Finance Capitalism and the Digital Economy

FINANCE CAPITALISM AND THE DIGITAL ECONOMY


An Explosive Symbiosis


By Philipp Staab


[This article published in WISO 15/2018 from the Friedrich Ebert foundation is translated abridged from the German on the Internet.]


[The financialization of the economy and the rise of the commercial Internet are directly connected. Decades ago, the demand of the financial markets fueled the development of digital technologies. Some of the central business models of the New Economy go back to models from financial management. The digital economy inherits the central role of private risk capital and systemic risks from the financial markets.


In Silicon Valley’s promotion of its image, the rise of Internet companies is presented as the history of risk-taking entrepreneurs who carry out creative and risky innovations in the form of “new combinations” (Schumpeter 1983). If one follows the popular narrative, the history of the commercial Internet began in the middle of the 1980s and since then developed largely independent of other developments of the political economy.


Today we know this narrative shifts attention to the important mainsprings of digitalization. At the beginning of the digital economy was an investing state that took over the start-up financing for the large majority of the base innovations of digitalization as an initial risk capitalist. In addition, the great trends of restructuring capitalism were very closely connected with the use of digital technologies since the 1970s (automation, globalization) and contributed to the rise of the technology sector.


A systematic understanding of the most important connecting lines between the commercial Internet and the financial sector for the digital capitalism of Internet companies is still absent. Long ignored, the latter was first the most important source for investments in and demand for digital technologies. Secondly, the financial market model helped form the second business model of the commercial Internet. Thirdly, the digital economy inherited a proper dose of its own systemic risks.


A Growth Tandem


The term financialization describes a change in the capital accumulation model in developed OECD economies since the late 1970s. The financial markets gained importance as a consequence. Financialization is a process in whose course real-economy businesses, states and private persons became increasingly indebted and simultaneously generate more and more financial investments (Sahr 2017).


The financialization of the economy and the rise of the commercial Internet form historically a historical tandem. The rise of the financial sector described with the term financialization is based in part on digital technologies in which enormous sums from financial management are invested. The goal is strengthening the infrastructure and pressing ahead with product innovations. High-frequency trading, automated investment trading in computing power, programming skill and hardware were product innovations. Products and services originating from the technology sector were necessary for those innovations. The search for investment possibilities in growth markets is a second reason for the investments of banks, investment companies and risk-capital funds in information- and communication-technologies that have constantly grown since the 1970s.


The budget that US banks spent for digital computer terminals and software increased 19% annually at the same time as the deregulation of the financial markets in the 1980s (Schiller 2014). Until recently, the financial branch was the second-largest demand sector for IT-products and services (Schiller 2011). Thus, financialization and digitalization stand in a co-evolutionary relation. The functioning of the financial system is characterized “by electronic and digital technologies, by the consistent linkage of information processing and telecommunication” (Vogl 2011).


Financialization plays a crucial role in building and developing the material infrastructure of the Internet and vice versa. So Hibernia Networks, a US provider of telecommunication infrastructure, laid the first transatlantic underwater cable in 2010 after the Dotcom crisis in 2000. The new cable should accelerate transatlantic data transfer around five milli-seconds. The speed-gain of the new cable does not give common users any appreciable advantage. However, these accelerations of data transfer were important for the banks of finance capitalism specializing in high-frequency trading
(Schiller 2014).


The needs of financial management were key factors for the growth of the infrastructure of digital capitalism in many other cases. Consequently, the net infrastructures, software-guided financial products and working methods formed the backbone of the global financial system (Schiller 2014).


Two of a Kind


The parallels between the financial- and the Internet economy are by no means exhausted with the capital transfusions from the financial sector in the form of investments and demand for digital technologies. Internet-companies learned money-making from the financial markets as appears in different aspects central for the commercial Internet.


So, for example, the markets for online advertising controlled by Google and Facebook resemble markets of the digitalized financial sector before their temporary collapse in 2008. In both cases, primary products – email accounts, social media accounts, Internet searches etc in the case of Internet businesses, awarding credit in the case of financial institutes – are not the central sources of business profits. Rather, Google and Facebook gather user-data to use this in the form of exploitation for personalized advertising.


There is a very similar logic in the realm of the banks with the notorious derivative trade. Derivatives is an umbrella term for a multitude of payment agreements that differ from classical credits … As a second parallel, the markets of the financial sector like online advertising are organized trough intensely automated market transactions. Their share has continuously increased in the last years. In 2010, algorithmic investments amounted to half of US stock market transactions (Lange 2016). Computer algorithms independently observe market fluctuations and buy or sell shares or currencies according to previously fixed criteria. So the purchase decisions for advertising places on online markets are extremely automated. In other words, they are based on algorithmic risk or profit calculations.


Automated transactions in the world of finance can also be applied as long-term investment projects (“systematic trading”). Most automated transactions occur in fractions of seconds as in high-frequency trading. This model plays an important part in organizing modern markets of personalized online advertising. Google’s auctions for advertising places run in real-time (Echtzeit). In other words, an auction mechanism runs in the framework of high-frequency betting on the expected future profits of the respective advertisement – in the background of every user’s search. The market of real-time betting borrowed from high-frequency trading could not even function without the value-creation model of the commercial Internet.


Piketty in the Internet


Private risk capital (venture capital) is a specific kind of capital that has become ever more important both for the financial sector in the last decades and for the commercial Internet at the beginning of every economic development is an important binding link between financial management and the Internet economy. Piketty’s element of digital capitalism appears here. In a world where wealth grows faster than income (Piketty 2014), an increasing number of investment possibilities face capital. During the 1990s, this capital could be absorbed to a smaller extent by stock markets and flowed in the form of private investments in risky business models. So risk capital has become a vehicle for increasing private wealth – a development that has unfolded particularly in the Internet economy since the 1990s.


New businesses usually hardly receive bank credits even if they follow high-risk business models. Private funders filled this gap in the 1990s. Their specific economic calculation is clearly different from a classical business perspective. Risk capital calculates in longer time periods of two to five years while traditional foundations usually aim at quick solvent numbers to quickly repay their credits… The goal is rather to bring the respective business into a promising position that it looks like a lucrative investment to other investors.


These new investors that gain shares in the respective businesses are the real target group of this kind of economics. The business is a product that must be cast with the most positive speculative expectations so the calculation proves right…As long as the hype functions in the Internet economy as during the 1990s, every business is a possible “disruptive” game-changer with a realistic chance for unprecedented profits. This was not true at that time. That is why the exit-spirals at the end resembled a gigantic risk cascade. Whoever was on board the sinking ship had to perish with the ship.


Risk Capital Seeks Profit


The significance of private risk capital has clearly risen since the 2008 financial crisis and appears in the world of technology startups with especial urgency. In the US, the amount of invested risk capital set a ten-year record in 2017 at $72 billion (Richter 2018), twice as much as 2008 (around $30 billion) and 4.5 times as much as 2002 (around $16 billion)… In an international comparison of big political economies, Germany is a relatively small market for risk-capital investments. The 100 startups with the most investments in Germany acquired $4.7 billion in investments between 2009 and 2015 (Ernst & Young 2017)…


Dot com – Bubble 2.0?


The same exit-calculations of risk-capital occur today as during the dot-com boom that marked economic activity (Staab 2018). Startups have increasingly become speculatively-traded goods. 76% of those businesses that dared to be listed on the US stock exchange in 2017 did this without investors gaining a profit from their shares…


Beyond these obvious parallels to the 1990s, there is also an important difference. The center-of-gravity of the exit-event shifted to acquisitions…


The risk-groups of online finance capitalism systematically changed. As investors were the crucial risk-group that was harmed when economic expectations turned out to be massively speculative, so the purchasing businesses and their employees must shoulder the burdens of later write-offs in cases of acquisitions.


The Coming Crisis


The situation of the digital economy structured by private risk-capital portends the coming crisis… The digital capitalism of the commercialized Internet took over Big Brother’s crisis-proclivity and did not only use investments and demand from the financial sector for its own growth and structured central business models. Those business models mirrored the model of the financial markets.