In previous posts (https://thenextrecession.wordpress.com/2013/02/10/why-is-there-a-long-depression/) I have pointed out the supposed conundrum between profits and investment present in many countries – namely profits are up, but investment is not matching the rise in profits. According to GMO, the financial asset manager, profits and overall net investment in the US tracked each other closely until the late 1980s, with both about 9% of GDP. But after the recession, from 2009, it went haywire. US pretax corporate profits are now at record highs – more than 12% of GDP – while net investment (that’s investment after replacing worn out old capital) is barely 4%.
US corporate profits recovered dramatically from the trough at the end of 2008. They surpassed their previous peak in 2006 by early 2010. But most of the recovery in profits since the end of 2008 has been hoarded and not spent on new investment. Undistributed profits have accumulated to $744bn from just $19bn at the end of 2008! Profits are up around $1trn since then, so only 30% of the increase in profits has been spent on new investment. This explains why the economic recovery has been so weak, with the US economy growing only barely at 2% a year. It is exactly the same story in the UK. According to Treasury Strategies, a body that looks at these things, corporate cash in the US was 10% of GDP in 2000 and is now 15%, while in the Eurozone the corporate cash pile has risen from 15% to 21% and in the UK from 26% in 2000 to 50% of GDP in 2012 (http://treasurystrategies.com/news)!
Companies are stockpiling cash rather that investing. Take the latest data from the UK. The amount of cash held on the balance sheets of the UK’s largest companies by market value has reached an all-time high to stand at £166bn, according to Capita Asset Services. Gross cash balances for FTSE 100 companies have risen by one-third from £123.8bn since 2008. Yet British capitalist companies are still failing to invest that cash. The Economist showed that the UK was ranked 159th globally in 2012 when comparing investment as a share of GDP, behind by Paraguay.
But, as Marxist economist Mick Brooks explains (in an email to me – see https://thenextrecession.wordpress.com/2012/08/20/capitalist-crisis-theory-and-practice/), cash reserves are a sum, a stock, accumulated over years. They are not an indication of current profitability. The rate of profit is a flow measured over time. So we need to look at the net asset position of companies – not just their pile of cash and other assets but also their underlying debts and balance the two off against each other. Companies can pay for investment in two ways; by directly investing their own profits or by borrowing and going into debt. In recent years, there has been a tendency for corporations to become more reliant on debt finance. The reason why the ‘credit crunch’ (when bank lending suddenly stopped) had such wide and rapid repercussions on the ‘real economy’ was because firms were head over heels in debt.
US companies are reputed to have a cash mountain of $2trn with another $2trn offshore, according to Edward Luce (Stuck in the mud, Financial Times 13.05.13). This is for both financial and nonfinancial corporations. But, to put this in perspective, America’s GDP is around $15trn. And the corporate debt for nonfinancial corporations alone in the US is 72% of GDP. So cash assets are small compared to corporate debt. Perhaps what is more relevant to our enquiry is not the total indebtedness of a country, or of its nonfinancial firms, but how the total debts of nonfinancial firms stack up against their assets.
However, most mainstream explanations of the conundrum do not draw upon the relationship between profitability, debt and investment. Paul Krugman suggests that investment is lagging profits because a general increase in monopoly power. “The most significant answer, I’d suggest, is the growing importance of monopoly rents: profits that don’t represent returns on investment but instead reflect the value of market dominance,” he wrote. But while more monopolies might explain higher profits with less investment,there is little evidence that monopoly power has risen in the last few years. After all, capital expenditures are low in competitive industries as well.
Another explanation is the post-Keynesian one: namely that high profits are mirrored in reverse by a fall in real incomes and in labour’s share of total national income. Stewart Lansley argues that the sustained squeeze on wages in recent years “sucked out demand”, encouraged debt-fuelled consumption and raised economic risk. (http://www.newleftproject.org/index.php/site/article_comments/wage_led_growth_is_an_economic_imperative).
Austrian school economist Benjamin Higgins reckons that businesses won’t invest because they may be more or less “uncertain about the regime,” by which he means, they are worried that investors’ private property rights in their capital and the income it yields will be attenuated further by government action: regulation, taxation and other controls. In a way, this explanation is similar to that of Michal Kalecki, at the other end of the spectrum of political economy. Kalecki reckoned that full employment and economic recovery under capitalism could not be achieved because capitalists feared government stimulus policies to boost demand through spending and investment would encroach on capitalist power (see his famous essay, The political aspects of full employment (http://courses.umass.edu/econ797a-rpollin/Kalecki–Political%20Aspects%20of%20Full%20Employment.pdf). Capitalists would (irrationally) prefer no recovery to one led by government.
But there is no need for the ‘fear of government’ argument, rational or irrational. It’s not fear of government that stops investment picking up, but the objective reality of low profitability. Cash flow and profits may be up for larger companies, but the rate of profit has not recovered in many capitalist economies, like the UK and Europe.
This argument is backed up by several studies. JP Morgan economists recently made a study of global corporate profitability. They concluded that what they call “profit margins” have fallen in Europe and in emerging economies over the past two years. They also concluded that US profitability has stagnated over the last six quarters, on their measure. JP Morgan’s measure of profitability is not a Marxist one and it is not even a measure of corporate profits against corporate capital. But even so, it does produce a global measure of corporate profitability that shows a fall from near 9% before the Great Recession down to under 4% in the trough of 2009 before recovering to 8% in 2011. But in 2012, it declined again to 7%, 13% below its peak in February 2008 when the Great Recession began. This decline in global profitability was mainly driven by Europe and by a fall in emerging economies. Similarly, my own analysis of profitability as measured by the EU AMECO net rate of return on capital and US data, indexed from 2005 shows the same thing (see my post, https://thenextrecession.wordpress.com/2013/02/25/deleveraging-and-profitability-again/).
The EU Commission has also commented on corporate profitability and investment in Europe. In its Winter Economic Forecast report (2012), it noted that non-residential investment (that excludes households buying houses) as a share of GDP “stands at its lowest level since the mid-1990s”. And the main reason: “a reduced level of profitability”. The report makes the key point that “measures of corporate profits tend to be closely correlated with investment growth” and only companies that don’t need to borrow and are cash-rich can invest – and even they are reluctant. The Commission found that Europe’s profitability “has stayed below pre-crisis levels”.
The EU report also found a “strong negative correlation between changes in investment since the onset of the crisis and pre-crisis debt accumulation, suggesting that the build-up of deleveraging pressures has been an important factor behind investment weakness”. The Commission reckoned that Eurozone corporations must deleverage further by an amount equivalent to 12% of GDP and that such an adjustment spread over five years would reduce corporate investment by a cumulative 1.6% of GDP. Given that gross non-residential investment to GDP is at a low of 12% right now, that’s a sizeable hit to investment growth.
According the Bank for International Settlements (BIS), in its latest annual report of June 2013, the level of debt in the world economy has not fallen much despite the Great Recession. Indeed, the average non-financial debt to GDP ratio for the major developed markets is currently 312% (June 2013) compared to 280% in March 2007. While the household debt ratio has declined from 97% of GDP to 88% now, non-financial corporate debt has risen from 101% to 105% now and government debt has rocketed from 83% to 120%.
The BIS also found that of 33 advanced and emerging economies, 27 have non-financial debt to GDP levels above 130%. Two of those have ratios above 400%, four between 300-400%. Only six have ratios below 130% and only three below 100% of GDP – namely Turkey, Mexico and Indonesia. Of the 33 economies, 18 have rising debt ratios, 11 are flat and only four have falling debt ratios. Of those four, three are in IMF or Troika bailout programmes (Greece, Ireland and Hungary). Only Norway has reduced its overall non-financial debt ratio ‘voluntarily’. Only Mexico and Thailand have reduced their overall debt levels in the last 15 years. Household debt ratios have fallen in some developed markets, including the UK and the US, as well as some peripheral EMU countries. But 27 economies have experienced a rise in private debt-to-GDP ratios since the global financial crisis.
Large multinationals have preferred to invest in emerging economies rather than in the domestic economy. And cash-rich companies have taken advantage of credit-fuelled (QE) stock markets to buy back their own shares rather than invest and boost dividends. In contrast, small businesses cannot invest because they cannot borrow on current terms and many are zombie companies just able to pay the interest on their debt. They have been hoarding labour rather than invest in new equipment and labour saving systems. Overall corporate debt levels just remain too high to allow new investment – paying down debt or holding cash is safer.
The conundrum of rising profits and stagnant investment in productive assets shows that the “recovery” is weak and partly ‘artificial’. It depends much on central bank liquidity injections, which find their way into the financial sector, not the real economy. Until there is a sufficient rise in profitability in the productive sectors and fall in net debt for corporations, private sector investment will continue to fall behind profits and cash piles will rise further and companies hoard rather than invest.