Why has investment been weak?

by on December 29, 2017 at 2:30 am in Economics | Permalink

Germán Gutiérrez and Thomas Philippon have a new paper on this topic:

We analyze private fixed investment in the U.S. over the past 30 years. We show that investment is weak relative to measures of profitability and valuation — particularly Tobin’s Q, and that this weakness starts in the early 2000’s. There are two broad categories of explanations: theories that predict low investment along with low Q, and theories that predict low investment despite high Q. We argue that the data does not support the first category, and we focus on the second one. We use industry-level and firm-level data to test whether under-investment relative to Q is driven by (i) financial frictions, (ii) changes in the nature and/or localization of investment (due to the rise of intangibles, globalization, etc), (iii) decreased competition (due to technology, regulation or common ownership), or (iv) tightened governance and/or increased short-termism. We do not find support for theories based on risk premia, financial constraints, safe asset scarcity, or regulation. We find some support for globalization; and strong support for the intangibles, competition and short-termism/governance hypotheses. We estimate that the rise of intangibles explains 25-35% of the drop in investment; while Concentration and Governance explain the rest. Industries with more concentration and more common ownership invest less, even after controlling for current market conditions and intangibles. Within each industryyear, the investment gap is driven by firms owned by quasi-indexers and located in industries with more concentration and more common ownership. These firms return a disproportionate amount of free cash flows to shareholders. Lastly, we show that standard growth-accounting decompositions may not be able to identify the rise in markups.

On the road I have yet to read it, but it looks like one of the most important papers of the year.

1 JSK020 December 29, 2017 at 3:01 am

Seems to overturn the much stated assumption here that increased industry concentration isnt a problem. who wudda thunk it?

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2 Tyler Cowen December 29, 2017 at 9:11 am

At least based on the abstract, they seem to think that dividend payments mean no investment, recently John Cochrane has dealt with that mistake.

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3 sk December 29, 2017 at 1:27 pm

with most companies barely if even earning their WAAC investment for the sake of investment is hardly a good thing

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4 Dots December 29, 2017 at 6:31 am

Corporate governance seems like the easiest lever, no? Burn the Icahns, even if u cant achieve Germán-style worker council participación

Can gov cut deals with biz that spare monopolists from breakup but compel them to invest/research?

Seems like monopolists combine revenue security, scale, and scope enjoyed by gov with better resistance to kludge and capture by employees. But understandable they need fire under butts if laurels presently cushion them. Put Coke, Pepsi, Apple, and comcast to work!

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5 rayward December 29, 2017 at 7:17 am

Finally! James Tobin was one of America’s greatest economists, and his examination of weak investment in productive capital and the depressed rate of return to productive capital since 1980 is mostly ignored because many of today’s economists prefer myths to reality. Based on this study by Gutierrez and Philippon, I am not confident that the corporate tax cut will provide much help. Indeed, China has already responded with a tax cut of its own: https://www.nytimes.com/2017/12/28/business/tax-bill-china.html

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6 rayward December 29, 2017 at 7:42 am

America’s highly developed capital markets facilitate the most efficient allocation of a scarce resource, capital. That’s the theory, and the rationalization of today’s largest investment funds for their strategy for selecting investments. Many of the largest investment funds are replacing analysts with computer engineers and quants. How do they select investments? I assume by identifying and exploiting market anomalies. Does that allocate capital to sectors or companies with the highest rate of return? Does that allocate capital to productive capital (plant and equipment), the kind of investment that increases productivity and economic growth? Read the article linked in my comment above. China isn’t simply providing a corporate tax cut, China is directing capital to specific sectors, to productive capital in those sectors. No, I don’t prefer government favoring or disfavoring particular sectors or companies, I prefer markets to allocate capital. But I don’t worship at the alter of markets because markets are a false God.

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7 derek December 29, 2017 at 9:33 am

Short termism and quasi-indexers mean pension fund investments. No risk but steady high return. The easiest way to do that in the moderate term is to bleed the company dry. Sell assets, profitable ones preferably to get a bundle of cash.

Or go offshore.

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8 ʕ•ᴥ•ʔ December 29, 2017 at 10:02 am

I doubt economy wide measure of investment can tell us anything useful. Boring run of the mill companies probably improved their website in 2017, maybe bought a few efficiency improvements. But transformational technologies never come from run of the mill companies. They come from the sort of outliers which never show up in averages.

AirBnB was and is tiny, but the impact it will ultimately have on things like the timeshare industry is massive.

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9 P Burgos December 29, 2017 at 4:41 pm

But will it have any impact on investment? My recollection was that investment, as jargon for economist, was specifically referring to plant and equipment, and sometimes intangibles or goodwill on the books of companies. Don’t get me wrong, using existing assets more intensively should drive up productivity to some extent and that is a good thing, but that isn’t the same thing as investment.

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10 Philo December 29, 2017 at 10:44 am

“These firms return a disproportionate amount of free cash flows to shareholders.” And what do the shareholders do with the cash–maybe *invest* it?

The analysis looks to be superficial and short-sighted.

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11 ʕ•ᴥ•ʔ December 29, 2017 at 10:50 am

If the money just chases itself in index funds, expanding PEs, without as much tangible investment, that becomes a “too much financialization” argument.

Still having trouble wrapping my head around “average investment” though.

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12 Nate F December 29, 2017 at 10:53 am

I’d go with a mix of a lot, but the IT investment is hard to quantify.

Where I work, a lot of productivity improvement (our “capital”) is improved policies and procedures and project management system that is near open source levels of free. At a previous job they had the same thing but spent far more to get it (they used a more expensive system that was worse in my opinion).

Plus a lot of Millennials are spending a large chunk of their cash on debt payments and not spending. That’s a transfer from an age group with a high propensity to spend to one that has a low propensity to spend.

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13 Sebastian H December 29, 2017 at 12:05 pm

This is why the idea that the corporate tax break will lead to more or higher paying jobs seems unlikely. Corporate America is sitting on some of the largest cash reserves ever. If they were going to invest more or pay more, they could have done it last year, or the year before.

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14 spencer December 29, 2017 at 12:26 pm

Maybe the problem is cheap labor — both domestically and foreign.

Because labor is cheap firms do not need to invest in equipment to make their employees more productive.

So we are getting a more labor intensive economy where over the last few years, growth in net capital spending per employee has been negative. Since this is a major driving force behind productivity growth it seems obvious to me that we are not going to see an improvement in productivity growth.

This is the major fallacy behind the libertarian belief that cheap labor is the answer to almost every problem.

Cheap labor leads to less investment and weaker growth–PERIOD.

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15 TallDave December 29, 2017 at 5:53 pm

Because of THEM. You know who I mean.

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