Investment Versus Consumption

Casey Mulligan has emerged from his eerie to tell us that the emphasis on consumption, and especially the emphasis by Keynesian economists on consumption, is just missing the boat. The real issue is investment. If only we would encourage investment the economy would roar back to life; jobs would be abundant; and your lilacs would bloom earlier than ever before.

This despite the piles of unused cash sitting on corporate balance sheets.

This despite Alan Greenspan’s apoplexy over the aversion of business towards illiquid assets. That’s Greenspan speak for factories and so forth, i.e. stuff you can’t sell in a hurry.

As I see it the right wing economists who parade under the banner of orthodoxy are stuck with a really bad argument. They want to disparage the notion that consumption is a problem in its own right, rather than being a mere symptom of a deeper issue. Yet they have no explanation for why business is apparently willing to sit on piles and piles of cash instead of investing it.

Oh wait. They do know why: it’s the government stupid. Or as they would prefer: it’s the stupid government.

It’s always the government that mucks things up in the right wing economist narrative. Never their beloved private sector.

This is, in my view, rubbish.Not just that, but it illustrates why the very economists who laud capitalism so much fail to understand it very well.

The economy right now is experiencing a period of very low interest rates. No news there. That means that businesses can borrow at very low rates. Their cost of capital is low. They have piles of cash. So the rate of return a project has to return to them is also very low. That means that the profit a new investment has to make before it gets approved and returns a positive cash flow to the business is equally low. Yet businesses are not making such investments. They are preferring to sit on piles of cash earning even less. They are foregoing profit opportunity. As Greenspan points out they prefer liquid to illiquid assets.

Why?

This is the crux of the debate.

The right wingers claim that it is unpredictable government intervention and high prospective taxes that hold business back. The current high debt levels imply high future taxes, and so eat into those profits on new investment and make it difficult to identify the return required bothy to pay those higher taxes and to meet an adequate return on equity.

This is as if large corporations paid taxes.

And it is as if they are not able to plan around the problem. It is just not plausible that business cannot make money from all that cash when interest rates are as low as they are. The marginal impact of future tax increases could not possibly undermine every single potential investment. Some, perhaps. Very few I would wager.

Given those animal spirits we laud so much in our business class, these are the folks who ran straight aground in the high tech and real estate bubbles despite a mine load of evidence they were being stupid, I find it beyond belief that they are not gung-ho to make a quick buck any way they can. Isn’t that why they are paid enormous bonuses? They are profit driven even if it means taking on risk. Heck, their greatness is supposed to be their willingness to charge ahead an innovate, take risks, and bask in the subsequent glory.

I assume they lost that skill.

They must have done if they cannot borrow at today’s rates and make money somehow. Most of the big companies don’t even need to borrow: they just need to be willing to become illiquid. Horrid though though that may be. For the right winger orthodoxy to stand scrutiny our entire business class has to be frozen with fear, and incapable of taking risk to make a profit. Apparently government policy is one risk too far. All the other risks are small by comparison.

Mulligan always seems to make the same point: we need to encourage investment. It’s the supply side we need to address. So the switch from consumption to higher savings is not a bad thing for him. That reduced consumption has less of a proportionate impact than the offsetting rise in investment does. Remember that savings and investment equal one another. So when savings goes up, so does investment. At least theoretically. And since investment is a much smaller number in total than consumption, each extra dollar added to it has a bigger proportional impact. Thus, to Mulligan, it is investment that needs a boost since it will have a larger marginal impact on activity and thus jobs.

And this is where we keep going in circles: the cash available for investment is high already. It isn’t being used.

You can get a headache from this circularity.

An alternative view, one that I find more persuasive, is that business cannot see making a profit from ramping up investment, despite the low capital costs they are facing? Why? Because consumers aren’t buying as much as before. Demand is less, even prospectively, than is necessary to entice business to loosen its purse strings. With weak sales forecasts there is no incentive for business to live up to the right wing dream. On the contrary, the easy way to make profit at the moment is to keep costs under control, maintain a hiring freeze, and deploy current resources more effectively. That means keeping a lid on wages and using overtime and current facilities. Expansion is just not needed to play that game. At least near term. Plus, as we all know, the economy is still awash with spare capacity. Mulligan doesn’t seem willing to explain why a business would build a new factory if it has one sitting idle. Invoking government intervention surely cannot explain that.

The capitalist concern is to make profits, not, necessarily,to invest.

The problem is one of philosophy. When you build a utopian theory and then try to use it as a basis for policy prescriptions, it runs afoul of the muckiness of the real world. Perfectly obvious explanations in utopia are revealed to be less than convincing here on earth where motivations and expectations can be contradictory, and less than ideal. Businesses may not be rational in the intense meaning of that word within right wing orthodoxy, but they are sensible, and they are motivated by profit. Were there a buck to be made, someone would be trying. That they are not, at least in sufficient numbers, tells me that the deeper root of our economic malaise is not the lack of investable funds, but the lack of investable opportunities.

And to me that means demand needs a boost. Consumption is the laggard right now. Not investment.