The article investigates how financialization impedes climate change mitigation by examining its effects on the early history of one low-carbon industry, solar photovoltaics in the United States. The industry grew rapidly in the 1970s, as large financial conglomerates acquired independent firms. While providing needed financial support, conglomerates changed the focus from existing markets in consumer applications toward a future utility market that never materialized. Concentration of the industry also left it vulnerable to the corporate restructuring of the 1980s, when the conglomerates were dismantled and solar divisions were pared back or sold off to foreign firms. Both the move toward conglomeration, when corporations became managed as stock portfolios, and its subsequent reversal were the result of increased financial dominance over corporate governance. The American case is contrasted with the more successful case of Japan, where these changes to corporate governance did not occur. Insulated from shareholder pressure and financial turbulence, Japanese photovoltaics manufacturers continued to expand investment throughout the 1980s when their American rivals were cutting back. The study is informed by Joseph Schumpeter’s theory of creative destruction and Hyman Minsky’s theory of financialization, along with economic sociology. By highlighting the tenuous and conflicting relation between finance and production that shaped the early history of the photovoltaics industry, the article raises doubts about the prevailing approach to mitigate climate change through carbon pricing. Given the uncertainty of innovation and the ease of speculation, it will do little to spur low-carbon technology development without financial structures supporting patient capital.

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INTRODUCTION

Reducing carbon emissions to safe levels means replacing the present industrial system. Low-carbon technologies, which are currently marginal, need to become competitive enough to mount a wave of “creative destruction,” to use Joseph Schumpeter’s (1) term, sweeping away fossil fuels. Technological revolutions normally occur when profit opportunities in established industries are exhausted, but this one would have to occur much sooner, engineered through state policy. Ultimately, however, state policy is only as effective as the innovative capacity of private firms. It is therefore concerning that this capacity appears to have been weakened by financialization (2, 3). In the past 40 to 50 years, advanced economies have become increasingly subjected to the vicissitudes of financial markets. Ever-larger amounts of credit have been created to trade existing assets such as real estate rather than productive investments. The most visible effect of this process has been a series of asset bubbles, followed by painful periods of deleveraging [(4), p. 62]. As John Maynard Keynes recognized, capitalist economies always contain the capacity for both “enterprise” and “speculation,” and if left unchecked, the latter will come to dominate over the former. Economists at the Bank for International Settlements have found that financialization harms innovative firms, which operate by creating intangible future assets that are difficult to collateralize (5). This shift has also changed corporate governance, bringing an increase of “financial controllers in the management of corporations” and of “the stock market as a market for corporate control in determining corporate strategies” (6). As a result, firms have become less oriented toward investing to improve their long-term performance and more oriented toward enriching their managers and investors in the short run (3). Reinforced by managerial incentives, increasing amounts of profits are spent on dividends and stock buybacks, leaving less for investment in long-term technological development (7). While the financial sector has grown as a share of advanced economies, nonfinancial firms have become financialized, drawing profits from financial activities and orienting their strategy toward maximizing the value of their financial assets instead of productive ones. Hyman Minsky feared that this process, already visible by the 1980s, would not only cause fragility but also would undermine “the capital development of the economy,” that is, the development of its productive capabilities (8). Instead of serving industrial development, finance had come to serve itself.

Finance is an essential component of industrial change because it allows technologies to be developed before they can generate a return. But if finance no longer serves industrial change but instead prioritizes rent-seeking (seeking to increase its share of existing wealth without creating new sources of wealth), creative destruction of the present carbon-intensive industrial system cannot occur. The aim of this article is to investigate this issue through a study of the emergence of one low-carbon industry, solar photovoltaics (PV) in the United States. The focus is on the period after the first oil shock in 1973 until the end of the 1980s. The case is contrasted with the more successful development of the industry in Japan. In the late 1970s, American firms held 90% of the global market share; by 2005, it had declined to under 10%, whereas the Japanese share had risen to almost 50% (9). Changes to corporate governance and organization brought by financialization are identified as major causes of the difference in outcome.

This study is informed by Schumpeter’s theory of creative destruction, which remains the most useful tool for understanding industrial change; it also is influenced by the financial insights of Schumpeter’s student, Hyman Minsky. Economic sociology will also be applied to analyze the central role of uncertainty in innovation and the social mechanisms to overcome uncertainty in concrete social and institutional conditions. These insights will be outlined in a rather lengthy theoretical section. The goal is to provide a coherent synthesis of three large and synergistic bodies of work, ranging from a stylized view of the microlevel interactions between entrepreneurs and financiers (and workers) up to the macrolevel of institutional arrangements of comparative capitalisms. Beyond shedding light on the emergence of the industry under study, this synthesis might be used to guide other similar studies. A more comprehensive study would include an in-depth analysis of industrial policy and the social forces behind it, but as the study will show, changes to corporate governance were major determinants of the outcome because industrial policy was dominated by large firms in both countries.

The article concludes with a discussion of implications for low-carbon industry development in the future. The study highlights the tenuous and conflicting relationship between finance and production, calling into question proposals to mitigate climate change based on the assumption of a harmonious relationship. Carbon pricing rests on the idea that, if government policy makes one industry uncompetitive, finance will automatically flow to another. This article indicates that such a result can only be expected under certain conditions, which do not appear to apply in the advanced world at the present.

Finance and innovation Finance is an integral component of innovation because it allows technologies to be paid for before they exist. It acts as a bridge between the expectations of future profit and the ability to realize it by assembling the needed resources in the present. By creating new purchasing power in the process, finance also expands the money in circulation, thereby allowing aggregate profits to exist (10). This makes finance the defining feature of capitalism, a system that evolves through continuous forward-looking investment in new capabilities, motivated by the prospect of using them to produce output for profit. When private and public banking merged into a coherent financial system in early modern Europe, it created the “infrastructural power” needed for a transition from feudalism to capitalism (11). Pools of safe financial claims to real wealth enabled the application of long-term rational calculation to industrial production [what Weber defined as the essence of capitalism (12)], and the widespread circulation of these claims created markets where profits from this rationalized production could be realized. Joseph Schumpeter noted that introducing a financial sphere into a static economy makes it dynamic (13). It orients the economy toward the future, changing calculations of economic value from including only existing resources to also including those resources that might be expected to exist in the future. As a result, the horizon opens up to potentially infinite possibilities for technological advances. This shift also introduces a certain fictitious quality to the economy because the future is unknowable and expectations will inevitably diverge from actual outcomes. Financial claims correspond to the value of real assets, but the correspondence is never absolute. This separation between present and future value that finance introduces is what gives capitalism its instability. Schumpeter saw that finance destabilizes the economy by enabling entrepreneurs to introduce innovations that cause creative destruction. However, it can also be destabilizing in a different way. Finance has a tendency to decouple from production and fuel asset bubbles instead of industrial change. It then becomes a tool of value extraction instead of creation, a process that we now recognize as financialization. Schumpeter had a lucid analysis of the role of finance in production, but the full implications were better explored by his student Hyman Minsky. The theories of both will be used to guide the empirical study. The future orientation of technological development also calls for an inclusion of economic sociology into the analysis to account for the formation of perceptions and social mechanisms to overcome uncertainty. Sociology is also needed to account for the fact that capitalism, as Schumpeter and Minsky insisted, is an evolutionary system that interacts with changing institutions over time. What follows is a summary of Schumpeter’s views of the role of finance in industrial development, Minsky’s additions, and a set of sociological tools to situate their universal logic in concrete social and institutional settings. Because it takes time to assemble innovations before they can generate a return, Schumpeter argued that the process must be paid for in advance. The mechanism that makes this possible is credit. That is why Schumpeter defined capitalism as a system “in which innovations are carried out by means of borrowed money” [(14), p. 223)]. He viewed the financial system as the “headquarters of capitalism,” determining which technologies are allowed to emerge [(15), chapter 3]. Capitalist production depends upon the interaction of two roles, the financier and the entrepreneur. The financier owns monetary claims to real wealth and operates by leveraging them in pursuit of more claims. The entrepreneur operates by producing the real wealth that makes financial claims valuable in the first place. In Schumpeter’s view of capitalism, financiers create credit for entrepreneurs, who spend it into existence in the act of investment; the bank notes circulate as money throughout the economy and end up as profit on the balance sheets of the most innovative entrepreneurs, allowing them to repay the debt. If there is money left, they can plow it back into further innovation, repeating the circuit on a larger scale. An expanded market share can act as a staging ground for increasingly capital-intensive innovation, creating barriers to entry for new entrepreneurs; however, as long as these have access to credit, they can introduce innovations that make the technologies of incumbent firms obsolete. This system of decentralized credit creation for innovation and continuously reinvested profits makes for a highly dynamic economy in which the means of production are continuously revolutionized. In Schumpeter’s view, finance is subordinated to production. He built his dynamic theory of capitalism by introducing a financial sphere into the static economy of Leon Walras and never abandoned Walras’ model of an economy in which all productive resources were fully used (16). Hyman Minsky was able to advance on this view by incorporating crucial insights from John Maynard Keynes (16). Keynes argued that the existence of money as a store of wealth allows capitalists to leave productive resources unused. The traditional economy has only one price level for consumption goods. In Schumpeter’s theory, one can also find a price level for capital goods, that is, machinery and plant, which are expected to produce the consumption (and capital) goods of the future. In Keynes’s view, a capitalist economy also has a separate price level for financial assets. The difference in price between capital and financial assets determines real investment. When the expected return on capital goods exceeds the return on financial assets (that is, when demand is strong), capitalists will choose investment. When the expected return drops below the expected return on financial assets, capitalists will hoard their cash or spend it bidding up the value of financial assets. Because investment becomes the incomes that generate demand, the process is self-reinforcing. Keynes differentiated between “enterprise” and “speculation”; the organization of money markets determines which one will prevail. “When the capital development of a country becomes the by-product of the activities of a casino,” he argued, “the job is likely to be ill done” (17). Minsky went on to explore what happened when innovation within the financial sphere itself causes it to decouple from production, spinning off into a self-referential loop of speculation (18). Even if the financial system begins as subordinated to production, financial innovators will find easier ways to make money. If left unchecked, innovative and profit-seeking financiers will break free of constraints and turn to speculation. Thus, finance becomes an instrument of rent-seeking. Hence, what is missing from Schumpeter’s theory is the fact that innovation is not the only use for which credit can be created: It can also be created to buy existing assets, in which case it does not fuel creative destruction but asset bubbles. There is also a limit to how much profit firms can reinvest. Production under capitalism is carried out for profit, and some point in the circuit profit will be extracted from the enterprise to be stored as liquid wealth. Only if capitalists are as austere as the monk-like toilers of Max Weber’s The Protestant Ethic and the Spirit of Capitalism, and as confident in the future as to keep no amount of their wealth in cash, would they reinvest all their profits in production. As Keynes famously recognized (19), the common practice of storing wealth in cash and existing assets leaves real resources in the economy unused. As long as hoarding and speculation are available as options to financiers, their willingness to invest in innovation is limited. It is safer to live off the income streams of past investments, as “rentiers.” A fully production-oriented economy is only possible if the financial component of capitalism is entirely subordinated to the entrepreneurial function, in which case it might no longer be recognizable as capitalism at all, but rather a centrally planned economy where decentralized financial decisions are curtailed. Compared to the safety of lending for existing assets, innovation is an uncertain activity that prudent financiers tend to avoid. They are particularly unlikely to finance new and unproven entrepreneurs who face powerful competition from incumbent firms. Established firms can use retained earnings to innovate but tend to do so in ways that build on their existing capabilities, not in ways that make them obsolete. Innovation is rarely economically rational; as the economist and venture capitalist William Janeway puts it, it is dependent on “sources of funding that are decoupled from economic concern” (20). In the early stage, this usually means the state, which is free from financial constraints and guided by noneconomic goals such as national security (or hopefully, if under sufficient popular pressure, concern about climate change). At a later stage, financially unconcerned sources of funding may also include irrationally exuberant investors caught up in the speculative manias, which often surround new technologies. Hence, while speculation undermines creative destruction when it involves existing assets, a certain amount of it that is directed at new technologies is often necessary for it to take off. Neo-Schumpeterian economist Carlota Perez ascribes a certain temporal logic to the process: Financial capital tends to back new technology in the deployment phase, often creating a bubble that draws in sufficient resources for the technology to succeed. When profit opportunities are exhausted, it leaves to seek out new ones, which may include innovations. In empirical studies, the universal logic of this model needs to be augmented with contextual detail. Whether financiers invest in creative destruction or not depends on the opportunities and constraints afforded them by specific institutional arrangements. Both Schumpeter and Minsky insisted that capitalism is an evolutionary system that adapts to institutional change. As Schumpeter stressed, economic sociology is therefore needed as a “bridge between theory and history” (21). Another reason to view creative destruction through a sociological frame is the inherently uncertain nature of innovation and the centrality that perceptions of the future this entails. As game theory indicates, isolated individuals acting under uncertainty lead to suboptimal “prisoner’s dilemma”–type outcomes. Uncertainty compels actors to adopt a prosocial orientation, turning market transactions into hierarchical transactions and limiting transactions to known parties and those with a reputable standing, among others (22). Interaction is made less uncertain through “social devices” such as habits, institutions, organizational structures, and outright domination (23, 24). Because the future is unknowable, investment decisions are always made on the subjective basis of confidence in the future, what Keynes called “animal spirits.” Routine investments can be made by extrapolating past trends into the future, but investments in innovation must be based on more elaborate “fictional constructions” of future states (24). These are constructed by the various actors involved in the innovation process and must be shared by them if the innovation is to succeed. The collective nature of innovation calls for a relational perspective, in which actors are analyzed not only on the basis of their individual characteristics but also by how they relate to each other. This applies to the various actors needed to cooperate in the innovation process, beginning with the entrepreneur and the financier. If they succeed in turning the venture into an enterprise, they must also resolve the tension between manager and employee. The tension within the capitalist class, between the entrepreneur and the financer, and between capital as a whole and labor also interact with each other in institution-specific ways. The relational perspective is also needed to analyze competition between firms. Creative destruction is a power struggle between incumbents and challengers, which devise strategies by taking each other’s presumed actions into account. The power balance is observed by financiers, who restrict finance to what they perceive to be the winning side. As Weber argued, finance is a weapon in the struggle for economic existence (25). As the guarantor of the financial system and arbiter of market competition, the state plays an inescapable role in creative destruction. States may keep financial flows under strict control or allow financialization to proceed unhindered. The state is also a major source of spending and often sets the direction of innovation through industrial policy. The points made above will be elaborated in a series of propositions to guide the empirical study.

Proposition 1: Innovation is uncertain Innovation is, by definition, an uncertain activity whose outcome is unknowable. For financiers, There is uncertainty about the talent of the entrepreneur, the market need for the product, the development of a saleable product, the raising of second-round financing for working capital and expansion; the manufacturing of the product, competitors’ responses, and government policies [(26), p. 137]. Decisions to invest in innovation can therefore not be made on the basis of probabilistic calculation. As Jens Beckert argues, they must be based on fictional constructions of the future (24). These are socially constructed, if only in the sense that they must be shared to be realized. Collectively held expectations create the certitude necessary to commit resources to uncertain projects. As long as they do not stray too far from real technological constraints, they can be self-fulfilling. New industries begin as visions in the minds of entrepreneurs. In the early stage, there are various such visions competing with each other. As the industry matures, the list of alternative designs is narrowed down, until a dominant one is arrived upon, to the exclusion of others (27). The dominant design will then be improved upon with use and made increasingly dominant through learning, economies of scale, and network effects. When studying technological trajectories, it is therefore important to examine the visions held by the involved actors, how they were formed, and how they shaped the outcome.

Proposition 2: Uncertainty is overcome through cooperation For new entrepreneurs, there is no history of income statements for financiers to evaluate or existing assets to be pledged as collateral. There is only an intangible idea, which can only be judged on the basis of expected future profitability. Financiers who determine which projects to fund must do so, on the basis of detailed knowledge attained from, and about, the entrepreneur. This makes financing an inherently social process, “embedded in relations of a strikingly personal sort” [(28), p. 137]. Even in the most mundane forms of banking, Schumpeter [(14), pp. 116–117] noted, The banker must not only know what the transaction in which he is asked to finance and how it is likely to turn out, but he must also know the customer, his business, and even his private habits, and get, by frequently ‘talking things over him’, a clear picture of the situation. But if banks, whether technically so called or not, finance innovation, all this becomes immeasurably more important. To overcome uncertainty, the entrepreneur and financier need to collaborate closely, sharing the entrepreneur’s knowledge of production with the financier’s knowledge of markets. Because there is no objective metric to evaluate whether an innovation will succeed and the loan will be repaid, creditworthiness is “socially constructed” in the interactions between them [(29), p. 251]. Entrepreneurs’ ability to attain finance is largely determined by their network position. Ideally, it combines close ties that transmit the trust needed to maintain a credit line with ties to more distant connections that provide access to more remote information and market opportunities (30). Venture capitalists, who specialize in early-stage funding, need to be “rich in relationships even more than cash” (31). They operate by bridging “structural holes” in networks between entrepreneurs and large institutional investors (32, 33). Entrepreneurs seeking to construct innovative enterprises do so by harnessing the power of their networks to gather resources, discover opportunities, and gain legitimacy (27). Although Schumpeter emphasized the role of the financial system as the handmaiden of creative destruction, he probably overestimated its role in funding new enterprises, which was uncommon even in his day (34). Most new ventures are financed by the entrepreneurs themselves or by money from family and friends (35). Early-stage finance often has “affective and charitable dimensions” [(36), p. 1688]. As Janeway argues, new technologies need support of a non-economic nature (20). The importance of cooperation to reduce uncertainty makes it important to pay attention to the concrete relations between entrepreneurs and financiers when studying the emergence of new industries.

Proposition 3: Investment decisions have signaling effects Investment decisions are observed by actors other than the directly involved parties. If one financier grants a loan to an entrepreneur, it sets off a “sociological multiplier” that signals to other financiers that the venture is a sound investment [(37), p. 55]. Conversely, if one financier rejects an investment, it signals to others that it might be wise to do the same. This effect makes it important to study how investment decisions affect other parties through signaling.

Proposition 4: Financial flows are shaped by power configurations between incumbent and challenger firms New entrepreneurs face the entrenched power of established firms (38). Incumbents seek to stabilize their position by integrating upstream or downstream, diversifying into new lines of business, or seeking protection from the state. Challengers have to operate within the constraints set up by incumbents until they gather enough strength to dislodge them. Power asymmetries between incumbents and challengers are observed by financiers and shape their lending decisions. Market power is considered in financial evaluations of firms, allowing them to borrow on better terms than challengers (8). O’Sullivan [(39), p. 6] suggests that “we could ask whether incumbent firms dominate because they are more innovative or because entrants are too financially constrained to compete with them.” It is therefore important to examine how an industry was shaped by dynamics between incumbents and challengers.

Proposition 5: Infant industries need protection Uncertainty and market power are hostile forces from which infant industries need protection until they mature. Schumpeter (1) argued that these could be provided by the monopoly power of large corporations, which allows them to cross-subsidize new product lines with their existing ones. Because firms rarely innovate in ways that would undermine their existing capabilities, the protected spaces for radical new low-carbon technologies would likely have to be provided by the state (40). As Kenney and Hargadon (41) demonstrate, private venture capital is not a viable model for most low-carbon technologies, which are capital-intensive and in direct competition with existing alternatives. Therefore, analyzing industry emergence makes it necessary to find out the extent to which immature technologies allowed protected spaces to mature.

Proposition 6: Finance and production have different logics, driving them apart Fruitful cooperation between entrepreneurs and financiers is not guaranteed because they have different objectives. The goal of the entrepreneur is to expand production, and money is a mean to this end. The goal of the financier is to make money, and production is one, but not the only, mean to this end. If the financier could, he would rather skip the production phase altogether and turn money directly into more money. As Keynes observed, if there is easy money to be made by speculating on the future price of financial assets, capitalists will avoid investing in capital assets (8). Because financial firms are profit-driven actors just like all others, Minsky recognized that financial innovators will inevitably find ways of making a profit without having to engage in production. Others will follow their lead, eventually raising pressure on the state to legitimate financial innovations and give new financial instruments parity with state currency in the interest of maintaining financial stability. The tension between the entrepreneurial and financial component of innovation can be resolved because both have a mutual interest in assuring that the loan will be repaid. However, circumstances determine whether the financier will want this to occur through the continued operations of entrepreneur’s enterprise or by having it liquidated. Following Carlota Perez, the entrepreneur can be seen as a representation of “production capital,” which is tied down in equipment, personnel, knowledge, and routines, whereas the financier represents “financial capital,” which is free to move [(42), p. 6]. Production capital is the agent for the accumulation of wealth making capacity; its natural horizon is long-term and it remains tied to its expertise. Financial capital is the agent for reallocating wealth in order to constantly maximize short-term returns. Production capital is therefore path-dependent while financial capital is fundamentally footloose and flexible. While production capital is oriented toward expanding production, financial capital is oriented toward the moment when production is concluded and output is converted into money. Financiers and entrepreneurs can thus be defined as “the embodiment of two different moments in the circuit of capital” (43). Finance has a disciplining effect on production capital, compelling it to increase efficiency, reduce costs, and provide products that customers want. However, it may impede the ability to develop entirely new products for markets that do not exist, which is an inefficient process of trial and error. Financial capital may aid creative destruction by redeploying resources from old to new industries. However, it may lack the patient capital to sustain them. The outcome is an empirical issue that varies between times and places, making it important to be attuned to historical and institutional analysis. Just like Schumpeter, Minsky saw capitalism as a system evolving through time, taking different forms under different institutional regimes. After financial speculation caused the Great Depression, finance was reined in during the managerial era, which, in turn, was followed by the era of money manager capitalism, in which finance again was allowed to break free (16). Given the differing logics of finance and production, it is important to ask how firms maintain “financial commitment.”

Proposition 7: The balance of power between financial and production capital affects firm strategy In small firms, strategy can be set by the founder because ownership and control are vested in the same person. As the firm grows, these issues can become contested. Founders who want to leave their creations intact when they retire can make a profitable exit by selling shares in the enterprise on the stock market and leave it in the hands of the manager. Buyers of the stock become owners of financial claims on the enterprise but do not necessarily exercise control over the enterprise. In this case, financial control over production is diminished. When firms pay down debt and rely on retained earnings, the balance of power shifts from financial to production capital. The separation of ownership and control can lead the balance of power to shift in favor of productive capital, as was the case during the managerial era (44). After the Second World War, Minsky argued, deficit spending by the American government allowed corporate profits to rise to the level where corporations did not have to rely on external finance (16). This gave them managerial autonomy, allowing them to focus on long-term technological development. Although financial evaluations are based on publically available information, investments can be made out of retained earnings on the basis of specific knowledge of the firm’s capabilities that are only available to the firm itself. Hence, by relying on retained earnings, firms can free themselves of financial control and separate innovation from the incompatible logic that animates financial markets. This dimension of strategic control is essential to innovation (45). The development led Keynes to perceive a tendency for “the big enterprise to socialize itself” and have it run in the interest of managers and employees instead of shareholders (46). Ultimately, this would lead to the “euthanasia of the rentier.” A side effect, according to Minsky, was that corporate organization descended into bureaucratization. Although government spending supported profits, only a small part of it went to technological development; the rest was used to underwrite consumption through welfare programs and military spending. Separation of ownership and control can lead to concern about excessive autonomy of managers to pursue growth strategies that do not necessarily make economic sense or only do so on a long-time horizon (47, 48). The function of finance, it may be argued, is to keep this from happening (43). During the 1980s “shareholder revolution,” financiers reasserted control. Thus, it ended the “independence of corporations from the money and financial markets that characterized the managerial era,” as Minsky argued (16). Instead, a new era of “money manager capitalism” came, in which the “main purpose of those who controlled corporations was no longer upon making profits from production and trade but rather to assure that the liabilities of the corporations were fully priced in the financial market, to give value to stockholders,” leaving “little in the way of internal finance left for the capital development of the economy.” Proponents of shareholder value argued that profits should not be reinvested but that managers should “disgorge the cash” so that other investors can find better use for them [(49), p. 323]. Since then, corporations have, to an increasing extent, become “managed by the markets” (50). The need to satisfy shareholders by meeting quarterly requirements for earnings per share has lead managers to engage in financial engineering, such as stock buybacks, rather than investing in long-term innovation. Companies that manage to invest heavily in long-term innovation tend to be insulated from shareholder pressure through special classes of stock that keep founders in control [(51), p. 12]. Financial control is not necessarily exerted from outside the firm but can be implemented by financially oriented managers from the inside. Neil Fligstein has documented how this process began more than a decade before the shareholder revolution, during the merger wave of the late 1960s when corporations began expanding into unrelated businesses, turning themselves into financial conglomerates and managing their divisions like financial assets in a portfolio of stocks (52). A firm dominated by the agents of production capital tends to take a technology-based, internal diversification strategy, gradually expanding into new areas bordering their existing capabilities. A firm dominated by financial capital will be governed as a portfolio of assets, buying and selling divisions like shares on the stock market. Song [(53), p. 380] distinguishes between internal and external diversifiers in the following way: Internal diversifiers generally exploit any synergies between current business lines and newly added business lines. External diversifiers decentralize operational functions to the operating divisions and concentrate mainly financial and legal control at top-level corporate headquarters. External diversification can undermine the organizational coherence of the firm and move strategic control from actors that are knowledgeable about production to central headquarters governing through financial metrics. Innovation can be defined as an information creation process that proceeds through a process of small but cumulatively important contributions from those who are technologically knowledgeable (54). Christensen et al. (55) argue that financial control is an “innovation killer” because the richness of tacit knowledge is lost when it is transformed into simple numbers. Financial calculations are incapable of evaluating future technology and therefore invariably overestimate the life expectancy of existing technologies. The significance of power struggles between production capital and financial capital, which shape corporate governance, makes it important to focus on the issue of how actors who are knowledgeable about production processes maintain strategic control.

Proposition 8: The relation between finance and production affects the relation between management and labor Schumpeterian theory is mainly concerned with the tension within the capitalist class between the entrepreneur and the financier. Innovation is also shaped by the tension between capital as a whole and labor. Production and finance capital both belong to the capitalist class. Their collective goal vis-à-vis workers is to extract as much effort as possible for the least cost. Conversely, workers can be viewed to have the opposite goal, to exert as little effort as possible for as much pay as possible. However, the effort-minimizing worker may predominantly apply to alienated labor. Innovation would not be possible if human beings did not have an inherent will to create, an activity that is rewarding in its own right. The task of the innovative enterprise is to harness this drive. It can be done by sharing productivity gains with workers, giving them long-term careers and the ability to advance within the corporate hierarchy. William Lazonick refers to this solution as organizational integration (45). Most innovation is incremental, consisting of minor but cumulatively major improvements to processes and products. Workers, who have local, tacit knowledge to upgrade the work process and equipment, are potentially major contributors to the process. When they are barred from participating, or when their tasks are narrowly defined and low-skilled, their incentives and abilities to improve the work process are diminished [(56), part 1]. Production capital and labor share the same preference for stability and long-term commitment. By freeing the firm from shareholder control, it may allow to orient itself to maximize benefits for employees, depending on institutional arrangements. When studying innovation, it is therefore important to examine to what extent firms achieve organizational integration.