Posts Tagged ‘investment’

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Kevin Hassett and the other members of the president’s Council of Economic Advisers are just like the long-haired preachers Joe Hill sang about more than a century ago. They come out every night to tell us what’s wrong and what’s right. But when asked about something to eat, they answer in voices so sweet:

You will eat, bye and bye
In that glorious land above the sky
Work and pray, live on hay
You’ll get pie in the sky when you die.
That’s a lie

With one notable exception: according to the Council (pdf), that “glorious land above the sky” lies just on the other side of the Trump administration’s proposed tax reform. And workers, whose real wages have stagnated for decades now, won’t have to die to receive their pie in the sky.

Reducing the statutory federal corporate tax rate from 35 to 20 percent would. . .increase average household income in the United States by, very conservatively, $4,000 annually. The increases recur each year, and the estimated total value of corporate tax reform for the average U.S. household is therefore substantially higher than $4,000. Moreover, the broad range of results in the literature suggest that over a decade, this effect could be much larger.

There’s no other way to put it. That’s a lie.

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As is clear from this chart, both corporate profits (the red line) and investment (the blue line) have soared in recent decades. There’s simply been no shortage of investment or investment funds, either from retained earnings or in terms of money borrowed from financial institutions. At the same time, the wage share of national income (the green line in the chart) has fallen precipitously.

So, even if cutting corporate tax rates (and thus permitting higher retained earnings) did lead to more investment, there’s no guarantee workers’ wages would increase as a result. They haven’t for decades now. Why should that change in the future?

Moreover, there’s no guarantee higher retained earnings would lead to more investment. Just as likely (perhaps even more so), corporations would be able to use their profits for other purposes—including higher CEO salaries, increased dividends to stockholders, and more mergers and acquisitions—which have nothing to do with raising workers’ wages.

The only result would be more corporate power and more obscene levels of inequality in the United States.

And that’s no lie.

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“When I use a word,” Humpty Dumpty said in rather a scornful tone, “it means just what I choose it to mean—neither more nor less.”
“The question is,” said Alice, “whether you can make words mean so many different things.”
“The question is,” said Humpty Dumpty, “which is to be master—that’s all.”

Alice in Wonderland (pdf) is the key to understanding much of what is happening in the world today—especially the language of economics.

For example, we’re going to hear and read a great deal about tax reform in the days and weeks ahead. But, based on the proposals I’ve seen, nothing in the way of tax reform is being proposed.

The usual meaning of reform is that it involves changes for the better. Most of the so-called reforms that are being proposed by the Trump administration—including the vague speech by Donald Trump yesterday—are just cuts in the tax rates that will directly benefit wealthy individuals and large corporations.

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Supposedly, the rest of us will eventually benefit because of increased investment. However, as is clear from the chart above, both corporate profits and private domestic investment are doing just fine without a cut in tax rates. But the benefits to the rest of us simply haven’t appeared.

Moreover, as I have explained before, U.S. corporations are not losing out in the competitive battle with foreign corporations because they face tax rates that are much too high.

And, no, as I have also explained, repatriating corporate profits will not lead to more investment, government revenues, and jobs.

In fact, as Patrician Cohen makes clear, the whole idea of repatriating profits held abroad makes no sense.

That’s because repatriation is not really about geography. Most of the money is not stashed in some underground vault overseas, but already in American financial institutions and capital markets. Repatriation is in effect a legal category that requires a company to book the money in the United States — and pay taxes on it — before it can be distributed to shareholders or invested domestically.

The whole notion of earnings trapped offshore is misleading, Steven M. Rosenthal, a tax lawyer and senior fellow at the Urban-Brookings Tax Policy Center. “The earnings are not ‘trapped,’” he said. “They’re not offshore. They’re not even earnings. They’re accounting gimmicks that allow earnings to be shifted abroad.”

What’s more, companies already get something akin to tax-free repatriation by borrowing against those funds, with the added bonus of being able to deduct the interest paid on those loans from their tax bill.

What if corporations are induced to book their overseas profits in the United States? We probably won’t see much if any increase in private investment, since corporations aren’t facing any kind constraint in profits or their ability to borrow beyond their current profits. What is much more likely is some combination of more mergers and acquisitions, more stock buybacks, more payouts to shareholders, and more compensation distributed to CEOS.*

And that’s going to lead to even more inequality in the United States.

Alice surely would have seen through the meanings of all these misleading words concerning tax reform.

 

*AT&T is a good example of a company that already passes a low effective tax rate by exploiting tax breaks and loopholes. However, according to Sarah Anderson,

Despite the enormous savings AT&T has realized, the company has been downsizing. Although it hires thousands of people a year, the company, by our analysis at the Institute for Policy Studies, reduced its total work force by nearly 80,000 jobs between 2008 and 2016, accounting for acquisitions and spinoffs each involving more than 2,000 workers.

The company has also spent $34 billion repurchasing its own stock since 2008, according to our institute report, a maneuver that artificially inflates the value of a company’s shares. This is money that could have gone toward research and development or hiring.

Companies buy back their stock for various reasons — to take advantage of undervaluation, to reward stockholders by increasing the value of their shares or to make the company look more attractive to investors. And there is another reason. Because most executive compensation these days is based on stock value, higher share prices can raise the compensation of chief executives and other top company officials.

Since 2008, [AT&T CEO Randall] Stephenson has cashed in $124 million in stock options and grants.

Many other large American corporations have also been playing the tax break and loophole game. Their huge tax savings have enriched executives but not created significant numbers of new jobs.

Boeing is another good example. As Justin Miller explains,

Boeing has received a tax refund in five of the past ten years. It saves itself $542 million a year using a special domestic manufacturing tax break, and $1.8 billion in further cuts thanks to a research and development tax credit. Boeing also benefits from the immensely favorable depreciation schedules on capital that has saved it billions of dollars over the past decade.

Boeing also entered into a $9 billion tax incentive deal with Washington state back in 2013—the largest corporate subsidy ever—to “maintain and grow its workforce within the state.” But, as Michael Hiltzik points out in the Los Angeles Times, the company has since cut nearly 13,000 jobs (about 15 percent of its Washington workforce) as it sets up shop in cheaper states that offer incentives of their own.

It still manages to enrich its shareholders though. On the same day that it announced a production slowdown in December, Hiltzik notes, Boeing also announced a 30 percent increase in its quarterly dividend and a new $14 billion share-buyback program.

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One of the arguments I made in my piece on “Class and Trumponomics” (serialized on this blog—here, here, here, and here—and recently published as a single article in the Real-World Economics Review [pdf]) is that, in the United States, the class dynamic underlying the growing gap between the top 1 percent and everyone else was the much-less-remarked-upon divergence in the capital and wage shares of national income. Thus, I concluded, “the so-called recovery, just like the thirty or so years before it, has meant a revival of the share of income going to capital, while the wage share has continued to decline.”

Well, as it turns out, that conclusion is more general, characterizing not just the United States but much of global capitalism.

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We know that—not just in the United States, but in a wide variety of national economics—the share of income going to the top 1 percent has been rising for decades now.

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Thanks to the work of Peter Chen, Loukas Karabarbounis, and Brent Neiman (and the full paper [pdf]), we also know that corporate profits (across some 60 countries) have also been rising.

We document a pervasive shift in the composition of saving away from the household sector and toward the corporate sector. Global corporate saving has risen from below 10 percent of global GDP around 1980 to nearly 15 percent in the 2010s. This increase took place in most industries and in the large majority of countries, including all of the 10 largest economies.

According to their analysis, the rise of corporate saving mirrors an increase in undistributed corporate profits, corresponding to a decline in the labor share for the global economy.

Moreover, the increase in corporate saving exceeded that in corporate investment, which implies that the corporate sector improved its net lending position. Just as I concluded in the case of the United States, the improved net lending position of corporations is associated with an accumulation of cash, repayment of debt, and increasing equity buybacks net of issuance.

If you put the two trends together—increased individual income inequality and increased corporate savings—what we’re witnessing then is increasing private control over the social surplus. Wealthy individuals and large corporations are able to capture and decide on their own what to do with the surplus, with all the social ramifications associated with their decisions to invest where and when they want—or not to invest, and thus to accumulate cash, repay debt, and repurchase their own equity shares.

And proposals to decrease tax rates for wealthy individuals and corporations will only increase that private control.

Why is it anyone would want to save such an economic system?

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Special mention

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The capitalist machine is broken—and no one seems to know how to fix it.

The machine I’m referring to is the one whereby the “capitalist” (i.e., the boards of directors of large corporations) converts the “surplus” (i.e., corporate profits) into additional “capital” (i.e., nonresidential fixed investment)—thereby preserving the 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 well-paying jobs.

The presumption of mainstream economists and business journalists (as well as political and economic elites) is that the capitalist machine is the only possible one, and that it will work.

Except it’s not: corporate profits have been growing (the red line in the chart above) but investment has been falling (the blue line in the chart), both in the short run and in the long run. Between 2008 and 2015, corporate profits have soared (as a share of gross domestic income, from 3.9 to 6.3 percent) but investment has decreased (as a share of gross domestic product, from 13.5 to 12.4 percent). Starting from 1980, the differences are even more stark: corporate profits were lower (3.6 percent) and investment was much higher (14.5 percent).

The fact that the machine is not working—and, as a result, growth is slowing down and job-creation is not creating the much-promised rise in workers’ wages—has created a bit of a panic among mainstream economists and business journalists.

Larry Summers, for example, finds himself reaching back to Alvin Hansen and announcing we’re in a period of “secular stagnation”:

Most observers expected the unusually deep recession to be followed by an unusually rapid recovery, with output and employment returning to trend levels relatively quickly. Yet even with the U.S. Federal Reserve’s aggressive monetary policies, the recovery (both in the United States and around the globe) has fallen significantly short of predictions and has been far weaker than its predecessors. Had the American economy performed as the Congressional Budget Office fore­cast in August 2009—after the stimulus had been passed and the recovery had started—U.S. GDP today would be about $1.3 trillion higher than it is.

Clearly, the current recovery has fallen far short of expectations. But then Summers seeks to calm fears—”secular stagnation does not reveal a profound or inherent flaw in capitalism”—and suggests an easy fix: all that has to happen is an increase in government-financed infrastructure spending to raise aggregate demand and induce more private investment spending.

As if rising profitability is not enough of an incentive for capitalists.

Noah Smith, for his part, is also worried the machine isn’t working, especially since, with low interest-rates, credit for investment projects is cheap and abundant—and yet corporate investment remains low by historical standards. Contra Summers, Smith suggests the real problem is “credit rationing,” that is, small companies have been shut out of the necessary funding for their investment projects. So, he would like to see policies that promote access to capital:

That would mean encouraging venture capital, small-business lending and more effort on the part of banks to seek out promising borrowers — basically, an effort to get more businesses inside the gated community of capital abundance.

Except, of course, banks have an abundance of money to lend—and venture capital has certainly not been sitting on the sidelines.

Profitability, in other words, is not the problem. What neither Summers nor Smith is willing to ask is what corporations are actually doing with their growing profits (not to mention cheap credit and equity funding via the stock market) if not investing them.

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We know that corporations are not paying higher taxes to the government. As a share of gross domestic income, they’re lower than they were in 2006, and much lower than they were in the 1950s and 1960s. So, the corporate tax-cuts proposed by the incoming administration are not likely to induce more investment. Corporations will just be able to retain more of the profits they get from their workers.

But corporations are distributing their profits to other uses. Dividends to shareholders have increased dramatically (as a share of gross domestic income, the green line in the chart at the top of the post): from 1.7 percent in 1980 to 4.6 percent in 2015.

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source (pdf)

Corporations are also using their profits to repurchase their own shares (thereby boosting stock indices to record levels), to finance mergers and acquisitions (which increase concentration, but not investment, and often involve cutting jobs), to raise the income and wealth of CEOs (thus further raising incomes of the top 1 percent and increasing conspicuous consumption), and to hold cash (at home and, especially, in overseas tax havens).

And that’s the current dilemma: the machine is working but only for a tiny group at the top. For everyone else, it’s not—not by a long shot.

We can expect, then, a long line of mainstream economists and business journalists who, like Summers and Smith, will suggest one or another tool to tinker with the broken machine. What they won’t do is state plainly the current machine is beyond repair—and that we need a radically different one to get things going again.

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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.