Posts Tagged ‘investment’

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We’ve just learned that the corporate payouts—dividends and stock buybacks—of large U.S. firms are expected to hit another record this year. At the same time, John Fernald writes for the Federal Reserve Bank of San Francisco that the “new normal” for U.S. GDP growth has dropped to between 1½ and 1¾ percent, noticeably slower than the typical postwar pace.

What’s the connection?

Fernald, as is typical of many others who have concluded the United States has entered a period of slow growth, blames the “new normal” on exogenous events like population dynamics and education.

The slowdown stems mainly from demographics and educational attainment. As baby boomers retire, employment growth shrinks. And educational attainment of the workforce has plateaued, reducing its contribution to productivity growth through labor quality. The GDP growth forecast assumes that, apart from these effects, the modest productivity growth is relatively “normal”—in line with its pace for most of the period since 1973.

What Fernald and the others never mention is that American companies’ embrace of dividends and buybacks comes at the expense of business investment, which is an important contributor to worker productivity and long-term economic growth.

In other words, what they overlook is the possibility that the current slowdown—which, “for workers, means slow growth in average wages and living standards”—may be less a product of exogenous events and more the way the U.S. economy is currently organized.

When workers produce but do not appropriate the surplus, they are victims of a social theft. And then, when a larger and larger portion of of the surplus is distributed to shareholders (both outside investors and corporate executives)—that is, the tiny group at the top who share in the booty—workers are, once again, made to pay the cost.

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I know I shouldn’t. But there are so many wrong-headed assertions in the latest Bloomberg column by Noah Smith, “Economics Without Math Is Trendy, But It Doesn’t Add Up,” that I can’t let it pass.

But first let me give him credit for his opening observation, one I myself have made plenty of times on this blog and elsewhere:

There’s no question that mainstream academic macroeconomics failed pretty spectacularly in 2008. It didn’t just fail to predict the crisis — most models, including Nobel Prize-winning ones, didn’t even admit the possibility of a crisis. The vast majority of theories didn’t even include a financial sector.

And in the deep, long recession that followed, mainstream macro theory failed to give policymakers any consistent guidance as to how to respond. Some models recommended fiscal stimulus, some favored forward guidance by the central bank, and others said there was simply nothing at all to be done.

It is, in fact, as Smith himself claims, a “dismal record.”

But then Smith goes off the tracks, with a long series of misleading and mistaken assertions about economics, especially heterodox economics. Let me list some of them:

  • citing a mainstream economist’s characterization of heterodox economics (when he could have, just as easily, sent readers to the Heterodox Economics Directory—or, for that matter, my own blog posts on heterodox economics)
  • presuming that heterodox economics is mostly non-quantitative (although he might have consulted any number of books by economists from various heterodox traditions or journals in which heterodox economists publish articles, many of which contain quantitative—theoretical and empirical—work)
  • equating formal, mathematical, and quantitative (when, in fact, one can find formal models that are neither mathematical nor quantitative)
  • also equating nonquantitative, broad, and vague (when, in fact, there is plenty of nonquantitative work in economics that is quite specific and unambiguous)
  • arguing that nonquantitative economics is uniquely subject to interpretation and reinterpretation (as against, what, the singular meaning of the Arrow-Debreu general equilibrium system or the utility-maximization that serves as the microfoundations of mainstream macroeconomics?)
  • concluding that “heterodox economics hasn’t really produced a replacement for mainstream macro”

Actually, this is the kind of quick and easy dismissal of whole traditions—from Karl Marx to Hyman Minsky—most heterodox economists are quite familiar with.

My own view, for what it’s worth, is that there’s no need for work in economics to be formal, quantitative, or mathematical (however those terms are defined) in order for it be useful, valuable, or insightful (again, however defined)—including, of course, work in traditions that run from Marx to Minsky, that focused on the possibility of a crisis, warned of an impending crisis, and offered specific guidances of what to do once the crisis broke out.

But if Smith wants some heterodox macroeconomics that uses some combination of formal, mathematical, and quantitative techniques he need look no further than a volume of essays that happens to have been published in 2009 (and therefore written earlier), just as the crisis was spreading across the United States and the world economy. I’m referring to Heterodox Macroeconomics: Keynes, Marx and Globalization, edited by Jonathan P. Goldstein and Michael G. Hillard.

There, Smith will find the equation at the top of the post, which is very simple but contains an idea that one will simply not find in mainstream macroeconomics. It’s merely an income share-weighted version of a Keynesian consumption function (for a two-class world), which has the virtue of placing the distribution of income at the center of the macroeconomic story.* Add to that an investment function, which depends on the profit rate (which in turn depends on the profit share of income and capacity utilization) and you’ve got a system in which “alterations in the distribution of income can have important and potentially offsetting impacts on the level of effective demand.”

And heterodox traditions within macroeconomics have built on these relatively simply ideas, including

a microfounded Keynes–Marx theory of investment that further incorporates the external financing of investment based upon uncertain future profits, the irreversibility of investment and the coercive role of competition on investment. In this approach, the investment function is extended to depend on the profit rate, long-term and short-term heuristics for the firm’s financial robustness and the intensity of competition. It is the interaction of these factors that fundamentally alters the nature of the investment function, particularly the typical role assigned to capacity utilization. The main dynamic of the model is an investment-induced growth-financial safety tradeoff facing the firm. Using this approach, a ceteris paribus increase in the financial fragility of the firm reduces investment and can be used to explain autonomous financial crises. In addition, the typical behavior of the profit rate, particularly changes in income shares, is preserved in this theory. Along these lines, the interaction of the profit rate and financial determinants allows for real sector sources of financial fragility to be incorporated into a macro model. Here, a profit squeeze that shifts expectations of future profits forces firms and lenders to alter their perceptions on short-term and long-term levels of acceptable debt. The responses of these agents can produce a cycle based on increases in financial fragility.

It’s true: such a model does not lead to a specific forecast or prediction. (In fact, it’s more a long-term model than an explanation of short-run instabilities.) But it does provide an understanding of the movements of consumption and investment that help to explain how and why a crisis of capitalism might occur. Therefore, it represents a replacement for the mainstream macroeconomics that exhibited a dismal record with respect to the crash of 2007-08.

But maybe it’s not the lack of quantitative analysis in heterodox macroeconomics that troubles Smith so much. Perhaps it’s really the conclusion—the fact that

The current crisis combines the development of under-consumption, over-investment and financial fragility tendencies built up over the last 25 years and associated with a nance- led accumulation regime.

And, for that constellation of problems, there’s no particular advice or quick fix for Smith’s “policymakers and investors”—except, of course, to get rid of capitalism.

 

*Technically, consumption (C) is a function of the marginal propensity to consume of labor, labor’s share of income, the marginal propensity to consume of capital, and the profit share of income.

 

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One thing is clear in the current conjuncture: corporate investment in capital equipment is declining, and it’s dragging overall economic growth and labor productivity down with it.

In the second quarter of 2016, the U.S. economy grew at an annual rate of only 1.2 percent, which caught business commentators and Wall Street analysts by surprise. They expected something closer to 2.6 percent. And while consumer spending continued to increase (at at rate of 4.2 percent in the second quarter), business investment fell (at a 2.2 percent pace), and companies ran down inventories for the fifth consecutive quarter.

So,  what’s going on?

Given the centrality of business investment to capitalist growth, you’d think the business press would have a cogent, carefully elaborated analysis of why it’s declining during the current recovery.

Well, they don’t. All they can do is invoke their usual hand-waving gesture, “political uncertainty,” as the underlying cause. Political uncertainty is blamed for the slowdown in mergers and acquisitions and for sputtering business investment.

Most CEOs will be risk-averse and conservative with their balance sheets until they see signs of a growth rebound, even though they’re sitting atop piles of cash and the cost of capital is at all-time lows. They will also hold off investing until they have a better sense of the future tax and regulatory burdens they are likely to face next year.

Yes, there is a high degree of political uncertainty (in the United States, the United Kingdom, and elsewhere). But that doesn’t explain corporate behavior, especially their investment decisions.

One can just as easily reverse the argument: Political realities have to respond to corporate decisions (especially when growth is slowing). And the slowing of economic growth itself is a consequence of the corporate decisions to curtail private nonresidential fixed investment.

The alternative explanation is that corporations are responding quite certainly to their own market signals. First, they’re choosing to substitute labor for capital, given depressed wage growth around the globe.

“Instead of buying an expensive piece of machinery, businesses are hiring really cheap workers they can fire whenever they want,” said Megan Greene, chief economist at Manulife Asset Management.

And they’re reacting to the decline in their own index of success and failure, the corporate profit rate (which, as one can see in the chart of the top of the post, has been falling during the last two years).

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It’s not that corporations are doing nothing: they are engaged in massive mergers and acquisitions (just not at the same pace of 2015) and they’re using the profits they’ve accumulated since the recovery began to increase dividends, buy back stock, and reward their top managers.

So, is capital on strike? The Wall Street Journal suggests it is: “The investment plunge is a signal that business is on strike.”

And, given the way the economy is currently organized, the rest of us are forced to endure the consequences of capital’s decision to do whatever is necessary to restore its profitability.

Oops!

Posted: 29 April 2016 in Uncategorized
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DJIA

Capitalism is, if anything, remarkably unstable.

Yesterday, the Dow Jones Industrial Average dropped more than 200 points (a bit more than 1 percent). And, today, it’s already down more than half that amount—and headed lower.

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What’s going on?

Well, for one thing, corporate profits are declining.

U.S. corporate profits, weighed down by the energy slump and slowing global growth, are set to decline for the third straight quarter in the longest slide in earnings since the financial crisis.

Weakness was felt across the board, with executives from Apple Inc. to railroad Norfolk Southern Corp. and snack giant Mondelez International Inc. saying the current quarter remains tough. 3M Co., which makes tapes, filters and insulation for consumer electronics, forecast continued weak demand for that industry. Procter & Gamble Co.reported sales declines in its five business categories despite price increases.

And that’s exactly how capitalism works: corporations got exactly what they wanted in the early years of the recovery—with cheap financing, low wages, and foreign sales, which fueled high profits. And now those same conditions are coming back to bite them. And so they’re deciding to engage in less investment, which is further slowing growth and cutting into profits.

As we know, under capitalism, what goes up must come down—even for capitalists and their profits.

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What are U.S. corporations doing with all the surplus they’re managing to rake in? Well, they’re not investing it. Instead, they’re paying it out to shareholders and upper-management, buying back their stock and expanding their portfolios of financial assets, and hoarding the rest in cash. The net effect is to dampen the rate of economic growth and the creation of new jobs.

And that’s worrying mainstream economists and others who celebrate capitalists, since they appear to be failing in their “historical mission” to accumulate capital.

According to a recent paper by Joseph W. Gruber and Steven B. Kamin (pdf), of the Board of Governors of the Federal Reserve System, in the years since the Great Financial Crash, investment spending by non-financial corporations (the red line in the chart above) has been much lower than their “savings” (undistributed profits, the blue line), which has placed them in the position of being net lenders (the black bars at the bottom of the chart).

Their conclusion?

we find that the counterpart of declines in resources devoted to investment has been rises in payouts to investors in the form of dividends and equity buybacks (often to a greater extent than predicted by models estimated through earlier periods), and, to a lesser extent, heightened net accumulation of financial assets. The strength of investor payouts suggests that increased risk aversion and a precautionary demand for financial buffers has not been the primary reason firms have cut back investment. Rather, our results are consistent with views that, for any number of reasons, there has been a decline in what firms perceive to be the availability of profitable investment opportunities.

In other words, corporations have been distributing their profits for many uses other than real investment, a process that started before the crash and has quickened in the years since.

As it turns out, I’ve been teaching about Marx’s theory of the accumulation of capital this week, using the following equation:

ΔK = Δc + Δv = βDI = s – [(1-β)DI + DO + DM + DR]

The idea is that the accumulation of capital (ΔK = Δc + Δv) represents a distribution of the surplus to internal managers (βDI), which is equal to the difference between the total surplus (s) and all other distributions of the surplus—to internal managers other than for the purpose of accumulation ([1-β]DI), to owners (DO), to merchants (DM), and all others (DR ). Obviously, if the distributions of the surplus in the form of CEOs salaries, dividends, merchants, and all others (e.g., taxes to the state, rent to landowners, interest payments, and so on), plus cash holdings, increase, then less accumulation of capital—that is, investment—will take take place.

And that’s exactly what’s been going in recent years—thus undermining the legitimacy of both capitalists and of capitalism.

As Marx wrote (in chapter 24 of volume 1 of Capital), in one of the most quoted and yet misinterpreted passages:

Accumulate, accumulate! That is Moses and the prophets! “Industry furnishes the material which saving accumulates.” Therefore, save, save, i.e., reconvert the greatest possible portion of surplus-value, or surplus-product into capital! Accumulation for accumulation’s sake, production for production’s sake: by this formula classical economy expressed the historical mission of the bourgeoisie, and did not for a single instant deceive itself over the birth-throes of wealth. But what avails lamentation in the face of historical necessity? If to classical economy, the proletarian is but a machine for the production of surplus-value; on the other hand, the capitalist is in its eyes only a machine for the conversion of this surplus-value into additional capital. Political Economy takes the historical function of the capitalist in bitter earnest.

Bitter earnest, indeed—on the part of classical economists then and mainstream (neoclassical and Keynesian) economists today.

Thanks to Bruce Norton, we know that that passage is not Marx’s assertion that capitalists are driven to accumulate capital. Instead, it’s what mainstream economists (then as now) claim is the role capitalists can and should play. It’s one side, if you will, of our pact with the devil: the capitalists are the ones who get and decide on the distribution of the surplus, and then they’re supposed to use the surplus for investment, thereby creating economic growth and jobs.

When they fail to to fulfill that historical mission, and use the surplus to line their own pockets and to share it with their friends, they break the pact and lose their legitimacy in having sole control over the surplus.

Mainstream economists want to do everything possible to encourage the capitalists to accumulate capital. The rest of us recognize that the time has come to replace the capitalists and use the surplus to benefit the mass of people who, until now, created but have had no say in deciding what should be done with the surplus.

Investment

Both sides of mainstream economics will likely claim support in the International Monetary Fund’s latest report, the April 2015 World Economic Outlook—especially chapter 4, on business investment.*

The Keynesians will certainly like the relationship between investment and output—in other words, the idea that private business investment has declined since the start of the economic crisis because aggregate demand has fallen. Even more: they’ll find support in claim that fiscal policy aimed at reducing budget deficits has actually undermined private investment (which is the flip side of the Keynesian crowding-in argument, i.e., the notion that deficit spending doesn’t crowd out private investment, as neoclassical economists claim, but actually spurs or crowds in corporate investment).

The neoclassicals, for their part, will be encouraged by the focus on “business confidence,” that is, the argument that uncertainty (e.g., with respect to government policies) has played a role in discouraging business investment.

In other words, for Keynesians, the problem with insufficient business investment is mostly on the demand side; while for neoclassical economists, it’s mostly on the supply side.

And, true to form, the authors of that section of the report suggest policy changes on both the demand and supply sides:

We conclude that a comprehensive policy effort to expand output is needed to sustainably raise private investment. Fiscal and monetary policies can encourage firms to invest, although such policies are unlikely to fully return restore investment fully to precrisis trends. More public infrastructure investment could also spur demand in the short term, raise supply in the medium term, and thus ‘crowd in’ private investment where conditions are right. And structural reforms, – such as those to strengthen labor force participation, – could improve the outlook for potential output and thus encourage private investment. Finally, to the extent that financial constraints hold back private investment, there is also a role for policies aimed at relieving crisis-related financial constraints, including through tackling debt overhang and cleaning up bank balance sheets.

What no one seems to want to admit—the authors of the report as well as mainstream (both Keynesian and neoclassical) economists—is that private corporations, which got us into this mess in the first place, have failed to get us out of it. They’re the only ones that have benefited from the recovery, as corporate profits have reached record levels, but they haven’t responded by increasing investment. Instead, they’ve been using the profits they’re accumulated to buyback their stock, engage in new mergers and acquisitions, and distribute them to high-level executives and shareholders.

They want us to believe they’re superman. But we know they’ve simply failed—on both the demand and supply sides.

*To be clear, the chart does not indicate actual declines in business investment and output. Rather, it represents percent deviations from forecasts in the year of recessions.

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It’s a good thing I don’t teach Money and Banking. I wouldn’t be very good at it. That’s because, as Magpie and Bruce remind me, my understanding of money and banking is riddled with myths and bad textbook theories.

But I am willing to learn. . .

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Lesson #1: it is not the case, as countless textbooks and on-line courses teach, that banks collect the deposits of countless small savers and loan them out for investment projects. That image—of banks as useful financial intermediaries, given the existence of money—is simply false. Instead, what banks (commercial banks, that is) do is make interest-earning loans and leases and then, on the opposite side of the ledger, credit deposits—thus creating money.

So, what role do customer deposits play if not to create loans? According to Ellen Brown, “while banks do not need the deposits to create loans, they do need to balance their books; and attracting customer deposits is usually the cheapest way to do it.”

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Lesson #2: quantitative easing has not involved the Fed printing money, and then giving that money (as costless or free cash) to banks in order to encourage lending (much less to buy back government debt). Instead, what the Fed has done is expand bank reserve deposits by purchasing Treasury bonds (and mortgage-backed securities) from banks, thereby increasing both the Fed’s holding of Treasury securities and the excess reserves of depository institutions.

The fact is, however, banks of late have renewed their purchases of government debt instruments (as we can see in line 3 of the latest Assets and Liabilities of Commercial Banks in the United States statement). The question is, why? According to Bloomberg, commercial lenders have increased their holdings of Treasury bonds this year “as loan growth fails to keep up with record deposits and banks prepare for rules that take effect in January requiring them to hold more high-quality assets.”

As I see it, banks are not lending at the pace we (and, for that matter, the Fed) would like not because they don’t have adequate reserves (as Paul Krugman argues today) but because they don’t see enough profitable opportunities among their corporate customers—who are not investing but, instead, hoarding their cash, buying back stock, and finding ways to shelter their income from taxes.

The fact is, the nature and pace of the current recovery are not determined by the savings of individuals and households, but of the profit-seeking investment decisions of large private banks and corporations.

So, thanks to Magpie and Bruce, I’ve learned a few things. But, I’ll admit, I still may be getting some of this wrong—and therefore am still not ready to teach Money and Banking.