The Corporate Savings Glut

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.

Tags: US Economy, Corporate Issues (all tags)

Comments

6 Comments

Yet another reason

to raise taxes on the wealthiest individuals.  Make companies decide whether they want >50 % of the raise they give to their top people to go to the Feds or if they would rather reinvest in their own business.  I think if they're properly motivated, they'll do the right thing.

The best way to accomplish this is to create at least two more tax brackets above our current cutoff of ~$250k.  Obama correctly stated a while back that if you make more than $250k you're probably rich.  True.  But if you make >$1M or >$10M, you're fuckin' rich as hell.  Make the marginal rate on these tax brackets >50%.  The idea of taxing the richest people isn't to get money into the Treasury (although it may help a bit), it's to encourage better investing practices among these people and corporations.  It'd be like a soft cap on executive salary - something that is uniformly believed to be out of balance.

Right now seems to be the right time to have this debate.  I have no illusion that it would pass the Senate, but even talking about it would be beneficial.

by the mollusk 2010-07-06 01:34PM | 0 recs
RE: Yet another reason

Don't need additional tax brackets until we first expose more income to the existing ones.
Simplification is the political entry to begin the balancing of the entire economy.
We have to understand that it is perceived fairness that has been the cover used to distort the system. Consolidating the number of income types would play into the fairness narrative.

by Judeling 2010-07-06 04:31PM | 0 recs
This is very interesting

I have never worked for a publicly traded company; and the executives I know are, for the most part, associated with privately held firms. 

They all insist that the major disadvantage of the publicly held model is the obsession with the quarterly numbers, which (combined with the use of professional managers whose primary goal is to maximize the numbers in the next 4 yrs...corresponding to their vesting period) drives down investment that would take longer to come through.

There are only so many ways to invest money in yourself and have a short payoff (< 4 yrs) that is relatively secure etc..  Hence, there is a driving force against investments.

 

Your statistics supports that argument... I had never bought that arguyment because it is anathema to the concept of a corporation (The first principle of forming a corporation is that the corporation believes it can use money more effectively than having that money invested anywhere else).

 

One potential solution would be to have a substantial fraction of the stock (options + grants) be vested over a longer period of time..say >7 yrs.

by Ravi Verma 2010-07-06 01:37PM | 0 recs
First things first.

A person with your knowlege should not be waiting on the sidelines for a job. Good luck anyway.

Secondly, the old Reagan notion that reducing taxes on the wealthy and corporations will increase investment and thus raise all boats, is a fallacy proved many times over. Greed is good seems to be the same old motivator of the wealthy and corporations, and many poor and working people actually continue to believe it. Even if he were alive today, Milton Friedman would continue to urge even more tax benefits for the wealthy, while recommending that goverment programs like Social Security would climb out of future debt if it only went into private investment, that is to say, CEO and executive salaries. This was Bush's last stand and fortunately if failed.

by MainStreet 2010-07-06 01:52PM | 0 recs
financial sector

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

Which explains numbers like this:

The Quiet Coup: From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits.

In 1986, that figure reached 19 percent.

In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period.

This decade, it reached 41 percent...

by jeopardy 2010-07-06 02:28PM | 1 recs
I'm saving too

It's the smart thing to do after the mayhem of the last 10 years.

by eroded47095 2010-07-07 11:57AM | 0 recs

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