Monday, February 21, 2011
Adventure Capital: Condos, Groupon, and Big Pharma
By Nick Werle
The late economist Hyman Minsky wrote that after fortunes inflate on the back of a speculative bubble, and after investors’ irrational optimism and overvalued assets inevitably collapse, an economy enters a “period of revulsion,” when people remember that it’s risky to bet big on an uncertain future. Likewise, it’s always during the depths of a hangover that a drinker remembers how whiskey invites its own overconsumption and swears that the only way to avoid another descent into this purgatory is to never touch the stuff again. But after the fog leaves and with a clear head regained, he forgets the pain after the party and declares another Manhattan to be an eminently reasonable investment. Of course, the trick is to recall at just that moment how miserable you’ll be after another three. A pessimistic economist faces the same cyclical popularity as a tee-totaling friend; a consoling voice the morning after becomes a buzz killer as soon as night falls again.
For economists focused on capitalism’s tendency to foment crisis, it’s important to make the most of investors’ revulsion. Indeed, if there’s ever a time for Marxists to find an eager audience for their theories of capitalist overaccumulation, it’s in the wake of a financial crisis. The moment is particularly ripe for David Harvey, a Marxist trained as a geographer, who has made a career of explaining why surplus capital has such an affinity for real estate and describing how overproduction regularly reconfigures the spaces in which we live. Both Ben Bernanke and a slew of Neo-Keynesians led by Paul Krugman have pointed to a “global savings glut” – originating in the current-account surpluses of net exporters such as China, Japan, and Germany and flowing to the bloated real estate markets of the United States and Western Europe – as the fundamental imbalance responsible for the latest boom and bust. To Harvey and his fellow Marxists, the global savings glut is not a historical fluke but an instance of an intrinsic tendency for capitalist economies to overproduce, and the great North Atlantic real estate bubble is but another temporary answer to their perpetual problem: What can absorb the great mass of overaccumulated capital?
Insofar as capital always seeks to realize a profit by selling commodities for more than they cost to produce, the economy always requires new inputs to account for the creation of this surplus value. As Benjamin Kunkel explains in his illuminating review of Harvey’s work, “the full cash value of today’s product can therefore be realized only with the assistance of money advanced against commodity values yet to be produced.” It is credit, which Marx includes in the broader category of “fictitious capital,” that permits “money values backed by tomorrow’s as-yet unproduced goods and services to be exchanged against those already produced today.” Of course, this forward-looking financing scheme requires that those future values are actually produced, so banks can be repaid and accumulation can continue. As Harvey writes,
A proper allocation of credit can ensure a quantitative balance between [today’s consumption and tomorrow’s production]. The gap between purchases and sales… can be bridged, and production can be harmonized with consumption to ensure balanced accumulation. Any increase in the flow of credit to housing construction, for example, is of little avail today without a parallel increase in the flow of mortgage finance to facilitate housing purchases. Credit can be used to accelerate production and consumption simultaneously.
In a steadily growing economy, haute finance expands credit to both consumers and producers, anticipating that the latter will sell enough tomorrow to cover the former’s spending today.
The danger, and for Harvey the inevitability, is that financiers profiting by underwriting both the demand and the supply sides of a growing economy will overindulge, eliciting the production of more commodities than can possibly be sold for a profit and the creation of more fictitious capital than can ever be backed by actual production. In the North Atlantic real estate bubble, as clear a case of overindulgence as there ever was, this meant more the construction of more houses than could possibly be sold and the issuance of more mortgage debt than could possibly be repaid with workers’ long-stagnant wages. As a geographer, Harvey’s interest lies in the physical results of this continual overproduction. The “spatio-temporal fix,” as he calls it, yields more than just unwanted condos; the necessary expansion of infrastructure that goes along with these binges – for example America’s post-war suburbanization, the global spread of identical glass and steel office towers, Dubai and Saudi Arabia’s booming ex nihilo oases, and China’s stimulus-fueled real estate bubble – fundamentally reshape where and how humans live their lives.
As an economist, however, Harvey’s attention falls on property values, long a sore subject for Marxist theory. If all value represents some quantity of real human labor expended, as Marx holds, then it doesn’t make sense that a plot of unimproved land can have a value, even though no labor has transformed it yet. In his 1982 Limits to Capital, Harvey proposes to treat ground rents, the value of a property beyond anything built on it, as a pure financial asset. “Like all such forms of fictitious capital,” Harvey writes, “what is traded is a claim on future revenues, which means a claim on future profits from the use of the land or, more directly, a claim on future labor.” Thus, property values can be considered fundamentally speculative, regardless of whether a given price seems appropriate or has clearly been inflated by irrational exuberance. Real estate, then, is the perfect capital sink to absorb the surplus value created by a broader speculative binge. As an intrinsically speculative asset, property can easily accrue the added value necessary to finance excess consumption elsewhere in the economy. As a natural resource, a piece of earth has the aura of a good always in limited supply, helping rationalize its rising price. As a physical place, land provides a site for building, allowing it to absorb a great deal of additional surplus labor and surplus capital before starting to look overvalued. The credit system permits capital to finance both the supply and demand of real estate on borrowed money, so long as property values continue to rise.
This treatment of property values is easily extended to another speculative landscape: the Internet. The way venture capital poured into not-yet-or-maybe-never-profitable dot-com startups in the late ‘90s is akin to how developers’ dollars rapidly inflated the value of the ground under Floridian swamps in the early ‘00s. Both pots of money were allocated in anticipation of the properties’ future productivity. The inflowing capital, whether it went to building e-commerce engines or McMansions, seemed to justify the rising property values. Credit financed years of spending (on servers and software engineers in one case and on roads, schools, and stainless steel kitchen appliances in the other) before the assets’ overvaluation became too obvious to ignore. Today, after overproduction has left a housing glut and a real estate market unfit for further investment, capital is returning to cyberspace. The gathering buzz surrounding the impending IPOs of Facebook and Groupon and a possible $10 billion purchase of still-profitless Twitter are based on a shared belief that social media will bring real future production, unlike last time. But extending Harvey’s analytical framework to digital properties illuminates how the Internet now serves an identical systemic purpose as real estate: It is an absorbant destination for overaccumulated capital. Whether or not the market judges $15 billion a fair price for Groupon, Harvey’s work suggests viewing its capitalization as a fundamentally speculative investment in fictitious capital.
Marxists see the search for assets that can absorb the economy’s overaccumulated capital as the necessary papering over of a fundamental capitalist contradiction. As the coordinated lowering of capital controls has increased the fluidity of international financial markets, liquid capital can chase profits around the globe. The non-linearity of investment fads – think of the surging popularity of emerging markets, mortgage-backed securities, and dot-com stocks – makes this profit chase an intrinsically bubbly undertaking, and one can tell a compelling history of the macroeconomic business cycle by tracking the flows of capital among the three fundamental asset classes: securities, commodities, and real estate. The power of Harvey’s theory of property values lies in his analysis of the ways in which capital finances both the demand and supply sides of a speculative industry, allowing asset values to continue inflating until someone declares that things have gotten out of hand.
Consider, for instance, the financial dynamics of the American health care industry; the amount of capital and labor allocated to it is astounding. In 2008, the sector weighed in at a monstrous 16% of GDP in 2008, easily outstripping all other nations’ medical systems, according to the OECD. The second-most profligate country, France, spent just over 11% of GDP on health care. Unlike more centralized systems, the American medical industry is structured to incentivize the prescription of high-cost, cutting edge therapies rather than funding cheaper preventative care. Decentralized in the name of the free market, the existing American health insurance structure has defied fundamental economic logic, financing an ever-increasing demand for expensive medical services even as prices continue their seemingly interminable rise and the quality of care provided stagnates. Surgeon and New Yorker contributor Atul Gawande has made a career out of highlighting intuitive, cheap, and effective cost-control and quality-improving strategies, such as employing operating room checklists and dispatching teams of nurses and social workers to keep tabs on the highest cost patients and reduce their emergency room admission rate. Despite their low cost and effectiveness, the fixes Gawande champions struggle to attract broad support from a medical industry that nets more from a bypass surgery and a life-long course of statins than quarterly appointments with a nutritionist. The result is an intrinsically shortsighted health care system unable to tackle America’s stubborn and costly public health problems, such as obesity. Although many of the cost-saving components of Obamacare are intended to rationalize a permissive and inefficient insurance regulatory system, it remains to be seen whether it will be able to sufficiently alter the existing incentive structure, even as it drives millions of new customers into the arms of private insurance companies.
Capital is doing just as well on the supply side. The biomedical technology sector is among America’s most successful, thanks in large part to a financing system that makes biotech a lucrative target for venture capital. Despite the massive sunk costs endemic to funding hit-or-miss biotech research – the industry has lost nearly $100 billion since 1976, according to an executive at Genentech – the potential upside to drug research is enormous thanks to a set of globally enforced intellectual property laws that guarantee a steady stream of profits for any drugs that gain FDA approval. Key industry victories, such as the ban included in the Medicare Part D prescription drug bill that banned Medicare from using its large market share as leverage to bargain for lower prices, help maintain unnecessarily high drug prices. Internationally, economic rents derived from intellectual property claims, including pharmaceutical patents, are an increasingly important revenue source for the US, as IP-intensive industries accounted for approximately 60% of total US exports from 2000-2007. And domestic investors are protected from competition as well; even as foreign purchasers of Treasury debt fund this extravagant system, foreign capital faces protective restrictions on foreign direct investment in American biotech companies.
Although a medical system unable to contain administrative, provider, or drug costs may be good for financial capital, it is as unsustainable for the country at large as a housing bubble. The weight of insurance obligations is a leading drain of America’s international competitiveness, accelerating the decline of domestic manufacturing and initiating a race to the bottom in coverage that the new health law aims to arrest. The implications for labor are serious. If increases in health care costs continue to outpace GDP growth, workers’ income available for non-medical expenses will continue to shrink, medical expenses will remain the leading cause of personal bankruptcies (another arena in which capital has won substantial legislative victories), and the right will continue to cite generous benefits packages as justification to further erode collective bargaining rights.
Overall, Harvey’s work inhabits the familiar Marxist duality between trenchant economic analysis and leftist disgust. He describes financial capital as a class buoyed by a theoretical utopianism and emboldened by a practical disregard for macroeconomic consequences. During the housing bubble, it was “as if the banking community had retired into the penthouse of capitalism where they manufactured oodles of money by trading and leveraging among themselves without any mind whatsoever for what the working people living in the basement were doing.” While financing both sides of a Ponzi-like economy with privatized gains and socialized losses, capital seems as unconcerned with the massive misallocation of resources and erosion of competitiveness as H.G. Wells’ Eloi were with the subterranean world of the Morlocks. And while few pronounce medicine a bubble waiting to pop, it resembles our recent real estate overindulgence in both the mechanisms of its malignant growth and its potential to cripple America’s long-term economic health.
Posted by Nick Werle at 12:20 AM | Permalink