Wallets Wide Shut

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Mareeg.com-NEWPORT BEACH, CALIFORNIA – Some economists, like Larry Summers, call it “secular
stagnation.” Others refer to it as “Japanization.” But all agree that after too many
years of inadequate growth in advanced economies, substantial longer-term risks have
emerged, not only for the wellbeing of these countries’ citizens but also for the
health and stability of the global economy.

Those looking for ways to reduce the risks of inadequate growth agree that, of all
possible solutions, increased business investment can make the biggest difference.
And many medium-size and large companies, having recovered impressively from the
huge shock of the 2008 global financial crisis and subsequent recession, now have
the wherewithal to invest in new plants, equipment, and hiring.

Indeed, with profitability at or near record levels, cash holdings by the corporate
sector in the United States have piled up quarter after quarter, reaching all-time
highs – and earning very little at today’s near-zero interest rates. Moreover,
because companies have significantly improved their operating efficiency and
lengthened the maturities on their debt, they need a lot less precautionary savings
than they did in the past.

However one looks at it, the corporate sector in advanced economies in general, and
in the US in particular, is as strong as it has been in many years. Non-financial
firms have achieved a mix of resilience and agility that contrasts sharply with
prevailing conditions for some households and governments around the world that have
yet to confront adequately a legacy of over-leverage.

But, rather than deploy their abundant cash in new investments to expand capacity
and tap new markets – which they have been very hesitant to do since the global
financial crisis erupted – many companies have so far preferred (or have been
pressured by activist investors) to give it back to shareholders.

Last year alone, US companies authorized more than $600 billion of share buybacks –
an impressive amount by any measure, and a record high. Moreover, many companies
boosted their quarterly dividend payouts to shareholders. Such activity continued in
the first two months of 2014.

But, while shareholders have clearly benefited from companies’ unwillingness to
invest their ample cash, the bulk of the injected money has been circulating only in
the financial sector. Little of it has directly benefited economies that are
struggling to boost their growth rates, expand employment, avoid creating a lost
generation of workers, and address excessive income inequality.

If advanced economies are to prosper, it is necessary (though not sufficient) that
the corporate sector’s willingness to invest match its considerable wallet. Six
factors appear to pose particularly important constraints.

First, companies are concerned about future demand for their products. The recent
economic recovery, as muted as it has been (both in absolute terms and relative to
most expectations), has been driven by the experimental policies that central banks
have pursued to sustain consumption. Now, with the US Federal Reserve beginning to
withdraw monetary stimulus, and with growth in emerging countries slowing, most
companies are simply unable to point to massive expansion opportunities.

Second, with China such an influential driver of global demand (both directly and
indirectly through important network effects), the outlook for the world’s
second-largest economy has a disproportionate impact on projections of global
corporate revenues. And, as China’s excessive domestic credit growth and
shadow-banking system attract increased attention, many companies are becoming

Third, while companies recognize that innovation is a key comparative advantage in
today’s global economy, they are also humbled by its increasingly winner-take-all
nature. Successful innovation today is a lot less about financing and much more
about finding the “killer app.” As a result, many companies, less convinced that
“normal” innovation yields big payoffs, end up investing less overall than they did

Fourth, the longer-term cost-benefit analysis for would-be investors is clouded by
legitimate questions about certain operating environments. In the US, many companies
expect major budgetary reform; but they are not yet able to assess the impact on
their future operating profits. In Europe, politicians are aware of the need for
major structural reforms, including those required to solidify regional integration;
but companies lack adequate clarity about the components of such reforms.

Fifth, the scope for risk mitigation is not as large as financial advances would
initially suggest. Yes, companies have more hedging tools at their disposal. But the
ability to manage downside risk comprehensively is still limited by incomplete
longer-term markets and public-private partnerships that cannot be sufficiently

Finally, most corporate leaders recognize that they owe a large debt of gratitude to
central bankers for the relative tranquility of recent years. Through bold policy
experiments, central bankers succeeded in avoiding a global multi-year depression
and buying time for companies to heal.

But, working essentially alone, central banks have not been able to revamp properly
the advanced economies’ growth engines; nor do they have the tools to do so. Though
many corporate leaders may still be unable to grasp the precise threats, they seem
uneasy about the longer-term collateral damage implied by running modern market
economies at artificially repressed interest rates and with bloated central-bank
balance sheets.

The good news is that each of these constraints on investment can – and should – be
addressed; and recent US business investment data suggest some progress. The bad
news is that it will take a lot more time, effort, and global coordination. In the
meantime, the corporate sector will only gradually take on more of the heavy
lifting. That will be enough to keep the advanced economies growing this year;
unfortunately, it will not be enough to attain the faster growth that their
citizens’ wellbeing – and that of the global economy – urgently requires.

Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and the author of When Markets

Project Syndicate

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