In his Wall Street Journal column today Joseph Sternberg asks the question I have been asking for over a decade. Of the factors that produce growth the factor that is lagging is business investment. Where’s the business investment?
Net private fixed investment (expenditures on equipment, machinery or property minus depreciation) averaged around 8% of gross domestic product between 1947 and 1990, with significant spikes during booms—it hit 10% of GDP under Ronald Reagan. It has lagged since then, however. As of late 2018, amid another burst of GDP growth, net investment was barely half the Reagan level.
The low net-investment baseline Mr. Trump inherited (from Republican and Democratic predecessors alike) doesn’t fully explain today’s shortfall. Despite faster growth, investment has not accelerated under Mr. Trump as much as during past periods of economic strength. Net investment grew by 8% in 2006, 10.9% in 1998 and 16.7% in 1984—the peaks of those business cycles. Mr. Trump managed investment growth of only 6.9% in 2018 and the rate is drifting downward again, not least thanks to Mr. Trump’s antitrade policies.
There is a direct causal connection between low business investment and low productivity gains. Labor productivity increases when businesses invest. I had hoped that the reduction in corporate income taxes would have spurred an increase investment and for a while there that’s just what happened. But my hopes were dashed in the last quarter of 2018 and since. Once again business investment has not risen as it should.
I think the lesson is pretty clear. Executive compensation needs to be tied to earnings not to stock values and that’s especially true when we have a Federal Reserve that’s determined to subsidize the stock market. Over the last couple of decades stock prices have become unmoored from corporate earnings and we need to undo the Clinton Administration’s regulations on executive compensation. We shouldn’t care how high executive compensation increases as long as it’s based on things we care about, i.e. earnings not stock prices. If we want to regulate something it should be to limit the percentage of earnings that can be devoted to executive compensation rather than discouraging investment.
I mean if your compensation is rising anyway, why take the risk of investing?
There is another possibility and that is that we have lost the ability to measure business investment. If that’s the case we are also unable to measure gross domestic product. I don’t think that’s the case and if we had heretofore unmeasured Reagan era levels of business investment I think it would feel more like a business boom than it does but at least it should be mentioned.
[…] If we want to regulate something it should be to limit the percentage of earnings that can be devoted to executive compensation rather than discouraging investment.
Using government to determine economic outcomes is a bad idea. Companies should pay income tax because they use, directly or indirectly) public goods and services. Individuals should pay income tax because they use, directly or indirectly) public goods and services.
Likewise, deductions and exemptions should be eliminated, along with the progressive tax scheme. All income, no matter the source, should be taxed. The 1% would not be able to exclude any money, but “soaking the rich” would cause pain for the 99%, as well.
Homeowners will be taxed the same as renters, and donating money will be rewarded in heaven, not on earth.
In a financialized economy, ROI is maximized by investing in the production of financial goods and services. Producing an auto loan is more profitable than producing an automobile, and an automobile manufacturer could increase overall profit as long as the vehicle loan profit exceeds the vehicle manufacture losses.
In 1993 changes to the deductibility of executive pay caused companies to compensate executives more with stock options than with direct pay which in turn led to the present situation. I am merely arguing for a return to the status quo ante.
I understand, but I doubt there can be any return. If a modernized G-S were created, it might be possible, but it might not. I think it is more likely that new schemes would be devised.
The government will never be able to “outfox the fox”.
Tis is going to sound like I just went to a management meeting ( I did) but I think the culture around management has changed. Maximizing short term profits is now accepted as the cultural norm for large businesses. Making sure that you (management) look after yourself, even at the expense of screwing the employees is now accepted behavior. Until that changes I dont think we are likely to see investment on a large scale again, barring some tech breakthrough.
Of course I could be wrong. I am always amazed at the cost of managing IT. For what we spent on IT the last few years we could have built new hospitals. I wonder if some of that potential investment money is sneaking into IT somehow?
Steve
This notion that all you have to do is let public valuations expand and ride the wave to executive compensation has an analog in private equity. Its simply known as multiple expansion.
In 25 years I have never, ever seen, heard of or advocated as a board member/owner retarding EBITDA enhancing capacity or productivity capital investment in favor of riding the wave. Ever. In the three publicly traded companies I worked for earlier in my career I, similarly, know of no such advocacy. Its always driven by demand estimates, competitive requirements and resource availability and allocation.
In my opinion observers who claim this to be the case are simply projecting their own biases onto management and boards. It shows no understanding of an investors mentality, and if examples are available they are most assuredly a tiny minority.
I should have noted that we, as partners, and all of our senior managers, are compensated by equity gain. No one talks about riding waves. No one who wants to remain employed.
The late Dan Rostenkowski used to say “Don’t take a bribe; just hand them your business card.” That things are not spoken of does not constitute proof that they are not being done.
Additionally, I don’t think the greatest problem is in the small to medium-sized companies you deal with. I think it’s in the big companies.
Dave, I think that when you use the word ‘earnings’ you really mean ‘profits’ or perhaps even ‘after tax profits’. Earnings can be manipulated to ensure large executive compensation packages, a la Fannie Mae and Freddie Mac, or by burning through your inventory by selling it at a loss. Either way it’s an eventual loser for the firm, but if the executive in question believes he can pass the buck while keeping the compensation, it’s a winning strategy for him personally.