New theory for why companies sit on ungodly piles of cash

By Max Ehrenfreund, The Washington Post

It’s is one of the most important yet least understood sources of ordinary Americans’ economic frustration: U.S. companies aren’t investing as much as they used to.

When corporations don’t invest or invest less, they put fewer people to work building factories, making equipment and conducting research. But investment has slumped in recent years, and researchers say there isn’t any obvious or consensus reason for the investment slowdown.

Now, two economists at New York University, Germán Gutiérrez and Thomas Philippon, think they might have at least a partial explanation. In a paper published this week by the National Bureau of Economic Research, they argue that increasing concentration of economic power in the hands of relatively few behemoth corporations — in some cases to the point where companies enjoy a near monopoly — could explain the pattern: The big firms, unconcerned about their competitors, simply have no need to invest in staying ahead.

“It explains a big chunk of why investment is low in the U.S. today,” Philippon said.

In separate research, the two economists found that market power has not become more concentrated in Europe. As a result, European markets are now more competitive than those in the United States — a remarkable shift in a country where free markets have long been not just a point of pride, but also a priority for national economic policy. “It’s a complete reversal,” Philippon said. “The U.S. has always been the more pro-competition place, but it’s not true any more.”

Whether other experts will agree that the lack of competition accounts for the lethargic pace of investment remains to be seen. Some economists feel there might be other reasons that investment has been so slow. For instance, new technologies might allow companies to earn impressive profits without putting in much money.

“The data’s not completely dispositive at this point,” said Janice Eberly, an economist at Northwestern University. “I don’t think they’ve entirely ruled out other explanations, but it’s very intriguing.”

Corporations raise the overall level of economic activity when they spend money. Corporate investment is also an important source of technological progress, as firms learn how to produce more kinds of products more efficiently. That makes everyone better off.

Mysteriously, though, investment has slowed. The shortfall amounts to roughly a tenth of the total amount of private capital invested in the economy, Gutiérrez and Philippon write.

Instead of investing, corporations have been paying more money out to Wall Street by issuing dividends and repurchasing shares.

For decades, U.S. corporations typically paid out no more than 4 percent of their total assets, Gutiérrez and Philippon have found. These days, 6 percent is typical, and in 2007, corporations paid out 7 percent.

More troubling, economists are not sure why corporations are not investing. One possibility is that there simply are not many opportunities to make money. In an aging population, fewer young people are spending money on cars, houses, televisions and other goods, so corporations do not have the same expanding market they did in the past.

While the 20th century was a period of rapid technological progress, some economists warn that progress may be running its course, and fewer important new inventions and discoveries remain. Perhaps corporations are not investing because they do not have as many chances to develop and market new things.

Gutiérrez and Philippon are skeptical of these arguments, however. They point out that according to a common indicator of future corporate profitability based on stock prices, investors are very optimistic about the future for U.S. firms.

Instead, they argue that “a significant part” of the shortfall in corporate investment is due to the fact that fewer and fewer corporations control more and more of the American market.

For instance, one commonly used measure of concentration roughly doubled between 1985 and 2015, Gutiérrez and Philippon estimate. Meanwhile, the number of firms that open or close their doors in any given year has steadily declined.

During the Reagan administration, around 11 percent of existing establishments would close up shop in a typical year. More recently, the figure has been between 8 percent and 9 percent. Those figures suggest that the competition in American capitalism is not as fierce as it used to be.

If a firm has many rivals, investments in better quality or cheaper production could pay major dividends by allowing the business to undercut its rivals. When consumers have fewer choices, firms do not have to improve their prices or their products to win customers, and investing is less attractive financially.

Economists have long theorized that declining competition and more consolidation could explain some of what’s wrong with corporate investment and the U.S. economy.

“This kind of divergence — in which high profits don’t signal high returns to investment — is what you’d expect if a lot of those profits reflect monopoly power,” liberal economist Paul Krugman wrote in the New York Times in 2014.

Gutiérrez and Philippon are the first to present hard evidence supporting this theory, although their case is not necessarily conclusive.

They found that firms in more competitive industries also tend to invest more. On the other hand, it could simply be that there is more competition and more investment in those sectors because there are better opportunities for turning a profit — not because the competition is forcing them to invest.

To rule out that possibility, Gutiérrez and Philippon looked back to the Clinton administration, an exuberant time when entrepreneurs were starting up new firms all over the country and intensifying competition.

In Silicon Valley, venture capitalists were throwing around cash — $100 billion in 2000, for instance — but the enthusiasm was not limited to technology. Gutiérrez and Philippon cite research showing that to some degree, bubbles affected seven out of 10 sectors in the Standard & Poor’s 500-stock index during that time.

All the excitement resulted in new firms and increased competition (as well as corporate investment) for years to come in those sectors. They were not, however, any more profitable over the long term. That fact suggests that competition on its own — and not just the hope of profits — can force companies to invest more.