Data from the US Federal Reserve last week painted a troubling picture of business investment. In the second quarter of 2019, business investment fell by 1 per cent — the largest quarterly fall since 2015. Data from the Fed shows that gross private domestic investment stood at just 17.6 per cent of GDP in the second quarter of 2019 — having fallen from nearly 20 per cent before the financial crisis — and on current trends the situation is getting worse, not better.
This is worrying for two reasons. First, investment — in machinery, training, research — is what drives profits and productivity growth over the long-term. No wonder US productivity growth is stagnant. Second, when business investment starts to fall it tends to take wages, employment and, ultimately, growth down with it.
Most commentators will point to the ongoing trade dispute between China and the US as the primary source of the problem, much as commentators in the UK view Brexit as the source of all our economic woes. But the true cause is an extractive, financialised corporate culture that forsakes long-term investment for the sake of short-term financial gain.
In the 1980s, the ideology of shareholder value took hold of Wall Street. The immediate catalyst was Ronald Reagan’s neoliberal deregulatory agenda, then also gripping Thatcher’s Britain. As financial markets were deregulated, large institutional investors — and the investment banks who managed their money — came to play a much more significant role in corporate governance.
Share ownership changed substantially — pension funds accounted for less than 10 per cent of corporate stock ownership in 1970 compared to 37 per cent today, and foreign ownership has risen from 10 per cent to 25 per cent over the same period. Pension fund capital tends to be managed by large asset managers who hand their capital over to brokers and investment banks that earn their money from fees. They have encouraged, and often forced, private corporations to put shareholders first.
The impact this has had on corporate governance has been profound. In 1969, the chief executive of IBM claimed that the company was run based on the logic of stakeholder value, saying “we serve our interests best when we serve the public interest”. Forty years later, the company’s 2015 road map was shaped around a promise to “leverage our strong cash generation to return value to shareholders by reducing shares outstanding”.
Some say this isn’t such a bad thing — increasing shareholder value means boosting people’s retirement savings. But aside from the fact that pensions wealth and individual share ownership are highly unequally distributed, there are real reasons to worry about the financialisation of our corporate culture.
Corporations have a choice about what to do with their earnings. They can invest them in expanding production through, for example, building a new factory or funding more research and development. Or they can distribute them to shareholders, use them to buy back their own shares or merge with or acquire other corporations. The former tends to benefit the corporations’ long-term profitability, whilst the latter delivers a short-term boost to the share price.
In theory, the practice of putting shareholders first could have encouraged sensible investment to maximise long-term returns. But the logic of the quarterly earnings statement produced a highly short-termist form of capitalism that sacrificed investment, and worker retention, in favour of distributing profits to shareholders today. A worker whose pension is invested by his employer might find his pensions savings being used to pressure his employer to cut their wages.
Private investment fell sharply in the US over the course of the 1980s — from 20 per cent of GDP in 1984 to 15 per cent in 1991. And as corporations have cut costs in an attempt to boost profits, wages have fallen too. The average worker in the US is no better off today than they were in 1978. The incentives to focus on the share price became so entrenched that corporations would often take out debt to boost their share price, which effectively involved extracting profits from the future to pay to shareholders today.
The actors that epitomised the logic of shareholder value were the corporate raiders who took over Wall Street in the 1980s. They would load up on cheap debt before buying entire corporations, stripping out and selling off their assets, and using the returns to repay bondholders and dish out money to shareholders. Carl Icahn was one of the most notable American corporate raiders, who made famous the practice of “greenmailing” — buying up shares in a company and threatening a hostile takeover unless the company repurchased the greenmailer’s shares at a premium.
In the 1990s and 2000s corporate raiding gave way to private equity, mega-mergers and debt-leveraged buyouts. The value of M&A activity in the US more than trebled between the end of the 1980s and the early 2000s. The result was the concentration of American capitalism in ever fewer hands and the rise of some of the largest monopolies in the world.
These monopolies generate their super-profits by restricting production to raise prices, so they can’t invest these profits in production. Instead, they are sitting on huge corporate cash piles, which they often invest in financial markets or lend to other corporations — behaving a lot like large institutional investors.
Financialisation has strangled investment and devastated the productivity of American capitalism. The logic of the US’ financialised corporate culture was made abundantly clear when Donald Trump introduced his latest round of tax cuts. US corporations used the cuts to buy back their own shares — in the first three quarters of 2018, after the cuts were introduced, share buybacks rose by 52.7 per cent on 2017.
Bernie Sanders’ recently announced plan to give workers a stake in their corporations — modelled on the Labour Party’s Inclusive Ownership Funds — would go some way to definancialising the US corporation. Workers would be able to push back against the logic of shareholder value and argue for long-term investment in production and worker retention.
But more radical measures are needed too. In the UK, I’ve argued for the introduction of a People’s Asset Manager who would invest on behalf of the UK’s pension funds and act as an activist shareholder in the corporations it controlled, pushing for long-term, sustainable investment and fair wages. Replicating this in the US would transform American capitalism.
It will also be critical to create a public banking system to direct capital into the right places, and reform the current system of financial intermediation that allows large investment banks to take advantage of long-term investors.
Only by socialising ownership and finance can the US hope to generate the investment it needs to decarbonise and rebalance its economy.