Corporate savings

Dead money

Cash has been piling up on companies’ balance-sheets since before the crisis

Nov 3rd 2012

MONETARY stimulus gets you only so far. In America, third-quarter profits and revenues for companies in the S&P 500 index appear to have fallen year on year for the first time since 2009, according to Thomson Reuters. Profits for roughly half the firms in the European Stoxx 600 have fallen short of expectations so far.

Companies in search of a culprit may want to glance in the mirror. Firms are trimming their budgets for everything from technology-consulting services to semiconductor equipment in the face of what Sir Martin Sorrell of WPP, a British advertising and marketing giant, calls four “grey swans” (unlike black swans, people know about grey ones). The four worries unnerving business are: the euro-zone crisis; upheaval in the Middle East; a possible recession in China; and America’s economic health and “fiscal cliff”—the combination of tax increases and spending cuts scheduled to occur at the end of this year.
This is not a new problem. Investment has steadily risen since the recession ended, but not as vigorously as profits. In America, for example, nominal capital expenditure this year (on an annualised basis) has risen by 6% compared with 2007; internal cash flow is up by 32%. Companies have been net suppliers, instead of users, of funds to the rest of the economy since 2008. Firms in the S&P 500 held roughly $900 billion of cash at the end of June, according to Thomson Reuters, down a bit from a year earlier but still 40% up on 2008.

Business leaders and conservative critics cite that cash mountain as proof that meddlesome federal regulations and America’s high corporate-tax rate is locking up cash and depressing investment. But that cannot explain why the same phenomenon prevails worldwide. Japanese companies’ liquid assets have soared by around 75% since 2007, to $2.8 trillion, according to ISI Group, a broker. Cash stockpiles have continued to grow in Britain and Canada, too, to the immense frustration of policymakers there.

Dead money” is how Mark Carney, the Bank of Canada’s governor, has described the nearly $300 billion in cash Canadian companies now hold, 25% more than in 2008. Mr Carney admonished them to “put money to work and if they can’t think of what to do with it, they should give it back to their shareholders.”

No single factor seems to explain companies’ high savings. The Bank of England notes that natural-resource companies account for a disproportionate share of the cash build-up. That may reflect the boom in commodities prices and the paucity of promising new sources of supply.

Low interest rates have reduced borrowing costs, adding roughly a percentage point to American profit margins, according to BCA Research. (Yet rock-bottom interest rates also make it less attractive to hold cash.) The financial crisis has made firms more skittish about relying on banks or securities markets for funds. Since questions were raised in 2008 about the ability of General Electric’s finance arm to fund itself, the company has been stockpiling cash: $85 billion at the end of the third quarter, the most in the S&P 500.

A rapid reversal is unlikely. That’s because rising corporate saving has deeper roots than the crisis, the commodities boom or this interest-rate cycle. In a recent study Loukas Karabarbounis and Brent Neiman at the University of Chicago found that across 51 countries they examined between 1975 and 2007, companies’ share of private saving rose in aggregate by 20 percentage points. In countries where corporate saving rose, labour’s share of GDP in the corporate sector shrank, by five percentage points in aggregate.

Mr Karabarbounis and Mr Neiman link both rising corporate saving and labour’s shrinking share of GDP to a fall in the relative price of investment goods that began in the early 1980s. That drop may be down to the plunging cost of computing, or to the shift in capital-goods production towards lower-wage developing countries, or both.

Whatever the reason, firms have responded by substituting away from labour and towards capital, and by more than textbook economic models imply. And to finance this investment companies have steadily boosted saving over time. (Just as households can save each year and take out a mortgage, that does not mean firms stopped borrowing: indeed, American businesses have by some measures become more indebted in recent decades.)

The authors do not have comparable data for all 51 countries since 2007. But they do have numbers for the four largest economies (see chart). The data there show that the corporate share of private savings has since dipped a bit, in part because household savings have risen, although it remains high in absolute terms. (Labour’s share of GDP has stabilised at a low level.) The urge to save may be lessening. Japanese firms, with few growth prospects at home, have been making foreign deals. Marc Zenner of JPMorgan Chase notes that in the past 18 months firms that announce acquisitions have been rewarded with higher share prices.

Yet even if they are loosening the purse strings a bit, companies are unlikely to abandon their frugal ways in the near future. Falling corporate-tax rates have increased the appeal of capital over labour; heightened uncertainty and capricious funding markets seem a recurring part of the landscape.

That should make firms all the more determined to fund growth internally. Between now and 2016, GE expects to generate $100 billion in cash, enough to finance investment, acquisitions and dividends, and to buy back enough stock that shares outstanding will be lower than before the crisis. Asked recently if GE was tempted to spend more of its cash pile on acquisitions, Jeffrey Immelt, the chief executive, replied: “It’s not burning a hole in our pocket.”

November 1, 2012 7:58 pm

France: Reluctant to reform

Hollande is under pressure on the economy but looks unwilling to use shock tactics demanded by business
France's President Francois Hollande leaves a meeting at the OECD headquarters in Paris on October 29, 2012©AFP
Hanging back: President François Hollande says proposals from industry offer ‘no magic formula’

Fabien Cohen, a tousle-haired 25-year-old in a hoodie and a denim jacket, cuts a figure about as far from the image of the suave grands patrons of French business as it is possible to imagine.

Yet the internet entrepreneur has found himself making common cause in recent weeks with the leaders of traditional industry against the policies of François Hollande, the new Socialist president.

Mr Cohen is one of the founders of Les Pigeons, a group of mostly young small-business owners that reacted furiously on Facebook and Twitter to plans to impose a sharp rise in capital gains tax. Their response wrongfooted a government more focused on fending off protests against Mr Hollande’s 75 per cent marginal income tax rate and other new levies on big companies and the wealthy.

“I didn’t believe it when I heard it,” says Mr Cohen, a university dropout who is in talks with potential investors to raise €500,000 for his second internet start-upWhoozer, a smartphone application he likens to a “local Facebook”.

“You can’t tax someone who takes a risk and someone who doesn’t take a risk at the same level. It is unfair and it is confiscatory for entrepreneurs and their associates.”

The “pigeons” – French slang for “suckers” – clocked up more than 70,000 backers online for their warning that a proposed rise in CGT to as high as 60 per cent on entrepreneurs and investors selling out of their businesses could strangle new start-ups in France and drive investment abroad.

At the same time as the government was confronted by Mr Cohen and his fellow Pigeons, it was squaring up to the problems facing one of its most venerable industrial companies: PSA Peugeot Citroën.

PSA’s car sales are falling sharply at home and in its main southern European markets, and it is being outperformed by rivals such as Germany’s Volkswagen. The company is in the midst of a plan to close a plant outside Paris and cut its workforce by more than 6,000. It has had to turn to the state for a €7bn guarantee to prop up its finance arm.
Les Pigeons and Peugeot help illustrate Mr Hollande’s biggest challenge: how to reverse France’s declining ability to compete internationally and revive an economy that has shown zero growth for the first three quarters of this year, with unemployment rising to more than 10 per cent of the workforce.

An important moment will come next week when Louis Gallois, former chief executive of European aerospace company EADS, delivers a report commissioned by the government on how to restore competitiveness.

Industry leaders, riled by what they see as the unwarranted tax burden loaded on to business by the government since it took office in May, have been clamouring for a competitiveness shock. The phrase was coined by Mr Gallois himself this year.

“The profit margins of our businesses are at a historic low. Unemployment undermines social cohesion and excludes our youth. France needs profound transformation. It is urgent to act now,” wrote a group of chief executives from companies listed on France’s CAC 40 in an appeal to Mr Hollande this week.

The importance of steering the country back on to a growth path extends well beyond France itself. With Italy and Spain already battling recession, the eurozone’s struggle to emerge from its sovereign debt crisis would be hard hit if France, itself also yet to overcome a rising debt burden, were to slide into reverse.

“If François Hollande does badly, France will be sick and the eurozone will be in trouble,” says one senior state official.

The country retains underlying strengths. It has an array of leading global companies, impressive infrastructure, low energy costs thanks to its nuclear industry and high productivity. It is in the world top 10 as a destination for foreign direct investment, outperforming Germany.

But it badly needs to regain lost ground in international markets. At a meeting this week with the heads of five international economic institutions, including the OECD club of mostly rich nations and the International Monetary Fund, Mr Hollande said competitiveness was part of a triple challenge facing the country, along with indebtedness and weak growth.

The indicators are readily apparent. France has slipped in the latest World Economic Forum global competitiveness ranking to 21st, from 15th two years ago. It trails Germany in sixth place and the UK in eighth. Its share of both global and eurozone exports has dropped sharply. The trade balance has swung heavily into deficit, reaching €70bn last year, compared with a German surplus of €150bn.

The effect has been painful. In the past decade, 700,000 manufacturing jobs have been lost as the number of exporting companies has fallen 15 per cent to less than 100,000, against almost 250,000 in Germany.

There are fears that if action is not taken quickly, the weakened economy could lurch into crisis. “You remember the Titanic, supposedly unsinkable,” said Laurence Parisot, head of Medef, the employers’ federation, in an interview this week with industry publication L’Usine Nouvelle. “I feel that the iceberg is very near.”

Business wants much deeper cuts to France’s very high public spending to replace dependence on raising taxes to cut the budget deficit. “With record public spending of 56 per cent of gross domestic product, we have reached the limit of what is sustainable,” the CAC 40 bosses said.

They want reforms to free up labour and product marketssimilar to those launched in Germany a decade ago, and more recently in Italy and Spain – which France has resisted for years. Pressure also comes from outside. Chancellor Angela Merkel’s German government, the European Commission, the OECD, the IMF and the European Central Bank have all made clear their anxiety for Mr Hollande to act.

Business leaders are pushing hardest for labour costs to be cut. They propose lifting heavy social welfare charges on employers, and financing the reduction with a combination of raising value added and other taxes and cutting public spending.

Mr Gallois suggested a transfer of €30bn-€50bn before starting his work for the government, and is almost certain to do so again when he publishes his report on Monday. But Mr Hollande – a famously cautious politician – and his ministers have been busily playing down expectations that they will adoptshock measures, talking instead of a “trajectory” of action over the president’s five-year term. “There is no magic formula,” Mr Hollande said recently.

. . .

The government has two objections to putting the emphasis on employer welfare charges. First, it disputes the importance of labour costs in French competitive weakness. Second, next year’s budget already includes €20bn in tax rises to help hit next year’s target of reducing the budget deficit to 3 per cent of GDP, and fears a further increase in VAT or other taxes would tip the economy into recession.

“I don’t think we can afford to finance such a plan,” says Fleur Pellerin, minister for small businesses and digital industry. “What we really want is not to limit the discussion on competitiveness only to the cost of labour. We think it is not really critical. The statistics show the cost of labour in industry is in line with that of the eurozone. It is a bit higher than what it is in Germany but not the other eurozone countries.”

The Elyseé is emphasisingnon-cost issues, aiming to foster innovation, skills and research and development to improve the quality and value of French products. “We need to organise our industrial policy so we focus on the sectors of the future, like biotech and the digital economy, where we know growth rates will be high in the future,” Ms Pellerin says.

It is targeting the relatively low number of small and medium-sized enterprises with export reach in France, especially compared to Germany. It is grouping state agencies into a new public investment bank, with €40bn in lending and investment firepower, to boost investment in SMEs. It is also cutting tax rates for smaller companies and extending access to the research tax credit system, one of the OECD’s most generous.

The government has also rowed back to some extent on the new CGT regime following pressure from Les Pigeons. “We’ve learnt from the experience,” says Ms Pellerin. “We must multiply the signs that we are supporting them rather than chasing them out of the country.”

Mr Gallois, the CAC 40 bosses and Medef all back these “non-costinitiatives. But most insist urgent action must be taken to cut the overall burden of taxes on employment. “They represent 26.3 per cent of added value against just 15.6 per cent in Germany,” Ms Parisot told L’Usine Nouvelle. “The gap is gigantic. French businesses are suffocating.”

. . .

The government’s reaction to the Gallois report, due on Tuesday, will give an important indication of how far and how fast Mr Hollande is willing to go in adopting reforms.

A further test will come later this year with the outcome of talks between employers and unions on proposals for German-style changes to labour market regulation. In exchange for limiting job cuts, employers are seeking relaxation of the rigid regime on plant closures, redundancy conditions, wages and working time. Mr Hollande wants a deal – but it is not clear how far he is willing to push the unions if they hold out.

Despite holding a decisive parliamentary majority and controlling most big cities and municipalities, the president faces a significant leftist wing in his Socialist party. He seems reluctant to confront this, much less risk provoking street protests. There is already disquiet in the party over tough budget targets set by Mr Hollande and little appetite either for deeper spending cuts or appeasing the business community.

The comparison often made is with reforms enacted in Germany by Gerhard Schröder. But asked recently whether he would follow the same course, Mr Hollande pointed out that the former Social Democratic chancellor undertook his reform programme only after he had won re-election.

The question is whether a further deterioration in the economy will force the president’s hand. France is benefiting from a very easy ride from financial markets at the moment. If that changes, pressure could mount.

One veteran industrial figure sympathetic to Mr Hollande says he would have to take action, not least because Italy and Spain are rapidly improving their own competitiveness. Hitting the rich is not enough. He will be forced to move. But he’ll do it in steps, never announcing his plans. He’s like [former Chinese leader] Deng Xiaoping. He’ll take a step in the right direction, but if it gets too hot, he’ll step back.”

For his part, Mr Cohen may not stick around long enough to find out. The young Pigeon is planning to fly off with his small Whoozer team to set up in San Francisco. He had already decided to do so before the CGT issue blew up. “That is where things are happening,” he says.

Copyright The Financial Times Limited 2012.

Marshmallows and markets
Could guarantees make pensions more appealing?

Nov 3rd 2012

MOST people pay careful attention to their wage packets. But they tend to be much less interested in their pensions, even though their financial well-being in the last 20-30 years of their lives depends on them.

That is a great pity, since responsibility for pension provision has been steadily shifting from the company to the individual. Around 70% of American retirement schemes are now defined-contribution (DC) plans, under which the final pension amount is dependent on investment performance. In Britain the proportion of pension assets represented by DC plans rose from 8% in 2001 to 39% in 2011.
Poor stockmarket performance has reduced the return that investors get on their savings. Meanwhile, very low interest rates and improved longevity mean that a much larger pension pot is required to generate a given retirement income. According to Alexander Forbes, a consultancy, the average British 30-year-old in 2000 could have expected a pension contribution of 12% of wages to generate a retirement income of 67% of their final salary; a 30-year-old today could expect an income worth only 39% of final salary.

The greater cost of providing a pension is the main reason why companies have stopped providing defined-benefit (DB) schemes, under which they promised workers a specified pension, and switched the burden to employees. But the risk also makes pensions a very unsatisfactory product for employees. They put money aside every month but have no idea how much they will receive.

Most humans have a problem with deferred gratification. A famous test for children offered them a single marshmallow up front, or two if they waited; only 30% had the necessary self-control to delay.

Pension saving is even more of a test of patience: workers have to wait 40 years or more for the pay-off. Their pension pots may not even be worth the sum total of their contributions; they may have swapped marshmallows for gruel.

It would surely make pension saving more attractive if workers could be given a much better idea of the eventual rewards for their thrift. A new report from the British Institute and Faculty of Actuaries examines whether it might be possible to offer guaranteed pensions in the DC market.

There is a simple way of offering a (virtually) guaranteed pension. If investors buy index-linked government bonds, their savings will be protected against inflation unless the government defaults. But this is expensive because the returns are so low.

That expense explains why most corporate and government pension funds have followed the strategy of taking more risk (usually by buying equities) in the hope that excess returns from the market will let them make lower contributions.

In theory, you could insure against equity risk in the derivatives market by buying a put option (the ability to sell shares at a set price). Over the long run equities normally rise in value (although that is not certain, as Japanese investors know all too well). Even so, buying a long-term put option is actually more expensive than buying a short-term contract.

So the actuaries examine other approaches, using sophisticated hedging techniques that rebalance the portfolio to avoid substantial losses. The idea is to take advantage of the higher returns that equities can generate but in a low-risk fashion that means the cost of purchasing a guarantee is reduced.

Although this seems a sensible way forward, a couple of caveats are needed. First, the actuaries cannot say how much a guarantee would cost. They can calculate only the maximum a pension scheme should pay for a guarantee without making the strategy self-defeating. And any guarantee will involve only the return on contributions; it will not protect the worker against inflation.

The second caveat is that a guarantee is only as good as the guarantor. Pensions are long-term products and the recent crisis has demonstrated that insurance companies and investment banks (the likely guarantors) cannot be relied upon to survive for decades.

That raises the question of whether the government should step in. Governments may not want to add to their unfunded long-term liabilities. But if a guarantee could be provided for low-risk DC schemes, workers might be persuaded to save more. And if they do not save more than they do now, they may end up relying on government benefits in any case.