By Anna Stansbury and Lawrence H. Summers
The Washington Post
May 31, 2019
Sen. Marco Rubio (R-Fla.) recently released a thoughtful report highlighting a substantial issue in the American economy: the steady decline of American private investment.
The trend, Rubio contends, is the result of shareholder capitalism and corporate short-termism. In other words, business decision making has shifted toward “delivering returns quickly and predictably to investors, rather than building long-term capabilities through investment and production,” as he writes in his analysis.
We welcome Rubio’s focus on this issue, as investment is central to economic growth — particularly in the growth of productivity and therefore the growth of workers’ pay. The pervasive weakness of investment relative to saving has also resulted in a period of secular stagnation, in which we can attain reasonable growth only with a combination of large budget deficits, extraordinary monetary policies and high levels of leverage.
While we admire the seriousness of the report — and its open-mindedness in drawing on several thinkers associated with the political left — we disagree with its premise.
First, if shareholder capitalism and corporate short-termism were the key causes of the decline in investment, we should expect to see the phenomenon most clearly in countries like the United States with stronger variants of shareholder capitalism. Yet the trend is a global phenomenon. Investment by the non-financial corporate sector has weakened in not just the United States but also in Britain, France and Germany in the past two decades. At the same time, all 10 of the world’s largest economies have seen substantial increases in corporate gross savings.
Falling investment and rising savings have meant that corporations, on net, have lent out their profits rather than borrow money to invest in expanding their business. This has been the case not just in the United States but also in Canada, Japan, Britain and the Netherlands since around 2000. We’ve also seen it occur in Germany in recent years. While some of the cross-country differences in these trends might be correlated with the nature of corporate governance institutions, that it’s happening across so many countries with different institutions suggests that other explanations — and not shareholder capitalism and corporate short-termism — are likely more important.
Second, using similar logic, if shareholders’ desire for short-term returns were behind the fall in corporate investment, we would expect to see the phenomenon concentrated in publicly listed companies, which are most subject to shareholder pressure. This does not seem to have been the case: Investment by publicly listed companies is estimated to make up just under half of total U.S. investment, yet the decline in net investment by publicly listed companies mirrors the decline for the economy as a whole.
Third, it is not clear that shareholder pressure always incentivizes companies to pursue short-term profits at the expense of long-term investment opportunities. We are living in a world where 84 percent of tech initial public offerings (IPOs) are for companies that are not profitable. Uber is valued at $70 billion even though it makes essentially no profits. And Amazon first reported a quarterly profit four years after its IPO in 1997. For these companies, it does not seem that shareholder capitalism has created a systemic bias toward short-termism; on the contrary, shareholders have been willing to pay high prices for companies on the expectation that they will make profits in the distant future.
More broadly, if shareholders do tend to ignore long-term investment opportunities and seek out companies that focus on delivering near-term profits, one would expect the corporations that deliver high earnings in the short term to be overvalued. But on the contrary, value stocks — which have high earnings relative to their share price — have instead historically systematically outperformed the market.
Fourth, we are not altogether sure that a more long-term, institution-building approach, without shareholder pressure, always results in more efficient allocation of investment. General Motors, for example, engaged in a big investment push in the decade prior to its bankruptcy. General Electric embarked on a number of takeovers in the name of long-termism in the decade prior to its near collapse in 2017 and 2018.
In fact, shareholders might have too little — not too much — power over the typical publicly listed corporation. There is substantial research suggesting that greater shareholder power and oversight are associated with more efficient allocation of corporate funds. This includes, for example, research showing that the presence of at least one large shareholder is associated with better discipline of CEO pay; that rules strengthening independent director requirements on boards were associated with lower executive compensation; and that anti-takeover laws (implicitly reducing accountability to shareholders) were associated with less creation of new plants and lower productivity.
There are plenty of other possible explanations for why investment has weakened. These include increased monopolypower in the American economy, which might lead to reduction in firms’ propensity to invest, as well as the falling price of capital goods, which might reduce the amount of saving that can be absorbed by investment. We have also seen a shift in our economy toward sectors with lower capital intensity — largely services and digital products — which directly reduces the volume of investment needed for production.
This, of course, does not mean shareholder capitalism is flawless. There are certainly grounds on which it might be desirable for companies to make business decisions in the interests of a broader set of stakeholders, rather than to maximize shareholder value. Yet we doubt that substantially strengthening corporate investment would be one of them.
We would also note that the goals of raising private investment — boosting economic growth, raising living standards, reducing risks of secular stagnation — could also be accomplished through public investment. There is no shortage of public investment opportunities in the United States, including in infrastructure, education, health care and climate change reduction. If raising investment is to be a priority, then we should not overlook public investment.
Rubio is right that the decline in investment is a serious issue, and his recent report has made a valuable contribution to the debate. But it is important we diagnose the problem correctly. Only then can we properly address the underlying causes.
Lawrence H. Summers is Charles W Eliot university professor at Harvard and a former US Treasury secretary.
Anna Stansbury is a Stone PhD scholar in Harvard’s Program in Inequality and Social Policy.