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Knaves & fools, contd
What are the actual economic functions of the stock market?

Since posting ignorantly on that subject (30 April ff.), I have made some effort, using the Web and the Harvard libraries, to find out, if not the answer to the question, at least the state of informed opinion on it. Despite something like a day's work (including walking four times thru that wonderful dead-white tunnel between the Widener & the Pusey), I have not succeeded in doing so. There seem to be no books or articles whose purpose is to discuss the question; what I find is flat statements, which disagree violently but are not accompanied by refutations of one another, in works that are mainly concerned with other subjects.

The standard term for the direct use of retained profits to finance investment appears to be "internal financing".

The statement by Lester Thurow in 1976 that I quoted in my comment on Tony Berno's comment (2 May) is more accessible in his book Generating Inequality ( He is concerned mainly with one role of the stock market: as a way of for some people to get rich. In 1982, however, he & Robert Heilbroner published a popular exposition with a broader purpose, called Economics Explained. It contains a chapter called "Saving and Investing", in which it is explained that the capital market (which in 1976, we recall, was negligible for practical purposes) is of critical importance:
``Thus the process of saving and investing goes directly to the central issue of macroeconomics. Household savings are `acquired' by the business sector to finance the building of new capital goods.''
No numbers about the extent to which that happens.  Internal financing is barely mentioned.

Another popular book, Investing in One Lesson by Mark Skousen, Ph.D. (Regnery, 2007), is more vigorous:
``If the stock market were abolished in major industrial nations, or discouraged through confiscatory taxation, it would likely provoke massive layoffs and a depression as the sources of capital dried up.  Many new company expansion plans would come to a quick halt. Granted, companies could raise investment funds from the bond market or from bank loans, but the cheapest and most liquid form of capital -- issuing stock to the public -- would no longer exist.''
The cheapest and most liquid except for internal financing, which Dr Skousen does not see fit to mention at all.

I did find some more statistics.  In ``Comparative Financial Systems: A Survey'' by Franklin Allen & Douglas Gale (2001), Table 2 (for five countries; here I present only the column for the US):

Unweighted Average Gross Financing of Nonfinancial Enterprises 1970-1989 (% of total)
Internal                           91.3
Bank Finance                16.6
Bonds                             17.1
New Equity                      -8.8
Trade Credit                    -3.7
Capital Transfers             ---
Other                                 -3.8
Statistical Adjustment    -8.7 [I don't know what that means]

In ``The Financing of Industry, 1970-1989: An International Comparison'', by Jenny Corbett and Tim Jenkinson (, Table III:

                             1970-1974    1975-1979    1980-1984    1985-1989
Internal                     74.5                91.5                89.6              103.7
Bank finance           26.6                14.1                12.9                15.0
Bonds                       15.7               14.9                 10.9                24.8
New equity                 7.3                  0.7                  -4.8              -29.6
Trade credit              -2.8                 -5.4                  -1.7                -4.7
Capital transfers      ---                     ---                     ---                   ---
Other                       -10.8                  -8.7                  -0.6                 1.8
Statistical adj.        -10.5                  -7.1                  -6.3             -11.0

These tables confirm Thurow's early statement that internal financing was dominant. But they reveal something far more damning: The contribution of the stock market to capital formation ("new equity") can be negative, and was increasingly so during the period covered. US corporations spent more money buying back their own stock than they took in by issuing stock. It seems that the reason for doing so was to ward off takeover attempts by reducing the amount of available stock and bidding up the price of what was left. (It springs to my wicked mind that the latter effect would also be pleasing to the officers of the company in raising the market value of their own stockholdings. Perhaps they even followed up their companies' purchases with sales of their own.) In any case, these forays into the market used up money (some earned, some borrowed) that could have been used for productive investment.

Once again, neither of these last two investigations was concerned with the stock market as such. But maybe, in view of the prevalence of party questions, the way to find out things from economists is, in fact, to look at what they let slip when they are talking about something else.

N.B. In poohpoohing the stock market, I am biting the hand that feeds me. Much of my net worth is due to modest deposits made in CREF in the 1960s, since when, of course, it has done very well on the whole. The recent crash has cut into it, but not overwhelmingly, because I had followed prudential advice & moved most of my accumulation out of stocks as my retirement approached. If the stock market is really just a lottery, then I am a lottery winner. But, if so, that is only one way that I have had more luck than I deserve.


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