disgorge the cash – Page 3

Still Disgorging

From Bloomberg last month:

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…

This is a familiar theme to readers of this blog.

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.

Review of Dumenil and Levy

The new issue of Rethinking Marxism has my review of The Crisis of Neoliberalism by Gérard Duménil and Dominique Lévy. Since RM is paywalled — a topic for another day — I’m putting the full text here.

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.

“Disgorge the Cash” in The New Inquiry

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 Cash and I

Martin Wolf in the FT the other day:

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. [1] 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.[1] 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…

[1] 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.

[2] 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.

The Capitalist Wants an Exit, Short Fiction Edition

“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.

– from Tom McGuane, “Gallatin Canyon”.

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.

When Do Profits Count?

From today’s New York Times story about the new crop of billion-dollar internet startups:

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.)

EDIT: From the Grundrisse:

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.

What Is Business Borrowing For?

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.

The Story of Q

More posts on Greece, coming right up. But first I want to revisit the relationship between finance and nonfinancial business in the US.

Most readers of this blog are probably familiar with Tobin’s q. The idea is that if investment decisions are being made to maximize the wealth of shareholders, as theory and, sometimes, the law say they should be, then there should be a relationship between the value of financial claims on the firm and the value of its assets. Specifically, the former should be at least as great as the latter, since if investing another dollar in the firm does not increase its value to shareholders by at least a dollar, then that money would better have been returned to them instead.

As usual with anything interesting in macroeconomics, the idea goes back to Keynes, specifically Chapter 12 of the General Theory:

the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment. For there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectations of the professional entrepreneur.

It was this kind of reasoning that led Hyman Minsky to describe Keynes as having “an investment theory of the business cycle, and a financial theory of investment.” Axel Leijonhufvud, on the other hand, would warn us against taking the dramatis personae of this story too literally; the important point, he would argue, is the way in which investment responds to the shifts in the expected return on fixed investment versus the long-term interest rate. For better or worse, postwar Keynesians including the eponymous Tobin followed Keynes here in thinking of one group of decisionmakers whose expectations are embodied in share prices and another group setting investment within the firm. If shareholders are optimistic about the prospects for a business, or for business in general, the value of shares relative to the cost of capital goods will rise, a signal for firms to invest more; if they are pessimistic, share prices will fall relative to the cost of capital goods, a signal that further investment would be, from the point of view of shareholders, value-subtracting, and the cash should be disgorged instead.

There are various specifications of this relationship; for aggregate data, the usual one is the ratio of the value corporate equity to corporate net worth, that is, to total assets minus total liabilities. In any case, q fails rather miserably, both in the aggregate and the firm level, in its original purpose, predicting investment decisions. Here is q for nonfinancial corporations in the US over the past 60 years, along with corporate investment.

The orange line is the standard specification of q; the dotted line is equity over fixed assets, which behaves almost identically. The black line shows nonfinancial corporations’ nonresidential fixed investment as a share of GDP. As you can see, apart from the late 90s tech boom, there’s no sign that high q is associated with high investment, or low q with low investment. In fact, the biggest investment boom in postwar history, in the late 1970s, comes when q was at its low point. [*]

The obvious way of looking at this is that, contra Tobin and (at least some readings of) Keynes, stock prices don’t seem to have much to do with fixed investment. Which is not so strange, when you think about it — it’s never been clear why managers and entrepreneurs should substitute the stock market’s beliefs about the profitability of some new investment for their own, presumably better-informed, one. Just as well, given the unanchored gyrations of the stock market.

This is true as far as it goes, but there’s another way of looking at it. Because, q isn’t just uncorrelated with investment; for most of the period, at least until the 1990s, it’s almost always well below 1. This is even more surprising when you consider that a well-run firm with an established market ought to have a q above one, since it will presumably have intangible assets — corporate culture, loyal customers and so on — that don’t show up on the balance sheet. In other words, measured assets should seem to be “too low”. But in fact, they’re almost always too high. For most of the postwar period, it seems that corporations were systematically investing too much, at least from the point of view maximizing shareholder value.

I was talking with Suresh the other day about labor, and about the way labor organizing can be seen as a kind of assertion of a property right. Whether shareholders are “the” residual claimants of a firm’s earnings is ultimately a political question, and in times and places where labor is strong, they are not. Same with tenant organizing — you could see it as an assertion that long-time tenants have a property right in their homes, which I think fits most people’s moral intuitions.

Seen from this angle, the fact that businesses were investing “too much” during much of the postwar decades no longer is a sign they were being irrational or made a mistake; it just suggests that they were considering the returns to claimants other than shareholders. Though one wouldn’t what to read too much into it, it’s interesting in this light that for the past dozen years aggregate q has been sitting at one, exactly where loyal agents for shareholders would try to keep it. In liberal circles, the relatively low business investment of the past decade is often considered a sign of something seriously wrong with the economy. But maybe it’s just a sign that corporations have learned to obey their masters.

EDIT: In retrospect, the idea of labor as residual claimant does not really belong in this argument, it just confuses things. I am not suggesting that labor was ever able to compel capitalist firms to invest more than they wanted, but rather that “capitalists” were more divided sociologically before the shareholder revolution and that mangers of firms chose a higher level of investment than was optimal from the point of view of owners of financial assets. Another, maybe more straightforward way of looking at this is that q is higher — financial claims on a firm are more valuable relative to the cost of its assets — because it really is better to own financial claims on a productive enterprise today than in the pr-1980 period. You can reliably expect to receive a greater share of its surplus now than you could then.

[*] One of these days I really want to write something abut the investment boom of the 1970s. Nobody seems to realize that the highest levels of business investment in modern US history came in 1978-1981, supposedly the last terrible days of stagflation. Given the general consensus that fixed capital formation is at the heart of economic growth, why don’t people ask what was going right then?

Part of it, presumably, must have been the kind of sociological factors pointed to here — this was just before the Revolt of the Rentiers got going, when businesses could still pursue growth, market share and innovation for their own sakes, without worrying much about what shareholders thought. Part must have been that the US was still able to successfully export in a range of industries that would become uncompetitive when the dollar appreciated in the 1980s. But I suspect the biggest factor may have been inflation. We always talk about investment being encouraged by stuff that makes it more profitable for capitalists to hold their wealth in the form of capital goods. But logically it should be just as effective to reduce the returns and/or safety of financial assets. Since neither nominal interest rates nor stock prices tracked inflation in the 1970s, wealthholders had no choice but to accept holding a greater part of their wealth in the form of productive business assets. The distributional case for tolerating inflation is a bit less off-limits in polite conversation than it was a few years ago, but the taboo on discussing its macroeconomic benefits is still strong. Would be nice to try violating that.

The Capitalist Wants an Exit, Facebook Edition

In today’s FT, John Gapper reads the Facebook prospectus. [1] And he doesn’t like what he sees:

There is still time to cancel its IPO and the filing provides plenty of reasons why it ought to… It begs a question if a company trying to raise capital from investors cannot think of anything to do with the money. Yet this is Facebook’s predicament – as it admitted in its filing on Wednesday, its cash flow and credit “will be sufficient to meet our operational needs for the foreseeable future”. … So what are its plans for the additional $5bn it may raise from an IPO? It intends to put the cash into US government bonds and savings accounts…

Gapper, looking at the IPO from the perspective of what it does for Facebook the enterprise, understandably thinks this is nuts. Why incur the costs of an IPO and the ongoing requirements of a public listing, if you have so little need for the cash that you are literally just planning to leave it in a savings account. But of course, the purpose of the IPO has nothing to do with Facebook the enterprise.

Given that it doesn’t need capital…, why the IPO? … Facebook’s motivation is clear: to gratify its venture capital investors and employees. This is not a cynical statement; it is a quote from Mr Zuckerberg’s letter to new shareholders. “We’re going public for our employees and our investors,” he writes. “We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment.”

In terms of Silicon Valley’s logic, it makes sense… For the company itself, however, the logic is far less obvious. As a corporate entity, Facebook could clearly thrive without seeking new shareholders, whose main purpose is to allow the insiders to get rich and eventually exit.

As I’ve written before, the function of the stock market in modern capitalism is to get money out of corporations, not put money into them. The social problem they are solving is not society’s need to allocate scarce savings to the most promising investments, but wealth-owners desire to free their fortunes from particular firm or industry and keep them as claims on the social product as a whole.

[1] It’s been said before, but can I just point out how unbearably stupid is the FT’s policy of actively discouraging people from excerpting their articles?

Dividing the Spoils

In response to the last post, commenter 5371 asks, “An anti-managerial counterrevolution which the managers themselves ended up leading?” Fair question, here’s my answer:

I think there is a very convincing story in which the emergence of the modern corporation in the early decades of the 20th century, and then the vast expansion of the federal administrative apparatus in the New Deal and (especially) World War II, created a class of professional managers with substantial autonomy from the notional owners of capital. (Not as cohesive as the enarques in France, but the same kind of stratum.) As managers of firms they pursued a variety of objectives, of which providing a satisfactory (not maximal) flow of payments to shareholders was just one among others.

At some point (in the late 1970s, let’s say) this arrangement broke down, with conflicts both between managers and owners over the fraction of surplus flowing to the latter, and between owners and workers, over the size of the surplus, with mangers basically on the side of owners. The second of these conflicts was, in some sense, more fundamental, but the first one was also real and important.

You then had a series of institutional changes that were intended to realign the interests of managers with owners, in terms of both conflicts. During the period of realignment, these changes took the form — at least at times — of open conflict, with recalcitrant managers forcibly removed by LBOs, etc. But over time, top management was effectively absorbed into the capitalist class proper, and stopped seeing themselves as the social embodiment of the firm as a social organism or representatives of society as a whole. At the same time, there does have to be continuous policing to ensure that management doesn’t deviate from the goal of maximizing payments to shareholders. That is finance’s other function, along with intermediation, and it’s this second function that has been responsible for finance’s growth over the past decades. (Along with the rents that financial institutions and asset-owners claim in the course of doing their enforcement work.)

So in terms of overt conflict between owners and managers, the shareholder revolution is over; the shareholders won. The fly in the ointment is that no one is policing the police, and unlike other institutional supports of the capitalist system (the actual police, say, or the legal profession or academia) they don’t have the right internal norms to make them reliable servants.

That’s how it looks to me, anyway. I realize this is just a set of assertions, which would need to be backed up with evidence/examples to convince anyone who’s not already convinced. As usual, I recommend Doug H.’s Wall Street (especially chapter 6, which I’m having my students read this semester) and Dumenil & Levy’s Crisis of Neoliberalism to see the argument developed properly. One of these days maybe I’ll write something substantive on it myself.

I should add, an interesting aspect of the counterrevolution of the rentiers is the way that the claim of shareholders on the maximum possible payments from “their” firms has become an accepted moral principle. There are lots of educated people, even liberals, who unquestioningly believe that it is morally wrong for managers to have any objectives except maximizing future dividend payments. E.g. look at this old Baseline Scenario post on Goldman Sachs’ relatively low 2009 bonuses, with the unironic title Good for Goldman:

Goldman did the right thing here.We all know that Goldman made a lot of money last year. … Many people think that it made that money because of government support, but that’s beside the point here; right now, this is purely a question of dividing the spoils between employees and shareholders.

Historically, investment banks have given a large proportion of the profits (here, meaning before compensation and taxes) to the employees. For example, in 2007 Goldman gave $20.2 billion out of $37.8 billion to its employees, or 53%. There are undoubtedly many reasons for this. … More insidiously, investment banking executives tend to see their employees as younger versions of themselves, which creates a sense of solidarity… Contrast this to, say, Wal-Mart, where top management has very little in common (socially, educationally, economically, politically, etc.) with the vast majority of their employees. As a result, investment bankers are overpaid. …

Goldman should reduce its per-employee compensation expenses even further, and should try to push the industry to a new equilibrium where the payout ratio is in the 30-40% range and average compensation for investment bankers is in the $300-400,000 range. And Goldman’s shareholders should apply pressure to make this happen; basically, they should try to squeeze labor.

I find this sort of thing fascinating. James Kwak is a liberal, one of the good guys. But it’s awfully hard not to read him here as saying it’s a good thing that Wal-Mart execs have nothing in common with the proles to distract them from serving their true masters, and that where a sense of solidarity does exist between managers and workers, it’s an “insidious” problem that needs to be stamped out. There’s nothing ironic in those “should”s.

Of course I’m no fan of traders, financial engineers, and the rest of the pirates, but as Kwak himself says, this is “purely a question of dividing the spoils.” So I don’t see why the silent partners who finance the privateers have any better claim than the guys with flintlocks and cutlasses, or why we should treat it as something to celebrate when the financiers get a bigger share of the take. [1] What’s strange is how many people, many not especially rich or conservative, have been somehow convinced that the biggest problem with businesses is that they aren’t run purely enough for profit, and that employees still have too much control over their work and pay. That in any conflict between owners and workers or managers, the social interest is obviously — obviously — on the side of the owners. It’s nuts.

[1] Ok, yes, about 15 percent of corporate equity is owned by pension funds. So yes, salaried workers (including me and probably you) do in some sense confront employees, at both Goldman and Wal-Mart, as owners. We can’t just say “the capitalist is the personification of capital” and be done with it, as Marx did; capitalist as economic function and capitalists as sociological category don’t coincide as nicely as they did in his day. But why should we let our little interest as junior capitalists dominate our much larger interests as workers, citizens, and human beings? Why should we assume that the claims on business exercised by virtue of capital ownership, are the only ones that are morally legitimate?