The US needs to rediscover the meaning of investment
Fortunes are made in financial markets without benefiting the real economy
Oren Cass
American capitalism has undergone a transformation into a system that might more properly be called “uncapitalism”.
The real economy now serves the financial sector, instead of vice versa.
Investment shortfalls and overheated financial markets have contributed to stagnant productivity and wages, declining international competitiveness and rising wealth inequality.
In a new American Compass report, we analyse nearly 50 years of public-company financial data and show that firms neither tap financial markets to fund growth nor reliably reinvest in their own health — which is what traditional models expect and what they once did.
Historically, most companies fit the profile of “sustainers”.
Their capital expenditure exceeded their consumption of fixed capital and profits both funded this investment and returned cash to investors.
From 1971 to 1985, sustainers made up 82 per cent of the market capitalisation of US-headquartered companies on the New York Stock Exchange and Nasdaq.
Another 9 per cent of market cap were “growers”, which had capital expenditure in excess of profits and raised money on the markets to close the gap.
Sustainers and growers have been overtaken by a third category of “eroders”.
The eroder has sufficient profit to both replenish the assets it consumes and return cash to shareholders.
But it chooses to do only the latter, handing back profits at the expense of its capital base.
From 1971 to 1985, eroders accounted for 6 per cent of market capitalisation. By 2017, that had risen to 49 per cent.
The sustainer share had fallen to 40 per cent and the grower share to 3 per cent.
Net outflows from publicly traded companies to asset-holders rose from 1.5 per cent of US gross domestic product in 1971-1985 to 3.5 per cent as of 2017.
It is not clear what the asset-holders have done to merit this windfall.
Defenders of this sorry situation argue that companies are disgorging their cash because they have no use for it, and the investors who receive it can redeploy it more productively.
But that reinvestment is not occurring.
Rather, confusion distorts the meaning of the terms investor and investment.
Most so-called investors make no actual investments, which require the allocation of capital towards productive activities such as building structures, installing machines or creating intellectual property.
They are engaged in non-investment, merely trading one pile of assets for another. When a speculator acquires shares, or a buyout artist takes over a firm, no capital necessarily reaches the firm itself.
Someone who held equity now holds cash, and someone who held cash now holds equity.
When a public company hands its profits back to the financial markets, it throws the resources from firms that might invest it productively over an invisible wall to non-investors in the financial sector who are unlikely to do so.
Non-investors may choose to convert their capital into consumption, or turn around and non-invest in some other asset.
Intel might buy back shares and the sellers use the proceeds to buy shares in, say, Boeing, transmitting the proceeds to another seller who then non-invests in something else.
The final resting place seems most often to be Treasury debt, financing spending on entitlement programmes.
Great fortunes are made moving around these piles of money and extracting value from the assets of firms that underlie the financial instruments.
But no innovation is spurred nor groundwork laid for prosperity.
To achieve that, policymakers will have to put the financial sector back in its place, and business leaders will have to rediscover the meaning of investment and move off Wall Street to pursue it in the real economy.
The writer is executive director of American Compass
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