New industrial revolution is here – so where is the investment that can make it happen?
Companies prefer to hand cash to their shareholders and bosses, rather than put it into emerging technologies, writes Larry Elliott
Prepare for the age of the driverless car and the robot that does the housework. That was the message from the World Economic Forum this year as it hailed the start of a new industrial revolution. According to the WEF, the fourth big structural change in 250 years is upon us. The first industrial revolution was about water and steam. The second was about electricity and mass production. The third harnessed electronics and information technology to automate production. Now it is the turn of artificial intelligence, nanotechnology, biotechnology, materials science, 3D printing and quantum computing to transform the global economy. “The speed of current breakthroughs has no historical precedent,” the WEF said. “When compared with previous industrial revolutions, the fourth is evolving at an exponential rather than a linear pace.”
But if this really is the dawning of a new age, it seems somebody forgot to tell the people with the power to turn ideas into products. The multinational companies that bankroll the WEF’s annual meeting in Davos are awash with cash. Profits are strong. The return on capital is the best it has been for the best part of two decades. Yet investment is weak. Companies would rather save their cash or hand it back to shareholders than put it to work.
One possible explanation for this corporate caution is that businesses think bad times are just around the corner. If, for example, companies thought the tepid recovery from the financial crisis was a brief respite before another downturn, it would make sense to stash some money away now. Any UK company that fancies a risk-averse approach has the perfect excuse for sitting pat: the uncertainty caused by Brexit. But this is not an entirely convincing explanation. As the economist Paul Ormerod noted in a recent article for City AM, corporate hoarding was going on well before Brexit became an issue and it affects all western capitalist countries, not just Britain.
Ormerod illustrates the point by contrasting the behaviour of the US corporate sector over the past decade with that during the Great Depression. If ever there was a time when companies might have been excused for salting their cash away it was the 1930s, when the US economy contracted by a quarter.
Yet in the dark years after the Wall Street crash, the US corporate sector ran down its cashpile, so much so that it had negative savings from 1930 to 1934. The new breed of US executives has done things differently. US corporate saving has been higher since the crash than it was in the decade before it.
Another explanation is that the smart people running companies know what they are doing, and are simply waiting for the right moment to invest in the fourth industrial revolution. This is not entirely convincing either, since one of the core principles of investing is that the biggest profits are reserved for those who seize the opportunities first. Other reasons suggested are that cutting-edge companies need less physical capital than in the past, and that innovative companies need money in the bank unless somebody comes along with a takeover bid.
But the most obvious explanation is that the people running companies are dominated by short-term performance targets and the need to keep shareholders sweet. Up until the 1980s, investment by the US corporate sector averaged 4% of GDP while dividends averaged 2%. Today, it is the other way around. Distributed profits used to average 35-45% of total US corporate profits in the 1950s, which is why there was plenty left over to invest in growing the business. Yet for the past few decades the trend has been unmistakable: less money for investment, more set aside for dividends. Were he still alive, Milton Friedman would have said company bosses were doing exactly the right thing. Friedman believed strongly in shareholder value maximisation. That model has certainly delivered for the top 1%. They own 40% of the US stock market and benefit from the dividend payouts and share buybacks that drive prices. Those running the top 1% of companies have remuneration packages loaded up with stock options, so they too get richer as the share price goes up.
But what of the other 99%? What gains they get to the value of their pensions from rising share prices are dwarfed by the impact of weaker investment. And it is the lack of investment that explains why the recovery from the recession has been so feeble, productivity so poor, why average incomes have flatlined and growth has been accompanied by a buildup in consumer debt.
This was not quite what was promised when the Thatcherites and the Reaganites took control 40 years ago. Then, weak growth was blamed on overmighty trade unions and a state that spent and borrowed too much. Private investment, it was said, was being crowded out by wasteful public investment. Governments that borrowed for their pet projects drove up market interest rates, making investment less attractive for an army of frustrated entrepreneurs. This explanation no longer holds. Official and market interest rates have been ultralow for a decade; trade unions have been smashed; nationalised industries privatised. So where’s the investment?
Back in the “bad old days”, a loose social contract applied. Companies gave a slice of their profits to shareholders but invested the bigger portion. Higher investment led to higher productivity, which financed higher wages, demand and profits. Both capital and labour benefited from this arrangement.
The new model – in which the fruits of weaker growth go disproportionately to the 1% – was never likely to work as well and, sure enough, by all the key metrics – investment, living standards, productivity – growth rates are lower now than they were when Friedman and his disciples took control. What was promised was a new golden age of capitalism. What they have delivered is a world on the brink of secular stagnation – longterm failure of economic progress due to lack of investment.
If innovation is going on apace (which it is) and companies have cash in the bank (which they do), one solution is simply to wait for the moment when entrepreneurs rediscover what Keynes called their animal spirits. Another would be for governments to say enough is enough. If, despite the lowest ever borrowing costs and repeated cuts in corporate taxation, the private sector won’t invest in the fourth industrial revolution, the public sector will. The argument for a national investment bank is that entrepreneurs are not actually very entrepreneurial and that opportunities are being squandered as a result.
Return on capital is the best it has been for two decades. Yet investment is weak
Wall Street has seen prices continue to rise, but the money made often goes into shareholders’ pockets, rather than being reinvested