Europe’s policymakers have a point. The region has a wide variety of corporate financing channels – bank lending, institutional capital, venture capital, government promotional banks and ( to a lesser extent ) private credit – but it structurally lacks a deep and coherent layer of early-stage corporate growth and risk capital that is comfortable with, say, taking intangible assets as collateral or funding negative cashflows.

But the leap policymakers make from the gap in funding this very specific layer of the European corporate ecosystem to their preferred solution – to push households out of deposits into equities, which they claim will super-charge innovation, research and development ( R&D ) and long-term growth – is ideological and built on flawed assumptions. The problem is not household savings behaviour. The problem is an imperfect capital allocation infrastructure.

The first flawed assumption is that capital markets fund innovation, R&D, capex, etc. I mean flawed in the real world, not what the academic textbooks tell you. Second, that hard-pressed households in a cost-of-living crisis can financially absorb or psychologically stomach the risk and volatility to earn equity returns.

The misleading narrative about cash deposits being disseminated by the European policy machine and the self-serving cosmos wrapped around it ( stockbrokers, consultants, pro-market lobby groups, financial market trade bodies ) is centred on their premise that the lending that is created as an imprint of those deposits has little to no economic value. By conflating the low value of lending, they’re creating a false, highly skewed narrative whose only justification seems to be to perpetuate their eternal capital markets fixation.

Capital markets don’t fund innovation

Here’s my first conundrum, about capital markets funding innovation, R&D, etc. Most equity investing is in the secondary market, where inflows just pump stock prices. But what of last year’s US$157 billion in EMEA ( Europe, Middle East and Africa ) common stock sales? How much of that even went to companies? With raging certainty, the vast majority – and I’m including initial public offerings ( IPOs ) here – went to selling institutional shareholders, exiting founders, venture capital backers and management. And to investment banks, lawyers and other service providers in the form of transaction fees.

But what of the tiny fraction of that cash pile that did end up going to companies from the sales of new shares? R&D, growth and innovation, right? No. Most was allocated to mergers and acquisitions ( M&A ), and to financial engineering in various forms: deleveraging, balance-sheet repair or improvement, ratings protection or enhancement, pension deficit funding and working capital.

In other words, equity is used as a financial tool not a productive one. That’s fine in the round but less so in the context of arguments about the value of mobilizing risk capital for growth and the quest to boost public equity inflows, including through regulatory means or by enhancing tax benefits.

Even in the pre-IPO phase, while early-stage equity is geared to R&D, product development, capacity building, proof of concept, market entry, customer acquisition, etc, the differences between private and public equity narrow as companies move along the evolutionary spectrum. And as companies stay private for longer, the differences become much less pronounced by late stage.

Bonds fund refinancing not innovation

When it comes to the funds raised through corporate bond issuance, bond investors ( unlike bank lenders ) are happy to bear long-dated, unsecured, mark-to-market risk all resting on expected future cashflows, so that surely offers borrowers the latitude to use bond proceeds to fund R&D, innovation, growth and long-dated projects.

In theory yes, but much ( most? ) of the US$5.8 trillion raised last year by investment-grade companies went to refinancing existing debt or to liability management. That’s an issue in the narrow context of mobilising resources to fund innovation and capex for growth. It’s impossible to ascertain how much of the cash that was opaquely allocated to the general corporate purposes catch-all use-of-proceeds bucket went to capex or R&D. But it was very little.

[European private credit doesn’t change the story, incidentally. Direct lending is predominantly an M&A/buyout tool for financial sponsors. It doesn’t fund corporate innovation.]

Capex and innovation are generally funded from retained earnings not securities issuance. In the context of retaining cash in the company, the real drag here is dividends and share buybacks. Shouldn’t there be more policy activity around this?

Can we afford to switch into equities?

If capital markets are not reliably channelling funds to innovation, the case for pushing households into them presumably then rests on the allure of capturing superior long-term returns, so let’s look at the cash/equity equation from a saver’s perspective. The higher returns available from equity investing relative to cash investing are not in doubt in a long-term empirical context. But let’s be realistic here: no reasonable retail investor weights investment portfolios 100% to equities.

Assuming a reasonable level of policy rates, most investors with medium risk portfolios ( 40%-60% equities ) and 1%-plus fees would end up with returns not too dissimilar to cash. But those portfolios still expose households to equity like drawdowns during crises. Only high-risk portfolios with a high allocation to equities consistently and sustainably earn returns that are appreciably higher than cash.

Let’s stay with the point about high risk. How many people can realistically afford to lose money while holding their nerve during market volatility spikes over the course of the long-term investment cycle required to earn those theoretical higher returns?

If you take the UK working population between the ages of 18 and 59, remove everyone earning £100,000 ( US$ 133,733 )-plus and on low wages to create a reasonably representative middle, you end up with something like 70% of that population. If you then deduct essential household spending – sky-high housing, food, energy and transportation costs – from wages, those in the higher echelons of that population cohort may have – at best – around four months of gross income per year, which can be seen as a proxy for investing capacity in the form of discretionary income.

Extending the thinking into where the threshold might lie for being able to absorb portfolio losses at a financial level ( leaving aside psychological impacts ), probably up to half would consider a 20% portfolio reversal as materially destabilizing. Doesn’t that suggest that the investable surplus frontier of the UK economy, the proportion of the UK population that has the structural capacity to tolerate losing a chunk of their savings, even nominally, is not in the place policymakers think it is, and that those willing to put their investable surplus at risk is a lot smaller than policymakers think?

The theoretical returns superiority of equities may be a fact, but it does not translate into practical suitability for most households. Policymakers are ignoring or are unaware of this; surely a serious oversight. If capital markets don’t fund innovation, and households ( which generally lack sophisticated financial literacy ) can’t tolerate equity risk, the policy push to shift deposits into equities is misguided and structurally incoherent.

The real issue is the absence of institutional structures capable of underwriting intangible assets, absorbing early-stage risk and financing negative cashflows. That is a problem of market design, regulatory architecture and capital allocation norms, not household behaviour.