Is Capital Being Reallocated to High-Tech Industries?

Readers of this blog are familiar with the “short-termism” position: Because of the rise in shareholder power, the marginal use of funds for many corporations is no longer fixed investment, but increased payouts in the form of dividends and sharebuybacks. We’re already seeing some backlash against this view; I expect we’ll be seeing lots more.

The claim on the other side is that increased payouts from established corporations are nothing to worry about, because they increase the funds available to newer firms and sectors. We are trying to explore the evidence on this empirically. In a previous post, I asked if the shareholder revolution had been followed by an increase in the share of smaller, newer firms. I concluded that it didn’t look like it. Now, in this post and the following one, we’ll look at things by industry.

In that earlier post, I focused on publicly traded corporations. I know some people don’t like this — new companies, after all, aren’t going to be publicly traded. Of course in an ideal world we would not limit this kind of analysis to public traded firms. But for the moment, this is where the data is; by their nature, publicly traded corporations are much more transparent than other kinds of businesses, so for a lot of questions that’s where you have to go. (Maybe one day I’ll get funding to purchase access to firm-level financial data for nontraded firms; but even then I doubt it would be possible to do the sort of historical analysis I’m interested in.) Anyway, it seems unlikely that the behavior of privately held corporations is radically different from publicly traded one; I have a hard time imagining a set of institutions that reliably channel funds to smaller, newer firms but stop working entirely as soon as they are listed on a stock market. And I’m getting a bit impatient with people who seem to use the possibility that things might look totally different in the part of the economy that’s hard to see, as an excuse for ignoring what’s happening in the parts we do see.

Besides, the magnitudes don’t work. Publicly traded corporations continue to account for the bulk of economic activity in the US. For example, we can compare the total assets of the nonfinancial corporate sector, including closely held corporations, with the total assets of publicly traded firms listed in the Compustat database. Over the past decade, the latter number is consistently around 90 percent of the former. Other comparisons will give somewhat different values, but no matter how you measure, the majority of corporations in the US are going to be publicly traded. Anyway, for better or worse, I’m again looking at publicly-traded firms here.

In the simplest version of the capital-reallocation story, payouts from old, declining industries are, thanks to the magic of the capital markets, used to fund investment in new, technology-intensive industries. So the obvious question is, has there in fact been a shift in investment from the old smokestack industries to the newer high-tech ones?

One problem is defining investment. The accounting rules followed by American businesses generally allow an expense to be capitalized only when it is associated with a tangible asset. R&D spending, in particular, must be treated as a current cost. The BEA, however, has since 2013 treated R&D spending, along with other forms of intellectual property production, as a form of investment. R&D does have investment-like properties; arguably it’s the most relevant form of investment for some technology-intensive sectors. But the problem with redefining investment this way is that it creates inconsistencies with the data reported by individual companies, and with other aggregate data. For one thing, if R&D is capitalized rather than expensed, then profits have to be increased by the same amount. And then some assumptions have to be made about the depreciation rate of intellectual property, resulting in a pseudo asset in the aggregate statistics that is not reported on any company’s books. I’m not sure what the best solution is. [1]

Fortunately, companies do report R&D as a separate component of expenses, so it is possible to use either definition of investment with firm-level data from Compustat. The following figure shows the share of total corporate investment, under each definition, of a group of six high-tech industries: drugs; computers; communications equipment; medical equipment; scientific equipment other electronic goods; and software and data processing. [2]

hitech

As you can see, R&D spending is very important for these industries; for the past 20 years, it has consistently exceed investment spending as traditionally defined. Using the older, narrow definition, these industries account for no greater share of investment in the US than they did 50 years ago; with R&D included, their share of total investment has more than doubled. But both measures show the high-tech share of investment peaking in the late 1990s; for the past 15 years, it has steadily declined.

Obviously, this doesn’t tell us anything about why investment has stalled in these industries since the end of the tech boom. But it does at least suggest some problems with a simple story in which financial markets reallocate capital from old industries to newer ones.

The next figure breaks out the industries within the high-tech group. Here we’re looking at the broad measure of investment, which incudes R&D.

techsectors

As you can see, the decline in high-tech investment is consistent across the high-tech sectors. While the exact timing varies, in the 1980s and 1990s all of these sectors saw a rising share of investment; in the past 15 years, none have. [3]  So we can safely say: In the universe of publicly traded corporations, the sectors we think would benefit from reallocation of capital were indeed investing heavily in the decades before 2000; but since then, they have not been. The decline in investment spending in the pharmaceutical industry — which, again, includes R&D spending on new drugs — is especially striking.

Where has investment been growing, then? Here:

hitech_oil

The red lines show broad and narrow investment for oil and gas and related industries — SICs 101-138, 291-299, and 492. Either way you measure investment, the increase over the past 15 years has dwarfed that in any other industry. Note that oil and gas, unlike the high-tech industries, is less R&D-intensive than the corporate sector as a whole. Looking only at plant and equipment, fossil fuels account for 40 percent of total corporate investment; by this measure, in some recent years, investment here has exceeded that of all manufacturing together. With R&D included, by contrast, fossil fuels account for “only” a third of US investment.

In the next post, I’ll look at the other key financial flows — cashflow from operations, shareholder payouts, and borrowing — for the tech industries, compared with corporations in general. As we’ll see, while at one point payouts were lower in these industries than elsewhere, over the past 15 years they have increased even faster than for publicly traded corporations as a whole. In the meantime:

Very few of the people talking about the dynamic way American financial markets reallocate capital have, I suspect, a clear idea of the actual reallocation that is taking place. Save for another time the question of whether this huge growth in fossil fuel extraction is a good thing for the United States or the world. (Spoiler: It’s very bad.) I think it’s hard to argue with a straight face that shareholder payouts at Apple or GE are what’s funding fracking in North Dakota.

 

[1] This seems to be part of a larger phenomenon of the official statistical agencies being pulled into the orbit of economic theory and away from business accounting practices. It seems to me that allowing the official statistics to drift away from the statistics actually used by households and businesses creates all kinds of problems.

[2] Specifically, it is SICs 83, 357, 366, 367, 382, 384, and 737. I took this specific definition from Brown, Fazzari and Petersen. It seems to be standard in the literature.

[3] Since you are probably wondering: About two-thirds of that spike in software investment around 1970 is IBM, with Xerox and Unisys accounting for most of the rest.

Do Shareholder Payouts Fund Investment at New Firms?

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. [1]

youngsharesmallshare

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. [2] 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.

noncorporateshare

 

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.

 

[1] 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.

[2] 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.

The Myth of Reagan’s Debt

BloomCounty
… or at least don’t blame him for increased federal debt.

 

Arjun and I have been working lately on a paper on monetary and fiscal policy. (You can find the current version here.) The idea, which began with some posts on my blog last year, is that you have to think of the output gap and the change in the debt-GDP ratio as jointly determined by the fiscal balance and the policy interest rate. It makes no sense to talk about the “natural” (i.e. full-employment) rate of interest, or “sustainable” (i.e. constant debt ratio) levels of government spending and taxes. Both outcomes depend equally on both policy instruments. This helps, I think, to clarify some of the debates between orthodoxy and proponents of functional finance. Functional finance and sound finance aren’t different theories about how the economy works, they’re different preferred instrument assignments.

We started working on the paper with the idea of clarifying these issues in a general way. But it turns out that this framework is also useful for thinking about macroeconomic history. One interesting thing I discovered working on it is that, despite what we all think we know,  the increase in federal borrowing during the 1980s was mostly due to higher interest rate, not tax and spending decisions. Add to the Volcker rate hikes the deep recession of the early 1980s and the disinflation later in the decade, and you’ve explained the entire rise in the debt-GDP ratio under Reagan. What’s funny is that this is a straightforward matter of historical fact and yet nobody seems to be aware of it.

Here, first, are the overall and primary budget balances for the federal government since 1960.  The primary budget balance is simply the balance excluding interest payments — that is, current revenue minus . non-interest expenditure. The balances are shown in percent of GDP, with surpluses as positive values and deficits as negative. The vertical black lines are drawn at calendar years 1981 and 1990, marking the last pre-Reagan and first post-Reagan budgets.

overall_primary

The black line shows the familiar story. The federal government ran small budget deficits through the 1960s and 1970s, averaging a bit more than 0.5 percent of GDP. Then during the 1980s the deficits ballooned, to close to 5 percent of GDP during Reagan’s eight years — comparable to the highest value ever reached in the previous decades. After a brief period of renewed deficits under Bush in the early 1990s, the budget moved to surplus under Clinton in the later 1990s, back to moderate deficits under George W. Bush in the 2000s, and then to very large deficits in the Great Recession.

The red line, showing the primary deficit, mostly behaves similarly to the black one — but not in the 1980s. True, the primary balance shows a large deficit in 1984, but there is no sustained movement toward deficit. While the overall deficit was about 4.5 points higher under Reagan compared with the average of the 1960s and 1970s, the primary deficit was only 1.4 points higher. So over two-thirds of the increase in deficits was higher interest spending. For that, we can blame Paul Volcker (a Carter appointee), not Ronald Reagan.

Volcker’s interest rate hikes were, of course, justified by the need to reduce inflation, which was eventually achieved. Without debating the legitimacy of this as a policy goal, it’s important to keep in mind that lower inflation (plus the reduced growth that brings it about) mechanically raises the debt-GDP ratio, by reducing its denominator. The federal debt ratio rose faster in the 1980s than in the 1970s, in part, because inflation was no longer eroding it to the same extent.

To see the relative importance of higher interest rates, slower inflation and growth, and tax and spending decisions, the next figure presents three counterfactual debt-GDP trajectories, along with the actual historical trajectory. In the first counterfactual, shown in blue, we assume that nominal interest rates were fixed at their 1961-1981 average level. In the second counterfactual, in green, we assume that nominal GDP growth was fixed at its 1961-1981 average. And in the third, red, we assume both are fixed. In all three scenarios, current taxes and spending (the primary balance) follow their actual historical path.

counterfactuals

In the real world, the debt ratio rose from 24.5 percent in the last pre-Reagan year to 39 percent in the first post-Reagan year. In counterfactual 1, with nominal interest rates held constant, the increase is from 24.5 percent to 28 percent. So again, the large majority of the Reagan-era increase in the debt-GDP ratio is the result of higher interest rates. In counterfactual 2, with nominal growth held constant, the increase is to 34.5 percent — closer to the historical level (inflation was still quite high in the early ’80s) but still noticeably less. In counterfactual 3, with interest rates, inflation and real growth rates fixed at their 1960s-1970s average, federal debt at the end of the Reagan era is 24.5 percent — exactly the same as when he entered office. High interest rates and disinflation explain the entire increase in the federal debt-GDP ratio in the 1980s; military spending and tax cuts played no role.

After 1989, the counterfactual trajectories continue to drift downward relative to the actual one. Interest on federal debt has been somewhat higher, and nominal growth rates somewhat lower, than in the 1960s and 1970s. Indeed, the tax and spending policies actually followed would have resulted in the complete elimination of the federal debt by 2001 if the previous i < g regime had persisted. But after the 1980s, the medium-term changes in the debt ratio were largely driven by shifts in the primary balance. Only in the 1980s was a large change in the debt ratio driven entirely by changes in interest and nominal growth rates.

So why do we care? (A question you should always ask.) Three reasons:

First, the facts themselves are interesting. If something everyone thinks they know — Reagan’s budgets blew up the federal debt in the 1980s — turns out not be true, it’s worth pointing out. Especially if you thought you knew it too.

Second is a theoretical concern which may not seem urgent to most readers of this blog but is very important to me. The particular flybottle I want to find the way out of is the idea that money is neutral,  veil —  that monetary quantities are necessarily, or anyway in practice, just reflections of “real” quantities, of the production, exchange and consumption of tangible goods and services. I am convinced that to understand our monetary production economy, we have to first understand the system of money incomes and payments, of assets and liabilities, as logically self-contained. Only then we can see how that system articulates with the concrete activity of social production. [1] This is a perfect example of why this “money view” is necessary. It’s tempting, it’s natural, to think of a money value like the federal debt in terms of the “real” activities of the federal government, spending and taxing; but it just doesn’t fit the facts.

Third, and perhaps most urgent: If high interest rates and disinflation drove the rise in the federal debt ratio in the 1980s, it could happen again. In the current debates about when the Fed will achieve liftoff, one of the arguments for higher rates is the danger that low rates lead to excessive debt growth. It’s important to understand that, historically, the relationship is just the opposite. By increasing the debt service burden of existing debt (and perhaps also by decreasing nominal incomes), high interest rates have been among the main drivers of rising debt, both public and private. A concern about rising debt burdens is an argument for hiking later, not sooner. People like Dean Baker and Jamie Galbraith have pointed out — correctly — that projections of rising federal debt in the future hinge critically on projections of rising interest rates. But they haven’t, as far as I know, said that it’s not just hypothetical. There’s a precedent.

 

[1] Or in other words, I want to pick up from the closing sentence of Doug Henwood’s Wall Street, which describes the book as part of “a project aiming to end the rule of money, whose tyranny is sometimes a little hard to see.” We can’t end the rule of money until we see it, and we can’t see it until we understand it as something distinct from productive activity or social life in general.

Further Thoughts on Anti-Financialization

I want to amplify the last point from the previous post, about anti-financialization.

If we go back to the beginning of the national accounts in 1929, we find personal consumption accounts for around 75% of GDP. (This is true whether or not we make the C&F adjustments, since in 1929 the imputed and third-party component of consumption were either nonexistent or small.) During the Depression, the consumption share rises to 85% as business investment collapses, during the war it falls to below 50%, and it rises back to around two-thirds after 1945. It’s in the second half of the 1940s, with the growth of pension and health benefits and the spread of homeownership, that we start to see a large wedge between headline consumption and actual cash expenditures by households.

We can think of the ratio of adjusted consumption to GDP as a measure of how marketized the economy is: How much of output is purchased by people for their own use, as opposed to allocated in some other way? In this sense, the steady fall in adjusted consumption as a share of GDP represents a steady retreat of capitalist production in the postwar US. It was squeezed from both sides: from “above” by public provision of health care, education and retirement security, and from “below” by the state-fostered growth of self-provision in housing.

Consumption spending by households bottomed out at 47 percent of GDP in 1981. With the neoliberal turn, the process of de-marketization largely halted — but it did not reverse. Since then, consumption spending by households has hovered around 47-48% of GDP. The phenomena of household financialization, “markets for everything,” etc. are real — but only at the level of ideology.  Private life in the US has not become more commodified, marketized or financialized in recent decades; over a longer horizon the opposite. What has happened is that a thickening veneer of fictional market transactions has been overlaid on a reality of social consumption.

In reality, neither collective provision of health care (or of education, public safety, etc.) nor self-provision of housing has been replaced to any noticeable degree by market purchases. What we’ve had, instead, is the statistical illusion of rising private consumption spending — an illusion fostered by the distortion of the national accounts by the dominant economic theory. When health insurance is purchased collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase health coverage individually. When retirement savings are carried out collectively by government or employers, the national accounts pretend that people were paid in cash and then chose to purchase financial assets. When people buy houses for their own use, the national accounts pretend they are profit-maximizing landlords, selling the use of their houses in the rental market. When liquidity constraints force people to hold financial wealth in low-yield forms, the national accounts pretend that financial markets are frictionless and that they are receiving the market yield in some invisible form. Together, these fictional transactions now make up 20 percent of GDP, and fully a third of apparent household consumption.

Of course, that might change. The decline of homeownership and the creation of a rental market for single-family homes may turn the fiction of a housing sector of tenants and profit-seeking landlords into a reality. One result of Obamacare — intended or otherwise — will be to replace collective purchases of health insurance by employers with individual purchases by households. Maybe the Kochs and Mark Zuckerberg will join forces and succeed in privatizing the schools. But none of that has happened yet. What’s striking to me is how many critics of contemporary capitalism — including Cynamon and Fazzari themselves — have accepted the myth of rising household consumption, without realizing there’s no such thing. The post 1980s rise in consumption is a statistical artifact of the ideology of capitalism — a way of pretending that a world of collective production and consumption is a world of private market exchange.