Is capitalism devouring itself? It’s an argument that people have been making since Karl Marx’s time. But an increasing number of non-Marxists are now starting to argue that there might now be something in the idea.
In a recent BBC interview, Andy Haldane, the Bank of England’s free-thinking chief economist, suggested that listed businesses have been returning an excessive amount of their cash flow to shareholders, rather than investing the money. By reducing their future productive capacity, these companies “are almost eating themselves”. He also suggested that this underinvestment by listed firms is part of the explanation for “subpar” global economic growth in recent years.
Hillary Clinton, who is running once again for US President, said something similar in New York last week, when she warned about the short-termism of American businesses, which spend too much cash buying back their own shares. “It is clear that the system is out of balance,” she told an audience at New York University.
And it’s not a view limited to Democrat politicians and maverick central bankers such as Mr Haldane. Larry Fink, the head of the giant American fund manager BlackRock, is another critic of corporate share buybacks that come “at the expense of building long-term value”. In April, Mr Fink wrote to the bosses of America’s 500 biggest companies urging them to stop fixating on short-term results.
This represents something of a vindication for the veteran City of London economist, Andrew Smithers, who has been making this argument about chronic under-investment by publicly listed firms for many years. Mr Smithers blames the way managements are remunerated, stressing that executives’ bonuses are nowadays usually linked to “return on equity” and share price. Buying back shares using free cash flow reduces the level of that equity, thus artificially boosting both returns and bonuses.
Ms Clinton, Mr Haldane and Mr Fink seem to see buybacks are a consequence of the preferences of short-termist shareholders, rather than managements’ incentives. Ms Clinton proposes reforming US capital gains taxes to incentivise longer-term holding of shares, while Mr Haldane moots reforms of UK company law, which would better balance the interests of shareholders with those of other “stakeholders” in a business’s success.
Yet before a debate on the best corrective surgery can begin, it’s vital to question whether the thesis itself stands up to scrutiny. Are returns to shareholders really crowding out corporate investment?
It’s certainly true that investment as a share of GDP has fallen in most developed countries (see first chart) since 1980, and buybacks have become much more common in the US and the UK. The second chart shows the ratio of corporate cash spent on investment to cash spent on investment in America, indicating a substantial decline since the 1970s. Data for the UK does not show such an extreme trend. But buybacks are undoubtedly more common here than they were 35 years ago.
There is some evidence buybacks might be crowding out investment. A 2004 survey of American firms found a majority of managers questioned would not proceed with a profitable long-term project if it meant that the firm would miss the consensus forecast of profits in a given quarter. A 2014 study that examined the behaviour of both listed and private US firms found the listed firms invest substantially less, especially in industries in which the share price is most sensitive to earnings news.
John Kay’s landmark review of UK equity markets for the Coalition government in 2012 concluded that short-termism among shareholders and company managers is a problem. One of its recommendations was an end to mandatory quarterly reporting, to encourage managers to take a longer view.
One objection to the underinvestment thesis is that capital investment has become cheaper in recent decades, meaning firms simply don’t need to spend so much to boost their capacity. The argument goes that the era when capital expenditure meant commissioning the construction of an expensive new production line is over. Investment now might just as easily be in a revolutionary new piece of software, or slicker design.
Some of the biggest share buybacks in recent years have been by US tech firms. Apple, Microsoft and IBM have accumulated huge cash piles. But what are they supposed to spend the money on? Apple is not a conservative company. If Tim Cook and his team saw a promising opportunity to invest, wouldn’t they seize it?
But while that may be true for some firms, it’s unlikely to hold for all. The International Monetary Fund recently dismissed the idea that aggregate shortfalls in capital investment relative to expectations before the financial crisis are due to the falling price of capital goods. However, it should be noted that the IMF does not back up the shareholder capitalism analysis. Instead, the Fund’s economists concluded investment weakness is primarily due to weak consumption demand, rather than the incentives affecting managements.
Perhaps the strongest objection to the crowding-out thesis is that Germany and Japan, which are home to the kind of “long-termist” and “stakeholder” models of capitalism that Mr Haldane and Ms Clinton favour, have also seen investment trending down as a share of GDP over the past three decades.
More empirical research is required. Yet the critics of the shareholder-dominated model of capitalism have asked an important question. And if global corporate investment continues to fall short of hopes, the more adherents their ex-planation is likely to attract.Reuse content