Why is U.S. corporate investment not more robust?

by on July 25, 2013 at 3:07 am in Economics | Permalink

Here is an excellent FT survey article on that question, by Robin Harding.  It may be gated for many of you, in any case this part is worth reproducing:

But perhaps the most remarkable result comes from newly available data on private companies studied by Alexander Ljungqvist and colleagues at Harvard and New York University. They find that, keeping company size and industry constant, private US companies invest nearly twice as much as those listed on the stock market: 6.8 per cent of total assets versus just 3.7 per cent.

Private companies are four times more responsive to new investment opportunities and, when a private company goes public, it changes its behaviour.

Mr Ljungqvist says he has not examined the effect of this difference on overall investment in the economy. Given the size of the S&P 500, however, investment might be percentage points of GDP higher if its members invested like private companies.

A few other points:

1. How non-residential investment looks depends a great deal on whether you consider the gross or net figure.  The net figure is much lower because computer equipment depreciates quite rapidly.

2. We may be undercounting intangible investment, as discussed in the article.

3. Amazon is one company which invests a great deal, yet it is not obvious they are making profits from such investments.

4. Apple is constrained in its investments, and for a good while has been insanely profitable.  Of course this may not last so very much longer.

5. Paul Krugman discusses monopoly rents and investment here.

The full article is here, I hope you can read it, high quality throughout.

prior_approval July 25, 2013 at 3:47 am

Amazon is playing a long game – their investments are intended to ensure that no competitor can afford to compete with them.

A strategy which just may pay off, as Amazon is about the only survivor from the very first wave of ‘pure’ Internet investment in the mid-90s. A strategy which has entwined a not insignificant portion of the current commercial web into relying on Amazon for revenue (affiliate links are certainly worth thousands of dollars a year to web sites that continually play up their Amazon affiliation – instapundit or little green footballs comes to mind), much like that same commercial web relies on Google.

Andrew` July 25, 2013 at 5:17 am

Yes, tis the question.

Peter Schaeffer July 26, 2013 at 3:07 pm

PA,

“Amazon is playing a long game”

+1

That’s certainly my impression as well. Amazon is strikingly successful across a wide range of internet domains. Apple is justifiably famous for reinventing itself via the iPod, iPhone, iPad, etc. with less fanfare Amazon has transcended it’s original business.

Amazon has relentlessly moved into new online categories, frequently with quite favorable results. How many people know that Amazon dominates cloud computing via EC2/S3? 2012 revenues exceeded $60 billion (3X 2008 revenues).

Shane M July 25, 2013 at 3:55 am

Is it possible public firms are increasingly outsourcing investment to private firms – who then sell to the public firms once the startup phase transitions into the mature phase? Instead of becoming a forum for capitalists to raise money – are the public markets now a way to cash out?

Ashwin Parameswaran July 25, 2013 at 4:00 am

As the FT article highlights, what is striking is the emphasis on low-risk cost-reducing innovation and the neglect of high-risk exploratory innovation.

This investment ‘deficit’ has been with us since the 80s at least and the obvious explanation is the increasingly crony capitalist nature of our economy. To quote from an earlier post of mine:

“The cause of the investment deficit is an increasingly financialised, cronyist, demosclerotic system where incumbent corporates do not face competitive pressure to engage in risky exploratory investment.”

More at http://www.macroresilience.com/2011/12/07/the-great-recession-business-investment-and-crony-capitalism/

Frederic Mari July 25, 2013 at 6:49 am

Very interesting. I have the same intuitions ( http://theredbanker.blogspot.com/2012/11/the-true-lessons-of-recession-really.html or http://theredbanker.blogspot.com/2013/03/refreshing-macro-part-4-profit-matters.html ) but you put it better.

Do you mind if I re-posted your article on my blog (with links and references, of course)?

Asdf July 25, 2013 at 4:28 am

One of the things libertarians never figured out was the difference between entrepreneur-owners and managerialism (what all large companies are run on). There is this mental image of the large company as the small scaled up, maybe with some acknowledgement of a little principal agent problem. This is about as big an understatement as they come. Large human institutions are operating in a qualitatively different way then small ones. It’s often hard to call it capitalism in the noble producer bringing his goods to market sense. The economics of managerialism require an entirely different perspective. From the managerial perspective low r&d makes perfect sense.

Rahul July 25, 2013 at 5:09 am

This is a huge point. I don’t think going public matters so much as just the scale of things. At a certain size the overheads of the principal agent problem blow up into components that are critically large.

In my personal experience it was surprising how early these overheads start becoming huge. Even in modest sized firms (~1000 employees) the waste is huge. In a large company, only a fraction of the managerial time goes into activities helping the bottom-line. A big chunk of time is spent in protecting turfs, expanding domains and budgets and generally doing activities that ensure personal survival than truly helping the firm.

I don’t know any feasible alternative though.

Ray Lopez July 26, 2013 at 2:21 am

But the study by Asker et al. account for size, they factor it in (“First, private firms grow substantially faster than public ones, holding firm size and industry constant”), so size does not matter. However, given that there are far more (seems to me) public large firms than private large firms, perhaps there is a subtle built-in bias against big firms in the Asker et al study, meaning that as firms get bigger, they become more conservative, depending on market power rather than innovation to get ahead, and this is why you see less innovation. The few large private firms (Cargill? Koch Industries?) are outliers to this ‘large firm’ bias.

As for why large firms have more fat–one managerial theory is that large firm over-hire, so when it becomes time for a replacement of an in-house position, they can ‘hire from within’ rather than hiring an outsider who does not understand their business. I personally don’t believe this is true, but I’ve heard corporate apologists make it.

As for innovation decreasing since the 1970s, blame it on our patent system which doesn’t reward innovation sufficiently, and on hippie culture IMO.

Andrew` July 25, 2013 at 5:16 am

You sure it’s libertarians who don’t get it?

Brian Donohue July 25, 2013 at 9:02 am

Yeah. Why are libertarians singled out for not understanding agency and governance issues? Doesn’t public choice theory grow out of this perspective? By all means, let’s talk about principal-agent problems and how they are being addressed in ALL spheres.

anon July 25, 2013 at 10:12 am

+1

This resembles the attempt by many non-libertarians to equate libertarian’s belief in free markets freedom of association with pro-business, especially pro-big business, and pro-crony capitalism.

Asdf, this quiz might help:
http://www.bcaplan.com/cgi-bin/purity.cgi

Also see this chart:
http://pbs.twimg.com/media/BDP6uytCMAAzH1V.jpg:large

Z July 25, 2013 at 7:28 am

This is a huge point. Maybe some libertarians get it, but it is never at the top of their list of talking points. They certainly have a romantic view of business that does not comport with reality. Conservative Inc. is the worst offender. They carry on about big business as it all of them started in a basement and were developed through nothing but hard work. The truth is, most of our large multinationals are nothing more than money laundering operations.

NPW July 25, 2013 at 8:29 am

And liberals never get that this applies tenfold to large governments.

Rahul July 25, 2013 at 8:38 am

I’d say both are true.

Though the inefficiency of one is not as often recognized.

Frederic Mari July 25, 2013 at 8:41 am

A friend of mine was fond of proposing to dissolve every big entity, private, public or governmental every 15 years to escape the problem of regulatory capture, rent-seeking and turf warfare at the expense of the bottom-line.

Not realistic (and he knew it) but definitely on to something… :)

derek July 25, 2013 at 9:40 am

Imagine if 2008 had been left to run it’s course. The financial industry would look much different, the insurance industry, auto industry. GE gone. It seems that the market agrees with your friend. Damn libertarians.

Andrew' July 25, 2013 at 9:22 am

In the early oughts it was a semi-official plank to make small business the key constituency of the National Libertarian Party because of their lack of representation by the other two parties.

Tom West July 25, 2013 at 10:18 am

Well, I have to say, I’ve not heard a lot about “private choice” :-).

steve July 25, 2013 at 10:31 am

I disagree. Libertarians do understand that many businesses become inefficient due to size or poor management. In a laze-faire economy. these companies go broke.

It is the non-libertarians who don’t seem to get that the crony capitalism that allows such firms to survive for decades past their usefulness today is not what Libertarians champion.

asdf July 25, 2013 at 2:14 pm

“In a laze-faire economy. these companies go broke.”

Is this true? Seems like an assumption. I’m not just talking about government bail outs (though the obvious and predictable political power large organizations have make such political outcomes likely, and thus this represents a political economy failure of libertarian thought which assumes away politics and classic human behavior). Several industries seems like natural oligopolies. Maybe its economies of scale. Maybe its an industry based on winner take all network effects. Whatever the reasons it can describe a lot of large industries.

Take my own industry of insurance. Its dominated by a few large players. There is no such thing as someone starting up an insurance company in their garage. It takes lots of capital and employees to make even a modest start. And if you are successful you end up being a big company that likely has all the same inefficiencies and pathologies of whomever you replaced.

It may be that the only economic equilibrium in such an industry is large inefficient companies operating in a semi oligopoly. However, if that is the case we can at least drop the moral dimension that the people managing these monstrosities are heroic Randian producers instead of private sector politicians climbing the social ladders of big companies that don’t compete in any meaningful way but rather trend toward some level of loosely agreed upon mediocrity.

Maurice de Sully July 25, 2013 at 3:01 pm

There are thousands of insurance companies int he US and the five biggest players- combined- soak up only about 1/3 of the total premiums written yearly in the US (according to NAICS.)

I think your underlying point is interesting- and its not totally inapplicable to the insurance market- but it’s not the best the best industry to make the point you seem to be making. Modernly, I can see a varied insurance market with lots of consumer options in a market driven economy. Certain other markets (energy) make the possibility of legitmate choice much more difficult IMO.

Andrew' July 25, 2013 at 3:13 pm

Huh?

Still with the strawman arguments against libertarians for which you don’t even provide any straw.

The likes of Chuck Schumer has been running the joint, so what the hell are you talking about?

steve July 25, 2013 at 5:01 pm

The only example I can think of for a natural oligopy is a limited natural resource. If you own the diamond mine, you can’t be kicked off in a libertarian society no matter how inefficient you become.

However, in the long run, even these companies face competition from substitutes generated through the market. Synthetic diamonds for example.

JWatts July 25, 2013 at 5:24 pm

though the obvious and predictable political power large organizations have make such political outcomes likely, and thus this represents a political economy failure of libertarian thought which assumes away politics and classic human behavior

I think you need to actually read what some Libertarian’s write. Libertarian’s are pretty strongly against such political outcomes. I don’t think you’ll find any Libertarian support for the GM & Chrysler bailouts or the Financial bailouts, etc. The Libertarian response was generally along the lines that those companies should go bankrupt and be restructured or the assets sold off to their competitors.

we can at least drop the moral dimension that the people managing these monstrosities are heroic Randian producers

That’s pretty much a strawman argument. Libertarian’s aren’t lionizing giant corporations as heroic producers Randian or otherwise.

asdf July 25, 2013 at 8:27 pm

Sully,

Your statistic misses the point. Let’s take individual health insurance because I dealt with that. In my state the local blue rakes in 70% of the market. Add in the next couple and you’ve basically got the entire market.

Now, you statistic would say something like: well, this other company is getting a lot of P&C premiums, so nobody controls the entire “insurance” market. But that’s silly. These are totally different insurance products/markets. Within products and markets there often isn’t much competition with a few players capturing nearly the whole thing.

Here are some nationwide statistics for HMOI/PPO coverage. This is only the top player. If you expanded to the top three you’ld be close to batting 1.000.

In In 96 percent (299) of the MSAs, at least one insurer
has a combined HMO/PPO market share of 30 percent
or greater.

In In 64 percent (200) of the MSAs, at least one insurer
has a combined HMO/PPO market share of 50 percent
or greater.

In In 24 percent (74) of the MSAs, at least one insurer
has a combined HMO/PPO market share of 70 percent
or greater.

asdf July 25, 2013 at 8:33 pm

JWatts,

Being against something, if its to be meaningful, means actually understanding why things happen and then taking steps to make sure they don’t happen.

Once these companies got so large and powerful it was inevitable they would influence government. Trying to say no after the fact, when you know saying no wont stop anything once its in motion, is a hollow gesture.

It would be like if you gave a bunch of fireworks and matches to a 10 year old and then left them unsupervised. Then when the kid blows his arm off you give a strong speech about how your against blowing your arm off. Meanwhile, if your actually anti arm getting blown off then you shouldn’t have given him the fireworks and matches in the first place. Just like you shouldn’t allow giant companies to reach the point where they can wield inordinate influence.

bill July 25, 2013 at 7:00 pm

OK Z so they are Big money money laundering Operations so that means they are Criminal organizations not Businesses. So whats your point when people want to bash libertarians . they always bring up corrupt Businesses.
I have never heard a libertarian condone Crime. But that is how those without an argument frame the discussion.
The truth is Libertarian , Capitalist or Socialist systems all work fine if we can keep the corrupt criminals from
Running the show.
So far were all doing pretty bad at controlling them they run the Government the businesses and everything else. I would like to see us all begin to address the Sociopath problem we have in most big institutions.
If we could address that problem we might find all these systems work fine and people could choose based on personality type which system they would like to be a part of.
So far nothing works very good for long cause the Sociopaths seem to rise to the top of any large organization

Turkey Vulture July 25, 2013 at 8:43 am

I think there are many libertarian-type folks who are skeptical of big business for many of them same reasons they are skeptical of big government.

mpowell July 25, 2013 at 11:33 am

This is fine and all (though this isn’t the best way to criticize libertarians, imop), but the study actually found a difference between public and private firms. So you have to explain that. I’d say it’s due to the influence of Wall Street and the CFO. Long term investment doesn’t look good in the next several quarters and this is what drives public companies. Most important investment is R&D wages and you can’t defer the accounting cost as you can with capital equipment. If you consider the way a public company evaluates external acquisition decisions and internal investment, you can see that they use wildly different expected rates of return. That doesn’t make sense for a privately owned company.

asdf July 25, 2013 at 2:15 pm

Public companies are managerial entities. Private firms, especially if they have a primary entrepreneur-owner who actually manages it, operate in a qualitatively different manner.

ThomasH July 25, 2013 at 5:46 am

Did the article not even consider tight (low ngdp target) monetary policy?

Brian Donohue July 25, 2013 at 9:11 am

Krugman needs a refresher in Industrial Organization. The welfare outcomes for a dominant firm are quite a bit different from a monopolist.

And I think it’s time for an exploration of a word thrown around a lot by both sides but with, I think, different definitions: rent.

What Krugman calls ‘rent’, Buffett would call a ‘moat’. It’s what we all crave- some measure of reliability/predictability against the vicissitudes of life. It’s why employees prefer fixed wages to being independent contractors. It seems to me there are good and bad moats.

msgkings July 25, 2013 at 3:55 pm

Very good comment.

JWatts July 25, 2013 at 5:44 pm

What Krugman calls ‘rent’, Buffett would call a ‘moat’.

+2, that seems exactly right. There’s nothing wrong with ‘rent’ if it’s a result of out performing your competitors.

And Krugman’s comment:
consider the differences between the iconic companies of two different eras: General Motors in the 1950s and 1960s, and Apple today.

Immediately makes me think of the famous comment to a Senate committee by GM’s president who was being nominated as Secretary of Defense: “What was good for the country was good for General Motors and vice versa” …”At the time, GM was one of the largest employers in the world – only Soviet state industries employed more people. In 1955, General Motors became the first American corporation to pay taxes of over $1 billion.”

http://en.wikipedia.org/wiki/History_of_General_Motors

That seems to represent a company with plenty of Economic rent. Indeed, does anyone really thing that General Motor’s in 1955 was in a more competitive market than Apple is today. Once again, Krugman makes a facile comment that is badly misleading.

errorr July 25, 2013 at 6:34 pm

A moat isn’t quite a rent but more a potential for rent. This is the Amazon model. Make of the world and moat but people fear that once it exists it can become a rent through monopolistic power.

Brian Donohue July 25, 2013 at 6:54 pm

Here’s a question: is it appropriate to envision a spectrum, at one end of which are interchangeable commodities and at the other end of which are The Indispensibles?

Nobody wants to be on the left end of the spectrum.

Mebbe we’re all rent-seekers.

Upon reflection, of course we are.

Brian Donohue July 25, 2013 at 7:01 pm

Yup. Is Apple anywhere near as ‘entrenched’ as GM was? 1% of the nation’s workforce? Holy crap. Only a Krugman or a Bork would think that was healthy and a Good Thing.

Microsoft/Intel is arguably the least transient ‘monopoly’ we’ve seen come down the pike. Turns out, they’re not a Destroyer of Worlds, but closer to a high-tech utility. And they’re shrinking in relative terms daily…yawn.

R Richard Schweitzer July 25, 2013 at 11:15 am

In large sectors of the “developed” economies we are looking at the one of the principal effects of separation of **control** from **beneficial ownership** of major enterprises.

Beneficial ownership is now “filtered” through layers of **managerial activities** such as investment fund management’s, pension fund management’s and other forms of in direct ownership requiring managerial functions and administration.

The major productive enterprises which are “publicly owned” are directed by managerial structures which control not only the applications of the productive assets, but, more importantly, the redeployment of surpluses (“profits”) from production and distribution. The representation of the interests of the beneficial owners is largely conducted through the other managerial structures of investment funds, pension funds and other collectives.

Thus, the disparate motivational characteristics extant within the several managerial structures have replaced the former motivational characteristics of direct ownership. We are in the age of *Managerial Capitalism.

Despite the disparate motivational characteristics of the different managerial structures, and despite the reasons for those differences, there is plausible evidence of the symbiotic relationship amongst the actual managers within those structures. That symbiosis probably results from the adjustments of activities and authorities in order to accommodate and mitigate any conflicting interests. Nevertheless some conflicts do reach the point of causing specific actions which directly affect the courses of enterprises.

These observations are not novel. The great classic:

“The Modern Corporation and Private Property” by Berle and Means

was first published in 1932 and last revised in 1967.

In the US we are seeing the development of some possible innovations such as Private Equity and Berkshire Hathaway as formats which eliminate some layers of management and place a new substitute for beneficial ownership to oversee managerial motivations. This tends to bring managerial motivations into better of alignment with the interests of beneficial ownership.

Students of the evolution of Western Civilization can observe the effects of the processes which determine the disposition or redeployment of surpluses that result in the expansion, stagnation or decline of civilizations. Unfortunately, this broader view concerning the disposition of surpluses is generally lost in the concentration upon specific current economic conditions.

Joe Smith July 25, 2013 at 11:54 am

“Apple is constrained in its investments”

Which is why it should just repatriate the profits, pay the US taxes and then pay out a humongous dividend.

collin July 25, 2013 at 1:03 pm

What if the modern economy needs less traditional “investment” in terms of building factories and capital stock? For a lot firms there true investment is R&D which is covered often by cash.Even if you did take into account Foxconn investment for Apple manufacturing, I bet the investment portion of Apple would still be way below GM of yesteryear. . Or is that China is forceing so much investment in their country, other coutnries don’t need to spend the investment?

Devin Lavelle July 25, 2013 at 2:29 pm

On point 1, wouldn’t that only be an issue if, for some reason, publicly held companies were investing significantly more in computers than privately held companies? Since they are accounting for size and industry, that seems unlikely, no?

Engineer July 25, 2013 at 4:22 pm

* Amazon is undoubtedly seeing big revenues and market share from AWS and the Kindle. They could probably make bigger profits but Bezos prefers market share. If Amazon hadn’t created the Kindle we would all be using Apple’s Ibooks instead, so if nothing else the Kindle was a brilliant defensive move.

* In tech the preference has been to let the VCs and startups do the real innovation, and then the big guys swoop in once the concept has been proven. IANAE, but to what extent does SarbOx encourage this?

* These days the VCs are focusing on comparatively cheap stuff like mobile apps. Again does SarbOx affect this?

AADL July 25, 2013 at 4:53 pm

There is no such thing as “market power,” nor are there monopoly rents on the market. They are a product of government-granted monopolies, such as occupational licensure, patents, copyrights, etc. Nor is Apple a monopolist; but the government runs one, the USPS. See Rothbard, Man, Economy, and State; and Power and Market.
Mainstream microeconomics is worse than useless on this subject. I have flipped through a number of mainsteam texts, and don’t recall seeing any actual firms discussed within the context of monopoly and “market power.”
Monopoly should be renamed crookopoly. Nixon would have understood it….

Tan S. Taafl July 25, 2013 at 5:31 pm

I am not sure what to make of all this research like the Ljungquist piece that shows that privately owned companies are outperforming listed companies. Assume we know that home-cooking is better and healthier than eating in restaurants. But at the same time the pool of those who cook at home and do it well is limited. Thus people who want to eat their Saltimbocca or Boeuf Stroganoff and cannot cook themselves, have to go to a restaurant. The same applies to entrepreneurship and investing: With a limited number of entrepreneurs and private investors, who can identify and fund entrepreneurs, we need to have public companies. There may be need for reforms here and there, but at the end the agency problems of companies with a widely dispersed ownership cannot be avoided I guess.

Floccina July 25, 2013 at 10:43 pm

Is apple really that different from Mercedes Benz?

ChrisA July 26, 2013 at 2:33 am

Undoubtedly a selection bias issue. Only firms that are sufficient mature and stable can list on the stock exchange. Mature and stable companies do not need as much investment.

mulp July 26, 2013 at 6:06 pm

Amazon is not mature and stable enough yet to be listed on the stock market?

The constant criticism of Amazon has been Amazon spends more on capital than its net revenue. That was the criticism before it IPOd, That was the criticism five years after it IPOd. And that is the criticism in 2012.

It can show a profit even with negative cash flow because its capital depreciation is so large.

If you look at the entire iXxxx value chain, the capital costs have exceeded net revenue for about a decade. So, if Apple is generating $1 a week in excess cash, where is all the capital investment? In China mostly in Foxconn.

Foxconn pays for all the capital required to bring Apple products to market and manufacture them, but Foxconn owns all the manufacturing so it is still earning money on capital investment for Apple from a decade ago because Apple’s volume is so much higher. But on top of that, Foxconn can take obsolete factories for Apple, and use them for making products for Apple’s low end competitor substitutes.

Amazon, and Google, are more like the merger of Apple and Foxconn.

I believe Amazon makes more money from selling services to competitors to the Amazon retail operation. If you want to sell books in competition with Amazon, it is easy to setup a store using Amazon, then have Amazon connect you to customers, and then you can have Amazon do the order fulfillment.

To compete with Apple, you need to figure out how to work with Foxconn who will only work with you if they see long term profit in the relationship – they don’t offer the Apple special sauce like Amazon offers competitors the Amazon month old sauce.

The market cap of Apple is based on the net revenue of Apple’s special sauce as long as it remains special, so it must be constantly getting more special – add cinnamon, now nutmeg, now ginger, now brandy, now hot pepper. As soon as you can buy Apple sauce anywhere that is almost as good, Apple’s market cap heads toward zero. Foxconn just keeps growing in capital assets, net revenue, and market cap as long as the market for the stuff it makes for everyone from Apple to Microsoft to Amazon… keeps growing. If the iPhone can’t be improved on and every competitor matches it, Foxconn does very well because lower retail prices will mean more sales until everyone on the planet has a smart phone and the sales rate falls to replacement.

And Amazon will keep growing as long as it is growing its capital assets that run the economy.

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