The state as the venture capital market maker: some concerns

As a matter of fact, there is considerable evidence of the state acting as a de facto venture capital investor and with favourable outcomes in terms of economic growth. For instance, Conti (2018), Howell (2017), and Keller and Block (2013) account for how various state initiatives to support early-stage development work in new ventures are conducive to economic growth. More specifically, these studies indicate that state initiatives are complementary to private equity investment inasmuch as, for example, R&D grants may serve to verify certain innovation concepts so that the threshold is lowered for venture capital investors. In this view, the state productively contributes to innovation-led growth and a dynamic economic system.

An alternative view of state-financed initiatives is to consider the scenario wherein such funds are no longer supplied, and markets are exclusively assigned the role to supply finance capital to enterprising activities. In this scenario, it is important to recognize alternative investment opportunities that private equity holders examine. The foremost investment opportunity is to reinvest the residual cash generated on the basis of stock ownership in

Thinly capitalized ventures 121 mature industries in the finance industry itself. The deregulatory policy of the last three decades in the United States and in Europe was intended to promote capital formation, which would result in a lower cost to acquire capital and therefore be supportive of increased entrepreneurial activity. One of the key mechanisms intended to serve this end is considerably more liberal legislation pertaining to securitization, wherein the cost for transforming illiquid asset holdings into tradeable assets is lowered (Shin, 2009). Given these stated policy objectives, the current situation wherein ventures suffer from an endemic shortage of venture capital supply, and this despite the sharp growth in the monetary base on various levels of analysis, is disappointing. Whereas, for instance, thinly capitalized banks can borrow money on easy terms during the upward turn of the business cycle (Adrian, Kiff, and Shin, 2018: 7), which increase the inflow of finance market actors and thickens finance markets, it remains complicated for equally thinly capitalized ventures to acquire even considerably lower amounts of finance capital to continue their development work.

Investment opportunities that attract residual capital

The legislative reforms and new deregulatory policy thus created a situation wherein the expansion of the finance industry and the monetary base fail to substantially increase the stock of operational venture capital. A critical commentator may then inquire where the surplus capital generated is channelled? The first immediate response to the collapse of the sub-prime mortgage market in 2007-2008 was investment in commodities trade, which resulted in a spike in the price of certain commodities (Williams and Cook, 2016; Sockin and Xiong, 2015; Tang and Xiong, 2012; Mayer, 2012; Nissanke, 2012). For instance, between 2007 and 2012, the volatility in oil prices was “exponentially greater” than during previous episodes of oil shocks, for example, the 1973 Organization of Petroleum Exporting Countries (OPEC) oil embargo, the 1979 Iranian revolution, and the 1990—1991 Persian Gulf war, Greenberger (2013: 709) writes. During this period, economist Mike Norman asserts (cited in Greenberger, 2013: 722), “oil prices are high because of speculation, pure and simple. That’s not an assertion, that’s a fact.” More recently, there is evidence that hedge funds, providing first-rate high-risk/high-return investment, have grown considerably in size and number. Hedge funds are notorious for their “confrontational approach” as fund managers seek to extract residual cash from companies that have “sound operating cash flows and returns on assets, typically have a low share price relative to book value and low dividend payout ratios” (Cheffins and Armour, 2011: 57). The demand for hedge fund investment indicates that the appetite for high risk (as opposed to uncertainty of any kind) may be considerable among investors. By the early 1990s, there were around 300 hedge funds, managing assets worth US$40 billion. By 1998, less than a decade later, these figures had grown almost tenfold. In 2006, there weremore than 8,000 hedge funds, holding more than US$1 trillion in assets (Cheffins and Armour, 2011: 79, 88). Lysandrou (2018: 55) reports that the aggregated hedge fund assets being managed “more than tripled between 2002 and 2007,” rising from US$600 billion to about US$2.2 trillion, while “the number of firms operating within the industry” doubled from circa 5,000 to 10,000 in the same period.

Furthermore, finance capital has been invested in tax havens. “The global rich,” Palan, Murphy, and Chavagneux (2010: 5) write, “held in 2007 approximately $12 trillion of their wealth in tax havens. It is as if the entire U.S. annual GNP were parked in tax havens.” The transfer of capital funds to these jurisdictions is also a direct consequence of changes in the global financial system. For instance, when the American sub-prime mortgage market became moribund in the 2007-2008 period, funds were transferred to, for example, Switzerland: between 2009 and early 2015, the total amount of foreign wealth managed in Switzerland “has increased by 18%” (Zucman, 2015: 60).1 Alstadsaeter, Johannesen, and Zucman (2019: 2074) examine data from the “Swiss Leaks” and “Panama Papers” in combination with tax amnesties conducted in the aftermath of the financial crisis of 2008-2009 for the three Scandinavian countries of Denmark, Norway, and Sweden. Without tax evasion activities, the top 0.01 per cent richest Scandinavians would have on average a marginal tax of 49 per cent in 2006, and on average the top 0.1 per cent would pay about 45 per cent of their income in taxes. In practice, when considering tax evasion efforts, the top 0.01 per cent of households effectively paid taxes at the level of 35 per cent. “[T]ax evasion erodes the progressivity of the tax system, and, accordingly to our estimates, makes it regressive at the top,” Alstadsteter, Johannesen, and Zucman (2019: 2099) say, in summarizing their results. Furthermore, while the Scandinavian countries are commonly portrayed as ranking high regarding respect for the rule of law and with the highest “tax morale” (Alstadsaeter, Johannesen, and Zucman, 2019: 2075), it is likely that tax evasion is even higher in other countries and regions. It is noteworthy that regressive tax systems are today implementing fiscal policies in, for example, the United States, wherein in 2018, for the first time in a hundred years, the “top 400 richest Americans have paid lower taxes than the working class” (Saez and Zucman, 2019: 22). Such empirical evidence regarding the magnitude of tax evasion in especially the top 0.01 per cent income groups is indicative of finance capital owners reinvesting their residual cash in various finance asset classes, but preferably not in new ventures. Expressed differently, the traditional role of capital owners as investors in production capital is abandoned and left for others to handle.

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