Rob Parenteau and I have an op-ed at the New York Times today. Rob’s last post here argued energetically that the now-established trend of the corporate sector to save, as opposed to invest in growth, in advanced economies, and even most emerging economies, was tantamount to capitalists abandoning their traditional role. It reminded me of an article I had written in 2005, “The Incredible Shrinking Corporation,” for the Conference Board’s magazine Across the Board, on how companies were trying to starve themselves into attractive- looking performance though the then-unprecedented act of saving in a time of economic expansion, which is tantamount to disinvestment. Rob’s post made further key points about the macroeconomic implications of corporate savings (given the norm of households savings as well) and made some policy recommendations.
I wish the headline were different (“Are Profits Hurting Capitalism?“), since the article is clearly about the corporate savings glut.
Rob and I thought readers would be interested in the how the draft we submitted compared with the edited version. The draft was titled “It’s the Corporate Savings Glut, Stupid! The Hysteria of Marching to Austeria”:
A series of disappointing data releases in recent weeks, including flagging consumer confidence and meager private sector job growth, is leading more and more experts to worry that the recession in the US and abroad is coming back. At the same time, many policymakers, particularly in the Eurozone, are slashing government budgets, which they contend will lower debt levels, and thereby restore investor confidence, reduce interest rates, and promote growth.
Yet many miss the fact that fiscal deficits are a nearly inevitable result of actions by corporations and households. Failure to understand these dynamics and address root causes is sure to make a bad situation worse.
Unbeknownst to most commentators, corporations in the US and many advanced economies have been underinvesting for some time.
The normal state of affairs is for households to save for large purchases, retirement and emergencies, and for businesses to tap those savings via borrowings or equity investments to help fund the expansion of their businesses.
But many economies have abandoned that pattern. For instance, IMF and World Bank studies found a reduced reinvestment rate of profits in many Asian nations following the 1998 crisis. Similarly, a 2005 JPMorgan report noted with concern that since 2002, US corporations on average ran a net financial surplus of 1.7 percent of GDP, which contrasted with an average deficit of 1.2 percent of GDP for the preceding forty years. Companies as a whole historically ran fiscal surpluses, meaning in aggregate they saved rather than expanded, in economic downturns, not expansion phases.
The big culprit in America is that public companies are obsessed with quarterly earnings. Investing in future growth often reduces profits short term. The enterprise has to spend money, say on additional staff or extra marketing, before any new revenues come in the door. And for bolder initiatives like developing new products, the up front costs can be considerable (marketing research, product design, prototype development, legal expenses associated with patents, lining up contractors). Thus a fall in business investment short circuits a major driver of growth in capitalist economies.
Companies, while claiming they maximize shareholder value, increasingly prefer to pay their executives exorbitant bonuses, or issue special dividends to shareholders, or engage in financial speculation. They turn their backs on the traditional role of a capitalist – to find and exploit profitable opportunities to expand his activities
Some may argue that lower investment rates are the result of poor prospects, but the data does not support that view. Corporate profits have risen as a share of GDP since the early 1980s, reaching unprecedented levels right before the global financial crisis took hold. Even now, US profit margins are nearly two thirds of the way back to their prior cyclical high, despite a subpar recovery.
What happens when corporations on balance are saving, and households in aggregate try to save too? Families and individuals typically tighten their belts and bolster their bank accounts in bad times; the tendency is even more acute now, since many are trying to pay down borrowings, which is a form of saving,
If households and corporations are both saving, it must be balanced by the other two sectors of the economy, the government sector and the import/expert secto. In other words, the foreign and government sectors must spend more cash than they are taking in. In lay terms, that means running a trade surplus and having the government incur budget deficits.
Therefore, when both domestic households and the corporate sector are saving at the same time, then you need to have a VERY large trade surplus, a very large government deficit, or some combination of the two. There is no other way to square this circle – anyone who tries to tell you otherwise does not understand double entry book keeping, which the West has used for at least the last five centuries with some success.
And what if a government embarks on an austerity program in the face of private sector efforts to deleverage? Income growth will stall, and if the austerity program is large or sustained long enough, falling household wages and business profits can result.
That result might not sound bad, since lower wages and prices would make US goods more competitive abroad. But in economies suffering from a debt hangover, as incomes fall, it becomes even harder to make payments on outstanding loans. Defaults and bankruptcies cascade through the financial system, leading to even more reluctance to borrow and lend. In other words, the result of Austerian fiscal policies, is deflation – falling wages and prices – which can easily snowball into a depression.
So rather than marching toward Austeria by pursuing what are being presented as “sustainable” or “sound” spending policies requiring immediate budget retrenchment – and such assertions can only be made by those willfully blind to the interdependence of cash flows at the macro level – we need to kill two birds with one stone. Rather than blindly marching to Austeria, we need to set fiscal policy to the task of incentivizing the reinvestment of corporate profits in business operations rather than games at the casino.
Possible measures to achieve these aims include:
1) an aggressive tax on retained earnings that are not reinvested with a 24 month period after they have been booked (this provision needs to be designed carefully to defeat efforts to circumvent it through artful accounting);
2) a financial asset turnover tax that raises the cost to management (and others) of speculating rather than reinvesting profits in productive capital investment;
3) a reinvigorated public or public/private investment program that helps speed up the shift to new energy technologies (as scaling up usually induces a drop in unit costs of production).
The entrepreneurial pursuit of profitable growth has been the vital engine of prosperity since the Industrial Revolution. Yet incentives for both managers and investors now favor myopia and speculation, undermining the very operation of capitalism. We need tax and regulatory policies to counter this destructive development, along with wider recognition that government deficits are necessary and salutary if the corporate sector is under-investing to boost its short-term profits and households are prudently refusing to increase borrowing to accommodate it.
When both households and businesses attempt to net save, the adoption of Austerian School fiscal policies in highly leveraged economies, is well nigh certain to bring back our grandparents’ experience of debt deflation and economic depression. We must stop and seriously ask ourselves, in whose interest might these Austerian policies be? None dare call it malpractice, malfeasance, or even outright madness
The NYT op ed is here. Enjoy!