Tag: macroeconomics = accounting + history

Fisher Dynamics Revisited

Back in the 2010s, Arjun Jayadev and I wrote a pair of papers (one, two) on the evolution of debt-income ratios for US households. This post updates a couple key findings from those papers. (The new stuff begins at the table below.)

Rather than econometric exercises, the papers were based on a historical accounting decomposition —  an approach that I think could be used much more widely. We separated changes in the debt-income ratio into six components — the primary deficit (borrowing net of debt service payments); interest payments; real income growth; inflation; and write downs of debt through default — and calculated the contribution of each to the change in debt ratios over various periods. This is something that is sometimes done for sovereign debt but, as far as I know, we were the first to do it for private debt-income ratios.

We referred to the contributions of the non-borrowing components as “Fisher dynamics,” in honor of Irving Fisher’s seminal paper on depressions as “debt deflations.” A key aspect of the debt-deflation story was that when nominal incomes fell, the burden of debt could rise even as debtors sharply reduced new borrowing and devoted a greater share of their income to paying down existing debt. In Fisher’s view, this was one of the central dynamics of the Great Depression. Our argument was that something like a slow-motion version of this took place in the US (and perhaps elsewhere) in recent decades.

The logic here is that the change in debt-income ratios is a function not only of new borrowing but also of the effects of interest, inflation and (real) income growth on the existing debt ratio, as well as of charge offs due to defaults.

Imagine you have a mortgage equal to double your annual income. That ratio can go down if your current spending is less than your income, so that you can devote part of your income to paying off the principal. Or it can go down if your income rises, i.e. by raising the denominator rather than lowering the numerator. It can also go down if you refinance at a lower interest rate; then the same fraction of your income devoted to debt service will pay down the principal faster. Our of course it can go down if some or all of it is written off in bankruptcy.

It is possible to decompose actual historical changes in debt-income ratios for any economic unit or sector into these various factors. The details are in either of the papers linked above. One critical point to note: The contributions of debt and income growth are proportional to the existing debt ratio, so the higher it already is, the more important these factors are relative to the current surplus or deficit.

Breaking out changes in debt ratios into these components was what we did in the two papers. (The second paper also explored alternative decompositions to look at the relationship been debt ratio changes and new demand from the household sector.) The thing we wanted to explain was why some periods saw rising debt-income ratios while others saw stable or falling ones.

While debt–income ratios were roughly stable for the household sector in the 1960s and 1970s, they rose sharply starting in the early 1980s. The rise in household leverage after 1980 is normally explained in terms of higher household borrowing. But increased household borrowing cannot explain the rise in household debt after 1980, as the net flow of funds to households through credit markets was substantially lower in this period than in earlier postwar decades. During the housing boom period of 2000–2007, there was indeed a large increase in household borrowing. But this is not the case for the earlier rise in household leverage in 1983–1990, when the debt– income ratios rose by 20 points despite a sharp fall in new borrowing by households.

As we explained:

For both the 1980s episode of rising leverage and for the post-1980 period as a whole, the entire rise in debt–income ratios is explained by the rise in nominal interest rates relative to nominal income growth. Unlike the debt deflation of the 1930s, this ‘debt disinflation’ has received little attention from economists or in policy discussions.

Over the full 1984–2011 period, the household sector debt–income ratio almost exactly doubled… Over the preceding 20 years, debt–income ratios were essentially constant. Yet households ran cumulative primary deficits equal to just 3 percent of income over 1984–2012 (compared to 20 percent in the preceding period). The entire growth of household debt after 1983 is explained by the combination of higher interest payments, which contributed an additional 3.3 points per year to leverage after 1983 compared with the prior period, and lower inflation, which reduced leverage by 1.3 points per year less.

We concluded:

From a policy standpoint, the most important implication of this analysis is that in an environment where leverage is already high and interest rates significantly exceed growth rates, a sustained reduction in household debt–income ratios probably cannot be brought about solely or mainly via reduced expenditure relative to income. …There is an additional challenge, not discussed in this paper, but central to both Fisher’s original account and more recent discussions of ‘balance sheet recessions’: reduced expenditure by one sector must be balanced by increased expenditure by another, or it will simply result in lower incomes and/or prices, potentially increasing leverage rather than decreasing it. To the extent that households have been able to run primary surpluses since 2008, it has been due mainly to large federal deficits and improvement in US net exports.

We conclude that if reducing private leverage is a policy objective, it will require some combination of higher growth, higher inflation, lower interest rates, and higher rates of debt chargeoffs. In the absence of income growth well above historical averages, lower nominal interest rates and/or higher inflation will be essential. … Deleveraging via low interest rates …  implies a fundamental shift in monetary policy. If interest-rate policy is guided by the desired trajectory of debt ratios, it no longer can be the primary instrument assigned to managing aggregate demand. This probably also implies a broader array of interventions to hold down market rates beyond traditional open market operations, policies sometimes referred to as ‘financial repression.’ Historically, policies of financial repression have been central to almost all episodes where private (or public) leverage was reduced without either high inflation or large-scale repudiation.

These papers only went through 2011. I’ve thought for a while it would be interesting to revisit this analysis for the more recent period of falling household debt ratios. 

With the help of Arjun’s student Advait Moharir, we’ve now brought the same analysis forward to the end of 2019. Stopping there was partly a matter of data availability — the BEA series on interest payments we use is published with a considerable lag. But it’s also a logical period to look at, since it brings us up to the start of the pandemic, which one would want to split off anyway.

The table below is a reworked version of tables in the two papers, updated through 2019. (I’ve also adjusted the periodization slightly.) 

Due to …
Period Annual PP Change in Debt Ratio Primary Deficit Interest Growth Inflation Defaults
1929 – 1931 3.7 -5.5 2.9 2.8 2.9 *
1932 – 1939 -1.2 -1.5 2.4 -1.6 -0.7 *
1940 – 1944 -3.8 -1.6 1.3 -2.5 -1.9 *
1945 – 1963 2.6 2.5 2.6 -1.5 -0.8 *
1964 – 1983 0.0 0.8 5.1 -2.4 -3.5 *
1984 – 1999 1.7 -0.3 7.5 -2.9 -2.1 -0.4
2000 – 2008 4.5 2.4 7.2 -1.7 -2.5 -0.8
2009 – 2013 -5.4 -3.7 5.8 -3.1 -2.3 -2.4
2014 – 2019 -2.0 -1.4 4.6 -3.4 -1.3 -0.6

Again, our central finding in the earlier papers was that if we compare the 1984-2008 period of rising debt ratios to the previous two decades of stable debt ratios, there was no rise in the primary deficit. For 1984-2008 as a whole, annual new borrowing exceeded debt service payments by 0.7 percent of income on average, almost exactly the same as during the 1964-1983 period. (That’s the weighted average of the two sub-periods shown in the table.) Even during the housing boom period, when new borrowing did significantly exceed debt service, this explained barely a third of the difference in annual debt-ratio growth (1.6 out of 4.5 points).

The question now is, what has happened since 2008? What has driven the fall in debt ratios from 130 percent of household income in 2008 to 92 percent on the eve of the pandemic?

In the immediate aftermath of the crisis, sharply reduced borrowing was indeed the main story. Of the 10-point swing in annual debt-ratio growth (from positive 4.5 points per year to negative 5.4), 6 points is accounted for by the fall in net borrowing (plus another 1.5 points from higher defaults). But for the 2014-2019 period, the picture is more mixed. Comparing those six years to the whole 1984-2008 period of rising debt, we have a 4.7 point shift in debt ratio growth, from positive 2.7 to negative 2. Of that, 2.1 points is explained by lower net borrowing, while almost 3 points is explained by lower interest. (The contribution of nominal income growth was similar in the two periods.) So if we ask why household debt ratios continued to fall over the past decade, rather than resuming their rise after the immediate crisis period, sustained low interest rates are at least as important as household spending decisions. 

Another way to see this is in the following graph, which compares three trajectories: The actual one in black, and two counterfactuals in red and blue. The red counterfactual is constructed by combining the average 1984-2008 level of net borrowing as a fraction of income to the actual historical rates of interest, nominal income growth and defaults. The blue counterfactual is similarly constructed by combining the average 1984-2008 effective interest rate with historical levels of net borrowing, nominal income growth and defaults. In other words, the red line shows what would have happened in a world where households had continued to borrow as much after 2008 as in the earlier period, while the blue line shows what would have happened if households had faced the same interest rates after 2008 as before. 

As the figure shows, over the 2008-2019 period as a whole, the influence of the two factors is similar — both lines end up in the same place. But the timing of their impact is different. In the immediate wake of the crisis, the fall in new borrowing was decisive — that’s why the red and black lines diverge so sharply. But in the later part of the decade, as household borrowing moved back toward positive territory and interest rates continued to fall, the more favorable interest environment became more important. That’s why the blue line starts rising after 2012 — if interest rates had been at their earlier level, the borrowing we actually saw in the late 2010s would have implied rising debt ratios. 

As with the similar figures in the papers, this figure was constructed by using the law of motion for debt ratios:

where b is the debt-income ratio, d is the primary deficit, i is the effective interest rate (i.e. total interest payments divided by the stock of debt), g is income growth adjusted for inflation, π is the inflation rate, and sfa is a stock-flow adjustment term, in this case the reduction of debt due to defaults. The exact sources and definitions for the various variables can be found in the papers. (One note: We do not have a direct measurement of the fraction of household debt written off by default for the more recent period, only the fraction of such debt written down by commercial banks. So we assumed that the ratio of commercial bank writeoffs of household debt to total writeoffs was the same for the most recent period as for the period in which we have data for both.)

Starting from the actual debt-ratio in the baseline year (in this case, 2007), each year’s ending debt-income ratio is calculated using the primary deficit (i.e. borrowing net of debt service payments), the share of debt written off in default, nominal income growth and the interest rate. All but one of these variables are the actual historical values; for one, I instead use the average value for 1984-2007. This shows what the path of the debt ratio would have been if that variable had been fixed at its earlier level while the others evolved as they did historically.  In effect, the difference between these counterfactual lines and the historical one shows the contribution of that variable to the difference between the two periods.

Note that the interest rate here is not the current market rate, but the effective or average rate, that is, total interest payments divided by the stock of debt. For US households, this fell from around 6 percent in 2007 to 4.4 percent by 2019 — less than the policy rate did, but still enough to create a very different trajectory, especially given the compounding effect of interest on debt over time. So while expansionary monetary policy is not the whole story of falling debt ratios since 2008, it was an important part of it. As I recently argued in Barrons, the deleveraging of US households is unimportant and under appreciated benefit of the decade of low interest rates after the crisis.

 

Corporate cashflows, 1960-2016

Here is some background on the investment question from the previous post, and related topics.

I’ve been fooling around recently with assembling a comprehensive account of sources and uses of funds for the US corporate sector from the Integrated Macroeconomic Accounts (IMA). (It’s much easier to do this with the IMAs than by combining the NIPAs with the financial accounts from the Fed.) The goal is a comprehensive account of flows of money into and out of the corporate sector, grouped in a sensible way.

My goal here is not to make any specific argument, but to provide context for a bunch of different arguments about the finances of US businesses. I think this an important thing to do – both mainstream and heterodox people tend to make claims about specific sets of flows in specific periods, but it’s important to start from the overall picture. Otherwise you don’t know what questions it makes sense to ask. It’s also important to give a complete set of flows, for the same reasons and also to check that one’s claims are logically coherent. Needless to say, you also have to measure everything consistently.

Some people do do this, of course — the social accounting matrices of Lance Taylor and company are the best versions I know of. But it’s relatively rare.

The IMAs are a fairly new set of national accounts, motivated by two goals. First, to combine the “real” flows tracked by the BEA with the financial flows and balance-sheet positions tracked by the Fed into a single, consistent set of accounts; and second, to produce a set of US accounts that conform to the System of National Accounts (SNA) followed by most of the rest of the world. (The SNAs are sort of the metric system of national accounts.) The first goal is more completely realized than the second – there are some important differences between the IMAs and SNAs. For our purposes, the most important one is the definition of the corporate sector.  In the SNAs corporate businesses include, broadly, any enterprise staffed mainly by wage workers that produces goods and services for sale; this includes closely-held firms, government-owned enterprises, and many nonprofits. In the IMAs, the corporate sector is based on tax status, and so excludes partnerships and small family businesses, nonprofits, and government enterprises.

The nonfinancial corporate sector on the IMA definition accounts for roughly 50 percent of US value-added. [1] I think there are good reasons to focus on this 50 percent. This is where most important productive activity takes place, and where essentially all the profit that economic life is organized around is generated. It’s also the sector where the conceptual categories of economics best correspond to observables. We don’t directly see output in public sector or nonprofits, don’t directly see wages and profits in noncorporate sector, we don’t see either in the household sector. Finance of course has its own issues.

In any case! Figure 1 shows the corporate sector’s share of value added since 1960.

Figure 1

 

I am not sure what substantive significance, if any, most of the movements in this figure have. Some large part, perhaps most, of them reflect definitional or measurement factors rather than any change in concrete economic activity. That said, the secular rise in finance as well as government does, I think, reflect changes in what people do all day. The only one of these lines that definitely means what it seems, is the long-run rise in government – given the way the accounts are constructed, there must be a corresponding rise in the share of public sector employment. The household sector line basically reflects changes in the weight of spending associated with owner-occupied housing – the nonprofit piece of this is fairly stable over time. The fall and rise in the noncorporate business sector may also reflect the changing weight of real estate – where noncorporate forms are common – and independent-contractor arrangements. But it may also reflect shifts in legal forms and/or BEA imputations, that don’t involve any substantive change in productive activity.

Nonetheless this figure is important — less for what it tells us about economic substance than for what it tells us about economic data. Any series that exclusively or disproportionately draws from the corporate sector (nonresidential investment is an obvious and important case) will be scaled by that top line. And any discussion of factor shares needs to take into account the change in the shares of sectors where wages and/or profits are not directly observed.

Figure 2 is the real point of this post. It’s my broadest summary of sources and uses of funds in the corporate sector. All are measured as a share of total corporate value added. The same data is shown in the table at the end.

Figure 2

 

I’ve organized this in a somewhat nonstandard way, but which I think is appropriate for the questions we are most interested in. The vertical scale is fraction of corporate value-added, or output. The heavy black line shows the share of output available to corporate managers. Above the line are three deductions from value-added: first, wages and other compensation of labor; second, in gray, taxes, including both taxes on production and corporate income taxes; and third, the narrow white band, net payments to the financial system. This last is interest and other property payments, less interest, dividends and other property payments received. These are the three categories of payments that are effectively imposed on corporations from outside. [2] The area below this line is the internal funds at the disposal of management – what’s often referred to as corporate cashflow.

In red are two main uses of funds by corporate managers. The bottom red area is investment. Above this is payouts — first dividends, and then the top red area, net share repurchases. This latter includes both repurchases in the strict sense and shares retired through cash mergers and acquisitions – aggregate data combines them. The difference between the black line and the red line is net financial saving by the corporate sector. Where the heavy black line is above the top red line, the corporate sector is a net lender in financial markets – its acquisitions of financial assets are greater than the new debt it is incurring. Where the red line is above the black line, as it usually is, the corporate sector is a net borrower – its new debt is greater than its acquisition of financial assets.

Finally, the dotted black line shows reported depreciation. (Consumption of fixed capital in the jargon of the accounts.) This is not actually a source or use of funds. And there are serious conceptual and measurement issues with defining it – so much so that, in my view, it’s probably not a usable category for describing real world economies. Nonetheless, it is necessary to define some other terms that play a big part in these discussions. Most importantly, profits can be regarded as the difference between cashflow and depreciation. [3] And net investment is the difference between investment and depreciation.

The same items are presented in the table at the end of the post, for three periods and for the most recent full year available.

As I discuss below, some terms are grouped here differently from the way they are presented in the IMAs. Obviously, how exactly we aggregate is open to debate, and the pros and cons of different choices will depend on the questions we are trying to answer. But I think some picture like this has to be the starting point for any kind of historical discussion of the US economy.

So what do we see?

First, the labor share (i.e. labor costs as a percent of value added) is quite stable around 63-64 percent of value added between 1960 and 2000. It only begins falling in 2002 or so, dropping about 4 points in the early 2000s and another 3 points in the wake of the Great Recession, with a modest recovery in the past couple years. This timing is quite different from the impression most people have — what you’d get from straightforwardly looking at the wage share of GDP — of a steady long-term decline from the 1970s.

There are two reasons for this difference. First, during the 1970s and 1980s, the non-wage share of labor costs (mainly health benefits) rose quite a bit, from around 5 percent to around 10 percent of total compensation. This explains why labor cost growth did not slow during this period, even though wage growth did slow. Since healthcare prices were rising quite a bit faster than overall prices during this period, the rising share of health benefits in compensation also meant that the cost of labor to employers was also rising faster than the value of compensation to workers. [4] This factor becomes less important after the early 1990s, when the non-wage share of labor compensation flatted out.

Second, the labor share in the corporate sector is quite a bit higher than the labor share in finance and noncorporate businesses — the two sectors whose share of GDP has increased in recent decades. This means that even if there were no change in factor shares within each sector, the labor share for the economy as a whole would fall. Again, I don’t know how much of the difference in factor shares between sectors is a measurement issue, how much it reflects shifting legal forms of organization of the same kinds of activities, and how much it reflects real differences in how claims on the social product are exercised. But either way, it’s important to understand that a large part of the observed fall in the labor share over the past generation is explained, at least in an accounting sense, by this shift between sectors.

Moving on to taxes, there is also a substantial fall in this claim on corporate value-added, from 16 percent in 1960 to around 11 percent today.  But here, the decrease comes earlier, in the 1960s and 1970s – the tax share has hardly changed since 1980. (I suspect that if this figure were extended to earlier dates, there would be a large fall in the tax share in the 1950s as well.) This means that after-tax profits show a more steady long-term rise than do pre-tax profits.

I should note that “taxes” here combines two items from the IMAs — taxes on production, and taxes on profits. In the national accounts, there are good reasons to separate these — taxes on production enter into the cost of output and so have to be treated as a factor payment, while taxes on profits are not part of costs and so are treated as a transfer. This distinction is critical if we are going to calculate GDP in a consistent way, but for substantive questions it’s not so important. To government, managers and other economic actors, taxes are all mandatory payments from the corporation to the state, however they are assessed.

After taxes comes net financial payments. As defined here, this is interest, rent and net current transfers, less interest, rent and dividends received. In other words, it is net payments on the corporate sector’s existing financial assets and liabilities.  It’s represented on the figure by the white space between the thin black line and the thick black line. The first thing to notice about these net payments by corporations is that they are almost always positive and never significantly negative. In other words, over the past 56 years the corporate sector as a whole has never received more income from its financial assets than it has paid on its financial liabilities. You can see that the largest share of corporate value-added going to financial payments came in the high-interest 1980s; in most other periods the balance has been close to zero.

I’ll come back to this in a later post – a next step in this project should be precisely to unpack that white section. But the fact that the net financial income of the corporate sector is small, never positive, and shows no significant trend over time, is already enough to reject one popular story about financialization, at least in its most straightforward form. It is simply not the case that nonfinancial corporations in the aggregate have turned themselves into hedge funds – have replaced profits from operations with income from financial assets. The Greta Krippner article that seems to be  the most influential version of this claim is a perfect example of the dangers of focusing on one piece of the cashflow picture in isolation. [5] She looks at financial income received by corporations but ignores financial payments made by corporations (mostly interest in both cases). So as shown in Figure 3, she mistakes a general rise in interest rates for a change in the activities of nonfinancial businesses.

Figure 3. Because she focuses on the heavy black segment in isolation, Krippner mistakes a period of high interest rates for a reorientation of nonfinancial corporations to financial profits.

 

Returning to Figure 2: After subtracting labor costs, taxes and interest and other financial claims, we are left with the heavy red line — the share of value added available as cashflow to corporate managers. This rises from 20 percent in the 1960s to as high as 25 percent in the 1990s, to around 30 percent today. This increase in the corporate profit share (gross of depreciation, net of taxes) is one of the central facts of modern US macroeconomic history.

In the broadest terms, corporations can use cashflow in three ways. They can invest it in order to maintain or grow the business; they can distribute it to shareholders; or they can retain it for later use in some financial form. This last use can be, and often is, negative, if investment and payouts are together greater than cashflow.

Investment here includes gross capital formation, defined in the national accounts as spending on durable equipment, structures, software, research and development, and the creation of intellectual property. (The last two items have been included in the national-accounts measure of investment only since 2013.) It also includes the change in private inventories and spending on nonproduced durable assets, which I assume is almost all land. This item is listed separately in the IMAs, and it’s not obvious how to handle it: Corporate purchases of land have different macroeconomic implications than spending on new means of production, but from the point of view of the people making the investment decision there’s no major difference between money spent on a building and money spent for the land it sits on. This item is generally very small — well below 1 percent of total investment — but, like inventories, it’s highly cyclical and so plays a disproportionate role in short-run fluctuations. About a tenth of the fall in investment between 2008 and 2010, for example, was in nonproduced assets.

Somewhat surprisingly, there is no downward trend in the investment share. It was 17 percent of value added in the 1960s and 1970s, versus over 18 percent in this decade, and 19 percent in the third quarter of 2017 (the most recent available).

If investment today is, if anything, historically high as a share of corporate output, why have so many people (including me!) been arguing that weak investment is a problem? There are several reasons, though perhaps none are entirely convincing.

First, as I pointed out in the previous post, in recent years there has been an unusual divergence between investment in the corporate sector and investment in the economy as a whole. Residential investment by households remains very low by historical standards; nonresidential investment by noncorporate businesses is also low. At the same time, financial and especially noncoporate businesses always invest at lower rates than nonfinancial corporations, so the rising share of these sectors leads to lower overall investment. Second, the recovery in corporate investment is relatively recent – things looked different a few years ago. Nonfinancial corporations’ investment share fell extremely sharply in 2009, to its lowest level in 45 years, and took several years to bounce back. So when we were discussing this stuff three or four years ago, the picture looked more like a secular decline. Third — and probably most relevant for my work — while investment is relatively high as a share of corporate value added, it is quite low as a share of profits or cashflow. There is a genuine puzzle of weak investment, as long as we don’t ask “why are corporations investing less?”, but instead ask “why haven’t high profits led corporations to invest more?” Fourth, there has been a large increase in reported depreciation — from around 10 percent of value added in the 1960s to around 15 percent today. While I think for a number of reasons that this number is not really meaningful, if you take it seriously, it means that while gross investment has risen slightly, net investment has fallen a lot, to about half its level in the 1960s and 70s. Finally, if you take a strong Keynesian or Kaleckian view that it’s business investment that drives shifts in demand, then the ratios shown here are not informative about the strength or weakness of investment. The ratio of investment to output, in this view, only tells us about the size of the multiplier. To assess the strength or weakness of investment, we should instead look at the absolute increase in investment over the business cycle, which — while it’s picked up a bit in the past year — is still quite low by historical standards. I’ve made this argument myself, but I wouldn’t want to push it too far — investment is not the only source of autonomous demand.

Moving on in Figure 2: Above investment is payouts – first dividends, then net share repurchases. Here we see what you’d expect: These flows have gone up a lot. Dividends have doubled from 4.5 percent of value added in the 1960s and 1970s to 9 percent today, while net repurchases have gone from less than nothing to 6 percent (and as high as 10 percent in the 2000s.) Measured as a share of corporate cashflow rather than value added, dividends have remained stable at around 50 percent. Retained earnings as conventionally defined — profits minus dividends — have also been roughly stable as a share of value added.

Including net share repurchases with dividends is the biggest way my presentation here departs from the format of the IMAs. There, net share issuance is classed as an addition to liabilities, just like issuance of new debt. Net repurchases are the same as negative issuance — the equivalent, in the IMA framework, of paying back loans. The difference, of course, is that share repurchases have no effect on the balance sheet. This is the fundamental reason I think it makes sense to group repurchases with dividends. The flow of dividend payments is not affected by the number of shares outstanding. [6] It’s also important that market participants clearly perceive share repurchases as equivalent to dividend payments. If you read the financial press, dividends and buybacks are always treated as two forms of shareholder payouts.

Personally, I don’t have any doubts that this is the right way to look at it — today. But this is a good example of how the relations between economic and accounting categories are always somewhat slippery and can change over time. Whether net share issuance should be classed with dividends (and interest payments, etc.) as a current transfer, as I do, or whether it should be considered a financing transaction, where the standard IMA presentation puts it, depends on the way these transactions are actually used – it can’t be answered a priori. Again, I think it’s reasonably clear that, given their use today, net stock repurchases should be grouped with dividends. But in the 1950s or 1960s, treating them as financing made more sense. Also, this adjustment needs to be made consistently. If we are going to count repurchases as dividends, we have to subtract them from the headline measures of retained earnings and corporate saving. We will probably want to make an equivalent adjustment to the accounts of other sectors as well, though this poses its own set of challenges.

Another thing to consider is that we see negative issuance not only when corporations repurchase their own shares, but when shares are purchased for cash as part of mergers and acquisitions. This is not necessarily a problem. If we are just adding up payments for the sector as a whole, the two sets of flows are equivalent. On a more concrete behavioral or policy level there are important differences, but we’ll pass over those for now.

If we look at dividends alone, 2016 saw them at their highest share of corporate value-added, of profits and of cashflow since the IMAs begin in 1960; and almost certainly since the 1920s. If we measure payouts as dividends plus net share repurchases, then 2016 levels were still a bit short of the peak in the mid-2000s. Share repurchases have been a bit lower (around 5 percent of value added) in 2017 than 2016; unfortunately, the quarterly IMAs don’t have dividend data, but the financial accounts suggest that dividends have declined somewhat as well. It seems that the 2-point decline in the profit share since its 2014 peak is now beginning to be reflected in payouts to shareholders. By comparison with any period before the mid-2000s, payouts are still very high. Still, their decline over the past year seems significant – though maybe the tax bill will give them a second wind.

The final item in Figure 2 is the space between the heavy red line and heavy black line. This shows the financing gap – the net financial borrowing (if positive, with the red line above the black line) or lending (if negative) by the corporate sector. In my opinion this is a much more relevant number than corporate saving as conventionally defined. As the figure shows, nonfinancial corporations are normally net borrowers in financial markets; the brief periods of net lending are all associated with deep recessions. As the figure also makes clear, however, this specific interpretation is quite sensitive to counting share repurchases as payouts. If net equity issuance is treated as a form of financing, then the aggregate corporate sector has been mostly close to a zero balance in financial markets and has more recently been a substantial net lender. On the other hand, if we think of this gap as showing the net credit-market borrowing by the nonfinancial corporate sector — as it more or less is — then the conclusion holds regardless of how you treat stock buybacks. Either way, by this measure the recent expansion is not exceptional: As of 2016 credit-market borrowing by the corporate sector was still smaller, as a share of value-added, than it was at the high points of the 1980s, 1990s or 2000s.

The same results are shown below for three periods and for the most recent year. I won’t recap the table, it’s the same stories as above. Just to be clear, the values are the averages for the periods shown for the flows listed in the second column. So for instance labor costs accounted for an average of 63 percent of corporate value-added during 1960-1979. The first column just shows the accounting relationships between the flows.

Flow 1960-1979 1980-1999 2000-2015 2016
100 – (A) Labor costs 63 64 60 59
– (B) Taxes 15 12 12 12
– (C) Net financial payments 1 2 1 1
= (D) Internal funds (cashflow) 21 22 27 29
(E) Dividends 5 5 7 9
+ (F) Net share repurchases -1 2 4 6
= (G) Payouts 4 7 11 15
(H) Investment 17 18 18 18
– (J) Depreciation 10 13 15 15
= (K) Net investment 7 5 4 3
(G) + (H) – (D) = (I) Financing gap 0 3 2 5
(D) – (J) = (L) Profits 11 9 13 14

What do we take from all this? Again, my goal here was not to make any particular substantive claim, but to lay out some essential context for more specific arguments about corporate finances that I’ll make in the future. But it is interesting, isn’t it?

 

 

[1] Value-added is the difference between sales and the cost of material inputs. It’s the best way to measure the output of various sectors. For the economy as a whole, total value-added is identically equal to GDP.

[2] Of course corporations have some control over their wage, tax and debt-service payments. But these are not mainly decision variables for corporate management in the same way that investment and shareholder payouts are. Or at least I think it’s reasonable to so regard them.

[3] Whether they are exactly this value or only approximately depends on the profits concept being used. In any case, it’s important to keep in mind that the values of depreciation used by corporations for reporting profits to financial markets and to the tax authorities, may be quite different from the depreciation reported in the national accounts.

[4] The different behavior of prices of workers’ consumption basket and of output in general was the subject of the first substantive post on this blog, seven years ago. It’s an important topic!

[5] While I don’t agree with the claims in this article, I’m a big admirer of Krippner’s other work.

[6] The big exceptions, of course, are cases that involve all of a given corporation’s shares — IPOs and transactions that take a company private. These do respectively create and extinguish dividend flows. For this reason, when using micro data, it may make sense to use gross rather than net repurchases; but this isn’t possible with the IMA data. IPOs however are a quite small part of the overall net issuance/repurchase of shares, and I am pretty sure that firms going private are as well. Private equity might create some more serious issues here — this is something I’d like to understand better. On the other hand, the advantage of using net rather than gross repurchases is that it eliminates repurchases that are simply compensating for stock issued as part of compensation packages.