Why Profits aren't Reinvested, Creating Jobs (in the U.S.)

First read "The Profits-Investment Disconnect" below by Paul Krugman:

I caught a bit of CNBC in the locker room this morning, and they were talking about stock buybacks. Oddly — or maybe not that oddly, given my own experiences with the show — nobody brought up what I would have thought was the obvious question. Profits are very high, so why are companies concluding that they should return cash to stockholders rather than use it to expand their businesses?

After all, we normally think of high profits as a signal: a profitable business is one people should be trying to get into. But right now we see a combination of high profits and sluggish investment :

What’s going on? One possibility, I guess, is that business are holding back because Obama is looking at them funny. But more seriously, 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 rather than returns on capital.

Next, we have a post at Mark Thoma's blog: "Market Power, 'the Profits-Investment Disconnect,' and the Mal-Distribution of Income" which references that post by Paul Krugman. The post below is from a collection of excerpted comments by the readers at Mark Thoma's post.

Why Profits aren't Reinvested and Creating Jobs

If the real job creators are labor and the middle class via their demand for products and services — and not billionaires hoarding idle cash — then four decades of lousy income growth for labor and the middle class would, thus, suppress capital investment. Tax code "reform" that gave capital gains a tax rate break is also bad policy. It just encourages asset stripping and does nothing to encourage real capital investment. All we've done over the past 4 decades is recycle cash amongst the top decile — and most of that amongst the 1 and 0.01 percent, [who have been] living off the capital investments made prior to 1980.

There is a severe disequilibrium between consumption "capital" and investment capital. We have a huge surplus of investment money that cannot find productive investment opportunities at the current level of consumption. When capital owners destroyed the unions and gamed the system to ensure that they would harvest all the benefits of increased productivity, they shot themselves in the foot. The result of this relative starvation of the consumer-class is an economy that is barely growing. The capital owners are still happy because they have yet to realize that the foundation for the value of their assets is dissolving under their feet.

The very rich] don't care how well the island economy is doing as long as they are the richest people on the island. Wealth is a relative value, mostly a positional good after basic needs, and after most exorbitant luxuries have been fulfilled. How do you spend over a billion dollars a year, like the top half dozen hedge fund managers make? Then work your way down from there to the meager millionaire CEOs with only ten to twenty million dollars per year total compensation wages and stock options — and that's why they contribute so little to consumption.

Rich people are not going to create some problem for themselves, see the error of their ways, and change. Power derived from wealth is an addictive drug that drives people mad with paranoid megalomania long after the utility of wealth for conspicuous consumption has been exhausted.

Dean Baker debunks the claims that free markets + tech progress + globalization aren't explicit policy choices.

• Market power bought a high dollar policy from our government.
• Market power bought a policy of not taxing the finance sector, like other sectors, promoting financialization.
• Market power bought free trade agreements that aren't free and forced manufacturing workers to compete unfairly, while retarding developing countries from training doctors, lawyers, (etc.) for themselves and to compete here.
• Market power bought a high unemployment policy, and associated policies against labor support.
• Market power bought a policy of no competition from government in the form of basic banking services from the Post Office, and that MyIra's must be rolled over to Wall Street once you have saved $15,000.
• Market power bought the policies Paul Krugman calls the Treasury View and The Doctrine of Immaculate Transfer.
• Market power bought a policy of tax breaks and extender incentives to offshore, and a policy of outsourcing without accountability.
• Market power bought a policy of shelving promising Ebola drug vaccines for 10 years instead of publicly funding clinical trial for generics with public research and test data.
• Market power bought a no risk retention despite Dodd-Frank this week, for mortgage securitizers, and staved off regulation of TBTF.
• Market power bought the abandonment of other policies like minimum wage, fiscal policy at lower bound (partly Says Law and Treasury View), blindness to the output gap and infrastructure, and education de-investment and inaction on student loans.

Dean Baker: "Why does the media give so much more attention to the jobs we lose due to 'environmental restrictions' rather than to the jobs we lose because of the trade deficit? (offshoring)

For any corporation, there's a tax rate at which using pre-tax profit to fund reinvestment breaks, even with taking profits and incurring the tax. What that rate may be is a matter of speculation for any particular corporation (e.g., depending their cost(s) structure, assessments of market projects of demand, etc.), but it seems to me that corporations think in these terms anyway.

Tax rates below that decision point are incentives to take profits and incur the lower tax [corporate tax rate vs. capital gains tax rate] instead of reinvesting, especially when demand is also low. High tax rates, on the other hand, would be an incentive for reinvestment, inasmuch as pre-tax profit represents an asset that would remain in the company and potentially grow, if used for reinvestment.

Have a look at this historical chart of retail sales over the past decade (Source: TradingEconomics.Com)

What can we read from it?

• Retail sales had a rebound (after the pit-fall) in 2008/2009 somewhat above 5%, closer to 10% initially.
• The pattern has settled down to a 5% increase recently.
• Companies lowered production capacities dramatically during the Great Recession. (Which is why they have such good profit levels presently.)
• They have been able to meet demand with their production capacity expanding only slightly (putting a few more people back to work) — meaning they are getting more "productive work" out of reduced staff levels.

But the next step downwards in unemployment might be the hardest. It is entirely possible that America's long-term unemployment level has changed permanently and dramatically upward one point or so. The unemployment rate could settle into the 5% level long-term, up from lower levels that the country enjoyed previously. The employment-to-population ratio is still stuck way below pre-2008 levels. So, there is a discrepancy between unemployment rate and total employment-to-population rates. Companies are meeting retail demand without the need to expand recruitment all that much. Is this the sort of outlook that seems propitious for substantiating the need of new investment spending?

Maybe our Job Creators will keep Investing in China

New York Times: China Will Keep Growing. Just Ask the Soviets:

China is a long-term economic juggernaut that will stand astride the global economy in another generation’s time ... Official forecasts — from international agencies to US intelligence circles — envision China continuing to grow rapidly over the next couple of decades, its economy eventually becoming much larger than that of the United States ... One forecast for 2040: Chinese economic output would be $123 trillion — about seven times the current size of the American economy — and three times the forecast for the United States in 2040. China’s experience from 1977 to 2010 already holds the distinction of being the only instance, quite possibly in the history of mankind, with "sustained super-rapid growth" for more than 32 years ... There are enormous implications for the global economy’s future. If China’s per capita G.D.P. kept growing from now until 2033 at the same rate as it has in recent decades, the country’s annual economic output would rise by $51.1 trillion over current levels in present-day dollars ... To put that in context, the current gross domestic product of the United States is about $17 trillion.

Now in 2014...