Secular stagnation as wising up

Andrew Smithers says:

A major cause of low investment is the incentives created by the bonus culture — the practice (now almost ubiquitous in quoted companies) of paying executives huge bonuses to reward short-term success.

I agree that many bosses are overpaid and that this is an economic problem, but I'm not sure about the mechanism Mr Smithers identifies.

Low investment and short-termism might be due not to misaligned incentives between shareholders and executives but are instead actually in shareholders' interests.

This is because creative destruction is inherently uncertain, and a rational response to such uncertainty should be to curb investment. For example, why retool a factory if future robotization will make that retooling obsolete? Why invest in a new car model if it will be supplanted by driverless cars? Why bother investing in a slightly better tablet if a rival will make an even better one?

Uncertainty should, in many cases, reduce (pdf) capital spending.

You might object that uncertainty has always been with us, so how can it explain low investment now?

Here's a theory. What we've seen since the early 00s is that firms have wised up. They know that, in the past, a lot of investment was driven by irrational overconfidence, by overly optimistic expectations for returns. They have learned from this error, and so have reduced capex.

Remember two important papers:

 - William Nordhaus's finding that only a "miniscule fraction" of the total returns to innovation accrue to companies.

 - Charles Lee's and Salman Arif's finding that higher capital spending leads to more earnings disappointments - which suggests that capex decisions are swayed by sentiment rather than by an improvement in genuinely profitable opportunities.

The rational response to these findings, surely, would be to become more sceptical about proposed investment plans, and thus to approve fewer of them.

Secular stagnation - in the sense of low investment even at low real interest rates - might therefore be due not (just) to a lack of profitable investment opportunities but rather to a more sober and less overconfident assessment of those opportunities. It is the result of boardrooms being dominated less by buccaneering adventurers and more by rational(ist) accountants.

Perhaps, then, we are at last seeing just what Keynes warned us of:

If the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die.

Comments

[Phil]

It's... the crisis of capitalism! At last!

Bit grim, isn't it?

[Steven Clarke]

Is this a paradox?

Individually rational decisions prove to be irrational for society as a whole?

[THSL]

"Why invest in a new car model if it will be supplanted by driverless cars? Why bother investing in a slightly better tablet if a rival will make an even better one?"

That just sounds like serious deflation to me, so no need at all to introduce all the uncertainty/sober stuff. Real rates just far far too high.

[Dave Timoney]

Smithers focuses on a particular mechanism - that bonuses incentivise short-termism and deter long-term investment - but there is another possible explanation, namely that there is a competition for funds between the capex schedule and the bonus pool.

It's worth remembering that the bonus culture has spread to most layers of management over the last 30 years, so the bonus pool is now a very large item in many companies finances. It's not just City banks or C-level executives any more.

[Lord]

This may be a long wave. Substantial investment in new technologies may lead to greater uncertainties and lower returns until investment has been trimmed back, leading to predictable profitable but stagnant business, which offers greater opportunities and more certain profits for what investment is undertaken until more and more is, resulting in stable long term growth even if it varies sharply over cycles.

[rogerh]

The long term is made up from a succession of short terms. Long term planning is for businesses that will be here in 20 years time - mining, aircraft, energy. But who wants to start up a new washing machine business - not many. Any fool can build a new Iphone - but making money from it?

The great businesses of the 20th century - electricity, radio, automobiles, radio, computers and semiconductors were all driven by an obvious application and potential demand. A one-year plan or no plan at all was enough to start. All led to a flush of enthusiasm followed by consolidation.

Engineering and design have become very predictable - everything is modelled and simulated to death and then sent to the robots for making. Mathematical expectation is here. We need to shake the world up a bit - perhaps a 'large hadron transistor' will do the trick. Or a social change - perhaps a nuclear armed ISIL would benefit more people than it upset.

[Matthew Maloney]

Beautiful quote by Keynes. I'm always sceptical of ascribing such elegant motivations like managers reading the literature on the externalities of their project investments or longitudinal studies of project returns by sector and firm size etc. Once you realise who most managers are its a better fit to perhaps suggest more mundane reasons.