Capitalists on strike

The most significant fact in today’s national accounts numbers is not the trivial downward revision to GDP growth. It is instead the fact that the UK’s fundamental economic problem - capitalists’ reluctance to invest - is as acute as ever.

My chart shows that, last year, non-financial firms capital spending was equivalent to just 65.7% of their retained profits - the lowest share ever*. To put this another way, firms’ desire to build up cash and/or reduce debt is at a record high - despite negative real interest rates.

Now, you might expect investment to be low, given weak aggregate demand and spare capacity. But my chart shows that capital spending as a share of retained profits was trending downwards before the recession. This suggests the reluctance to invest is a longish-term problem, reflecting the dearth of investment opportunities, and not just a cyclical one.

That said, I suspect this aggregate picture hides three separate things:

- Some firms are generating cash but lack investment opportunities - for either cyclical or secular reasons.

- Some, smaller, firms are forced savers, in that they’d like to invest but lack access to finance - though the Bank‘s credit conditions survey suggest this problem has declined since 2009. 

- Some firms have been highly indebted and thus unable or unwilling to borrow; the corporate debt-income ratio is still above its long-term average.

I say this is our fundamental problem simply because it is capitalists’ spending decisions that largely  determine growth and employment. Also, the counterpart of firms being large net savers is that someone has to be a borrower - and that someone is the government; the public deficit is, to a large extent, the counterpart of this corporate surplus.

You can read this chart as a refutation of neoliberalism. Neoliberals thought that if only taxes could be cut and labour’s bargaining power weakened, that capital spending would rise and economic growth follow. This has not happened. And it is, surely, unlikely that the corporate tax cuts Osborne announced in the Budget will significantly turn things around.

The question is: what, if anything, would turn it around? Yes, looser fiscal policy might give a cyclical kick to spending. But this doesn’t address the long-term secular downtrend in companies’ propensity to invest.

It might instead be that something more profound is happening. The difficulty of monetizing new innovations means that the profit motive is no longer sufficient to promote investment. This would be consistent with (though not proof of!) Marx’s prediction that capitalism would eventually retard economic growth:

At a certain stage of development, the material productive forces of society come into conflict with the existing relations of production…From forms of development of the productive forces these relations turn into their fetters. Then begins an era of social revolution.

* My chart shows a small rise in this share recently. This is because retained profits fell in Q3, rather than because investment is picking up significantly. In Q4 alone, capital spending accounted for only 60% of retained profits, the third-lowest proportion on record.

Comments

[Tim]

Perhaps the reason true capitalists are reluctant to invest is because they are aware that crony capitalists (banks) and the government have managed completely to distort the capital structure, thus making it impossible to distinguish between sensible investments and malinvestments. It is difficult to assess the likely return on any investment when the price of everything has been manipulated by central banks and investment ones. That makes "hoarding" entirely understandable.

[guthrie]

What just occured to my amateur brain was that if your economy is focused more on services, then there will come a time when re-investment simply isn't worth it. When you have a shop on every high street and shopping centre. When automatic checkouts are still only in their infancy; when you have borrowed too much to buy your shop fronts during a boom and thus owe too much to spend money on investment.

[theartteacher]

"I say this is our fundamental problem simply because it is capitalists’ spending decisions that largely determine growth and employment."

and

"The question is: what, if anything, would turn it around?"

For me the answer is to take this unjustified power away from capitalists and give it to democratic institutions. Simples.

[Keith]

I am slightly puzzled. Why does the corporate sector not pay out their savings as more dividends if they see no profitable investment opportunities? That is what they should do as the shareholders are the legal owners of the firm and if they did this the shareholders could spend more and boost consumer demand and Government income from direct and indirect taxes. Can chris explain that?

[chris]

@ Keith - one problem with paying dividends is that it commits the firm to continuing to do so, because a dividend cut is taken very badly by shareholders. It could be that firms would rather hang onto cash, perhaps for good reasons (they hope to invest sometime), perhaps for bad (they fear hard times).

[Richard]

"From forms of development of the productive forces these relations turn into their fetters. Then begins an era of social revolution."

How do we get there? What policies will be introduced and what institutions will be put in place? I understand why Marx didn't want to paint pictures of hypothetical utopias but he could at least have given some guidance beyond the 10 points mentioned in the Communist Manifesto. Soviet socialism didn't work so what's the alternative?

[Luis Enrique]

are these UK-owned non-financial firms or all non-financial firms operating in the UK, regardless of domicile? For example, does Nissan's investment in Sunderland show up here and how on earth are you accounting for the retained income of Nissan?

"it might instead be that something more profound is happening."

low investment is hard to interpret. For example, take a neoclassical economy on its balanced growth path. There investment is low, relative to investment whilst in transition, and that's optimal. Attempts to force higher investment would make people worse off.

or imagine an economy where investment was low because a corrupt government expropriates returns. Here low investment is optimal, given that behaviour, but if we are able to change the government, higher investment would be optimal.

if we suppose firms know what they are doing, so low investment is optimal in a sense, are we in the former or latter sort of situation? Perhaps all we need to do is change some policy (end neoliberalism!) investment would rise and that would be a good thing. Or perhaps we have low investment for sensible reasons and trying to push investment would simply entail misallocating resources.

it could be that the nature of the UK aggregate production function [**] has changed and is now less capital intensive.

[*] so to speak

[Paolo Siciliani]

@ Luis Enrique - you love to play Devil's Advocate, don't you? Quite pointless I find though. Anyway, you say "if we suppose firms know what they are doing, so low investment is optimal in a sense". Wait a second, firms may be investing less because they KNEW (and still believe) that consumption was fuelled by a credit boom that would ultimately turn out to be unsustainable. By this doesn't mean it was (and is) optimal not to invest from a welfare point of view. This is where you get at odds between the macro and the micro perspectives. Something that makes sense at the micro level (do not invest because current boom is unsustainable) is wrong at the macro level (if everything does the same the economy will implode). And this has nothing to do with a currupt state that expropriate rents. Quite the opposite indeed, it is because firms ability to extract rents is unrestrained, which lead the system to eat itself since with wages losing purchasing power and the period of easy credit over for good there is nobody out there willing to buy new funky widgets, let alone the export drive, which is another case of everyone trying the do the same thing, which at the macro/aggregate level cannot happen and will lead to a destructive race to the bottom.

[chris]

@ Luis - the figures refer to firms operating in the UK. If Nissan retains cash in the UK, it shows up in these data. If not, its a debt in the balance of payments.
You're right that we might have low investment for sensible reasons - either a dearth of profitable opportunities and/or a recognition that past investments were sometimes motivated by overconfidence. But this is still bad news, as it betokens low future growth.
I think we can discount the possibility that the aggregate produnction function is less capital intensive; if this were so, it would be more labour intensive and so employmnt would be rising.

[Peter]

"The difficulty of monetizing new innovations means that the profit motive is no longer sufficient to promote investment."

Apple suggest it can be done if you try.

[Wolfie]

Looks very much like a Marxian realization crisis

[littlekeithy]

How does the graph accord with high levels of FDI coming into the UK or are the inflows more about buying up UK firms and mainly in the financial sector?

Couldn't it be that buoyed by the decline in the wage share since 1975 that UK capitalists see no reason to invest and are consuming ever larger amounts of their own profits. It is certainly the case that the Tory policy on the economy since the 1980s has been to attack living standards, re Keith Joseph's quote about the "union problem" and the current coalition policies.

Blanchard of the IMF wrote yesterday there is no alternative to lower wage costs to get out of the crisis.

The graph does tend to match up with the Marxist view of the effects of the falling rate of profit, assuming that there is a decline.

However, there is no consensus on the direction, with some arguing for historic declines since 1970s, some saying there has been upswing since 1990s but now declining again (I tend to agree with that one) and others that we have entered a new boom period since the mid 1990s.

I think they all agree things aren't pretty.

[Phil]

The upward trend in 2008-9 is interesting, at least if it was the right kind of upward trend (per your footnote). By the time this shower's finished with us the Mail will be asking for Brown to come back.

[Leigh Caldwell]

Two thoughts:

First, should we expect investment to always be a high proportion of profits? In an economy where most people want to save for their future [for simplicity, let's assume saving is the same as investment], capital investment should indeed be more than 100% of profits, as the population will be net savers.

Perhaps an older population wants to dissave and thus disinvest; taking its profits from prior investments and consuming instead of reinvesting them.

If a higher share of capital is now owned by 65-year-olds than in the past, we might expect exactly this to happen. Overlapping generations models are all very well if the generations are homogeneous.

The depressing thing is that capital being disproportionately held by 65-year-olds is both a consequence _and_ a cause of low growth, so this problem might become self-feeding. Although human capital is probably possessed increasingly by younger people, so the terms of trade on which the old buy services from the young might change and partly redress the balance.

Second, and unrelated: Andrew Lilico's column yesterday, suggesting that we should increase interest rates to boost growth.

http://blogs.telegraph.co.uk/finance/andrewlilico/100015883/the-bank-of-england-should-raise-interest-rates-next-week/

His argument seems to be either that there is currently too much investment and this will result in lower long-term welfare (which seems unlikely) or that low interest rates keep alive unproductive firms which should go bust, allowing productive ones to grow. Is that a plausible description of the situation today? (Tim's comment above hints at the same thing)

[Luis Enrique]

Paolo,

do pay attention. I didn't say low investment has anything to do with corrupt states expropriating rent, I merely used that as an example of how investment behaviour may be only optimal because of something wrong we would wish to change. The other example I gave was of optimal low investment where there's nothing "wrong" and attempts to raise investment would make us worse off (although we would always wish to increase the rate of technical progress - so there's something we would wish to change in that sense).

your point that individual firms optimally choosing not to invest being not-optimal from a macro p.o.v. because of demand externalities is another example of investment behaviour being only optimal because of something wrong we would wish to change - in this case we would wish to solve the coordination problem that is preventing the economy from moving to a high-investment equilibria - you are telling a multiple equilibria story.

That's all well and good, but it doesn't change the point I was making that low investment is hard to interpret because there might be reasons why low investment is optimal in a broad sense, making attempts to push investment a bad idea.

as Chris says, in that case low investment is bad news because it is a symptom of something else - low growth.

Chris I'm not sure that employment would rise if the aggregate production function became less capital intensive. Imagine a world in which we produce services with zero (built) capital input - say we all run yoga classes in fields - and we import all the goods that require capital inputs by exporting services (we teach foreigners yoga for exorbitant fees). Who says employment has to be higher in that world?

[Paolo Siciliani]

@ Luis. I do pay attention, you tried to muddle the waters (in Popperian words, confute an argument) by proposing an alternative explanation. I said that this is pointless to the extent that your argument is unplausible (i.e, bonkers), which it is as you just kindly conceded. This is what you often do, coming up with fanciful alternative explanation to confute plausible narratives. Well, to me that's pointless. I rest my case.

[Britmouse]

My thoughts here:

http://uneconomical.wordpress.com/2012/03/29/uk-capital-formation-and-the-death-of-capitalism/

I struggle to see how this data describes a longterm secular downtrend, if only because we have a relatively short period, and it starts in the middle of a cyclical boom and ends in a cyclical bust.

There has not been an obvious secular decline in UK total economy capital formation either; housebulding explains some of the gap vs business investment.

[Luis Enrique]

Paolo,

oh do piss off - I don't like to be rude, but then I don't tend to tell other commentators their thoughts are pointless either.

now pay more attention. You wrote: " And this has nothing to do with a currupt state that expropriate rents" and I explained that I never said it did - and instead of saying something like "oh sorry, I got that wrong" you come back with more bluster. You would do better to acknowledge your errors.

my point was, and is, that low investment is hard to interpret. If you think otherwise, your waters could use some muddying. You mention Popper - I rather think he might have approved of the habit of considering alternative explanations for observed data rather than relying on one's ability to unerringly know the truth. Considering alternative hypotheses is the opposite of "pointless"

What argument have I made that's unplausible (bonkers)? What fanciful alternative explanation have I proposed?

I have argued that low investment MIGHT be optimal in a broad sense - because as Chris would put it, there is a dearth of worthwhile investment opportunities [*]. If there really is a dearth of worthwhile investment opportunities, we don't want people investing, do we?

as it happens, I genuinely don't know what the correct interpretation of the secular decline in investment is. It might be because government policy is wrong or there is some other failure that needs fixing, it might not be. You may believe if firms could be persuaded to raise investment we'd get a benign self-fulfilling prophecy. You may be wrong.

[*] in the neoclassical growth model, as the economy converges on its balanced growth path, the marginal product of capital falls until additional investment is no longer worthwhile and you reach a steady-state where investment "keeps up" with tech progress, depreciation, and pop growth, but no more than that. There is a secular decline in investment as convergence occurs. This is an illustration of an idea, not a proposed literal explanation for what's happened in the UK.

[Paolo Siciliani]

Your implausible (bonkers) alternative explanation was that the low rate of investment may be consistent with a government that expropriate rents. In this respect, I'd like just to remind you that it has been recently estimated that the corporate sectors sits on 750bn cash, so to use that alternative (?) explanation to argue that it's hard to infer anything policywise is pointless.

You still argue that "If there really is a dearth of worthwhile investment opportunities, we don't want people investing, do we?", that low investment "MIGHT be optimal in a broad sense, as implied by the neoclassical model, but you go on then to clarify that you do not mean this to be a "literal explanation for what's happened in the UK".

Basically, you don't have a clue because it can be anything - this is your typical contribution: it might be but it might not. Great, thanks mate, we got your point.

[Luis Enrique]

you write: "Your implausible (bonkers) alternative explanation was that the low rate of investment may be consistent with a government that expropriate rents. "

now stop a second and recognise: I did not propose government expropriating rents as an alternative explanation for low investment in the UK. And I have already told you that, in first para of above comment starting "do pay attention". Evidently you did not.

I have already explained I merely used that as an example of how low investment may be something that needs "fixing", in contrast to my other example in which low investment is not something to be fixed. Both examples illustrate the concept, that's all.

Yes, my contribution was to observe that it's hard to know what to make of the secular decline of investment. I would be delighted if you did get my point.