism and to pick out its phases. We may wonder why Minsky persisted in this erroneous analysis. We can assume that he underestimated one of the aspects of contemporary capitalism that he himself highlighted. This is a means of insisting on the fact that Minsky’s analysis of the evolution of capitalism is influenced by his system for handling a crisis. A syllogistic reasoning highlights the origins of this error. Major premise: the phases of capitalism are distinguished by their robustness and resilience to financial instability; minor premise: big government gives a means to cope with financial crises; ⁹ therefore, the size of government is a distinctive criterion as soon as a stable phase of capitalism gives way to an unstable phase. We have seen how contemporary capitalism adapts to the government’s presence and calls into question the idea that the size of government is a characteristic that enables us to follow the evolution of capitalism.

These criticisms are important but they do not highlight the main limitation in Minsky’s research on the evolution of capitalism. In my view, this limitation lies in the fact that this research fails to propose an analysis of institutional change, whereas such an analysis is necessary to understanding the transition between the various phases of capitalism.

Yet in a series of writings on institutions, Minsky has two main ideas that can be used, in my view, to think of the evolution of capitalism. The first is cited by Papadimitriou and Wray: “Institutions must be brought into the analysis at the beginning; useful theory is institution specific” (1998: 201). The second can be summarized as follows: the institutional structure evolves in response to profit-seeking activity. Thus, in a series of articles in the 1990s (Minsky 1992, 1996; Delli Gatti, Gallegati, and Minsky 1994; Minsky and Whalen 1996), Minsky insists on the importance of institutional analysis for understanding the trends in capitalism. While some Post-Keynesians are tempted to place institutions on a secondary level in order to build general theories, Minsky distances himself from generalist approaches and claims a theoretical construction whose usefulness derives from its specificity. This specificity takes into account particular features and provides a framework for explaining reality, which is diverse in nature. From this standpoint, taking institutions into account means assuming a form of relativism that does not renounce understanding economic systems, but instead urges them to be viewed in their multiple dimensions. Thus, the institution holds a major role in Minsky’s work. However, when reading Minsky’s writings in search of a clear and distinct definition of this reputedly central element, we are left dissatisfied; the word “institution” recedes with each conceptual investigation.

Indeed, there is no conceptual definition of institutions in Minsky’s research. Institutions are viewed via their functions: at times, they prevent risk-taking from occurring on a widespread basis (during the ascendant phase of the cycle); at other times, they curb downward spirals that could lead to debt deflation (once a crisis has broken out). According to this functionalist approach, when analyzing the viability of the capitalist regime, and thus understanding the mechanisms that drive the transition to financial weakness or debt deflation, institutions have a stabilizing role: “[t]o contain the evils that market systems can inflict, capitalist economies developed sets of institutions and authorities, which can be characterized as the equivalent of circuit breakers. These institutions in effect stop the economic processes that breed the incoherence, and restart the economy with new initial conditions and perhaps with new reaction coefficients” (Delli Gatti, Gallegati, and Minsky 1994: 6).

Thus, there is a certain contradiction between Minsky’s claims that institutions hold a central place in his system, and the lack of a conceptualization of institution. Due to this hiatus, it becomes difficult to conceive of institutional change. Thus, the main stumbling block in Minsky’s theory of the development of capitalism is linked to the weakness of his institutional analysis: he fails to propose an analysis of institutional change, whereas such an analysis is necessary for understanding the transition from one phase to the next. Hence the difficulty, within Minsky’s analytical framework, of highlighting the factors for a breaking point and the emergence of a new institutionalized compromise.

4.1. Institutional Change and FIH

Minsky shares FRT’s idea that an institutional configuration can initially favor an accumulation trend, then erode into a structural crisis. More than simple endogeneity of the cycle, this convergence of viewpoints between Minsky and FRT emphasizes that the seeds of instability are to be found in the success factors of the said configuration. However, this similarity should not obscure an essential divergence: while FRT is based on the long movement of transformation of institutional forms, under the impetus of a changing balance of powers, Minsky’s analysis gives particular importance to psychological factors to explain the crisis trend. In Minsky’s perspective, after a long period of tranquility, economic agents become overenthusiastic with recent successes, leading to a surge in investment and debt levels. This surge leads to a crisis if financing conditions evolve unfavorably.

Apart from this argument based on psychological motivations (memory-euphoria), Minsky says nothing about the explanatory factors for institutional change in the pre-crisis period. This fact opens him up to criticism of lacking precision in formulating his thoughts. This criticism focuses on two key concepts of Minsky’s theory: memories and anticipations modulated by length of time. Given the paradox of tranquility, the longer the period of economic expansion and stability, the more frequently investors and bankers will have risky behavior. However, this assertion is made without resolving the question of the necessary length of time for memories of crisis periods to be imprinted in investors’ animal spirits. Yet we know how difficult it is in social sciences to discern or assess psychological variables, and this calls into question FIH’s relevance to interpreting crises insofar as it says nothing about timing during the crisis. Given this relative indetermination of the length of time, the question of the end of the euphoric phase is unanswered.

We have to wait for the interpretation of Minsky’s system by Arestis and Glickman (2002), with what they call the relaxing of the orthodox barrier, to get an analysis of institutional change that will relativize without wholly eliminating the importance of psychological factors in the FIH. We can define the orthodox barrier as the set of regulations that govern financial activities. Thus, it lays out the prudential principles that banks and financial intermediaries are subject to. According to this interpretation, after a long period of success and tranquility, this financial conservatism or orthodoxy is replaced by more permissive rules, whereas crises and bankruptcies contribute to raising the orthodox barrier. This is what Minsky called “deregulation mania” (1986a [2008]: 221) during a period of tranquility. The lowering of the orthodox barrier produces an institutional void that prevents the banking system from having strong regulatory processes and leads to financial fragility with the generalization of risky finance (Sinapi 2011). With these interpretations, the crisis trend for Minsky comes in this sequence: crisis – period of tranquility – institutional weakening (financial deregulation) – financial weakening – downturn in the business cycle – crisis.

Here, a purely technical conception of institutions appears, as it is restricted to the function of overcoming market failures. Thus, institutions are presented as variables that must be evaluated according to their level of efficiency in the mission assigned to them. Yet this functionalist approach is unable to distinguish between the emergence and evolution of institutions, so it is ill-equipped to explain the long-term evolution of an institutional architecture (Lordon 2008; Thelen 2003). In other words, if the movement of the orthodox barrier, which is lowered or raised under the effect of memories of the crisis, is alone what determines the conditions for institutional robustness or weakness, the crisis has a single determinant that removes the complexity of its genesis. This narrow representation reduces the range of possibilities for crisis factors, impoverishes its definition, and limits the horizon for solutions. In addition to its difficulty explaining institutional change, this approach – whereby crisis periods are followed by strengthened regulations that fade away as the crisis recedes – is contradicted by recent history. The 1987 stock market crash, the collapse of LTCM, the bankruptcy of Enron, or the bursting of the Internet bubble, far from triggering stronger regulations of financial activities in the United States, were followed by “business as usual.”

This institutional interpretation of FIH gives the crisis an influence that goes beyond the framework of periods of financial disturbance, and provides elements for assessing the evolution of capitalism. Explained as an inadequate fit between the institutional structure in charge of regulating risk and initiatives taken by economic agents, the crisis is thus the result of an institutional failure. Once it is established that institutional fragility is the first step toward crisis, we must focus on whether this change in institutional structure has a relationship with the evolution of capitalism. The aim is to show how growth models undergo crises due to their success, not just because of their failures, while also determining the conditions that can trigger a shift to a new phase of capitalism. As a result, we must go beyond the short-term analysis of how a crisis begins, and instead focus on the long-term evolution of capitalism. Although Minsky’s work does take into account the long-term transition (in this respect, see the shift from stability to instability), in this particular case, this long-term view is hindered by the conceptual weakness of Minsky’s analysis of institutions.

In retrospect, we can say that the Great Depression gradually produced the conditions for postwar capitalism. The latter is unique in that it unfolded without any major crises. Resistant to periods of financial instability, its institutional configuration showed a stability that contrasts with the tendency of the current phase of capitalism to undergo crises. This therefore means that FIH is not sufficient to grasp all the dimensions of the financial fragility process, and we must focus on the specificities of contemporary capitalism in order to identify what accentuates its instability. In other words, Minsky’s business cycle theory must be completed by the developments on the evolution of capitalism to see how they enrich or impoverish FIH’s results. As Whalen puts it, “Minsky saw the need for nothing less than a thorough re-examination of ‘our current model of capitalism,’ he found the most effective way to obtain this ‘deeper look’ was to focus on long-term capitalist development rather than business cycles” (Whalen 2001). This more in-depth analysis involves setting the characteristics of MMC and FIH side by side, as I will do in the next section.

4.2. Money manager capitalism and FIH

Minsky’s writings on the evolution of capitalism and those on the instability of capitalism appear de facto to be disconnected: FIH is an analysis of the business cycle in the short run; the capitalist development theory is focused on the long run (Toporowski 2009). The former gives a certain interpretation of the financial instability hypothesis (Arestis and Glickman 2002; Sinapi 2005; Diop 2009) that puts forward the idea that a gradual weakening of institutions during the ascendant phase of the cycle is an integral part of capitalism and leads to a less robust system.

If the current phase of capitalism, presented as money manager capitalism, is so quick to undergo crises, this is because it has characteristics that act as catalysts for the factors of financial weakness identified by FIH. It becomes apparent that the demonstration of the instability of capitalism put forth by FIH is generic and must be adapted to the characteristics of the prevailing phase of capitalism. Hence it will be possible to understand the reasons why the forces of instability (which is an ahistorical aspect of capitalism) are sometimes contained or thwarted to produce periods of calm, and sometimes strengthened to trigger a destabilizing spiral.

In fact, if maximizing shareholder value is the primary goal of money managers, it becomes necessary for them to take more risks in order to increase dividends. Competition between financial institutions, strengthened by the threat of shareholder migration, becomes another reason that could explain the increasing financial fragility in this stage of capitalism. This is typically the case of what Goldstein (2008), following on Crotty (1993, 2003), refers to as coercive competition. This is a form of competition that results in decision making that is incompatible with stability of the economic system. ¹³ Indeed, in this competitive setup, the strategies of economic agents are solely focused on taking speculative positions across the board. It becomes impossible, for reasons such as the radical uncertainty generating strategic inertia, to adopt behavior different from the majority (Crotty 1993). During the ascending phase of the cycle, euphoria provides a profit opportunity for agents, but with pressure (by competition) to take advantage of it. This creates a situation that later leads to the suspension of the most common controls. Speculative behavior by banks becomes a survival instinct, as it is impossible to stay out of the bubble and maximize shareholder’s value. Mimetic effects developed in the Keynesian beauty contest that partially explained the bubble formation are thus reinforced by the constraint to serve maximum returns to shareholders. It is indeed interesting to underline that the psychological aspect, developed by Minsky in his FIH (after a long period of tranquility, economic agents are lured by recent successes, show a lower risk aversion, and become involved in risky projects), is bolstered by another macroeconomic principle, as maximization of shareholder value becomes central.

While this issue is interesting, it does not explain the resilience of the power of financial professionals during this phase of capitalism despite the periods of disruption that affect it, nor does it explain the persistent institutional weakness despite the crises in the United States. FRT gives particular importance to maneuvering by the main financial actors to dissuade supervisory authorities from regulating financial products, and gives a certain explanatory power to the “particularly active lobbying so that some financial products are not covered by any regulations” (Boyer 2011: 61).

We have seen how FRT considers institutions to bear the mark of their legal, political, and sociological history (Lordon 2008) and that their evolution is the result of transformations in the balance of powers, i.e. most often changes in objectives or strategies for the most powerful actors (Lordon 2008; Boyer 2003c). In other words, in this perspective, the lowering of the orthodox barrier – the deregulation mania – is no longer just the result of a numbing euphoria, but instead reflects the status of a balance of powers between bankers and legislators, between the main actors of finance and the state. And the more influence finance has over politics, the lower this barrier will be. Understanding the genesis of the crisis thus means giving a central role to the balance of powers between politics and the financial sphere in order to see the mechanisms of domination whereby the financial community successfully imposes its viewpoints, notably regarding regulation.

The hypothesis of a change in the level of the orthodox barrier due to the effect of the balance of powers between financial professionals and legislators is interesting in that it introduces the role of the long period covering the emergence of institutions, their gradual weakening or their relative strength. This is the idea that transformations in the balance of powers are necessarily long-term trends. However, this hypothesis also enables us to insist on the state’s role, as well as that of political decisions relayed by law and jurisprudence (Boyer 2003c). This is because the laws that must govern financial practices, take part in the monitoring of financial innovations, in brief, contribute to raising the orthodox barrier, are nothing more than the legislative materialization of government decisions. ¹⁴

Through this regulationist prism, the continual lowering of the orthodox barrier in MMC appears as the result of a balance of powers that is increasingly more favorable for the financial sector due to financial professionals taking on two sorts of power, on the cognitive and economic levels. ¹⁵ The cognitive power comes from the fact that the financial community has developed highly complex products. This enables it to have a lead over regulators and complicates the evaluation of these products. Increasingly disconnected from the underlying asset, derivatives are able to withhold from the public authorities the knowledge necessary for effective regulation. The economic power of the financial community in MMC is seen through the central position held by the financial sphere. Due to its status as the main creditor (for the financing of firms and governments), the financial sector holds considerable economic power, enabling it to influence the governance of firms and the orientation of public policy (Orléan 1999). Moreover, due to its interconnections with the real economy, it has become impossible to punish the speculative moves of financial institutions without bringing systemic risk to bear on the whole economy.

This two-fold taking of power places the financial community in a position of strength that enables it to use its full weight against measures it deems too intrusive. Proof of this lies in the series of regulatory changes favorable to finance throughout the pre-crisis period (Guerrera et al. 2008). The repeal of the Glass Steagal Act, the reform of corporate accounting (according to the fair value principle), and the reform of bankruptcy law ¹⁶ are all changes that show that, despite numerous warnings from financial disruptions throughout the 1990s-2000s, the financial community continues to influence legislation significantly. We can even add that this supremacy of finance continues after the subprime crisis, as shown by the speed at which bailout plans were implemented for investment banks with no real counterpart required, or the fact that the financial community demanded (via a surge in CDS prices on sovereign debt) and obtained austerity measures and influenced banking system reform plans (laws separating retail and investment banking activities were watered down). ¹⁷

According to the terms of a Marxist dialectic valued by FRT, the favorable evolutions mentioned above, obtained through the two-fold cognitive and economic power, eventually created the conditions that could have led to the bankruptcy of the financial sector. Indeed, because the legal and tax regulatory systems governing financial activities were shaped so as to strengthen the autonomy and dominance of finance, toxic products flourished and gradually laid the groundwork for the crisis.

To summarize, the money managers’ competition under the shareholder value maximization constraint in a FIH paradigm is a powerful factor of instability. This analysis aims at emphasizing that Minsky’s capitalism development theory can shed light not only on corporate governance but also on financial instability. An ultimate consequence of such a characteristic is that there is no mean-reversion force, and risky and speculative behavior thus becomes widespread. In the money manager capitalism era, the conclusions of the financial instability hypothesis are thus strengthened, as banks’ and firms’ forms of governance lead them to be more sensitive to shareholder value and thus less concerned with hedging their activities, and because the ascendancy of the financial sector in the balance of powers with the government prevents restrictive regulatory systems from being set up.