How economic culture evolves

What cultural evolution has to say about a changing economy

There has been a growing feeling that something is wrong with the direction America is heading since the turn of the century. The idea that we live in a time of crisis has gained currency in recent times. America in Crisis is an analysis of the political and economic dynamics responsible for this feeling. I use a cyclical concept, not William Strauss and Neil Howe’s generational cycle referred to in the previous link, but Peter Turchin’s secular cycle, with corrections that address some of the issues raised in the cited review. I believe a major driver of society is cultural evolution and talk about it a lot. There is also quite of bit of political, economic and financial discussion as I believe these disciplines are also very important to understanding what is going on. I wrote up my analysis in a book with the same name as this substack. I cover some of the material in the book here, plus new insights as they occur to me. For easier comprehension it may help to read posts in sequential order so that when an older post is referenced there is some familiarity.

In previous posts I have used the concepts of shareholder primacy (SP) and stakeholder capitalism (SC) business culture to describe how the modern American economy is different than the one that existed over the first several decades after WW II. This post describes in more detail how these different economic cultures arise as a result of cultural evolution. I first describe what cultural evolution is, how it works, and then how it applies to the economy.

Humans are a cultural species. As far as we know, Homo sapiens is the only species that possess cumulative, adaptive culture. We live in just about all terrestrial environments as a single species. Whilst most animals adapt to a new environment through biological evolution, becoming a different species adapted to the new environment, H. sapiens adapts to new environment through creation of a new culture, remaining as the same species because of the speed of adaptation.

Cultural evolution, like its biological cousin, involves reproduction on information with modification. Any time information is transmitted from one person to another constitutes reproduction of cultural information, therefore cultural transmission occurs far more frequently than gene transmission. This gives cultural evolution the potential to take place much faster than its biological analog. Unlike random mutation in biological evolution, cultural evolution often involves intentional changes to the cultural information an individual possesses. For example, the development of technology typically involves intelligent selection that steers cultural evolution towards a desired outcome.

An important difference between genes and culture is that the former is an individual property while the latter is collective. A community of humans can be thought of as a collection of brains exchanging information with each other―sort of a cultural super-organism. With the development of methods of storing cultural information outside of brains (such as writing) and transmission outside of social learning (such as literacy and the internet), the size of the hive mind was enlarged well beyond individuals in close physical contact. As a result of this, our species has become so smart that we have colonized every sort of environment (we can even live in outer space) and have become the most successful species ever to have lived on this planet.

Cultural evolution not only works to produce technologies allowing tribal bands to flourish in different environments, but also to compete more effectively with other groups for desirable places to live. Such same-species intergroup competition provides another type of natural selection beyond the challenges of the physical environment. Cultural evolution along these lines results in the development of social norms that cluster into cultural institutions that govern relationships between members of the group. Such evolution is adaptive if it aids group survival during hard times or prevents the group fission which typically happens when a group reaches a certain size. This latter outcome helps cultural groups to increase population size, enhancing success in sometimes-violent intergroup competition. Such norms can be thought of as “social scale-up” technologies. An example of this relevant to this discussion is capitalism, a social scale-up tech which increased the military power derivable from a given population (see  secs. 3.2 and  7.2.1 of America in Crisis for details).

Cultural evolution occurs though different processes than biological evolution. In biological evolution, differential reproductive success provides the selection: the variants with the most progeny, on average, increase their frequency in the population relative to others. Selection in cultural evolution also arises from replication, when a person acquires another’s behavior or knowledge through imitation or learning. With much more frequent transmission, cultural evolution is much faster than its biological cousin.

Cultural evolution is Lamarckian; acquired characteristics are inherited, which greatly speeds adaptation to changed environments; rather than waiting for a beneficial mutation to slowly spread through the population, a superior practice can be adopted right away by everyone. One type of cultural evolutionary mechanism is guided variation, in which individuals learn (or create) knowledge that is valued by others who then copy them. That is, the direction of evolution may be guided by the evolving subjects rather than chance.

Cultural transmission typically involves instinctual biases that aid in the evaluation of cultural information to discern that worth learning. Frequency bias is when common cultural attributes are disproportionately more likely to be imitated. Prestige bias is when successful or prestigious individuals are disproportionately copied. Prestige is often signaled by the presence of a symbolic prestige marker such as wealth, social status (e.g. a judge or pastor), celebrity, display of status goods, or personal behaviors (e.g. being “cool”). This bias underlies the use of celebrity endorsements in advertising and the phenomenon of social influencers on the internet.  Sometimes the bias trait is a symbolic marker of membership in a shared group or identity, which could be based on things like race, age, gender, occupation, or even popular culture preferences, such as fandoms. The combination of various kinds of biased transmission with frequency bias can result in the phenomenon of social contagion: which was discussed in a previous post.

This post uses these mechanisms to describe why and how the way the economy functions has changed over the last six decades. Table 1 from my inflation post shows that economic performance for working people was better in the decades after WW II than it has been in recent decades. The postwar economy was also associated with declining income inequality. Since around 1980 inequality has risen to a much higher level, where it has remained for the last decade. I propose this change in economic performance was caused by a shift from SC to SP business culture.

The key to the evolution of business culture is prestige bias and the kind of symbolic prestige marker that triggers the bias trait. The evolving pool here are capitalists: investors, entrepreneurs, CEOs and other executives. Elites in different cultures have used various things as prestige markers. For Yap Islanders the size of the yams one grows was one such indicator. A showy feast (potlatch) hosted indigenous chiefs in the Pacific Northwest was another. One such marker for Western capitalists was proclaimed by 20th century mogul Ted Turner, “life’s a game, money is how we keep score.”  Another source of capitalist prestige is the size and importance to the larger public of the enterprise that the capitalist creates or operates. Capitalists pursue a variety of businesses strategies in the quest to acquire prestige, in the process of which they accumulate capital (which is what makes them capitalists). Those strategies that achieve the greatest prestige are more likely to be copied and spread through the larger executive population.

Government economic policy strongly affects the prestige acquisition process. Consider a CEO in the 90% bracket with a corporate tax rate of 50%. Investors must surrender $5 of earnings for every additional dollar of after-tax CEO compensation. A board in this situation would not be able to justify any raise at all for that executive. In actuality, the CEO’s compensation would probably never have reached the 90% bracket in the first place. What this means is a government decision to have very high marginal income taxes with a much lower corporate rate creates a world in which executive compensation is restricted to quite low levels (see Figure 1).

Figure 1. Executive compensation and top tax rate over time

Restricted CEO compensation like that from the late 1930’s through 1960’s made it more difficult for executives achieve money-defined prestige (i.e. become one of the superrich). Not only that, but efforts to directly boost share price with stock buybacks were illegal. Hence, those executives with great prestige (whose ways would be most likely to be duplicated) were more likely be those whose focus was not on stock prices, but rather on building great corporations that were socially or economically important. Doing this means building things, something that economics writer Noah Smith argues is necessary for the US to remain a top tier country. It also means a strong demand for workers, an environment that is conducive to wage growth and union strength (see Figure 2).

Figure 2. Trends in wages and strike frequency over time (wage is cost of unskilled labor/2000)

To align investment with executive desire to build, a positive enterprise premium (see Figure 4 here) must be maintained by government policy. A positive premium means the return to capital from business is greater than the return from financial products, incenting investors to fund executives building stuff instead of buying financial products. This is achieved by a policy of low interest rates, low inflation, high top tax rate on dividends and rental income, and low stock market valuations (limiting potential for capital gains). According to the money flow inflation model doing this means running fiscal budgets that were balanced over the course of a business cycle in order to generate the low NAIRU required have both strong growth and low inflation. Government policymakers who could do this would create a population of capitalists focused on building stuff and accumulating real capital leading to strong economic and wage growth as shown in Figure 2.

On the other hand, when tax rates are low, there is no limit to the compensation executives can receive. Figure 1 shows that when the top rate fell, executive compensation soared. By using stock options boards can provide enormous compensation to executives when the market is rising at no cost to the company (there is a cost to shareholders).  Doing so aligns executive financial interests with a rising stock price, inculcating the “shareholder value” ethic that underlies the SP cultural variant. It is easy to see that low top income tax rate creates an environment that selects for the SP cultural variant.

Figure 3. P/R and Tobin’s q over time

The rise of a negative enterprise premium after 1980, means financial investments made more sense than productive ones. This situation should also be good for stock prices, which rose strongly for nearly two decades after 1982. In that year, stock buybacks became legal and SP businessmen could make use of them to enhance shareholder value. As the prevalence of SP culture rose, stock buybacks increased in popularity, which began to have an impact on stock market capitalization. This has created a new paradigm for the stock market in which old valuation models, such as the Buffet ratio, Tobin’s q, or my own P/R no longer apply (see Figure 3). This new paradigm creates the potential for a “permabull” market environment that further supports the SP cultural mentality, in which financial values are paramount.

The descriptions above show that top tax rate, interest rates, and labor demand/union power are important environmental parameters determining whether SC or SP culture will become dominant. Indeed, in the math model explaining how business culture (proxied by income inequality) evolves over time (see Figure 4) the environment (E) is a function of top tax rate, interest rates and strike frequency (see Secs. 3.4-3.6 in America in Crisis for detailed development).

Figure 4. Evolution of business culture

The rise of SP culture is problematic for several reasons. One is the associated tendency to not build stuff. The nation will need to build stuff (i.e. accumulate a lot of real capital—something SP culture eschews) in order to contend with issues like global warming and facing the challenge of an increasingly assertive China. Another is financialization of the economy and its effect on asset valuations. Since houses are assets, this SP cultural manifestation has put buying a house out of the question for young people, which likely plays a role in falling birth rates and feeds youthful discontent with capitalism which may lead to a search for alternatives to the current political order. Another important effect is how SP culture increases the risk of financial crises in accordance with Hyman Minski’s financial instability hypothesis (more on this in Sec 4.2 in America in Crisis). We’ve already had one financial crisis and the last time SP culture was in vogue we had them every 16 years on average (range 9-22). With the recent failure of Silicon Valley Bank, talk has surfaced in twitter about a potential banking panic suggests the financial fragility Minsky describes is once again present.

A fourth problem arises from income inequality, which I use as a proxy for SP culture. According to Structural Demographic Theory high inequality leads to elite proliferation, rising elite competition, and ultimately inter-elite conflict. Such conflict can take various forms: mass unrest, political coup, mass-mobilization war, civil war, or in its most extreme form, state collapse. Readers may see additional problems stemming from SP-friendly modernity. Though ruling elites enjoy great wealth and privilege from our current system, do these benefits outweigh the threats created by SP-sustaining policy?