A full page article in the FT a few days ago claimed that “experts are struggling to explain a great puzzle of the US economy.” It went on to note that since the late 1980s, new investment in the US has all but stalled. Corporate profits are at record highs, but big companies just aren’t investing the money in the kind of things that will bring them future streams of profits.
To some this seems, as the article says, “profoundly odd”. High profits suggest that it is easy to make money, while low interest rates mean that capital is “dirt cheap”. All economic logic suggests that companies should be borrowing and investing as fast as they can. Instead, they are sitting on cash, and if they are borrowing, they are often doing it to finance stock buybacks, one of the most value destroying pieces of idiocy Wall Street has yet come up with (see my previous columns on this).
At the same time, they are refusing to pay out any of the profits in the form of increased wages – unemployment in the US (and the UK) might not be as bad as once expected, but the share of GDP going to labour as wages is worse.
Reading this piece was rather frustrating for me, but it must have made poor Andrew Smithers – who was eventually quoted towards the end of the article – want to tear his hair out. For years now, he has been trying his damnedest to explain to policy makers and corporate leaders that incentives change economics.
There is no great puzzle here; to see why, look at what happened in the late 1980s. The idea of shareholder value suddenly took over our markets; executive pay was ‘aligned’ with that of shareholders, with the use of endless stock options and other incentives related almost entirely to short-term profits. That made the overriding desire of all executives everywhere to do nothing but raise their earnings per share (EPS – buybacks are magic for this by the way). And what happens when you invest in new businesses or new plants? Or if you pay higher wages? You got it: EPS falls.
It will be no surprise, then, to find that private companies in the US (which care more for longevity than next quarter’s EPS figures) invest nearly twice as much relative to their total assets every year than listed companies. Silly, isn’t it?
Poor Andrew, still trying to get policy makers to hear the truth, wrote again to the FT later in the week to make the point as clear as he possibly could. We have changed incentives, he said. This has changed behaviour, and along the way, changed the labour market and shifted the demand for capital. “It is often claimed this is incomprehensible. It is not.” And given that it is not, we need to act on it.
“Economic forecasting as well as economic policy needs to adapt to the change in corporate behaviour” (unless we can change corporate behaviour back of course). All this matters – it isn’t just about wages and their share of GDP, it is about the long-term economic damage done to economies when no one invests in them.