Radical Markets: Uprooting Capitalism and Democracy for a Just Society by Eric Posner & E. Weyl

Author:Eric Posner & E. Weyl [Posner, Eric]
Language: eng
Format: epub, pdf
Publisher: Princeton University Press
Published: 2018-05-14T22:00:00+00:00

Effortless Capitalism

The logic of shareholder capitalism suggests that investors wish to do as little work as possible while gaining a maximal stable return. Starting in the 1950s, economists developed financial ideas that came to be known as “portfolio theory” based on these principles.13 The major insight was that for the average investor, it makes more sense to buy shares in a diverse group of corporations mimicking the whole economy than to pick stocks based on conjectures about which companies are best managed. When an investor buys and holds just one stock, she bears the risk that the stock price will fall for reasons specific to that stock, such as its management being incompetent or deceitful. Investors can avoid these stock-specific risks by diversifying widely across the economy.

Further theoretical development reinforced these conclusions. The so-called efficient capital markets hypothesis emphasized that anyone trying to pick an “undervalued” stock is deluding herself. She is instead likely to be beaten to the punch by skilled professionals, who will raise the price of the stock before an ordinary investor can get there. This means that there is little point in stock-picking in the first place, certainly for amateur investors.14 “Behavioral finance” holds that ordinary investors often act irrationally.15 All this theory exhorted investors to simply diversify while paying as little as possible to dishonest money managers who claim to be able to “beat the market.”

The cheapest way to do this is via low-cost mutual funds (especially index funds) that track broad market indices. A mutual fund is a portfolio of stocks that may have an industry focus (e.g., energy) or a strategy (e.g., growth). An index fund (which is a type of mutual fund) holds a portfolio of stocks designed to exactly mimic the index of interest (e.g., S&P 500). Beginning in the 1970s, a huge demand developed for such funds, in part because of the shift of pension savings into the stock market spurred by various government reforms and in part because governments, persuaded by financial theory, encouraged investors to park their savings in such low-cost, diversified funds. The overall effect was that institutional investors, which controlled these funds, became the largest owners, and thus the largest controllers (at least in principle), of the major corporations.

Who are the institutional investors, anyway? They include companies that manage mutual funds and index funds, asset managers, and other firms that buy and hold equities on behalf of their customers. The largest names are those we mentioned above: Vanguard, BlackRock, State Street, and Fidelity. Index fund operations are relatively mechanical, so their costs are low; today they comprise probably less than a quarter of the offerings of institutional investors.16

Figure 4.2 displays the growth of the fraction of the US public stock market controlled by institutional investors. The control of institutional investors has risen dramatically, starting roughly in 1980 at about 4% control and leveling out around the Great Recession at 26%. While 26% is still a minority of the entire market, most of the equity in the

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