Wednesday, July 26, 2017

Profitability and investment again – the AMECO data

by Michael Roberts

Recently, Larry Elliott, the economics correspondent of the British liberal newspaper, The Guardian raised again the puzzle of the gap between rising corporate profits and stagnant corporate investment in the major capitalist economies. Elliott put it “The multinational companies that bankroll the WEF’s annual meeting in Davos are awash with cash. Profits are strong. The return on capital is the best it has been for the best part of two decades. Yet investment is weak. Companies would rather save their cash or hand it back to shareholders than put it to work.”

Why was this?  Elliott posed some possibilities: “corporate caution is that businesses think bad times are just around the corner”, but as Elliott pointed out the hoarding of corporate cash was “going on well before Brexit became an issue and it affects all western capitalist countries, not just Britain.” So he considered other reasons that have been raised before: “cutting-edge companies need less physical capital than they did in the past and more money in the bank unless somebody comes along with a takeover bid” or that “the people running companies are dominated by short-term performance targets and the need to keep shareholders sweet”.

So company managers use the cash to buy back their shares or pay out large dividends rather than invest in new technology. “Shareholder value maximisation has certainly delivered for the top 1%. They own 40% of the US stock market and benefit from the dividend payouts, and the share buybacks that drive prices higher on Wall Street. Those running companies, also members of the 1%, have remuneration packages loaded up with stock options, so they too get richer as the company share price goes up.”

There is some element of truth in all these possible explanations for ‘the gap’ between corporate earnings and investment that opened up in the early 2000s.  But I don’t think that corporate investment is abnormally low relative to cash flow or profits.  The reason for low business investment is simpler: lower profitability relative to the existing capital invested and the perceived likely returns for the majority of corporations.

I have dealt with this issue before in previous posts and in debate with other Marxist economists who deny the role of profitability in directing the level of corporate investment and, ultimately growth in production in the major capitalist economies.

The point is that the mass of profits is not the same as profitability and in most major economies, profitability (as measured against the stock of capital invested) has not returned to the levels seen before the Great Recession or at the end of neoliberal period with the crash in 2000.

And the high leveraging of debt by corporations before the crisis started is acting as a disincentive to invest and/or borrow more to invest, even for companies with sizeable amounts of cash. Corporations have used their cash to pay down debt, buy back their shares and boost share prices, or increase dividends and continue to pay large bonuses (in the financial sector) rather than invest in productive equipment, structures or innovations.

For example, look at the UK’s corporate sector.  Sure the mass of profits in non-financial corporations has jumped from $40bn a quarter in 2000 to £85bn now.  And it may be true that “the return on capital is the best it has been for the best part of two decades”, as Elliott claims.  But it is all relative.  The rate of return on UK capital invested has dropped from a peak of 14% in 1997 to 11.5% now.  Profitability recovered after the Great Recession trough of 9.5% in 2009 but it is still below the peak prior to the crash of 12.3% in 2006.  And UK profitability has stagnated since 2014, prior to Brexit.

Thus it should be no surprise that UK businesses have stopped investing in productive capital.

It’s the same story in the US, where not only is the average profitability of US corporations falling, but so are total profits in the non-financial sector.  Profit margins (profits as a share of non-financial corporate sales) measure the profit gained for each increase in output and these have been falling for some quarters.

And more recently, total profits in non-financial corporations have been contracting.

So again, it is no surprise that business investment is also contracting among US corporations.

I have dealt before with the argument that Elliott offers again that companies are “awash with cash”.
First, it is only a small minority of very large companies like Apple, Amazon, Microsoft etc that have large cash hoards.  The majority of companies do not have such hoards and indeed have increased levels of corporate debt.  And there is a sizeable and growing minority that have profits only sufficient to service their debt interest with none left for expansion and productive investment.  According to the Bank for International Settlements, the share of these ‘zombie’ companies has climbed to over 10%: “the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates”.

But perhaps the most compelling support for my argument that weak business investment in the major capitalist economies is the result of low profitability is some new evidence that I have gleaned from the EU’s AMECO statistical database. finance/ameco/user/serie/ SelectSerie.cfm

Based on the simple Marxist formula for the rate of profit of capital s/c+v, where s= surplus value and c= constant capital and v= variable capital, I used the following AMECO categories.  s = Net national income (UVNN) less employee compensation (UWCD); c = Net capital stock (OKND) inflated to current prices by (PVGD); v = employee compensation (UWCD).  From these data series, I calculated the rate of profit for each of the major capitalist economies.

Of course, the AMECO categories do not match proper Marxist categories for many reasons.  But they do give cross-comparisons, unlike national statistics.  And my results seem reasonably robust when compared with national data calculations.  For example, when I compared the net rate of return on capital for the US using the AMECO data and Anwar Shaikh’s more ‘Marxist’ measure for the rate of profit in US corporations for 1997-2011, I found similar peaks and troughs and turning points.

The results for profitability in the major capitalist economies, using the AMECO data, confirm that the rate of profit is lower than in 1999 in all economies, except Germany and Japan.  Japan, by the way, still has the lowest rate of profit of all the major economies.  Indeed, the level of the rate of profit is highest in the UK, Italy and an enlarged EU (which includes Sweden and Eastern Europe), while the lowest rate of profit is in the US and Japan.

All countries suffered a severe slump in profitability during the Great Recession, as you might expect.  Then profitability recovered somewhat after 2009. But, with the exception of Japan, all economies have lower rates of profit in 2016 than in 2007, and by some considerable margins.  And in the last two years, profitability has fallen in nearly all economies, including Japan.
The table below shows the percentage change in the level of the rate of profit for different periods.

So the AMECO data show that profitability is still historically low and is now falling. No wonder business investment in productive capital has remained weak since the end of the neo-liberal period (graph below for the US) and now is even falling in some economies.

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