In comments, Woj asks,
have you done any research on the decline in bank lending for tangible capital/investment?
As a matter of fact, I have. Check this out:
|Simple correlation between borrowing and fixed investment|
What this shows is the correlation between new borrowing and fixed investment across firms, by year (Borrowing and investmnet are both expressed as a fraction of the firm’s total assets; the data is from Compustat.) So what we see is that in the 1960s and 70s, a firm that was borrowing heavily also tended to be investing a lot, and vice versa; but after 1985, that was much less true. The same shift is visible if we look at the relationship between investment and borrowing for a given firm, across years: There is a strong correlation before 1980, but a much weaker one afterward. This table shows the average correlation of fixed investment for a given firm across quarters, with borrowing and cashflow.
|Average correlation of fixed investment for a given firm.|
So again, pre-1980 a given firm tended to borrow heavily and invest heavily in the same periods; after 1980 not so much.
I think it’s natural to see this change in the relation between borrowing and investment as a sign of the breakdown of the old hierarchy of finance. In the era of the Chandler-Galbraith corporation, payouts to shareholders were a quasi-fixed cost, not so different from bond payments. The effective residual claimants of corporate earnings were managers who, sociologically, were identified with the firm and pursued survival and growth objectives rather than profit maximization. Under these conditions, internal funds were lower cost than external funds, as Minsky, writing in this epoch, emphasized. So firms only turned to external finance once lower-cost internal funds were exhausted, meaning that in general, only those firms with exceptionally high investment demand borrowed heavily; this explains the strong correlation between borrowing and investment.
|from Hubbard, Fazzari and Petersen (1988)|
But since the shareholder revolution of the 1980s, this no longer really holds; shareholders have been much more effective in making their status as residual claimants effective, meaning that the opportunity cost of investing out of internal funds is no longer much lower than investing out of external funds. It’s no longer much easier for managers to convince shareholders to let the firm keep more of its earnings, than to convince bankers to let it have a loan. So the question of how much a firm borrows is now largely independent of how much it invests. (Modigliani-Miller comes closer to being true in a neoliberal world.)
Fun fact: Regressing nonfinancial corporate borrowing on stock buybacks for the period 2005-2010 yields a coefficient not significantly different from 1.0, with an r-squared of 0.98. In other words, it seems that the marginal dollar borrowed by a nonfinancial business in this period was simply handed on to shareholders, without funding any productive expenditure at all. This close fit between corporate borrowing and share buybacks raises doubts about the contribution of the financial crisis to the downturn in the real economy.
The larger implication is that, with the loss of the low-cost pool of internal funds, the hurdle rate for investment by nonfinancial firms is higher than it was during the postwar decades. In my mind this — more than inequality, tho it is of course important in its own right — is the structural condition for the Great Recession and the previous jobless recoveries. The downward shift in investment demand means that aggregate demand falls short of full employment except when boosted by asset bubbles.
The end of the cost advantage of internal funds (and the corresponding erosion of the correlation between borrowing and investment) is related to the end of the collapse of the larger post-New Deal structure of financial repression that preferentially channeled savings to productive investment.
UPDATE: I should clarify that while share buybacks are very large quantitatively — equal to total new borrowing by nonfinancial corporations in recent years — they are undertaken by only a relatively small group of firms. For smaller businesses, businesses without access to the bond market and especially privately held businesses, there probably still is a substantial wedge between the perceived cost of internal and external funds. It is quite possible that for small businesses, disruptions in credit supply did have significant effects. But given the comparatively small fraction of the economy accounted for by these firms, it seems unlikely that this could be a major cause of the recession.