Are shareholder payouts a tool for reallocating capital from large, established corporations to the newer, smaller firms with better prospects for growth? If so, we should see this reflected in the investment figures — the shareholder revolution of the 1980s, and the more recent growth of activist investors, should be associated with a shift of investment away from big incumbent firms. Do we see this?
As a simple test, we can look at the share of corporate investment accounted for by smaller and younger firms. And the answer this exercise suggests is, No. Within the corporate sector, there is also no sign of capital being allocated to new sectors and smaller firms. The following figures show the share of total corporate investment accounted for by young firms, defined as those listed for less than five years; and by small firms, defined as those with sales below the median sales for listed corporations in that year. 
The share of investment accounted for newer firms fluctuates between 5 and 20 percent of the total, peaking periodically when large numbers of new firms enter the markets.  The most recent such peak came in tech boom period of the late 1990s, as one might expect. But the young-firm investment share shows no upward trend, and since the recession has been stuck at its lowest level of the postwar period. As for the the share of investment accounted for small firms, it has steadily declined since the 1950s — apart from, again, a temporary spike during the tech-boom period. Like the investment share of newer firms, the investment share of small firms is now at its lowest level ever.
We come to a similar conclusion if we look at the share of investment accounted for by noncorporate businesses. Partnerships, sole proprietorships and other noncorporate businesses accounted for close to 20 percent of US fixed investment in the 1960s and 1970s, but have accounted for a steady 12 percent of fixed investment over the past 25 years. So the funds flowing out of large corporations sector are not financing increased investment in smaller, younger corporations, or in the noncorporate sector either.
This is not really surprising. Smaller and younger businesses are mainly dependent on bank loans, and shareholder payouts don’t increase bank lending capacity in any direct way. More broadly, it’s hard to see evidence that potential funders of new businesses are liquidity-constrained. Higher payouts presumably do contribute to higher stock prices, and perhaps marginally to lower bond yields, but any connection with financing for new businesses seems tenuous at best.
In any case, whatever the shareholder revolution has accomplished, there does no seem to have been any reallocation of capital to smaller, growing firms. Capital accumulation in the United States is more concentrated in large established corporations than ever.
 Data is from Compustat, a database that assembles all the income, cashflow and balance sheet statements published since 1950 by corporations listed on US markets. I’ve excluded the financial sector, defined as 2-digit NAICS 52 and 53 and SIC 60-69. Investment is capital expenditure plus R&D.
 I suspect the late-80s peak is an artifact of the many changes of ownership in that period, which are hard to distinguish from new listings.
With my colleagues at the Roosevelt Institute, I’m working on a long-delayed followup to the Disgorge the Cash paper.
One of the issues we are addressing is this: Aren’t higher shareholder payouts just a way of channeling funds from mature, slow-growing firms to fast-growing sectors that need capital? This has always been one of the main arguments in support of the shareholder revolution. Michael Jensen:
With all its vast increases in data, talent, and technology, Wall Street can allocate capital among competing businesses and monitor and discipline management more effectively than the CEO and headquarters staff of the typical diversified company. KKR’s New York offices and Irwin Jacobs’ Minneapolis base are direct substitutes for corporate headquarters in Akron and Peoria.
Can the data shed light on the claim that high shareholder payouts are just a way that capital markets reallocate scarce funds from stagnant established firms to up-and-coming innovators?
One line of evidence against this claim is presented in my original Disgorge paper, though not explained as clearly as it could have been. As the table below — reproduced from the paper — shows, the correlations of investment with profits and borrowing have weakened not just at the level of the individual firm, but for the corporate sector as a whole. If markets were mainly reallocating capital from the industries of yesterday to the industries of tomorrow, we would expect an inflow of funds into the corporate sector to be associated with a rise in investment somewhere, even if not in the firms that initially received them. But this is not the case — or at least, it is less the case than it used to be. The weakening of the aggregate relationship between cashflow from operations and borrowing, on the one hand, and investment, on the other, suggests that higher payouts from one business are not translated into more investment funding for another.
Now I want to present two more lines of evidence that point in the same direction.
First, we can compare sources and uses of funds for corporations in general with the same sources and uses for corporations in high-technology industries. Second, we can look at smaller and younger firms specifically, and ask if they account for a higher share of investment than in the old days of managerialism, when investment was more internally financed. In the next two posts that’s what I’ll do.
The OECD has just released its new Business and Finance Outlook for 2015. A lot of interesting stuff there. We’ll want to take a closer look at the discussion of the problems that low interest rates pose for pension funds and insurance companies — I’ve thought for a while that this is the most convincing form of the “reaching for yield” argument. But what I want to talk about now is the OECD’s apparent endorsement of the “disgorge the cash” thesis.
Chapter 2, “Corporate Investment and the Stagnation Puzzle,” has a very interesting discussion of shareholder activism and its effects on investment. The starting point is the puzzle that while participants in financial markets are willing to accept unprecedentedly low returns, the minimum returns on new investment projects remain high, as evidenced by depressed real investment despite sustained low interest rates. I think this apparent puzzle is, precisely, a rediscovery of Keynes’ liquidity premium. (Perhaps I will return to this in a subsequent post.) There are a number of ways to think about this, but one dimension is the pressure corporate managers face to avoid investment projects unless the returns are rapid, large, and certain.
Stock markets currently reward companies that favour dividends and buybacks and punish those that undertake more investment … which creates higher hurdle rates for investment.
Here in one sentence is the disgorge the cash argument.
Private sector companies in market-based economies allocate capital spending according to shareholder value. Earnings may be retained for capital spending and growth, but only if the return on equity exceeds the cost of equity. If this is not the case then … they will choose to use their operating cash flow in other ways (by issuing dividends, carrying out cash buybacks…) … and in the limit may close plants and shed labor.
The bolded sentence is puzzling. Is it description or prescription? (Or description of a prescription?) The rest of the section makes no sense if you think either that this is how corporate investment decisions are made, or if you think it’s how they should be made. Among other reasons, once we have different, competing discount rates, the “return on equity” no longer has a well-defined value, even in principle. Throughout, there’s a tension between the language of economic theory and the language of concrete phenomena. Fortunately the latter mostly wins out.
The last decade has seen the rising importance of activist investors who gain the support of other investors and proxy advisors to remove management, to gain influential board seats and/or to make sure that company strategy is in the best interest of shareholders… The question arises as to whether the role of such investors is working to cause short-termism strategies [sic] at the expense of long-term investment, by effectively raising the hurdle rate… Activists… favour the short-term gratification of dividends and share buybacks versus longer-term investment. Incumbent managers will certainly prefer giving in to shareholders desire for more ‘yield’ in a low-interest world to taking on the risk of uncertain long-term investment that might cause them to be punished in the share market. …
To test this idea, an index of CAPEX/(CAPEX + Dividends & Buybacks) was created for each company, and the following investment strategy was measured: sell the highest quartile of the index (capital heavy firms) and buy the lowest quartile of the index (Dividend and Buyback heavy firms). … Selling high capital spending companies and buying low CAPEX and high buyback companies would have added 50% to portfolio values in the USA, 47% in Europe, 21% in emerging economies and even 12% in Japan (where activists play little role). On balance there is a clear investor preference against capital spending companies and in favor of short-termism. This adds to the hurdle rate faced by managers in attempting to undertake large capital spending programmes — stock market investors will likely punish them. … it would be fairly logical from a management point of view to return this cash to shareholders rather than undertake uncertain long-term investment projects… The risks instead would be born more by host-country investment in capacity and infrastructure.
This is a useful exercise. The idea is to look at the ratio of investment to shareholder payouts, and ask how the stock price of the high-investment firms performed compared to the high-payout firms, over the six years 2009 through 2014. What they find is that the shares of the high-payout firms performed considerably better. This is important because it undermines the version of the disgorge argument you get from people like Bill Lazonick, in which buybacks deliver a short-term boost the share price that benefits CEOs looking to cash in on their options, but does nothing for longer-term investors. In Lazonick’s version of the story, managers are on one side, shareholders, workers and the rest of society on the other. But if high-payout firms perform better for shareholders over a six-year horizon (which in financial-market terms is almost geologically long term) then we have to slice things differently. On one side are shareholders and CEOs, on the other are us regular people.
The other thing that is notable here is the aggregating of dividends and buybacks in a single “shareholder payout” term. This is what I do, I think it’s unambiguously the right thing to do, but in somequarters for some reason it’s controversial. So I’m always glad to find another authority to say, a buyback is a dividend, a dividend is a buyback, the end.
Another way to see these two points is to think about so-called dividend recapitalizations. These are when a private equity firm, having taken control of a business, has it issue new debt in order to fund a special dividend payment to themselves. (It’s the private equity firm that’s being recapitalized here, not the hapless target firm.) The idea of private equity is that the acquired firm will be resold at a premium because of the productive efficiencies brought about by new management. The more or less acknowledged point of a dividend recap is to allow the private equity partners to get their money back even when they have failed to deliver the improvements, and the firm cannot be sold at a price that would allow them to recoup their investment. Dividend recaps are a small though not trivial part of the flow of payments from productive enterprises to money-owners, in recent years totaling between 5 and 10 percent of total dividends. For present purposes, there are two especially noteworthy things about them. First, they are pure value extraction, but they take the form of a dividend rather than a share repurchase. This suggests that if the SEC were to crack down on buybacks, as people Lazonick suggest, it would be easy for special dividends to take their place. Second, they take place at closely held firms, where the managers have been personally chosen by the new owners. It’s the partners at Cerberus or Apollo who want the dividends, not their hired guns in the CEO suites. It’s an interesting question why the partners want to squeeze these immediate cash payments out of their prey when, you would think, they would just reduce the sale price of the carcass dollar for dollar. But the important point is that here we have a case where there’s no entrenched management, no coordination problems among shareholders — and Lazonick’s “downsize-and-distribute” approach to corporate finance is more pronounced than ever.
Back to the OECD report. The chapter has some useful descriptive material, comparing shareholder payouts in different countries.
[In the United States,] dividends and buybacks are running at a truly remarkable pace, even greater than capital expenditure itself in recent years. There has been plenty of scope to increase capital spending, but instead firms appear to be adjusting to the demands of investors for greater yield (dividends and buybacks). … [In Europe] dividends and buybacks are only half what United States companies pay … While there is no marked tendency for this component to rise in the aggregate in Europe, companies in the United Kingdom and Switzerland … do indeed look very similar to the United States, with very strong growth in buybacks. … [In Japan] dividends and buybacks are minuscule compared with companies in other countries. …
Here, for the US, are shareholder payouts (gray), investment (dark blue), and new borrowing (light blue, with negative values indicating an increase in debt; ignore the dotted “net borrowing” line), all given as a percent of total sales. We are interested in the lower panel.
As you can see, investment is quite stable as a fraction of sales. Shareholder payouts, by contrast, dropped sharply over 2007-2009, and have since recovered even more strongly. Since 2009, US corporations have increased their borrowing (“other financing”) by about 4 percent of sales; shareholder payouts have increased by an almost exactly equal amount. This is consistent with my argument that in the shareholder-dominated corporation, real activity is largely buffered from changes in financial conditions. Shifts in the availability of credit simply result in larger or smaller payments to shareholders. The OECD report takes a similar view, that access to credit is not an important factor in variation in corporate investment spending.
The bottom line, though the OECD report doesn’t quite put it this way, is that wealth-owners strongly prefer claims on future income that take money-like forms over claims on future incomes exercised through concrete productive activity.  This is, again, simply Keynes’ liquidity premium, which the OECD authors knowing or unknowingly (but without crediting him) summarize well:
It was noted earlier that capital expenditures appear to have a higher hurdle rate than for financial investors. There are two fundamental reasons for this. First, real investors have a longer time frame compared to financial investors who believe (perhaps wrongly at times) that their positions can be quickly unwound.
From a social standpoint, therefore, it matters how much authority is exercised by wealth-owners, who embody the “M” moment of capital, and how much is exercised by the managers or productive capitalists (the OECD’s “real investors”) who embody its “P” moment.  Insofar as the former dominate, fixed investment will be discouraged, especially when its returns are further off or less certain.
Second, managers … operate in a very uncertain world and the empirical evidence … suggests that equity investors punish companies that invest too much and reward those that return cash to investors. If managers make an error of judgement they will be punished by activist investors and/or stock market reactions … hence they prefer buybacks.
Finally, it’s interesting what the OECD says about claims that high payouts are simply a way for financial markets to reallocate investment spending in more productive directions.
It is arguable that if managers do not have profitable projects, it makes sense to give the money back to investors so that they can reallocate it to those with better ideas. However, the evidence … suggests that the buyback phenomenon is not associated with rising productivity and better returns on equity.
Of course this isn’t surprising. It’s consistent with the academic literature on shareholder activism, and on the earlier takeover wave, which finds success at increasing payments to shareholders but not at increasing earnings or productive efficiency. For example, this recent study concludes:
We did not see evidence that targets’ financials improved… The targets’ leverage and payout, however, did seem to increase, suggesting that the activists are unlocking value by prompting management to return additional cash to shareholders.
Still, it’s noteworthy to see a bastion of orthodoxy like the OECD flatly stating that shareholder activism is pure extraction and does nothing for productivity.
UPDATE: Here’s James Mackintosh discussing this same material on “The Short View”:
 It’s worth mentioning here this interesting recent Australian survey of corporate executives, which found that new investment projects are judged by a minimum expected return or hurdle rate that is quite high — usually in excess of 10 percent — and not unresponsive to changes in interest rates. Even more interesting for our purposes, many firms report that they evaluate projects not based on a rate of return but on a payback period, often as short as three years.
 The language of “M and “P” moments is of course taken from Marx’s vision of capital as a process of transformation, from money to commodities to authority over a production process, back to commodities and finally back to money. In Capital Vol. 1 and much of his other writing, Marx speaks of the capitalist as straightforwardly the embodiment of capital, a reasonable simplification given his focus there and the fact that in the 1860s absentee ownership was a rare exception. There is a much more complex discussion of the ways in which the different moments of capital can take the form of distinct and possibly conflicting social actors in Capital Vol. 3, Part 5, especially chapter 27.
I have a working paper up at the Roosevelt Institute, as part of their new Financialization Project. Much of the content will be familiar to readers of this blog, but I think the argument is clearer and, I hope, more convincing in the paper.
Companies in the Standard & Poor’s 500 Index really love their shareholders. Maybe too much. They’re poised to spend $914 billion on share buybacks and dividends this year, or about 95 percent of earnings, data compiled by Bloomberg and S&P Dow Jones Indices show. Money returned to stock owners exceeded profits in the first quarter and may again in the third. The proportion of cash flow used for repurchases has almost doubled over the last decade while it’s slipped for capital investments…
Here are my own updated numbers. The figure shows dividends and total payouts for the S&P 500 and the nonfinancial corporate sector as a whole, for rolling five-year periods ending in the year shown. Payouts are given as a share of aftertax profits.
Shareholder payouts as a fraction of aftertax profits, 5-year moving averages
Unlike the past versions of this graph I’ve put up here, which came from the Flow of Funds, this is taken directly from the corporate financial statements compiled in Compustat. Among other things, this means that we can see share buybacks directly, rather than only net share retirement. But the picture is qualitatively similar to what you see in the aggregate data — after being quite stable at around 50% of after tax profits through the 1970s, payouts doubled to about 100% of aftertax profits during the 1980s, and have remained near that level over the past 25 years.
I haven’t broken out the S&P 500 before. (This is based on the current index membership — it didn’t seem worth the trouble to find historical indexes. So for the early years we are talking about a relatively small number of firms.) As you can see, the picture is basically similar. The rise in S&P payouts comes a bit later. And unlike the broader population of firms, there is no rise in dividends relative to profits in the 1980s and 1990s — the entire increase in payouts comes from buybacks. The other difference — not immediately evident from the chart — is that profits, not surprisingly, are more stable in the S&P 500 than in the smaller firms outside the index. You can’t tell from the figure, but the big spike in the black lines comes from a collapse in profits in the non-S&P firms, not an increase in payouts. The corporate sector excluding the S&P 500 reported substantial aggregate losses in 2001-2002, meaning a much lower denominator for the ratio in the early 2000s.
Incidentally, this figure was produced in R, which I am finally switching to after years of using SAS and (hangs head in shame) Excel. If you are starting a graduate program in economics — and I know some readers of this blog are — I strongly, strongly advise you to learn R and get in the habit of producing all your work in LaTeX with embedded R code, using sweave or knitr. Kieran Healey explains why. You should never cut and paste a graphic from one application to another, or copy statistical results by hand into a table. I think this is the single piece of advice I most wish I’d gotten when I started graduate school.
Incidentally, I do recommend the book, but I would suggest just reading chapters 3-6, where the core arguments are developed, and then skipping to the final three chapters, 23-25. The intervening material is narrowly focused on the 2008-2009 financial crisis and is of less interest today.
* * *
Historical turning points aren’t usually visible until well after the fact. But the period of financial and economic turmoil that began in 2008 may be one of the rare exceptions. If capitalism historically has evolved through a series of distinct regimes — from competition to monopoly in the late 19th century, to a regulated capitalism after World War II and then to neoliberalism after the crises of the 1970s, then 2008 may mark the beginning of another sharp turn.
That, anyway, is the central claim of The Crisis of Neoliberalism, by Gérard Duménil and Dominique Lévy (hereafter D&L). The book brings together a great deal of material, broadly grouped under two heads. First is an argument about the sociology of capitalism, hinging on the relationship between capitalists in the strict sense and the managerial class. And second is an account of the financial crisis of 2008 and its aftermath. A concluding survey of possibilities for the post-neoliberal world unites the two strands.
For D&L, the key to understanding the transformations of capitalism over the past hundred years lies in the sociology of the capitalist class. With the rise of the modern corporation at the turn of the 20th century, it became more problematic to follow Marx in treating the capitalist as simply the “personification of capital.” While the logic of capital is the same — it remains, in their preferred formulation, “value in a movement of self-expansion” — distinct groups of human beings now stand at different points in that process. In particular, “the emergence of a bourgeois class more or less separated from the enterprise” (13) created a new sociological gulf between the ownership of capital and the management of production.
Bridging this gulf was a new social actor, Finance. While banks and other financial institutions predate industrial capitalism, they now took on an important new role: representation of the capitalist class vis-a-vis corporate management, a function not needed when ownership and management were united in the same person. “Financial institutions,” D&L write, “are an instrument in the hands of the capitalist class as a whole in the domination they exercise over the entire economy.” (57) This gives finance a dual character, as on the one hand one industry among others providing a particular good (intermediation, liquidity, etc.) but also as, on the other hand, the enforcers or administrators who ensure that industry as a whole remains organized according to the logic of profit.
The stringency of this enforcement varies over time. For D&L, the pre-Depression and post-Volcker eras are two periods of “financial hegemony,” in which holders of financial claims actively intervened in the governance of nonfinancial firms, compelling mergers of industrial companies in the first period, and engineering leveraged buyouts and takeovers in the second. By contrast, the postwar period was one of relative autonomy for the managerial class, with the owners of capital accepting a relatively passive role. One way to think of it is that since capital is a process, its expression as an active subject can occur at different moments of that process. Under financial hegemony, the political and sociological projections of capital emanated mostly from the M moment, but in the mid-century more from C-C’. Concretely, this means firms pursued objectives like growth, technical efficiency, market share or technological advance rather than (or in addition to) profit maximization – this is the “soulful corporation” of Galbraith or Chandler. Unlike those writers, however, D&L see this corporation-as-polis, balancing the interests of its various stakeholders under the steady hand of technocratic management, as neither the result of a natural evolution nor a normative ideal; instead, it’s a specific political-economic configuration that existed under certain historical conditions. In particular, managerial capitalism was the result of both the crisis of the previous period of financial hegemony and, crucially, of the mobilization of the popular classes, which opened up space for the top managers to pursue a strategy of “compromise to the left” while continuing to pay the necessary tribute to “the big capitalist families.”
Those families — the owners of capital, in the form of financial assets — were willing to accept a relatively passive role as long as the tribute flowed. But the fall in the profit rate in the 1970s forced the owners to recohere as a class for themselves. Their most important project was, of course, the attack on labor, in which capital and management were united. But a second, less visible fight was the capitalists’ attack on the managers, with finance as their weapon. The wave of corporate takeovers, buyouts and restructurings of the 1980s was not just a normal competitive push for efficiencies, nor was it the work of a few freebooting pirates and swindlers. As theorized by people like Michael Jensen, it was a self-conscious project to reorient management’s goals from the survival and growth of the firm, to “shareholder value”. In this, it succeeded – first by bullying and bludgeoning recalcitrant managers, then by incorporating their top tier into the capitalist class. “During the 1980s the disciplinary aspect of the new relationship between the capitalist and managerial classes was dominant,” write D&L, but “after 2000, … managers had become a pillar of Finance.” (84) Today, the “financial facet of management tends to overwhelmingly dominate” and “a process of ‘hybridization’ or merger is under way.” (85)
These are not entirely new ideas. D&L cite Veblen, certainly one of the first to critically investigate the separation of management and control, and to observe that the “importance of securities in ownership of the means of production [gives] … the capitalist class a strong financial character.” But they make no mention of the important debates on these issues among Marxists in the 1970s, especially Fitch and Oppenheimer’s Socialist Revolution articles on “Who Rules the Corporations?” and David Kotz’s Bank Control of Large Corporations in the United States. Most glaringly, they fail to cite Doug Henwood’s Wall Street, whose Chapter 6 gives a strikingly similar account of the revolt of the rentiers, and which remains the best guide to relations between finance and nonfinancial businesses within a broad Marxist framework. While Henwood shares the same basic analysis as The Crisis of Neoliberalism, he backs it up with a wealth of concrete examples and careful attention to the language of the financiers and their apologists. D&L, by contrast, despite their welcome interest in the sociology of the capitalist class, never descend from a high level of abstraction. D&L would have advanced the conversation more if they had tried to build on the contributions of Fitch and Oppenheimer, Kotz, and Henwood, instead of reinventing them.
Still, it’s an immensely valuable book. Both mainstream economists and Marxists often imbue capitalist firms with a false homogeneity, as if the pursuit of profit was just a natural fact or imposed straightforwardly by competition. D&L offer an important corrective, that firms (and social life in general) are only kept subordinate to the self-expansion of value through active, ongoing efforts to enforce and universalize financial criteria.
The last third of the book is an account of the global financial crisis of the past five years. Much of the specifics will be familiar to readers of the business press, but the central argument makes sense only in light of the earlier chapters: that the ultimate source of the crisis was precisely the success of the reestablishment of financial hegemony. In particular, deregulation — especially the freeing of cross-border capital flows — weakened the tools states had previously used to keep the growth of financial claims in line with the productive capacity of the economy. (It’s an irony of history that the cult of central banking “maestros” reached its height at the point when they had lost most of their real power.) Meanwhile, increased payouts to shareholders and other financial claimants starved firms of funds for accumulation. A corollary of this second point is that the crisis was characterized by underaccumulation rather than by underconsumption. The underlying demand problem wasn’t insufficient funds flowing to workers for consumption — the rich consume plenty — but insufficient funds remaining within corporations for the purpose of investment. Just as investment suffered at the end of the postwar boom when the surplus available to capitalist firms was squeezed from below by rising wage claims, it suffered in the past decade when that surplus was squeezed from above by the claims of rentiers. So higher wages might only have made the crisis worse. This argument needs to be taken seriously, unpalatable though it may be. We need to avoid the theodicy of liberal economists, in which the conditions of social justice and the conditions of steady accumulation are always the same.
The Crisis of Neoliberalism is not the last word on the crisis, but it is one of the more convincing efforts to situate it in the longer-term trajectory of capitalism. The most likely outcome of the crisis, they suggest, is a shift in the locus of power back toward managers. Profit maximization will again be subordinated to other objectives. The maintenance of US hegemony will require a “reterritorialization” of production, which will inevitably weaken the position of fincance. There is an inherent conflict between a reassertion of state authority and the borderless class constituted by ownership of financial claims. But there is no such conflict between the interests of particular states, and the class constituted by authority within particular firms. “This is an important factor … strengthening of the comparative position of nonfinancial managers.”
Are we starting to see the dethroning of Finance, a return to the soulful corporation, and a retreat from the universalizing logic of profit? It’s too soon to tell. It’s interesting, though, to see Michael Jensen, the master theorist of the shareholder revolution, sounding a more soulful note. Shareholder value, he recently told The New Yorker, “is the score that shows up on the scoreboard. It’s not the objective… Your life can’t just be about you, or your life will be shit. You see that on Wall Street.” That business serves a higher calling than Wall Street, is the first item in the managerialist catechism. We might look at Occupy Wall Street and the growing movement against student debt in the same light: By singling out as the enemy those elites whose power takes directly financial form, they implicitly legitimate power more linked to control of the production process. Strange to think that a movement of anarchists could be heralding a return to power of corporate management. But history can be funny that way.
The New Inquiry, an excellent new online magazine some readers may be familiar, has published an article I wrote based on the various disgorge the cash posts on this blog. Thanks to the superb editing of Mike Konczal and Rob Horning, the article develops the argument more cohesively than I’ve been able to on the blog. Go read it there, and then, if you like, comment here.
UPDATE: Matt Levine at Bloomberg calls me “the world’s leading Marxist analyst of the capital structure of the modern corporation.” That’s very flattering, but not remotely the case. What little I’ve written about this is all based on things I’ve learned from Jim Crotty, Dumenil and Levy, and Doug Henwood. (Including the phrase “disgorge the cash,” which I got from Doug.) Any of them might be contenders for that title (I won’t pick one), but not me. I’m just developing their ideas. And of course the original source of all this stuff is Part 5 of Volume III of Capital, especially chapter 27.
The third challenge is over the longer-term sources of demand. I look at this issue in terms of the sectoral financial balances – the balances between income and spending – in the household, business, external and government sectors. The question, then, is where expansion will come from. In the first quarter of this year the principal offset to fiscal contraction was the declining household surplus.
What is needed, as well, is a big swing towards surplus in the US current account or a jump in corporate investment, relative to retained profits. Neither seems imminent, though the second seems more likely than the first. The worry is that the only way to balance the economy will be via big new bubbles. If so, this is not the fault of the Fed. It is the fault of structural features of the domestic and global economies…
This is a good point, which should be made more. If we compare aggregate expenditure today to expenditure just before the recession, it is clear that the lower level of demand today is all about lower consumption. But maybe that’s not the best comparison, because during the housing boom period, consumption was historically high. If we take a somewhat longer view, what’s unusually low today is not household consumption, but business investment. Weak demand is about I, not C.
This is especially clear when we compare investment by businesses to what they are receiving in the form of profits, or, better cashflow from operations — after-tax profits plus depreciation.  Here is the relationship over the past 40 years:
Corporate Investment and Cashflow from Operations as Fraction of Total Assets, 1970-2012
The graph shows annualized corporate investment and cashflow, normalized by total assets. Each dot is data from one quarter; to keep the thing legible, I’ve only labeled the fourth quarter of each year. As you can see, there used to be a clear relationship between corporate profitability and corporate investment. For every additional $150, more or less, that a corporation took in from operations, it would increase capital expenditures by $100. This relationship held consistently through the 1960s (not shown), the 1970s, the 1980s and 1990s.
But now look at the past ten years, the period after 2001Q4. Corporate investment rates are substantially lower throughout this period than at any earlier time (averaging around 3.5% of total assets, compared with 5% of assets for 1960-2001). And the relationship between aggregate profit and investment rates has simply disappeared.
Some people might say that the problem is in the financial system, that even profitable businesses can’t borrow because of a breakdown in intermediation, a shortage of liquidity, an unwillingness of risk-averse investors to hold their debt, etc. I don’t buy this story for a number of reasons, some of which I’ve laid out in recent posts here. But it at least has some certain prima facie plausibility for the period following the great financial crisis. Not for for the whole decade-plus since 2001. Saying that investment is low today because businesses can’t find anyone to buy their bonds is merely wrong. Saying that’s why investment was low in 2005 is absurd.
(And remember, these are aggregates, so they mainly reflect the largest corporations, the ones that should have the least problems borrowing.)
So what’s a better story?
I am going to save my full answer for another post. But regular readers will not be surprised that I think the key is a shift in the relationship between corporations and shareholders. I think there’s a sense in which the binding constraint on investment has changed from the terms on which management can get funds into the corporation, from profits or borrowing, to the terms are on which they can keep them from going out, to investors. But the specific story doesn’t matter so much here. You can certainly imagine other explanations. Like, “the China price” — even additional capacity that would be profitable today won’t be added if it there’s a danger of lower-cost imports entering that market.
The point of this post is just that corporate investment is historically low, both in absolute terms and relative to profitability. And because this has been true for a decade, it is hard to attribute this weakness to credit constraints, or believe that it will be responsive to monetary policy. (This is even more true when you recall that the link between corporate borrowing and investment has also essentially disappeared.) By contrast, household consumption remains high. I have the highest respect for Steve Fazzari, and agree that high income inequality is a key metric of the fucked-upness of our economy. But I don’t think it makes sense to think of the current situation in terms of a story where high inequality reduces demand by holding down consumption.
Consumption is red, on the right scale; investment is blue, on the left. Both as shares of GDP.
As I say, I’ll come back in a future post to my on preferred explanation for why a comparably profitable firm, facing comparable credit conditions, will invest less today than 20 or 30 years ago.
In the meantime, one other thing. That first graph is a nice tool for showing how a Marxist thinks about business cycles.
If you look at the graph carefully, you’ll see the points follow counterclockwise loops. It’s natural to see this as cycles. Like this:
Start from the bottom of a cycle, at a point like 1992. A rise in profits from whatever source leads to higher investment, mainly as a source of funds and but also because it raises expectations of future profitability. That’s the lower right segment of the cycle. High investment eventually runs into supply constraints, typically in the form of a rising wage share. At that point profits begin to fall. Investment, however, continues high for a while, as the credit system allows firms to bridge a growing financing gap. That’s the upper right segment of the cycle. Eventually, though, if profits don’t recover, investment will follow them downward. This turning point often involves a financial crisis and/or abrupt fall in asset values, like the collapse of tech stocks in 2000. This is the upper left segment of the cycle. Finally, in the lower left, both profits and investment are low. But after some time the conditions for profitability are restored, and we move toward the right and begin a new cycle. This last step is less reliable than the others. It’s quite possible for the economy to come to rest at the lower left and wobble there for a while without any sustained change in either profits or investment. We see this in 2002-2003 and in 1988-1991.
(I think the investment boom of the late 70s and the persistent slump of the early 1990s are two of the more neglected episodes in recent economic history. The period around 1990, in particular, seems to have all the features that are supposed to be distinctive to the current macroeconomic conjuncture. At the time, people even called it a balance-sheet recession!)
For now, though, we’re not interested in the general properties of cycles. We’re interested in how flat and low the most recent two are, compared with earlier ones. That is the structural feature that Martin Wolf is pointing to. And it’s not a new feature of the post financial crisis period, it’s been the case for a dozen years at least, only temporarily obscured by the housing bubble.
UPDATE: In comments, Seth Ackerman asks if maybe using total assets to normalize investment and profits is distorting the picture. It’s a good question, but the answer is no. Here’s the same thing, with trend GDP in the denominator instead:
As you can see, the picture is basically the same. Investment in the 200s is still visibly depressed compared with earlier decades, and the relationship between profits and investment is much weaker. Of course, it’s always possible that current high profits will lead an investment boom in the next few years…
 Cash from operations is better than profits for at least two reasons. First, from the point of view of aggregate demand, we are interested in gross not net investment. A dollar of investment stimulates demand just as much whether it’s replacing old equipment or adding new. So our measure of income should also be gross of depreciation. Second, there are major practical and conceptual issues with measuring depreciation. Changes in accounting standards may result in very different official depreciation numbers in economically identical situations. By combining depreciation and profits, we avoid the problem of the fuzzy and shifting line between them, making it more likely that we are comparing equivalent quantities.
 A rising wage share need not, and often does not, take the form of rising real wages. In recent cycles especially, it’s more likely to combine flat real wages with a rising relative cost of wage goods.
“All these people have a sort of parlay mentality, and they need to get on the playing field before they can start running it up. I’m a trader. It all happens for me in the transition. The moment of liquidation is the essence of capitalism.”
“What about the man in Rigby?”
“He’s an end user. He wants to keep it.”
I reflected on the pathos of ownership, and the ways it could bog you down.
The guy may just be selling a car dealership, but he gets it: You’re not a capitalist until you get to M’. Getting attached to C-C’ for its own sake will just bog you down. But of course, organizing life around the moment of liquidation has its drawbacks as well.
UPDATE: Variation on a theme. From today’s fascinating post by Felix Salmon on a lawsuit over some disputed Jackson Pollock paintings:
In this lawsuit, Mirvish has taken the idea of art-as-an-investment to a particularly bonkers extreme. In Mirvish’s world, it seems, artworks have no inherent value, just by dint of being beautiful or genuine or unique. Instead, an artwork is only an investment if it’s being shopped around — if someone’s trying to make a profit on it, by selling it.
Similarly, in Mirvish’s world, if a gallery has a claim to 50% of the value of a painting, but again isn’t actively shopping that painting around, then the gallery’s claim is worthless.
Value doesn’t inhere in a thing, only in the process by which that thing is eventually converted to money. Bonkers, sure, yes, but also the organizing principle of the world we live in.
Most of these chief executives are also veterans of the Internet bubble of the late ’90s, and confess to worries that maybe things are not so different this time. Mr. Tinker… said, “The reality is, I’ve taken $94 million in investors’ money, and we haven’t gone public yet. I feel that responsibility every day.” …
The nagging fear is that valuations, which are turned into profits only if the company goes public successfully or is bought for a high price, could still plunge.
The cheap pleasure here is gawking at the next stupid Pets.com. (The NYC subway right now is plastered with ads for some company that, wait for it, lets you order pet food online.) But maybe all of this lot will thrive, I have no idea. What I’m interested in is that bolded phrase.
You might naively think that whether a business makes profits is independent of who happens to own it. Profits appear as soon as a commodity is sold for more than the cost of its inputs. So the bolded sentence really only makes sense with the implied addition, profits for venture capitalists or for finance. But in the disgorge-the-cash era, that’s taken as read.
Capitalism is still about M-C-C’-M’, same as it ever as. But C-C’ now includes not just the immediate process of production, but everything related to the firm as a distinct entity. Profits aren’t really profits, under the current regime, as long as the claim on them is tied to a specific business or industry. And the only real capitalists are owners of financial assets.
(Of course what is interesting about the internet economy is the extent to which this logic has not held there. Functionally, profitability for internet companies has meant a relationship of sales to costs that allows them to grow, regardless of the level of payouts to financial claimants. Whether articles like this are a sign of a convergence of Silicon Valley to the dominant culture, or just an example of the bondholder’s-eye view reflexively adopted by the Times, I don’t know.)
It is important to note that wealth as such, i.e. bourgeois wealth, is always expressed to the highest power as exchange value, where it is posited as mediator, as the mediation of the extremes of exchange value and use value themselves. … Within capital itself, one form of it in turn takes up the position of use value against the other as exchange value…: the wholesaler as mediator between manufacturer and retailer, or between manufacturer and agriculturalist, or between different manufacturers; he is the same mediator at a higher level. And in turn, in the same way, the commodity brokers as against the wholesalers. Then the banker as against the industrialists and merchants; the joint-stock company as against simple production; the financier as mediator between the state and bourgeois society, on the highest level. Wealth as such presents itself more distinctly and broadly the further it is removed from direct production and is itself mediated between poles, each of which, considered for itself, is already posited as economic form. Money becomes an end rather than a means; and the higher form of mediation, as capital, everywhere posits the lower as … labour, as merely a source of surplus value. For example, the bill-broker, banker etc. as against the manufacturers and farmers, which are posited in relation to him in the role of labour (of use value); while he posits himself toward them as capital, extraction of surplus value; the wildest form of this, the financier.
Finance stands with respect to productive enterprises as capitalists in general stand with respect to labor (and raw material). So it makes sense that, from finance’s point of view, profit is not realized with the sale of the commodity, but only with the sale of the enterprise itself.