Joseph Schumpeter compared the function of banks under modern capitalism to Gosplan, the central planning agency of the old Soviet Union. Banks, through a conscious, deliberate decision, dedicate some fraction of society’s resources to some project that they have decided is worthwhile. “The issue to the entrepreneurs of new means of payments created ad hoc” by the banks, he writes, is “what corresponds in capitalist society to the order issued by the central bureau in the socialist state.”
[...]
This is not some weird quirk of venture capital. This is a central purpose of finance – to direct society’s resources to one activity that has not yet been successful in the market, but that somebody think could be. The defining characteristic of an entrepreneur is that they undertake some new activity, something that is not already being done, with funding provided by someone else. An entrepreneur in this sense definitionally faces a soft budget constraint.
This is not, again, an anomaly, it is not a breakdown of the normal operation of capitalism. It is essential to what makes capital such a powerful force for transforming our material existence. And it needs to be central to our theoretical accounts of capital and of the investment process.
[...]
Now, some people might say: This planning is based on the hope of future profit, it will eventually have to be validated by markets. But it is not incidental that the market outcome and the pursuit of profit are mediated by conscious planning.. They do not happen automatically. The judgement of the market can be deferred, in principle indefinitely.
We must also reject the idea that the assessment of future profitability is rational or objective. This is one reason the Levine story is useful – it focuses our attention on the ways that financing decisions are made in practice. Making energy from algae is cool! As he says, this an important part of the investment process. That should not be abstracted from.
[...]
Nor is it clear that future profit always is the motivation, certainly not the only one, and certainly in the early stages. It’s not incidental that Levine emphasis that algae energy could get funding in part because it is cool. It’s not, perhaps, incidental that OpenAI started its existence as nonprofit. The pursuit of profit is not always what motivates investment, especially when it involves fundamental departures from existing forms of production.
[...]
There is an idea — Anwar Shaikh offers a contemporary example — that the rate of profit is determined first, and then the rate of interest is secondary, a special case of profit, governed by it, or a deduction from it. But we can’t say what the profitability of the algae business even is, prior to the question of what terms it is financed. At one rate of interest it may be very profitable, at another less so or not worthier pursuing at all.
Now maybe you will say: sure, anyone can make a profit if they get that free Fed money. But it’s not just that. The relative profitability of different projects depends on the term on which they can be financed.
[...]
Partly this is just a simple matter of discount rates. In these narrow terms, the algae project is more profitable if the interest rate is 5 percent; the fossil-fuel project is more profitable if the interest rate is 10 percent.
More broadly we have to consider, for instance, whether the financing will have to be rolled over, if, say, the project takes longer than expected. What are financing conditions are likely to be at that point? If the loan is due and can’t be rolled over and the project has not generated sufficient returns to repay it, then the return on whatever capital the undertaker put in themselves will be negative 100 percent. The chance of this happening — which, again, depends as much on future financial conditions as on the income generated by the project itself — has to be factored in to the expected returns.
From the article:
[...]
[...]
[...]
[...]
[...]