The Corporate Savings Glut
by Charles Lemos, Tue Jul 06, 2010 at 11:46:08 AM EDT
Yves Smith who runs the Naked Capitalism blog and Rob Parenteau who is editor of The Richebächer Letter and the head of the financial advisory firm MacroStrategy Edge have an op-ed in the New York Times that points to one of the significant developments in the global economy over the past twenty years, a switch in the behaviour of corporations which are eschewing investment in productive assets in favour of financial ones as well as passing on a greater share of profits to corporate executives and shareholders. This switch in corporate behaviour has significant implications for the global economy.
Over the past decade and a half, corporations have been saving more and investing less in their own businesses. A 2005 report from JPMorgan Research noted with concern that, since 2002, American corporations on average ran a net financial surplus of 1.7 percent of the gross domestic product — a drastic change from the previous 40 years, when they had maintained an average deficit of 1.2 percent of G.D.P. More recent studies have indicated that companies in Europe, Japan and China are also running unprecedented surpluses.
The reason for all this saving in the United States is that public companies have become obsessed with quarterly earnings. To show short-term profits, they avoid investing in future growth. To develop new products, buy new equipment or expand geographically, an enterprise has to spend money — on marketing research, product design, prototype development, legal expenses associated with patents, lining up contractors and so on.
Rather than incur such expenses, companies increasingly prefer to pay their executives exorbitant bonuses, or issue special dividends to shareholders, or engage in purely financial speculation. But this means they also short-circuit a major driver of economic growth.
Their op-ed references a 2005 report by Jan Loeys and David Mackie of JP Morgan entitled Corporates Are Driving the Global Savings Glut which found that rise in the corporate savings rate has truly been a global phenomenon cutting across all regions and including both financial and non-financial corporates. They also found that relative to the past, the financial sector has played "an unprecedented role in boosting corporate saving, as benefited from record low funding rates, and the impact that this had on interest sensitive sectors."
While we normally think of savings as a net positive, that's not the case here. What we are seeing a pilfering of corporate assets primarily for the benefit of their executives. Rather than invest in productive capacity, profits are being redistributed internally to upper echelon management and shareholders in part because taxes on retained earnings, a policy switch that dates to the Reagan era, are too low. Indeed, Smith and Parenteau find that policymakers need to create incentives for corporations to reinvest their profits in business operations. They suggest two approaches: one way to do this would be to impose an aggressive tax on retained earnings that are not reinvested within two years. Another approach would be a tax on the turnover of corporate financial investments that would raise the cost of speculating with profits, rather than putting them into the business.