A quick lesson about basic finance. There are just three types of investment: ownership, lending, and cash or cash equivalents AKA stock, bonds, and cash equivalents. The cost of running a business, the part that most of us consider business investment, is included under the “ownership investment” category.
In recent years business investment has been flat. It’s proceeding at more or less a constant rate. I don’t have the statistics at the tip of my fingers to prove this but I believe that only a very small proportion of that investment has been in the cost of running a business and most has been in in the form of financial instruments or cash. Maybe one of my readers can do a better job than I at evaluating that.
That’s been my gripe for the last fifteen years. Investing in the financial economy and just leaving the money in financial instruments or cash does next to nothing for the real economy, the part that makes and sells things and employs people. It’s good for the financial sector but for the rest of us not so much.
The good thing about the tax reform that’s just been signed into law is that it might attract some of that cash, much of which is being held overseas, back into the United States and into the real economy. I wish that more effort had been expended in ensuring that was the case but I guess that half a loaf is better than none.
Doesn’t the removal of limitations on full-expensing, necessarily mean that businesses will increase business spending? If it doesn’t then the rule wasn’t serving any purpose anyway (or the five year sunset is too short to change much behavior).
Well, using the corporate finance definition of investment there are only two forms: equity and lending. Stock is evidence and the terms of ownership. Bonds are evidence and the terms of lending. Holding cash is not investment. Formally, the textbook definition of investment in the corporate finance sense is committing cash in the expectation of receiving future net cash flow(s) and with the risk or reward that the net cash flows will materialize and the original cash investment amount will increase or decrease in value.
I think it best to think of business investment as capital for expansion, efficiency (cost/productivity), quality or as replacement for the naturally depreciating capital base. It can be an offensive or defensive move. With that preamble…..
I assume the point of the blogpost is that businesses are not investing in the stuff in paragraph 2 at the desired rate. The usual boogyman is the “financialization” of the economy or investment in unrelated securities, rather than the core business.
Why would business investment be low, or declining? Because one day a guy from the finance staff at an oil company lost his mind and decided to recommend cutting back on pumps, valves and drill bits and start investing in futures and options? I don’t think so. (And let’s be real – oil exploration is risky, but investing in cattle futures is really risky and should be left to the professionals………….like Hillary Clinton.) I’ve got a few ideas:
– the capital intensity of the economy is declining. Steel, paper and chemicals companies invest, over the long haul, about 4-5% of sales in capital. Assembly companies less. Service companies generally even less. And guess what, if the American steel mill is shut down and China and India are making bar stock instead USX then you don’t need Liquid Air to build an air separation plant next to the BOF shop. And you don’t need lathes or heat treat facilities or machine tools to grind rolling mill dies, spindles etc etc. Its neat to talk about financialization, but the relative growth in services and the onslaught of manufactured imports doesn’t help.
– demand. I’ve been saying it for 9-10 years here, now. Show me demand, or the prospects for demand, and I’ll show you investment. People talk about financialization as just money trading hands. But the money doesn’t vaporize. Quite a few people see value here – because they pay for it voluntarily. Woudth that the same view of government was held. Talk about money just changing hands. And how efficiently? And for what? Other than the millionth Robert Byrd building, how much capital investment is generated by government vs the private sector?
– risk/reward. Why am I going to spend my, or my shareholders, money when I’ve got some yahoo in the White House talking about spreading the gains around and numbskulls from NY and CA wanting a cut of the action in taxes if, that is, I can get through the regulatory minefield and make the investment pan out?
So what have many corporations been doing in response? Investing in other corporations. That’s called mergers and acquisitions. And stock buybacks. That’s called disinvestment, or return of capital. In the recent environment it would almost be malpractice for large corporations to not do that. Let’s take my hypothetical oil exploration company. What do you want them to do, start a video game or social media company, or return capital? I’ve been telling you guys this. And what else do they do? They buy monopoly power from politicians. That’s regulatory capture, and pay for play……. But I’ll make anyone a bet. Compare the capital investment figures of large corporate to the increase in the balance sheet account called cash and securities. It won’t be close.
And as for small business owners – they’ve been buying bigger houses, cashing out to private equity guys, joining a third country club. I’ve been telling you guys for 9 years that so many are already rich; they don’t need to put up with this crap and take on the risk and aggravation of building the new warehouse. They gave Obama the investment finger.
What will happen now? Some reinvestment. Some fresh investment. Some dividend increases and stock buybacks. Some to employees. The mix? No one knows. But its better than it was.
It’s not low demand.
Personal consumption expenditures:
IMO “the capital intensity of the economy is declining” can be said another way. Managers are avoiding sectors (other than health care which is seen as a sure thing) that require capital investment in favor of sectors that require lower capital investment. That in turn is another way of saying that managers have become more risk averse than previously.
That other major economies, e.g. Germany, Japan, have a much lower dependence on PCE than we do is another indicator. In other words managers in those places are investing more than American managers are.
I think that manager preference plays a role, too. People tend to do what they’ve been trained to do. Far more managers are trained to be financiers than was the case 50 years ago and the rewards are higher due to changes in the tax code.
As to cash, Apple, Microsoft, Google, Cisco, and Oracle are sitting on an unprecedented amount of cash—about $2 trillion. Low inflation means that they see cash as safer than actual investment.
A lot of that cash is being held overseas which is why I’ve been pushing for corporate income tax reform. We’re getting some of that in the bill that was just signed into law.
This thread is fading into the past. But it’s an interesting subject with many facets. Worthy of future posts.
– Which came first, more managers trained in finance, or an economy more suited to finance majors than process engineers? As a guy with degrees and work experience in both, I would say the latter.
– “Managers are avoiding sectors (other than health care which is seen as a sure thing) that require capital investment in favor of sectors that require lower capital investment.” That is contra to your “do what you know” observation. Further, I think they are just following the growth, not attempting to dictate growth, or hoping for growth, through their capex decisions.
– which brings me to the graph, which we have all seen. Lower GDP is undeniable. And that’s final sales. It’s also intertwined with the mix issue. Like I said, you don’t need an air separation plant if you aren’t blowing oxygen into a BOF furnace, but rather are giving haircuts and providing sports or music entertainment.
GDP is rising at a slower rate than 30 years ago because of reduced business investment and government spending as a proportion of GDP not because of lower PCE. See here:
The demand that has decreased is the demand from business.