The weighted economy I: firms and markets

Though it feels like decades ago, one of the dominant themes of the fizzy turn of the millennium was the “weightless economy” in which the ratio of physical mass of output relative to value added was understood to be shrinking almost asymptotically due to rapid technological change.

In retrospect, it looks like “weightlessness” was at least in part a function of the technology-enabled virtualization of every possible cash flow into financial instruments. Or put another way, what has appeared to be a weightless economy was in large part the financialized economy, as the following chart from U. Michigan’s Greta Krippner implies.*

Source: Krippner, G. (2005) The financialization of America. Socio-Economic Review (2005)3, 173–208

The financial sector’s monopoly on this kind of virtualization stemmed from its control over access points to capital markets for both issuers and buyers. The wealth and power that accrued to the holders of those access points is perhaps the defining characteristic of our political economy today.

What is becoming increasingly clear that these are no longer the only access points that matter, nor is capital the only scarce resource. And while it is too early to draw any substantive conclusions, I think some recent developments signal a shift in the focus of economic activity that may provide the beginnings of an outline of what the post-industrial, post-finance world might look like.

One glimpse of this new outline came to light during the food crisis, when attention focused on the role of commodity index investment by institutions. I’m still working through the research on the topic because it’s both maddeningly contradictory and long on very limited “proof” statements. The bigger and more interesting issue is the move by Wall Street into the commodities markets as both agents in financial markets (hedging swap exposure using commodity futures) and principals in physical markets (both trading and taking delivery/warehousing as proprietary traders), along with a similar evolution by longstanding commodity giants such as Cargill, Bunge and ADM. Some recent stories:

A 2008 article by Bloomberg found that:

Commodity-index funds control a record 4.51 billion bushels of corn, wheat and soybeans through CBOT futures, equal to half the amount held in U.S. silos on March 1.

Per last week’s WS Journal,

Goldman’s warehouse on the banks of the Detroit River is one of more than 100 storage facilities controlled by the giant securities firm around the world. The warehouses are part of Wall Street’s effort to forge a new frontier in the commodities markets: warehousing metal.

In the past 18 months, Goldman, J.P. Morgan Chase & Co. and trading firms Glencore International PLC and Trafigura Beheer BV have snapped up warehouse operators, all of them accredited to house metal traded through the London Metal Exchange, or LME. The buying binge means the four firms now are landlords to about two-thirds of the LME’s entire metal stocks, from aluminum to copper to zinc.

From an April 2011 article in the Independent on the upcoming IPO of secretive commodity giant Glencore (the source of Marc Rich’s fortune):

[Glencore] is the largest of the world’s big four independent oil dealers, ahead of Trafigura, Vitol and Gunvor. The same quartet provoked controversy in 2009 by using fleets of oil tankers to store their valuable cargo off-shore during a glut of availability, waiting for its value to increase before selling it on for profits of 15 to 20 per cent.

The blurring of distinctions between commodity and financial activities is only going to worsen as each side moves toward some hybrid center. Wall Street banks have been closing their prop desks in preparation for Dodd Frank, which in practice means that commodity trading activity is moving into even less transparent hedge funds. At the same time, the commodity giants are moving to monetize their own deep expertise in the commodities markets by launching hedge funds, private equity and other vehicles to manage money for external clients.

This convergence points to an even greater concentration of economic power in an already concentrated commodity system. I don’t know the comparable figures for metals, mining, etc., but I do know that the level of market concentration with regard to agriculture amongst the incumbent commodity giants is profound. From the World Bank’s extremely helpful 2008 World Development Report:

Driven by gains from economies of scale and globalization of the food chain, multinational agroenterprises increasingly dominate the agribusiness sector along the value chain. They provide inputs such as pesticides, seeds, and crop genetic technologies that have consolidated horizontally and vertically into a small number of multinational firms. On the marketing side, a few multinational enterprises are broadly diversified from seeds, feeds, and fertilizers to product handling and processing of sweeteners and biofuels. Food processing firms are integrating backward to primary product handling and forward to retail distribution. Retailing has been transformed by the “supermarket revolution.”  National, regional, and global supply chains are being radically altered, bypassing traditional markets where smallholders sell to local markets and traders. Supermarkets control 60 to 70 percent of food sales in Argentina and Brazil, and are expanding rapidly in China, India, and urban Africa. Though these trends in agribusiness consolidation have been going on for years in industrial countries, they are now becoming common in developing countries as well.

In 2004 the market share for the four largest agrochemical and seed companies (the concentration ratio of the top four, or CR4) reached 60 percent for agrochemicals and 33 percent for seeds, up from 47 percent and 23 percent in 1997, respectively. The CR4 in biotechnology patents was 38 percent in 2004. In some subsectors, global concentration is much higher—in 2004 one company had 91 percent of the worldwide transgenic soybean area. It is generally believed that when an industry’s CR4 exceeds 40 percent, market competitiveness begins to decline, leading to higher spreads between what consumers pay and what producers receive for their produce.

The high concentration in multinational agribusiness is evident in coffee, tea, and cocoa. Coffee is produced by an estimated 25 million farmers and farm workers, yet international traders have a CR4 of 40 percent, and coffee roasters have a CR4 of 45 percent. There are an estimated 500 million consumers. The share of the retail price retained by coffee-producing countries—Brazil, Colombia, Indonesia, and Vietnam account for 64 percent of global production—declined from a third in the early 1990s to 10 percent in 2002 while the value of retail sales doubled. Similar concentrations are observed in the tea value chain where three companies control more than 80 percent of the world market. Cocoa has a CR4 of 40 percent for international traders, 51 percent for cocoa grinders, and 50 percent for confectionary manufacturers. Developing countries’ claim on value added declined from around 60 percent in 1970–72 to around 28 percent in 1998–2000.

Concentration widens the spread between world and domestic prices in commodity markets for wheat, rice, and sugar, which more than doubled from 1974 to 1994. A major reason for the wider spreads is the market power of international trading companies.**

The power this concentration gives agribusiness is evident in the Wikileaks cables, which included this blockbuster in the Guardian:

The US embassy in Paris advised Washington to start a military-style trade war against any Euroxpean Union country which opposed genetically modified (GM) crops, newly released WikiLeaks cables show.

In response to moves by France to ban a Monsanto GM corn variety in late 2007, the ambassador, Craig Stapleton, a friend and business partner of former US president George Bush, asked Washington to penalise the EU and particularly countries which did not support the use of GM crops.

“Country team Paris recommends that we calibrate a target retaliation list that causes some pain across the EU since this is a collective responsibility, but that also focuses in part on the worst culprits.

*

In other newly released cables, US diplomats around the world are found to have pushed GM crops as a strategic government and commercial imperative.

Imagine that same level of power over the entire commodity complex and it’s not hard to imagine a future in which Cargill matters a hell of a lot more than Goldman Sachs.

There is much more here than I can put into a single blog post, but to my thinking these patterns are indicative of a partial shift in the focus of economic activity and power away from the abstraction of capital markets and back to the physical world. What makes it fascinating is that, rather than a single step back toward manufacturing, the global economic system seems to be leaping backward from finance to primary production, albeit in a neo-feudalist way.

The following post will address the most tangible manifestation of this pattern – the global competition for land.

* Krippner’s book is excellent, though I wish the publishers had chosen a title that didn’t imply that her book was about the financial crisis. It’s much more interesting than that.

** This is a perfect example of the World Bank talking out of one side of its mouth in its research while doing the exact opposite. The private sector co-investment arm of the World Bank, the IFC, is now actively focused on bringing “efficiency” to the value chain.

With huge thanks to CSC for comments and suggestions.