Did Paul Krugman commit the Junker fallacy?

It’s possible that sluggish business investment reflects lack of confidence in the economic outlook –… that’s understandable given the bursting of the housing bubble…But…there is a more disturbing possibility.  Instead of investing in physical capital, many companies are using profits to buy back their own stock.

Here are longer excerpts.  Of course stock buy-backs do not take away resources for subsequent investment.  The money used to buy shares can still be funneled into the purchase of capital goods, as no real opportunities have been taken off the table. 

That said, cash "in the firm" is more likely to be invested than "cash in the hands of investors," for reasons of credit rationing and other institutional rigidities (for instance borrowing money brings more outside scrutiny).  Given the size and profitability of these firms, however, I do not expect that the credit rationing effect is a large one.  The causes of the sluggishness of investment are thus to be found elsewhere than through this financial mechanism.

Here is my earlier post on the Junker fallacy.  I believe this sort of argument was first criticized by Fritz Machlup in his book on the stock market.  Of course if you wish to save the claim through various second best arguments, comments are open…


Comments for this post are closed