Socialist Economic Bulletin
This negative trend of declining proportion of profits directed towards investment reached crisis proportions in 2008 and is the cause of the slump. As a consequence of the sharp fall in this investment ratio there has been a sharp rise in the both the capital distributed to shareholders and in the growth of a cash hoard held by Non-Financial Corporations (NFCs). This cash hoard is a barrier to recovery, releasing it could be the mechanism for resolving the crisis.
The chart below shows the level of surplus generated by US firms (Gross Operating Surplus) and the level of investment (Gross Fixed Capital Formation) for the whole economy. Since the former are only presented in nominal terms, both variables are presented here in the comparable way.
The nominal increase in profits has not been matched by an increase in nominal investment. In 1971 the investment ratio (GFCF/GoS) was 62%. It peaked in 1979 at 69% but even by 2000 it was still over 61%.
It declined steadily to 56% in 2008. But in 2012 it had declined to just 46%.
In a truly dynamic market economy there is nothing to prevent the investment ratio from exceeding 100% as firms utilise resources greater than their own (borrowing) in order to invest and achieve greater returns.
Therefore even an investment ratio of 69% is sign of a less than vigorous market economy.
However the subsequent decline in the investment ratio to 46% is a sign of enfeeblement. If US firms investment ratio were simply to return to its level of 1979 the nominal increase in investment compared to 2012 levels would be over US$1.5 trillion, approaching 10% of GDP. This would be enough to resolve the current crisis, although it would not prevent the re-emergence of later crises.
Distribution of profits
The uninvested portion of firms’ surplus essentially has only two destinations, either as a a return to the holders of capital (both bondholders and shareholders), or is hoarded in the form of financial assets. In the case of the US and other leading capitalist economies both phenomena have been observed. The nominal returns to capital have risen (even while the investment ratio has fallen) and financial assets including cash balances have also risen. One estimate of the former shows the dividend payout to shareholders doubling in the 8 years to 2012, an increase of US$320bn per annum.
The growth of cash balances is shown in the following data from the Federal Reserve. They are the changes in key balance sheet aggregates for US non-financial corporations from 2008 to Q2 2013.
Change in Balance Sheet Components, US NFCs, 2008 to Q2 2013, US$bn.
|Total net assets (deducting liabilities)||16,656||19,470||2,814|
Source: Federal Reserve
Total assets of US NFCs have risen by nearly US$4trillion over the period which is equivalent to approximately 25% of US GDP. The increase in net assets of US$2.8bn (after accounting for the rise in liabilities over the same period) is more than accounted for by a rise in financial assets of over US$3 trillion.
By comparison the rise in the current cost value of business equipment has been less than one-tenth that (and is accounted for by inflation).
Within the rise of financial assets, cash or near-cash instruments have contributed a rise of nearly $600bn (the biggest single contributor in the accounts is ‘miscellaneous financial assets’).
The same is true in other capitalist economies. In 1995 the investment ratio in the Euro Area was 51.7% and by 2008 it was 53.2%. It fell to 47.1% in 2012. In Britain the investment ratio peaked at 76% in 1975 but by 2008 had fallen to 53%. In 2012 it was just 42.9% (OECD data).
The cash hoards are no less striking. The total deposits of NFCs in the Euro Area rose to €1,763bn in July 2013 of which €1,148bn is overnight deposits. This is a rise of €336bn since January 2008, nearly all of which is in overnight deposits, €306bn. In Britain the rise in NFCs bank deposits has been from £76bn at end 2008 to £419bn by July 2013.
In reality, this extraordinary accumulation of cash by NFCs began well before the immediate depression in 2008, along with the slump in investment. Both of these merit further elaboration elsewhere.
The profitability (profit rate) of US firms and firms in other Western economies has fallen, and even the absolute mass of profits fell for a period in the recession. While the former has not recovered, the latter has. But this has not led to a corresponding rise in investment and the investment ratio has fallen sharply.
The destination of of these uninvested profits is twofold. Owners of capital are in receipt of record payouts. And the financial assets of NFCs have risen dramatically, often primarily cash as firms are unwilling to risk any type of investment.
This hoarded store of capital is both the main impediment to recovery and the potential source of resolving the current phase of the crisis.
We seem to have forgotten (or ignore) so much of what we should already know. Here’s former Chairman of the US Federal Reserve Marriner Eccles talking about the false equivalence of household and government debt in 1938 (p5)*:
“Isn’t it about time that we learned this simple truth? Is it so hard to understand that when an individual owes money he generally owes it to another individual, but when a nation owes money it owes it to itself? When an individual pays a debt, he pays it to someone else. When a nation pays a debt, it pays it to its own people. Now, this doesn’t mean that a nation can go on and on piling up debt or that any amount of expenditure and taxation is justified. The point is that we get into wholly misleading conceptions if we make the old mistake of confusing the matter of individual solvency with the solvency of the nation as a whole. The individual solvency depends upon continued income and living within that income. The nation’s solvency depends upon the productiveness of all of its people. The individual cannot create money. The government can and must as one of its fundamental sovereign functions. Its primary responsibility is to create an adequate supply of that money for the purpose of aiding production. The individual cannot increase his income by taxation. The Government can. In fact, it seems superfluous to pursue further the point that there is no comparability between the case of an individual and the case of a Government.”
And about the way we are mislead about the dangers of government debt (p7):
“I think it is unfortunate to say the least to have public attention misled into becoming alarmed over the wrong things. I very much regret that responsible leaders, however conscientiously, nevertheless mistakenly create public alarm over the solvency of the nation or the soundness of its credit, This is just what they do
when they call attention to one set of facts or figures without showing their relationship to other facts and figures. Isn’t it up to us to keep our eyes on the important things? And what seems to me to be vitally important is that the Government shall do all it can both to create an adequate supply of funds and then to facilitate the flow of funds throughout our economy in the most productive way possible— that is, productive of real wealth.That is what, as I see it, the Government has been attempting to do, often clumsily, awkwardly and ineffectively. I do not suppose anyone has been more critical openly than I have about policies or expenditures that seemed to me to be unproductive or that seemed to me to interfere with production. The point I want to make here is that I do not think it is realistic, or that it helps us to solve the problems before us today, or that it contributes to saving our system or our democracy to work ourselves up into a frenzy over deficits or increases in the debt while at the same time failing to take account of the enormous gains that have been made [In terms of growth of national wealth].”
All the things we hear today about the dangers of debt and deficits have been thoroughly debated and debunked a long time ago, and yet politicians continue to return to these themes when it suits their political purpose. We should be able to see through them by now.
Who caused this Crisis? Not Immigrants, Not Unions, Not “Scroungers”
By Michael Burke
Previously Published by Socialist Economic Bulletin
A crisis is an objective fact to which there can essentially be only two responses. The cause can be identified and addressed, or some other explanation can be advanced which effectively shifts the blame for the crisis elsewhere. The government and the supporters of austerity are increasingly bent on the second course.
A succession of scapegoats have been offered for the crisis, including perniciously both immigrants and ‘scroungers’, and now unions. However, as these cannot begin to provide an economic explanation for the crisis, the supporters of austerity also persistently claim that the cause of the current crisis is weak exports, effectively blaming foreigners for the British crisis.
The reality is very different. The chart below shows the trend of total domestic expenditure in the course of the present slump. This is the same as GDP minus the changes in both imports and exports. In 2008 and 2009 activity fell sharply and was followed by a mild recovery. But since the Tories began to implement austerity the domestic economy has stagnated.
Since the Tory-led Coalition’s Spending Review of 2010 total domestic expenditure has risen by just £864mn. Statistically, in terms of a £1.5 trillion economy, the change in total domestic expenditure has been zero.
By contrast, GDP has risen by €21bn since the Spending Review, or 1.1% in over 2 ½ years. This is driven by a rise in net exports. Exports have risen by £18.1bn since the Tory-led government began implementing austerity. But imports have fallen by £3.2bn over the same period. Arithmetically lower imports count as a positive contribution to growth, but they actually reflect the weakness of the domestic economy.
These totals are shown in the chart below. It should be clear that since austerity began the domestic economy has not grown at all while net exports have risen by £21.3bn. It is Britain which is a drag on the world economy not vice versa.
In terms of the components of total domestic expenditure, the fall in investment is entirely responsible for the continued stagnation of the economy. Investment (Gross Fixed Capital Formation) is the only category of the national accounts which has fallen over the period from the 3rd quarter of 2010 to the 1st quarter of 2013. Investment has fallen by £25.7bn in that time while government spending has risen by £12bn and household spending has risen by £13.2bn.
Far from dealing with the crisis the austerity policy has deepened it. In the preceding slump the decline in investment accounted for most of the fall in GDP, £42bn of a total economic contraction of £45.2bn. Since the imposition of austerity measures investment alone accounts for the slump, as every other component of GDP has risen, government and household spending and net exports.
It remains the case that it is private firms which are driving the slump in investment. But the government’s austerity policy includes a sharp cut in its own investment, which has exacerbated the slump.
Therefore, far from blaming everyone else it is the government’s own policies which have caused the stagnation. The latest scapegoat is the unions, following on from foreigner, immigrants and ‘scroungers’. But it is the austerity policy which has failed.
This has clear lessons too for the incoming Labour government. Only a policy which addresses the real source of the crisis – the collapse in investment – can hope to resolve the crisis. Otherwise the danger is that economic policy makers are left casting around for scapegoats to distract from the failure of these policies.