******************** POSTING RULES & NOTES ********************
#1 YOU MUST clip all extraneous text when replying to a message.
#2 This mail-list, like most, is publicly & permanently archived.
#3 Subscribe and post under an alias if #2 is a concern.
(Eduardo Porter is always very interesting.)
NY Times, Feb. 14, 2018
Big Profits Drove a Stock Boom. Did the Economy Pay a Price?
by Eduardo Porter
Stocks are too expensive.
This is not a market forecast. I wouldn’t be particularly surprised if
the Dow shrugged off its recent turbulence and continued its long upward
thrust. What I contend is that if the American economy behaved in the
way that most economists say market economies should, stocks would in
all likelihood be cheaper.
It is a grim proposition. Wall Street’s titans might welcome the fact
that equity prices have grossly exceeded what a well-functioning,
competitive economy should deliver. But for almost everybody else, it
amounts to a disaster. From wage stagnation to the depressed investment
rates that are holding back long-term economic growth, many of the fault
lines running through the American economy can be traced back to the
same root cause powering the rise of America’s overpriced stocks.
Consider a few facts. The average financial wealth of American
households — the market value of housing, stocks, bonds, business assets
and the like, beyond their liabilities — has grown much faster than the
nation’s income over the last half-century.
This would not be weird were American households saving more and
investing their savings in productive ventures. They are not. The
personal savings rate has declined sharply. The ratio of the capital
stock — the value of factories, machines and such — to the nation’s
economic output has actually declined a little since the 1970s.
What has enhanced wealth in recent years is the huge rise in stock
prices. The Standard & Poor’s 500-stock index increased 8 percent per
year from 1970 to 2015, on average. According to an analysis by Germán
Gutiérrez and Thomas Philippon of New York University, the ratio of the
market value of American corporations to the replacement value of their
capital stock has roughly tripled since the 1970s.
What makes this particularly puzzling for scholars reared on the
classical models of competitive economies is that all this happened
despite a persistent decline in real interest rates. In a more orthodox
economy, declining rates on corporate bonds would encourage a surge in
corporate investment. As companies invested more and more capital, the
returns on investments would gradually decline until companies’ returns
matched their cost of capital: the interest rate they pay to borrow.
The Stock Market Isn’t the Economy. Here’s How They Can Shape Each Other
Stock markets have recently fallen over fears that economic growth is
too strong. Here’s why, and one way how steep, sustained sell-offs could
end up hurting the economy.
In the United States, neither has occurred. Investment has been stuck at
stubbornly low rates. And even as interest rates have fallen, the
average return on productive capital has stayed roughly constant.
In a nutshell, the United States has built an economy where businesses
don’t invest even though it has rarely been cheaper to finance
investment. Still, they reap spectacular profits that warrant runaway
“These are not your father’s growth facts,” wrote Gauti Eggertsson,
Jacob A. Robbins and Ella Getz Wold of Brown University in an analysis
published this week by the Washington Center for Equitable Growth. The
puzzling facts of contemporary America suggest an economy poised to fail.
What happened? It turns out that there is one straightforward reason for
the American economy’s unorthodox behavior. As Mr. Eggertsson and his
colleagues argue, the standard economic theory based on competitive
markets cannot apply when markets are not competitive. And competition,
in the United States, is shriveling.
The scholars argue that the American economy is afflicted by “rents” —
returns in excess of what investments would yield in a competitive
economy, where fat margins are quickly whittled away by competition.
These rents don’t fall from the sky. Companies free of competitive
pressures, with the power to set prices more or less at will, squeeze
them from their customers and their workers. They pad corporate profits
and send stock prices sky high.
This doesn’t necessarily mean, by the way, that the corporate landscape
has been taken over by evil monopolists that resort to illegal tricks to
keep competitors out. High-tech titans like Google and Facebook may just
have the ability and the deep pockets to out-innovate everybody —
delivering wonderful new experiences to consumers along the way, and
maintaining monopoly control over their latest innovations. One
intriguing theory is that the globalized economy is reorganizing the
business landscape, encouraging the rise of corporate superstars.
Not everybody agrees that competition is waning. Hal Varian, Google’s
chief economist, argues plausibly in a recent study that the case to
worry about market concentration across the economy is weak. Even as
concentration has increased in many sectors, there is plenty of
competition in most industries and markets. Carl Shapiro, an antitrust
scholar from the University of California, Berkeley, who served in
President Barack Obama’s Justice Department, worries that the new
populism infecting American politics could prompt antitrust policy to
take aim at all big successful companies.
Still, there are good reasons to worry about rising rents, no matter
where they come from. Mr. Shapiro argues that while some measures of
market concentration may not be meaningful, persistently high profits
are of themselves a cause for concern.
Profits as a share of output have risen by half over the last 30 years.
Combined with evidence that large corporations are accounting for an
increasing share of revenue and employment, Mr. Shapiro writes, “it
certainly appears that many large U.S. corporations are earning
substantial incumbency rents, and have been doing so for at least 10
years, apart from during the depths of the Great Recession.”
This is particularly true in the tech sector, where a handful of
dominant companies — you know the ones I’m talking about — have
sustained spectacular profits for years. Their sky-high stock prices
suggest that investors expect high profits to continue as well.
“They probably are geniuses; what they are doing is wonderful,” Mr.
Shapiro told me. “Still, you would expect competition to erode away the
excess profits over time.”
Here is why we should worry.
Mr. Eggertsson and his colleagues built an alternative model of the
American economy by doing away with the assumption of perfect
competition. They contend that there are barriers to entry that stop
competitors and allow rents to persist.
In this economy, stock prices don’t just reflect the future stream of
normal economic returns that would accrue to a company’s capital
investment. They also include a claim to a stream of rents that generate
“pure profits.” These profits can’t be replicated by another company’s
capital investment. They are owned by a specific company.
So what features might an economy like this possess? Wages are unlikely
to rise much in a job market dominated by a few big employers. As I
speculated last week, markets dominated by a few businesses will most
likely deter start-ups from appearing on the scene.
Rising rents will take larger shares of the nation’s income. That will
bolster the proportion of income that goes to corporate profits but
squeeze the share that flows to workers — in wages and benefits — and to
productive capital. This will discourage both work and capital
investment. It will weigh on overall economic growth.
Rents interfere with incentives in a big way. Companies will spend more
time and effort trying to preserve those rents — often by working to
block rivals from their markets. Rivals will fight to grab a share of
those rents for themselves, perhaps through lobbying. Amid all this
jockeying, investment in productive capabilities will most likely be
neglected as a secondary consideration.
And inevitably, inequality will rise: The owners of the shares in the
powerful corporations capturing the economy’s growing monopoly rents
will peel further and further away from the average Jane and Joe, who
own little but their labor.
This is not the kind of economy proposed by classical economic theory.
It is not the kind of country portrayed by evangelists of the American
dream. But it looks as if we are stuck with it, regardless of what the
stock market does tomorrow.
Full posting guidelines at: http://www.marxmail.org/sub.htm
Set your options at: