Wednesday, 13 May 2015

Capital Markets Union – The Risk of Short-Termism

David Begg: The European Commission believes that European Capital Markets are underdeveloped. It considers that this is an aspect of the single market which needs deepening and more integration. Commissioner Katainen said recently that the goal of policy would be to create a Capital Markets Union in which the flow of capital will increase allowing business to expand and providing more options for people to save for their old age, and strengthen financial stability. With a still fragile banking system carrying €900 billion of uncertain debt this makes perfect sense, or does it?

According to the Commissioner this initiative is modelled on the United States where research suggests that a large proportion of risk sharing comes through Capital Markets. For sure the US has managed the fallout from the 2008 financial crisis much better than Europe but that does not mean that its Capital Markets function in an optimal way.

In theory companies are meant to raise money from the Stock Market to invest in future growth. Exactly the reverse is happening in the United States. Last year the volume of share buybacks by companies was $550 Billion while the amount of new money coming into the Market, mostly into mutual and exchange trading funds, was just $85 Billion. This obsession of companies pumping up their share price by buying their own shares is not without its critics even within corporate America. The Head of Blackstone, Larry Fink, who manages an asset portfolio of $4.65 trillion, was quoted in ‘The Financial Times’ on the 27th April as accusing America’s business leaders of eating their own seed corn. ‘Their obsession with short-termism’ he said, ‘would come at the expense of the future’.

Mariana Mazzucato, who was in town last week to deliver the Donal Nevin Memorial Lecture, is of the view that the problem of share buybacks is not isolated but rampant. According to her, 500 companies have spent $3 trillion on share buybacks in the last decade. She claims that the top pharma companies are spending a decreasing amount of funds on R&D at the same time that the State is spending more, making the innovation ecosystem more parasitic than symbiotic (Mazzucato, 2013:26). Similarly Will Hutton (2015:51) writes that British companies are hoarding £800 Billion that they would rather use buying back their own shares than committing to investment.

So there may be unintended outcomes if EU policy shifts towards the Anglo-American model with its short-termism and focus on maximising shareholder value. It may also have social consequences insofar as the reward system for Chief Executives built into the model tends to increase inequality. Moreover, a CEO whose remuneration is related to share price has a powerful incentive to use cash to buy back shares rather than to invest.

There is a deeper dimension to this as well. In a seminal work in 2001, Peter Hall and David Soskice wrote about what they described as The Varieties of Capitalism. The firm and its relations with markets is central to their theorising. In their typography Europe consists of both Coordinated Market Economies (CME’s) and Liberal Market Economies (LME’s). As the name suggests, CME’s depend on institutions while LME’s default to the free play of the market forces.

CME’s rely heavily on the availability of patient finance made available over long periods from the banking system. This allows firms to better ride out periods of economic downturn and to hoard labour until things pick up again.

LME’s are driven by shareholder value and short-termism and will shed labour in a downturn in order to underpin the share price. Britain and Ireland are classified as LME’s by Hall and Soskice while the Continental European countries (not including CEE countries) are considered to be coordinated market economies.

By recasting Capital Markets in the manner spoken of by Commissioner Katainen it seems to me that the Commission is consciously or unconsciously taking a decisive step towards the Liberal Market Economy Model with all that implies for precarious employment and potentially increasing inequality.

David Begg is Director of TASC


  • Hall, Peter and Soskice, David (2001), Varieties of Capitalism: The Institutional Foundations of Corporate Advantage. Oxford. Oxford University Press.
  • Luce Edward (2015), ‘US Share Buybacks Loot the Future’ The Financial Times, 27th April 2015: P11.
  • Hutton, Will (2015), ‘How Good Can We Be: Ending the Mercenary Society and Building a Great Country. Gt. Britain. Little, Brown.
  • Mazzucato, Mariana (2013), The Entrepreneurial State: Debunking Public V Private Sector Myths. London. Anthem Press.

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