Over the past century and a half the pendulum
has swung back and forth between two different systems of equity
finance, call them the Anglo-American decentralized market-based
system and the Germano-Japanese centralized bank-based system.
The Anglo-American system has many advantages:
that risk is spread because equity ownership is widespread and
diffuse; that information is public because it is largely revealed
through prices in relatively thick high-volume financial markets;
that corporate results reported according to accounting standards
are important channels of information transmission. But the Anglo-American
system also has the disadvantage that monitoring and controlling
firm managers often falls between the cracks.
The Germano-Japanese system--what Bo Cutter
calls "bank capitalism"--has the advantage that monitoring
and controlling firm managers is very definitely the business
of the unified institutions that hold and issue equity and have
long-term close relationships with operating firms. The Germano-Japanese
system has the disadvantage that information is harder to see
and harder to learn: there is more of a difference between insiders
and outsiders.
Now this opposition can be overstressed. There
are powerful elements of both systems in all economies. But it
is real. And over the past half century opinion has been excessively
volatile, swinging back and forth from overemphasizing the advantages
of one to overemphasizing the advantages of the other. Think
of American attempts to restructure Japanese finance in the Anglo-American
mode in the aftermath of World War II. Or think of Michael Jensen's
claims that the leveraged buyouts of the 1980s would move the
U.S. toward the Germano-Japanese system and be the wave of the
future. Or think of the dour declarations two years ago that
the Korean economy could not recover unless it dismantled its
Germano-Japanese-style system of equity finance--so vulnerable
to "crony capitalism" and replaced it with an Anglo-American
style system.
Yet all these predictions have been awry.
Japanese finance was not restructured, at least not fundamentally--yet
the Japanese economy after World War II boomed. The LBO boom
of the 1980s was a temporary phenomenon, not a sea-change to
a new world. And the Korean economy is recovering very rapidly
in spite of the failure of the Korean government to obay the
ukases of the IMF.
At the moment the Anglo-American model is
riding high. The reasons that it is riding high are in large
part sound: the Germano-Japanese system is vulnerable
to crony capitalism; that system is fundamentally unfair
to "outsiders"--and hence has a hard time raising funds
that are not channeled through the gatekeeping institutions of
finance capitalism.
But I am not as sure as Bo Cutter is that
the worldwide integration of equity markets is leading to a wave
that inherently strengthens the market-based, decentralized wing
of equity finance. For the Anglo-American system has vulnerabilities
too.
We know what those vulnerabilities are. The
NASDAQ 100's P-E ratio is 100. The S&P 500's P-E is 31. Some
people say that these high price earnings ratios exist because
investors have recognized that stocks are no riskier than bonds,
and hence have bid up stock prices until the expected real rate
of return on stocks is the 3 percent or so expected on bonds.
These people are wrong: investors are holding stocks because
they expect the future to be like the past--expect the next year
at least to deliver the double-digit real equity returns seen
in every year over the past decade.
I believe that either the NASDAQ portfolio
holders are realistic--and that the new companies will take immense
market share and profits away from old companies over the next
two decades--or the S&P portfolio holders are realistic--and
that old companies will successfully surf the technology wave.
And I believe that both cannot be right: some large component
of the global stock market today is way overvalued.
So I predict that a decade from now there
will be someone sitting here who will talk about the benefits
of patient capital, the advantages of relationship equity, the
unproductive distortions introduced into the world economy by
the froth on the wave of overoptimistic equity investment at
the turn of the millennium, and our renewed appreciation of the
virtues of the Germano-Japanese system whereby the corporate
decisions that are made are those that boost informed investors'
and analysts' views of the fundamentals of the business rather
than those that boost tomorrow's stock price.
And then, of course, the pendulum will swing
yet again...
Professor
of Economics J. Bradford DeLong, 601 Evans Hall, #3880