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Wallets Wide Shut

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.

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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 anxious.

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 before.

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 leveraged.

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 long-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 Collide.

Copyright: Project Syndicate, 2014.

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