Do Businesses Borrow to Invest in Productive Assets? Does the Business-Interest Tax Deduction Encourage That?
J.W. Mason at The Slack Wire gives us a telling and trenchant analysis of that question:
Short answer: They used to, but not any more. The correlation in the U.S. between fixed-capital investment and a) debt levels and b) change in debt levels has been vanishingly small since the late eighties.
…in the 1960s and 70s, a firm that was borrowing heavily also tended to be investing a lot, and vice versa; but after 1985, that was much less true.
It’s gotten really bad lately:
Regressing nonfinancial corporate borrowing on stock buybacks for the period 2005-2010 yields a coefficient not significantly different from 1.0, with an r-squared of 0.98.
As CEOs and their cronies have moved from being business-runners to financial arbitrageurs,*
…the marginal dollar borrowed by a nonfinancial business in this period was simply handed on to shareholders, without funding any productive expenditure at all.
This goes far in explaining an amazing fact about Dell, recently revealed by Floyd Norris:
It has spent more money on share repurchases than it earned throughout its life as a public company.
This is not an anomaly. Floyd pointed out to us some time ago that:
From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S.& P. 500 — generally the largest companies in the country — reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares.
As a group, shareholders were paid about $200 billion more than their companies earned.
Floyd’s post is aptly titled “Easy Loans Financed Dividends” (and buybacks).
I would take issue with one seemingly judicious caveat in JW’s piece:
It is quite possible that for small businesses, disruptions in credit supply did have significant effects.
Based on one piece of evidence that I’ve cited repeatedly, not so. Here from December 2009 (follow “Related Links” for more discussion and evidence):
Small businesses consistently put financing and interest rates at the very bottom or near-bottom of their lists of business constraints. That has been true for many years [almost three decades now...], it was true throughout the recent crisis, and it remains true at this very moment.
It really makes a fellow wonder: given all the (sensible) talk about ending the mortgage interest deduction for homeowners, why we aren’t hearing a similar quantity of talk about ending all interest deductions — especially the money-funnel sweetheart deal for the rich that is the business-interest deduction?
Anyone thinking we’ve become a Great Stagnation, or wondering why?
* JW describes that shift from businessperson to financial prestidigitator more fully (emphasis mine):
In the era of the Chandler-Galbraith corporation, payouts to shareholders were a quasi-fixed cost, not so different from bond payments. The effective residual claimants of corporate earnings were managers who, sociologically, were identified with the firm and pursued survival and growth objectives rather than profit maximization. Under these conditions, internal funds were lower cost than external funds, as Minsky, writing in this epoch, emphasized. So firms only turned to external finance once lower-cost internal funds were exhausted, meaning that in general, only those firms with exceptionally high investment demand borrowed heavily; this explains the strong correlation between borrowing and investment.
But since the shareholder revolution of the 1980s, this no longer really holds; shareholders have been much more effective in making their status as residual claimants effective, meaning that the opportunity cost of investing out of internal funds is no longer much lower than investing out of external funds. It’s no longer much easier for managers to convince shareholders to let the firm keep more of its earnings, than to convince bankers to let it have a loan.
Cross-posted at Asymptosis.