Corporate surplus hits record

The big story in today’s GDP numbers is that companies’ inability or unwillingness to invest has hit a record level. Non-financial firms’ financial balance - the gap between retained profits and investment - reached £26bn, or 7.4% of GDP, in Q4. This was by far the largest since current records began in 1987.
This is not simply because their spending has fallen - though fixed investment did fall 19.9% in the year to Q4. It’s also because their savings have risen. Retained profits hit a record (since 1987) 15.3% of GDP in Q4, thanks to higher profits, higher rent incomes and dividend cuts.
The counterpart to the corporate sector’s massive surplus is, of course, that the public sector is running a record deficit: across all sectors of the economy (which includes foreigners), the surpluses must sum to zero. Since 1987, the correlation between these two balances has been minus 0.55. If we add in households - which ran a huge surplus last year after years of deficit - and financial companies, the correlation approaches one.
There’s an optimistic and a pessimistic reading here.
The optimistic reading is that the corporate surplus will eventually fall. As banks become more willing to lend, firms will be able to invest. And those firms that are sitting on huge cash piles will eventually spend them. As the corporate surplus declines, so public borrowing will fall.
The pessimistic reading is that the corporate sector’s reluctance to invest is not merely a temporary cyclical artefact but rather a sign of a structural dearth of investment opportunities; even in the boom of 2007, firms had a large surplus. If this is the case, then a permanent large corporate surplus means permanent large government borrowing.
I’m not at all sure which of these is right. But I know two things. One is that people are under-estimating the significance of the latter possibility. The other is that government borrowing is - to a large extent - out of the government’s hands. This is the elephant in the room that last night’s Chancellors’ debate failed to mention.

Comments

[Luis Enrique]

I'd love to know more detail on this ... does this mean that the very same companies who were making redundancies because of the recession were actually piling up profits at the time? I find that hard to believe (say, car manufacturers - my brother works for Nissan and says they were even told to unscrew every other lightbulb to save money, and friends in other industries report sales falling, loses being made, and we all know businesses that have gone bust). Does this mean that aggregate operating profits have really risen over the recession? (you do write "thanks to higher profits" but I find this really hard to believe) so who are these firms making bumper profits during the recession, because they have to more than make up for all those losing it hand over fist (autos, retailers, airlines, construction etc.) and I'm finding all this rather difficult to get square. In which sectors are these non-financial firms that have seen profits increase during the recession? Can you name any names? Are some landlords? Have commercial property rents risen over the recession? How come all those banks are sitting on non-performing property portfolios then?

Can you break the data down into higher profits, higher rents, lower dividends and lower investment?

[Econoclast]

You don't mention households, but I think you should. Could it be that excessive household borrowing 'crowded out' business investment? In 2009, households ran a surplus, but that followed huge deficits through the early to mid 00s. The big question that no one seems willing to answer (least of all the politicians who supported the stamp duty cut) is: why have we borrowed so heavily to invest in housing rather than more productive assets? What does this imply for the long-term potential growth rate of the economy? I don't know the answer to the first question. But I have a reasonable view of the answer to the second. And it doesn't make happy reading.

[Luis Enrique]

[and ... it's a small point, but you have written in the past that the recession has been a good time for capitalists, citing profit data. If the increase in corporate savings has been achieved by cutting dividends, that tempers that story somewhat. Of course, if you're rich, your still rich if you dividend income dries up for a year or so, so still no sympathy for the rich]

[Luis Enrique]

umm, scratch that last daft comment ... of course you still own the retained profits. doh.

[Luis Enrique]

umm, scratch the last daft comment. you still own the retained profits. doh

[chris]

@Luis - there is, of course a vast range of experience. I suspect the rising suplus reflects two very different things. First, some firms would like to invest but can't raise the finance, so are in effect forced savers. Second, profits are rising sharply for some other firms: Kingfisher, Morrisons, Reckitt Benckiser to name but three.
Remember Geroski and Gregg's study of the 90s recession? It found that 40% of firms saw profits rise then, and that 10% of firms accounted for 84% of the gross fall in profits.
The breakdown of the aggregate data is in tables K1 and K2 here:
http://www.statistics.gov.uk/pdfdir/qna0310.pdf
@ Econoclast. I'm not sure that housing investment crowded out corporate investment because the cost of corporate capital was lowish in the boom, and firms didn't complain about the price or availability of capital then, according to CBI surveys. I share your hunch about why capex was low.

[Luis Enrique]

Thanks Chris ... I don't quite understand why being unable to raise finance is a barrier to investment if you have cash piling up in your bank account, and thanks for naming some names. Still very surprised if those firms doing well are sufficient to outweigh firms doing badly to deliver an aggregate increase in profits, but I guess I need to take the time to read the pdf. you link to.

[Rob Marrs]

Just a brief note to thank you for putting a blogpost of mine in the top blogging section. Very kind and much appreciated.

Rob

http://leftbackinthechangingroom.blogspot.com

[JP Valli]

your statement "This is not simply because their spending has fallen - though fixed investment did fall 19.9% in the year to Q4. It’s also because their savings have risen"...is a tautology. Clearly you don't have the most basic knowledge of economics.

The uselessness of the comment starts here and get even worse further down. I hope readers didn't waste more than 10 seconds of their days and, having spotted this weakness, stopped reading immediately, saving themselves from the other obviously circular comments that follow...

[Econoclast]

Chris - thanks. My term 'crowding out' probably wasn't appropriate. But I wonder if banks preferred to lend to households because of higher margins on mortgages and the obvious 'growth' attractions. Couple that with institutional investors' fixation on maintaining dividend payments, and I guess you end up with little incentive for companies to spend. It seems to be a mirror image of China's current investment boom.

[chris]

@JP Valli. It's not a tautology. The ONS defines the financial surplus (net lending) as savings (retained profits) minus investment (capital spending and inventories). There's nothing tautological about the former rising and the latter falling.

[Philip Walker]

If this is the case, then a permanent large corporate surplus means permanent large government borrowing.

Did you intend to ascribe a particular causal relationship to the logical relationship there? [Supplementary: if so, can you explain why you think it's that way round and not the other?]

[Jonathan]

To what extent does this lack of investment indicate a lower than anticipated level of production spare capacity and will this mean inflation will rise faster than predicted?

[vimothy]

"The other is that government borrowing is - to a large extent - out of the government’s hands"

Agreed.

[chris]

@ Phillip - there are (at least) two possible causal mechanisms from the corporate surplus to the government deficit.
One is the banking crisis. In preventing some firms from borrowing to invest, this has raised the corporate surplus. It has also reduced economic activity and hence tax revenues.
The other is that the dearth of investment opportunities - which has many possible causes - is depressing investment which in turn is depressing the economy and hence tax revenues.
In theory, of course, it could be that the government deficit crowds out corporate investment so the causality runs the other way. This would be the case if government borrowing raised the cost of borrowing generally. However, with risk-free rates so low, this is not happening. And credit spreads seem to have fallen since late 2008 as government borrowing has risen, so it's not obvious that borrowing is raising the risk element of companies' borrowing costs.
I suppose you could argue that there's some Ricardian equivalence at work - firms aren't investing because they anticipate higher taxes as a result of the government deficit. But it's not clear that there's any evidence for this.

[vimothy]

Wait a sec: isn't the vast majority of corporate investment financed from retained earnings?

Also, since we ain't on the gold standard any more, there isn't fixed amount of credit in the economy. There's no "crowding out". Firms and government do not compete for funds. Govt deficit spending *necessarily* increases the savings of the private sector.

[H Miracle Review]

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