Martin Wolf pointed towards corporations as one of the culprits of the savings glut. The savings glut is described by an excess of desired savings over desired investment. In the FT he writes,
Since the crisis, the corporate sectors of the big high-income economies have run surpluses of savings over investment, with the exception of France. The surplus savings of Japanese corporations are, amazingly, close to 8 per cent of gross domestic product. The corporate sectors have therefore contributed substantially to the savings glut.
Martin Wolf gives the reason for this phenomenon as arising from ageing and globalisation. In a previous post, I have also commented on why investment from companies might be lethargic, and furthered an idea from Ashok Rao, which is that the hurdle rates might be too high. From the post,
It was found that these hurdle rates are, on average, 400 basis points higher than the reported WACCs.
The real question then is whether managers are correct in their reluctance to invest. A look at capacity utilization suggests that they may be:
Capacity utilisation is still recovering and far from its peaks. At the same time nominal GDP growth remains very weak, which directly translates into dampened sales growth expectations.
Alongside with increased international competition, it is therefore rational for managers not to over-invest because this could lead to ruinous price competition. On top of this, research has shown that broad market ownership by large asset managers and in particular index trackers creates incentives against fierce competition and in favour of aggregate profit maximization (just short of outright collusion).
This idea is not far apart from the S-s theory formed by Herbert Scarf, which is described by Timothy Taylor in his blog,
Basically, the idea is that firms and stores don’t re-order more supplies every day. They re-order it in batches. They wait until the quantity on hand falls to some lower level s, and then place an order for a fixed amount which raises the quantity on hand up to the higher level S. The theory of how far apart s and S should be will depend on various measures of volatility and risk.
It turns out that the (S, s) theory isn’t just about business inventories. More broadly, it’s a theory about how economic agents make decisions when there are costs of adjustment, which can often lead to a situation where there are long periods where nothing much seems to happen, followed by sharp changes.
For example, this pattern often arises in business investment of many kinds, in hiring and firing decision by firms, in consumer purchases of big durables like cars and houses, and even in small-scale decisions like taking a larger fixed amount of cash out of the ATM machine, rather than going by the machine every time you need $20. It further turns out that these sharp and lumpy changes can be related to overall macroeconomic business cycles.
Although the demand is there, the perceived gain from the demand is not large enough to overcome the degree of uncertainty (and therefore the feared unpredictable loss) prevalent in the business environment today. Companies will not invest until and unless there is a substantial boost in demand or an impressive reduction in uncertainty.
From Sarah Gordon in the FT,
Deloitte, which has just analysed the views of 2,000 chief financial officers in 15 European countries, says confidence and risk appetite fell further in the past six months. It found the region’s CFOs were concerned about global economic, market and currency weakness, as well as geopolitical instability.
Two-thirds of CFOs surveyed said there was a high level of uncertainty facing their business, up from 60 per cent in the first quarter and — despite continuing high gross cash balances, only 41 per cent expected their companies to increase capital expenditure in the next year.
It therefore seems that the solution would be to reduce the fear stemming from the uncertainty, but how?
Providing a form of insurance for failed investments would be a radical suggestion, but then this gives rise to fraud and agency problems. Alternatively, companies could offer more vendor financing to encourage demand, but I’m not sure whether more household debt is the answer.
More mainstream solutions could involve macro prudential policy, or maybe to follow Larry Summers’ suggestion of smart tax reform and to discourage destructive activism by shareholders. He said recently, “We’re caught in a vicious cycle. Incomes are too low, therefore investments are too low. … We need to get out of that cycle”.