Financializing capitalism: 400 Years of equity market development

Introduction

Financialization’s domain is nebulous, involving all finance that goes ‘beyond its traditional role as provider of capital for the productive economy’ (van der Zwan, 2014: 99). Financialization of the state, banking sector, government debt management, businesses, housing, households, everyday life and pension savings have all been examined. Its origin is also uncertain, having been linked variously to industrialization, the shift from industrial to finance capital and post-1980 policy changes.

A common denominator of many studies is publicly traded equity. Van der Zwan (2014) recognized that the concept of ‘shareholder value’ underlies one school of financialization research and Krippner (2005: 175) adds ‘the explosion of financial trading and the proliferation of new financial instruments’ as another. Equity features in Lazonick’s (2010: 701) definition: ‘By financialization, I mean the evaluation of the performance of a company by a financial measure, such as earnings per share’.

Equity markets have drawn criticism throughout their existence. Following the 1688 Amsterdam stock exchange crash after years of volatility, de la Vega (2013 [1688]) described the market turning coals to diamonds, then stones and, finally, tears. He demonstrated an understanding of portfolio and risk management, behavioural factors like expectations and irrationality and recognized normal market operations as inherently problematic with stock buying becoming a game, turning merchants into speculators and stockbrokers into ‘card-sharpers’.

These problems remain, having inspired invective over four centuries. Defoe (1719: 4) described the 18th century equity market as a trade founded in fraud, nourished by ‘false News’, delusions and expectations. The 1720 South Sea and Mississippi Bubbles precipitated widespread market vilification. ‘Stock-market villains’ were a 19th century literary stereotype and financial plots were commonplace in Victorian fiction. In the 20th century, Keynes lamented the stock market becoming a casino (1936: 142) and like second-guessing a beauty contest (1936: 136). More recently, Kay (2015: 218) derided equity markets for extracting money from companies rather than adding it.

Amongst such criticism, Stiglitz declared: ‘No institution in our capitalist society is as venerable as the stock market’ (2013: 55). While stock markets (or, more precisely, equity markets) continue producing de la Vega’s ‘treasure of goblins’, they are a pillar of capitalism, embedded in salary, pension and tax regimes, and respected by governments, central banks, the IMF and World Bank.

This paradox and publicly traded equity’s role in financialization is the concern of this paper. It examines how trading the rights to a share of the profits of a small and declining number of listed companies (WFE Data) came to shape the global economy despite private companies’ greater numbers, assets and returns (Asker et al., 2011). Capitalism thrived before equity markets were developed, their rise to predominance representing a fundamental change. A critical overview of publicly traded equity’s 400-year history, with no presumption of its intrinsic merit, as key to understanding financialization and the potential for de-financialization, is missing from the literature. This paper seeks to make that contribution. The Dutch East India Company’s business model, introduced in 1602, is identified as a fork in the road for capitalism, inadvertently establishing market institutions for trading financial instruments and public equity through a breach of contract. The processes that subsequently transformed productive capitalism into financial, rentier capitalism are also considered. The paper does not debate the principle of equity or the existence of secondary markets but questions equity markets’ elevated position, the presumption of their merit, acceptance of the inevitability of their growth to dominance and the belief that listed companies represent an organizational apogee.

Polanyi (1945) argues that, as a social and political construct, markets are not inevitable but his central ‘fictitious commodities’ are land and labour. Neal (1990) considers financial capitalism’s origin as the rise of international capital markets but begins with Charles V’s Netherlands levies, not traded equity, and ends in 1825. Baskin and Miranti’s (1997) history of corporate finance and Poitras’ (2016) history of equity from antiquity, acclaim the modernity rather than examining the merit of 17th century financial innovations while Kindleberger’s (1978: 4) examination of bubbles, panics and crashes posits that, although they occasionally become overwhelmed, ‘markets work well on the whole’. Dore (2000: 8, 11) critically examines ‘stock market capitalism’ but focuses on policy decisions of 1980–2000 in the US and UK’s financialized, ‘pseudo capitalist’ economies with their ‘culture of making money’, compared with Japan and Germany’s ‘genuine capitalism’ and ‘culture of making things’ in ‘productivist’ economies.

Dore’s suggestions for reform cover social, ideological and technological change, while I propose structural change. The erratic, evolutionary rise of equity markets to predominance despite their destructive caprice required support from theoreticians and policymakers, suggesting that change was not an inevitable or natural outcome. Tracing equity market history allows de-financialized capitalism to be viewed as an alternative to financialized capitalism that is not inherently retrogressive. Like Stockhammer (2012: 64) I go ‘beyond the familiar call for more and better regulation and advocate de-financialization’, proposing evolutionary processes be reversed to ‘devolve’ in the biological sense. I contend that, by sidestepping or undoing some evolutionary steps of financialization based on questionable logic, capitalism could be re-focused on primary market activity and better support enterprise through direct investment in productive ventures.

The paper begins with the origin of the listed company in Amsterdam in 1602 and the evolution of publicly traded equity, before considering their contribution to the decline of the Dutch Golden Age. Similar patterns contributing to instability and, ultimately, Britain’s economic decline following the Industrial Revolution are then noted and contrasted with America’s industrialization. Publicly traded equity’s rise to prominence, despite such patterns, in both economies and economic thinking is then outlined, exposing the significant impact of theorists and policymakers since the 19th century. Business’ antipathy towards listed equity, and economies built on other types of finance, are then considered, revealing the potential of a capitalist model focused on productive, primary market activity, where listed companies and equity trading do not predominate. Finally, in support of de-financialization, ways of strengthening productive economies, and the reversal of some of the controversial steps that financialized capitalism, are proposed.

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Figure 1.

1602–1980 The development of capitalism's financialized, secondary market path alongside its original, primary market path.

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Figure 2.

Capitalism's financialized path since 1980 – an extension of Dore's (2000:4) diagram: ‘Neoliberalism and the rising dominance of the finance industry’.

Publicly traded equity and industrialization: Britain and USA

Britain’s industrialization replicates many Dutch Golden Age patterns, featuring publicly traded equity in a similar, under-recognized model of growth and decline. British entrepreneurial activity began flourishing during the 1760s without a formal stock market or actively traded equity. Curtailed by the 1720 Bubble Act and informal until 1801, the London Stock Exchange’s company activity related only to South Sea and East India Company stock until the Bubble Act was repealed in 1825. Enterprise was funded primarily by three sources: personal or family wealth, an informal ‘shadow’ capital market and formal credit providers, mostly county banks providing short-term bills and overdrafts for working capital but rarely long-term finance (Mokyr, 1999).

The revival of equity markets after a century of vilification following the South Sea Bubble reflected changing attitudes. Participants in commerce were ‘no longer crushingly scorned’ (McCloskey, 2008: 17), bringing new personalities to prominence. Driven by self-interest (Harris, 1997) MP Peter Moore, a director of joint-stock companies operating under various interpretations of the Bubble Act, was the key proponent of its revocation. Lord Chancellor Eldon, believing that paper transactions hindered real trade without contributing to national wealth (Harris, 1997) condemned repeal. Moore won the parliamentary debate and speculation began immediately, replicating Amsterdam of 1602.

A crash before the next parliamentary sitting saw record bankruptcies, including over 80 county bank failures (Harris, 1997). By 1827, 500 of the 624 companies formed in 1824–1825 had disappeared and only 15 were trading above par (Harris, 1997). Moore’s businesses failed in 1826 and he ended his days in exile, his downfall ascribed to personal failings while the market increased in stature. Lord Eldon’s arguments on the dangers of equity markets were not re-considered. A series of crashes followed. After the international 1837 crash, a speculative ‘mania’ almost doubled the railway stocks index. From 1844 to 1846, investors poured in almost half the value of British GDP but by 1851, prices had fallen by about a third (Odlyzko, 2010).

Mimicking Dutch patterns, spare capital was sent abroad, flowing into grandiose, speculative projects and servicing global expansion via stock markets because ‘that’s where the money was’ (Chabot and Kurz, 2009). This was rational for rentier investors, but it reduced the capital available for domestic activity and ‘ignored the less spectacular, sounder and probably smaller firms which were the potential sources of growth’ (Aldcroft and Richardson, 1969: 199). Britain’s high capital exports earned it the label of a nation of bankers and commission agents: ‘a rentier nation in danger of following the path of the Dutch by undermining its own industrial base in the long run’ (Pollard, 1985: 514). Following the 1873 Vienna stock market crash and financial crisis, Britain experienced two decades of economic stagnation. By the 1880s it was clear ‘from everyday observation, trade ledgers and profit and loss accounts’ (Feinstein, 1988: 1) that Britain’s economic prosperity and political status as ‘first industrial nation’ was declining.

Large infrastructure projects run by joint-stock companies, not businesses ‘run on the efforts of thousands of small-scale self-employed businessmen’ (Casson and Godley, 2010: 213) have been described as Victorian entrepreneurship’s distinguishing feature. However, manufacturing businesses overwhelmingly remained private. Public listings, like J&P Coats in 1890, were rare exceptions. Aldcroft and Richardson (1969: 184) argued that if private capital had been more difficult to procure and firms ‘forced into the market for their cash’ it might have had a ‘salutary effect on their whole performance’. Many enterprises did not require substantial initial capital, however, and most firms resorting to the market for funds ‘ended in disaster’ (Aldcroft and Richardson, 1969: 199).

Associating Britain’s Industrial Revolution with equity market development (Casson and Godley, 2010), a ‘wave of gadgets’ (Ashton, 1948: 59; Temin, 1996) or innovation in cotton and iron’s capital-intensive plant from 1801 to 1831 (Crafts and Harley, 1992) oversimplifies the era’s complex economic web. Reductive approaches ignore the entrepreneurship of establishing any business, undervalue less heroic innovation in ‘putting-out, wholesaling, retailing, credit and debt, and artisan co-operation’ (Berg and Hudson, 1992: 31) and omit poorly documented developments in shoemaking, tailoring, blacksmithing, food processing, metalwork, distilling, furniture, coach-making and chemical industries. If the period were studied as a Golden Age of enterprise including all perspectives to provide a more complete economic picture, the equity market’s contribution would not necessarily be found positive. Belief that equity markets were essential in funding the Industrial Revolution has no counterfactual and overlooks the financial sector’s failure to develop systems for providing capital for steady development of domestic manufacturing and lower order activities, a capability that diminished over time while the stock market grew (Best and Humphries, 1986). Lending institutions never served small and medium-sized enterprises’ (SME’s) demand for long-term capital (Elbaum and Lazonick, 1984) and Britain’s unique form of financial capitalism developed with greater separation between financial and industrial capital than elsewhere (Budd, 2000). Having found ‘clear evidence’ of a decline in business activity after 1839, Ward Perkins (1950: 75) mused: Did the ‘heavy programme of railway construction so distort the financial structure of the country that it could no longer serve the needs of commerce efficiently?’

Significantly, the financial structure behind America’s industrialization differed from Britain’s, particularly regarding publicly traded equity. It is a common misconception that equity markets were necessary in financing America’s large-scale canal and railway projects. These overwhelmingly used bond finance, much raised in London through Sterling bonds that diverted capital from the British economy. The few that used publicly traded equity helped drive New York exchange speculation in the 1830s (Chandler, 1954). For a short time, New England was an exception. Local prosperity saw a circle of wealthy entrepreneurs condemn the principle of debt and utilize private equity funding. However, the 1847 British Railway bubble collapse saw surplus finance dry up globally and New England returned to bond financing (Chandler, 1954).

America’s equity markets traded the securities of only the largest companies, favouring grandiose and foreign projects, until the 20th century (Cull et al., 2005). Industrial capital networks developed alongside, creatively financing American manufacturing as it joined Germany in overtaking Britain as an industrial nation. Entrepreneurs seeking finance in a ‘generally permissive regulatory environment’ (Cull et al., 2005: 28) established state banks, building and loan associations and trust companies themselves, replacing any that became unsuitable for local requirements through growth or merger (Lamoreaux et al., 2006).

Publicly traded equity in economic theory and policymaking

Despite negatively impacting productive economic activity in the Netherlands and UK over several centuries, the profile of equity markets within capitalism has risen dramatically. Many factors have contributed to this process.

Before considering the chronology, the fundamental problem of the perplexing nature of ‘the share’ and its market should be noted. Lawyers are clear that a share is not an interest in a listed company’s assets except in event of bankruptcy, but they are ‘much less clear what it actually is’ (Ireland, 1999: 33). Pennington (1989: 144) defined a listed company’s shares as ‘a species of intangible movable property which comprise a collection of rights and obligations relating to an interest in a company of an economic and proprietary character, but not constituting a debt’. The idea that shareholders ‘own’ a company while directors merely run it, widely believed as a capitalist tenet, it is not a legal certainty. Shareholders purchase a right to a share of company profits but dividends are not guaranteed. Directors are entitled to pay none (Warren Buffet has never done so) but shareholders have the right to dismiss directors.

A company’s share price, or Market Value, is equally perplexing. Founded on anything, rational or irrational, share prices change constantly. Volatility is inherent in equity markets, driven as much by sentiment as by qualities of underlying companies. Attempts to relate a company’s Market Value to its underlying Book Value have produced inconclusive results (Fama and French, 1995). A belief that high trading levels responding to new information increase price accuracy and market ‘efficiency’ has inspired the pursuit of increasingly sophisticated mathematical modelling and ‘frictionless’ markets. This has not resolved discrepancies between Book and Market Value, eliminated bubbles or addressed instability. Ultimately, there is no definitive formula behind a company’s share price.

Equity markets resemble candy trading in a cinema. When children make purchases at the candy bar they help sustain sectors of the Real Economy but, when trading the candy later, the exchanges do not contribute to the confectionary industry and prices may be determined by anything; perhaps the candy’s initial cost, its longevity and divisibility, the pocket money available or irrational exuberance. Latecomers arriving after the candy bar closed drive up prices. Whether the children pay twice or half the candy’s original purchase price, the candy-making industry is not affected. Patterns may be found, correlating prices to movie length, the number of children or funds available, inspiring predictions to be made. However, even with assumptions of rational decision-making and information symmetry, modelling this market would be challenging. Prices may be declared absurd but it is difficult to declare them ‘wrong’. Such is the nature of secondary markets, of which Stiglitz (1989: 56) observed: ‘what is remarkable is not that they do not work perfectly, but that they work at all.’

Stock markets were widely vilified after the 1720s South Sea and Mississippi bubbles and censured by early theorists. In Wealth of Nations (1776), Smith identified the ‘folly, negligence, and profusion’ of listed company management with directors, as agents managing other people’s money, lacking the ‘anxious vigilance’ (p. 606) of partners responsible for their own. Noting the ‘knavery and extravagance’ (p. 609) of stock market operations, Smith specifically excluded them as irrelevant to his thesis and the word ‘bubble’ is absent from the text. Smith’s ‘free markets’ were primary markets.

With the 19th century rise of data analysis, equity markets provided interesting input. Jevons (1884: 210), renown for correlating diverse commodity prices with weather and currency pressures, examined the periodicity of equity market downturns, beginning with the South Sea Bubble. Despite deploring ‘stock-jobbing’ as infamous, he reported being biased towards a theory of ‘commercial cycles’ of 10.466 years, having found stronger statistical patterns than amongst commodities.

By 1900, Wall Street’s activities are recognizable, described in works by Conant, who contested the view that stock markets were for ‘betting’, arguing that their fundamental purpose was ‘mobility of capital’ (1905: 89). Equity markets were, however, linked to ‘business’, not economic theory. Fisher (1906, 1907) pioneered links between accounting, economics and finance, re-shaping economics by applying a present value formula to ‘any income stream whatever’ (1906: 217) including bonds and shares. While Marx’s capitalists were productive industrialists, Fisher elevated the trader/speculator/rentier and their ‘investment’ activity. He disputed the claim that ‘productive’ entrepreneurs were most worthy of financial reward, promoting the ‘sleeping partner’ who ‘does not lift a finger’ (1907: 43) as deserving for abstaining from consuming their capital and lending it instead.

Veblen (1908) criticized Fisher’s work as taxonomy for businessmen. However it began an ontological shift, blending economic and financial terminology. Keynes intertwined terms further, equating equity market ‘investment’ to ‘saving’ (1936) and bank deposits to ‘hoarding’ (1930: 127) despite banks, as intermediaries, lending capital for productive purposes. He elevated shareholders to ‘entrepreneurs’, along with industrial shipbuilders like Cunard (Skidelsky, 1992) but only long-term holdings were ‘investments’. Speculators, whose short-term trading created ‘whirlpools’, were not ‘investors’. Hawtrey (1931: 618) accused Keynes of arguing from his definitions rather than causal relationships and ‘dictatorship of the vocabulary’: ‘Some of his definitions are undoubtedly valuable, and may well form an addition to economic language. But others impose on words of common use, such as Income, Profit, Investment, and Savings new and unfamiliar meanings’.

Fisher and Keynes’ promotion of equity markets within economics created schisms amongst theorists. When discussing ‘markets’, Keynes and Hayek were at cross-purposes. Like Smith (1776), Hayek’s (1945) markets were primary markets for labour and commodities like stationery, paper bags, screws, tools and tin. He used the term ‘stock exchange’ rarely and pejoratively, as representing ‘paper profits’ and ‘pseudo-profits’ (Hayek, 1975 [1939]: 133). Keynes’ elevation of financial markets to sole determinants of a natural rate of interest (Salerno, 2016) also clashed with Wicksell’s (1936 [1898]) conception that returns in the ‘real’ economy determined interest rates. Fisher and Keynes’ views prevailed, however, blurring distinctions between productive and non-productive finance, legitimizing equity market operations and cementing their position in monetary policy.

By 1929, Fisher was using the equity market as a leading economic indicator: a rising index indicated a sound economy and future growth. A week before the ‘Great Crash’, the Chicago Tribune reported a recession in demand for steel and cars (Mather, 1929), key drivers of oil, gas, coal and construction industries. Fisher, however, ‘read the market’ right up to the Crash, notoriously predicting further rises.

Equity markets’ suitability as leading indicators has escaped serious debate. S&P 500 equity prices remain one of eleven components in the Leading Economic Indicators Index although equity returns have not proven a compelling indicator (Frankel and Saravelos, 2010). Greenspan (2013) promoted the stock market beyond being a leading indicator of economic activity to a major cause of it. For Galbraith, it was a lagging indicator or one-way mirror: ‘cause and effect run from the economy to the stock market, never the reverse’ (Galbraith, 1975 [1954]: 111). Reflecting the industrial downturn noted in the 1929 media, Galbraith’s mirror could predict a crash while Fisher and Greenspan’s rising equity market cannot. A tenet of Neoclassical Economics is that market prices are always ‘right’, finding equilibrium between buyers and sellers. Justifying market prices in this way precludes the possibility of bubbles so crashes are a surprise. Since the South Sea Bubble there has been a major crash every 16.44 years, on average. Portes and Baldursson (2007) and Blanchard (2008) applied the Fisher/Greenspan reasoning and failed to predict the 2008 Crisis. Galbraith’s ‘mirror’, however, provides a simple answer to the Queens 2008 question of why the financial crisis was not predicted: namely that, as in 1929, equity markets were wrongly used as a forward economic indicator.

A mid-20th century re-evaluation of equity markets’ provided new propulsion for financialization. The Dow Jones index took 25 years to recover from the Great Crash, returning to its 1929 peak in 1954. Like Jevons cautiously re-examining equity markets more than a century after the South Sea Bubble, young economists again re-considered equity market ‘opportunities’ and developed theories of Portfolio Choice (Markowitz, 1952; Roy, 1952). These moved the field of finance beyond the interests of the firm to equity market patterns and optimal returns, reviving a focus on rentier finance.

As ultimate investors, shareholders were elevated beyond their right to a share in company profits at the directors’ discretion to ‘owners’ entitled to quarterly guidance and maximum dividends. The 1919 case of Dodge v. Ford Motor Co. had been brought after Ford’s ‘Model T’ profits were used to cut vehicle price, increase wages and re-invest in equipment, the Dodge brothers seeking to ensure that shareholder dividends were not incidental to company business. Corporations were found to be organized primarily for stockholder profit and directors required to work to that end. Subsequently, Friedman (1970) declared: ‘The Social Responsibility of Business is to Increase Its Profits’ and in 1981 Jack Welch, CEO of General Electric, implemented the principle of ‘Shareholder Value’. Despite subsequently rejecting this as ‘the dumbest idea in the world’ (Guerrera, 2009), it persists, inspiring shareholders to press for greater reward at the expense of other stakeholders.

Figure 1 illustrates the slow, sporadic development of capitalisms’ financialized path from its 1602 origin until the late 1970s. The VOC model was tested by various trading nations but not immediately adopted unchanged with universal enthusiasm. Despite centuries of frequent, dramatic crashes, market enthusiasts and various prominent economists promoted public listing and equity markets as a worthy mechanism within capitalism and, by the 20th century, change and complexity escalated rapidly.

From the 1970s, policy support by governments and institutions further legitimized and advanced traded equity. During the 1976 Party primaries, Reagan recommended the advice of economists who proposed ‘investing’ government pension funds in equity markets (Rosenbaum, 1976). President Ford, who was directly impacted by the 1929 Crash and had observed the market’s most dramatic post-1929 decline following his 1974 pardon of Nixon, firmly rejected this. Private retirement plans typically held only a small portion of US equity, with government pension funds of the Great Depression generation held in bonds, treasury bills and cash. Ford (1979: 365) supported this arrangement, considering it ‘absurd’ to risk huge federal sums on the ‘ups and downs of the market’. Reagan’s Presidential term instigated a flow of private pension funds into equity markets as ‘defined contributions’, transferring risk to pension holders and precipitating the rise of powerful institutional investors.

In 1977, prompted by the IMF to alleviate debt, the UK government sold part of its BP shareholding, garnering political support that inspired the privatization movement and 1986 ‘Big Bang’. Increased equity market accessibility and reduced regulatory ‘burdens’ revived London as a global finance centre. Publicly traded equity became entrenched in the political economy of developed nations and a solution to debt crises. The IMF, World Bank and OECD embraced the Financial Market Theory of Development (Levine, 1997, 2005) for developing countries. Based on historic evidence from 1960, it was not uncontested but, by 2005, 58 countries had opened stock exchanges.

De-regulation and the 1999 repeal of the Glass Steagall Act inspired active trading and allowed banks considerable freedom to engage with trading markets and derivatives that proliferated. Bank and pension fund involvement with equity markets placed Central Banks in an invidious position. The objective of ‘price stability’ became ‘financial stability’, something never achieved. During crises, interest rates were lowered to calm equity markets (Meyer, 2004), establishing a belief in monetary policy to underpin them, which induced moral hazard by apparently diminishing the need for prudence. With equity markets constantly fed by pension contributions providing a feedback loop of optimistic signals, Central Bankers are in a wilderness of mirrors searching their supervisory, regulatory and macroprudential tools for ways of containing constantly primed equity markets or providing damage control.

Finance sector jobs were added to the economy but introduced imbalances. Piketty (2014) did not emphasize equity markets as a source of inequality but Tomaskovic-Devey and Lin (2013) found equity trading regressive through many mechanisms. Apart from large financial sector salaries and executive bonuses paid in stock, newly floated companies yielded bonanzas for entrepreneurs while passive pension fund holders rode the market down as it fell. Bogle (2005) estimated that $2 trillion was transferred to ‘the 1%’ in the Reagan/Thatcher era’s 20-year bull market and capital flowing into financial markets from banks and pension institutions diminished funds available for small business, replicating patterns from the final stages of the Dutch Golden Age.

Dore (2000:4) illustrated the complex web woven by policies supporting equity market development. Since then, the web has become even more intricate. The essence of Dore’s diagram, ‘Neoliberalism and the rising dominance of the finance industry’, is shown in Figure 2. I have added further developments in italics to illustrate the increased confusion and conundrums created by continued ‘financial deepening’ in capitalism’s financialized path.

The 2007–2008 crisis has not produced a paradigmatic shift in economics but opinion is shifting against financialization. Turner (2010:6) noted: ‘There is no clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 to 30 years has driven increased growth or stability, and it is possible for financial activity to extract rents from the real economy rather than to deliver economic value’. Studies have raised the possibility of ‘too much finance’ (Arcand et al., 2012) and that it can harm economic growth (Law and Singh, 2014) but there is no consensus on whether the problem is finance’s quantity, type or inter-relationships nor what should change and how.

Achieving stability through regulation, without destroying freedom, has never proven possible. Repeated calls for new regulation indicate their impotence, as recently confirmed: ‘At present there is no adequate institutional structure for monitoring the asset bubbles and financial excesses and for taking action to moderate them’ (Smithers, 2010: 187).

The Glass Steagall Act, introduced after the 1929 Crash, was more a defensive strategy than a regulatory mechanism for stabilizing markets. It sought to minimize commercial banks’ exposure to volatile trading markets by separating institutions with a bank charter from market-related activities like equity trading and portfolio administration. Goodhart’s (2010) proposed paradigm shift to contra-cyclicality as a defensive approach to secondary market contagion indicates acceptance of regulation’s impotence against secondary market caprice. Structural changes have also been proposed as an alternative. Keynes (1936: 160) preferred public equity to be ‘permanent and indissoluble…except by reason of death or other grave cause’ and Keen (2010) proposed ‘Jubilee Shares’ that could be traded only once and expired after 50 years. However, both eliminate free equity markets as they are known. This risks engendering a new financial crisis and being self-defeating.

Productive businesses’ utilization of publicly traded equity

Given publicly traded equity’s entrenchment in the political economy and the difficulty of regulation, diminishing its profile appears implausible. However, re-considering capitalism from the perspective of productive businesses raises some possibilities for strengthening economies and reducing traded equity’s negative impact.

Globally, SME’s are the predominant form of enterprise, comprising 99% of OECD (2017) firms, while the small number of listed companies is declining (WFE Data). SME’s have a widespread preference for internal finance followed by bank debt (ECB Eurosystem, 2018; Giacosa and Mazzoleni, 2016; Matic et al., 2012). Publicly traded equity is not favoured and least used for SME financing (Davies, 2017; Matic et al., 2012) with no hard evidence suggesting this is due to poor market access (ECB Eurosystem, 2010–2018). With Italian and British studies showing less than 4% of eligible domestic private companies are listed on exchanges (Cao et al., 2011; Pagano et al., 1998), why so few firms ‘go public’ remains a key question.

Public equity finance has been affirmed as a choice, not a stage (Pagano et al., 1998), with companies ‘going public’ when uncertainty about their future profitability is high (Boehmer and Ljungqvist, 2004) or when founders choose to ‘cash out’ (Cao et al., 2011). Tech stocks are no exception. Shares in companies like Snap, Twitter and Spotify, sold at the height of their popularity, have delivered bonanzas for founders, creating lively trading markets despite uncertain revenue and profit models. Data show only 17% of the tech companies listing in 2017 were profitable (Ritter, 2018).

The range of large, unlisted companies, including Aldi, Bechtel, Beretta, Bloomberg, Boehringher Ingelheim, Bosch, Bose, Chanel, Hamburg Sud, IKEA, Leica, Mars, Miele, New Balance, Rolex, Steinway and Waitrose, demonstrates that listing is not essential for company prominence, profitability or longevity. Infrastructure equity finance failures, like the 2008 collapse of ‘BrisConnections’ airport link unit trust, also demonstrate that publicly traded equity cannot be presumed optimal for large-scale funding.

Although Cull et al. (2005: 4) ‘have no ambition … to challenge the idea that modern financial institutions are necessary for sustained economic growth’, their finding that small industrial and manufacturing businesses rarely raised equity capital on markets in western Europe, Scandinavia and North America, does challenge the presumption such institutions are essential in capitalism. After the Initial Public Offering provides a company with new finance, share trading is essentially ‘noise’, bringing the company no further capital with fees to traders and intermediaries producing a negative-sum game that ultimately extracts value from society (Bogle, 2014). Finding a ‘tendency, not without exceptions, for national financial systems to become more market-based as they become richer’ (Levine, 2005: 918) does not prove that listed companies are essential to an economy or that funding diversity is unimportant.

As an alternative to equity, debt still suffers the negative connotations ascribed by the 1830s New England railway financiers who pronounced that ‘hiring money’ and indebtedness should be condemned (Poor, 1849:145) before, themselves, reverting to bond finance following the 1847 Crash. Misconceptions associated with debt and the ‘Minsky moment’ help malign lending markets and institutions. Minsky’s ‘financial instability hypothesis’, founded on cyclical debt patterns that reflect economic optimism, fluctuating between conservative and imprudent, is an indictment of ill-considered debt usage, rather than of the principle of borrowed capital. Debt-fuelled rentier investment, leveraged investment trusts and unsound corporate financing pyramids (Galbraith, 1975 [1954]) misrepresent debt financing. Judicious debt management is possible. Prudent use of publicly traded equity, however, cannot prevent losses in downturns. Equity market volatility is constant, following new information or because the ‘buy the dip’ doctrine induces perpetual motion cycles.

Debt and untraded equity underpinned Dutch Golden Age capitalism prior to the VOC’s stock exchange. They would be perceived differently if private and SME business preferences drove capitalism as it did for centuries in Germany, where scepticism saw equity markets avoided until 1820 when trading commenced in Frankfurt. Banking, with its 15th century origins, and bonds remained the preference. Banks acquired stakes in regional institutions and diversified, recognizing creative entrepreneurs, not listed companies, as primary economic drivers (Landes, 1969). Private, credit and mortgage banks, cooperatives and Sparkassen offered various financing options to smaller interests, including farms, small businesses and the poor (Guinnane, 2002) while British banks became giant institutions favouring grand projects, clustered around the newly formalized stock market (Collins, 1991).

In Germany’s successful Mittelstand, bank and bond finance still prevails over traded equity. Described as ‘the most effective SME economy in Europe and possibly the world’ (Kay, 2015), Mittelstand exhibits many Dutch Golden Age characteristics. Businesses are embedded in local communities, often family-owned over many generations and predominantly funded by private or bank finance and reinvested capital, characteristics denigrated in the British context: Aldcroft and Richardson (1969: 132) criticized 19th century British manufacturers’ that re-invested capital instead of issuing dividends, were steeped in tradition and reluctant to list publicly for fear of losing control, particularly to foreign investors; those lacking ‘any appeal to the general public’, family-owned companies and businesses too small to ‘attract the issue houses’. Mittelstand indicates, however, that equity trading is not essential to contemporary business or economic success, and history suggests that enthusiasm for equity markets contributed to the demise of both the Dutch Golden Age and an embryonic ‘British Mittelstand’ that had financed the Industrial Revolution before the 1825 Bubble Act repeal.

The Mittelstand/Golden Age model cannot be a panacea for all of capitalism’s controversies. Conflict between owners, managers, workers, customers, institutions, the environment and the state would exist without listed companies and equity markets. These relationships require constant management in any economic model. The proposition is simply that equity trading is unproductive and, by diverting funds from productive economic activity, potentially destructive so lowering the profile of equity markets to reduce their impact would benefit capitalist economies.

De-financialization

It is neither necessary nor feasible to eliminate the equity markets that led financialization and now represent a long-standing freedom. Enforced de-financialization using restrictions or regulation risks an adverse market reaction and crash, potentially writing off the increased money supply that aimed at financial stability.

However, primary market capitalism continues to evolve, presenting opportunity for change. Peer investment, microfinancing, venture capital markets, local banks and credit unions are developing to meet SME’s particular funding requirements. Innovative lending is the ‘new frontier’ (Ali et al., 2012:14) of this ‘mini-revolution’ (Haldane, 2013). Economists’ views are also evolving. While most critics of stock market operations still accept their position within capitalism, Kay’s (2015) repudiation of ‘mark to market’ accounting that measures value using trading prices, King’s (2016) desert island parable highlighting equity markets’ economic irrelevance and research supporting re-nationalizing services (Dagdeviren, 2016) suggest a shift away from Keynes, Friedman and Greenspan’s 20th century market enthusiasm. Central bankers are also changing their approach. Federal Reserve Chairman Powell (2018) clearly confirmed his support for Congress’ monetary policy goals of ‘maximum employment and price stability’, not ‘financial stability’, which justified Greenspan’s financial market support.

Left to evolve naturally, de-financialization may continue, particularly if crashes persist, but this is uncertain. Detrimental impacts of equity trading could, however, be lessened if it was recognized as a subordinate, unproductive, ‘own risk’ activity and capitalism’s original, primary market path was fortified.

Developing financing patterns that bolster productive activity would support a return to a simpler but more productive capitalism that would absolve Central Banks of responsibility for ‘financial’ stability. Directing pension savings towards investment in productive activity, not into trading financial instruments, has been proposed in Australia as worthy of government support and a means of stimulating business (Poljak, 2018). It would help undo 1980s Greenspan/Reagan pension policies and reduce equity market prominence while filling SME funding gaps and providing economic stimulus. Other measures might include: re-balancing default pension portfolios that favour equities; de-coupling executive bonuses from equity markets, replacing media coverage of equities with reports of productive investment opportunities and scaling back policies like Europe’s Capital Markets Union to expand an ‘equity culture’. Additionally, support for increased variety among lending institutions, including cooperative banks and credit unions, would assist productive businesses that overwhelmingly prefer bank finance. With demonstrated success in Mittelstand, such institutions have proven more stable than commercial banks (Hesse and Čihák, 2017) and well placed to provide loan capital to enterprise.

External financing that mimics internal finance has yielded positive results, suggesting SME’s preference for internal finance presents opportunities for policymakers. Grameen Bank’s successful microfinancing model, an unusual ‘angel investor’ approach, mimicked ‘family-and-friends’ finance. Israel’s technological incubator programme established in 1991, offering high-risk loans as competitive grants to be repaid from future sales was another proxy for internal finance. Israel became a start-up nation and innovation leader after 1995, with R&D spending almost doubling by 2004 (Senor and Singer, 2009). Notably, however, successfully incubated companies that chose public listing subsequently failed to deliver returns to Israel’s economy (OECD Observer, 2011), repeating patterns associated with the Dutch Golden Age’s demise.

Devolution in economic theory is also possible. The fusion of language instigated by Fisher and Keynes and criticized by Veblen and Hawtrey has been given little scholarly reflection. Imprecise language still blurs productive and non-productive finance. ‘Financial markets’, ‘free market economy’, ‘capital markets’ and ‘financial institutions’ all amalgamate dissonant components. Whether ‘financial institutions’ are banks or markets; ‘markets’ are primary or secondary; ‘corporations’ or ‘public companies’ are listed or not; ‘stocks’ are bonds or equities, and publicly traded or not, is fundamentally important. Clarifying terms and concepts to distinguish productive from non-productive finance amounts to undoing Fisher and Keynes’ fusion of language and would require adjustments to theories, distinguishing an economy’s primary markets from secondary trading markets.

Devolution away from financialized capitalism by promoting primary economic activity over equity trading and reversing key historic changes would promote a de-financialized form of capitalism that favours productive investment over financial capitalism’s hallmark, non-productive trading markets.

Conclusion

Comparing equity market crashes with Tulip Mania, which is not part of equity market history, obscures the structural problems of listed companies and traded equity, while examining financialization only from the post-industrial era restricts our view of forces that have shaped financial capitalism. The 400-year history of publicly traded equity has been outlined to illustrate its role as a driving force of financialization in a process driven by choices, not inevitability. Equity trading developed inadvertently, not through careful planning. Always an enigmatic instrument, it originated in a breach of contract and inspired rentiers to create a market exploiting its exchange for profit. This was a fork in the road for capitalism, opening a path for unproductive, financial trading alongside that for developing productive primary markets.

Nowhere does history indicate that equity markets can be tamed, or that rogue users or poor regulation periodically spoil an essentially good system. Instead, history reveals inherent problems in the nature of equity and its market, exposing them as contributors to intransigent instability and inequality. Trading has been found to be regressive through many mechanisms. Better information and less restriction, proclaimed as making markets more ‘complete’ and ‘efficient’, has not made them stable, the mixture of ‘informed’, irrational and contrarian decision-making by traders reacting to myriad contextual factors driving perpetual volatility. History has shown repeatedly that capital poured into trading markets reduces that available for productive activity, with economic decline occurring when capital raising options for unlisted businesses are not maintained. Vestiges of productive, primary market capitalism can be found in Mittelstand, demonstrating that successful capitalist economies can function without predominant listed companies and equity markets. Bishop’s (2000) ‘non-corporate capitalism’ is not entirely an untried ‘leap in the dark’ (p. 24).

Eschewed by productive businesses and inherently unproductive, theoretical and political support has promoted equity markets to become leading economic indicators, prominent components of default pension settings and a key concern of monetary policy. The possibility of undoing these extended roles and moving to a simpler form of capitalism focused on productive activity represents a dramatically different future. Distinct alternatives to contemporary capitalism can be found within its varieties. Emphasizing direct finance for productive enterprise while side-lining equity market trading as an ‘own risk’ activity that is not underwritten by Central Banks, is an alternative capitalist model with attributes of Mittelstand and historic economies that functioned successfully before equity trading as an end in itself, introduced a fork in capitalism’s road.

Spontaneous changes are occurring in capital-raising options, Central Banks’ approach to ‘price’ or ‘financial’ stability and economists’ attitudes to equity markets, so devolution may already be underway. History will determine whether evolutionary change without policy assistance is sufficient to re-direct capitalist economies away from the financialization path and back towards a model that prioritizes direct investment in productive economic activity.