‘All capital is finance, and only finance’ according to Nitzan and Bichler (2009: 262). From a top-down perspective of business this may be true for, as Nitzan and Bichler forcefully argue, capital is purely a pecuniary claim over an expected future stream of earnings discounted to its present value. All capitalist entities follow this ritual of capitalization, and thus all are part of the nomos of finance.
However, from a bottom-up perspective, things look rather different. A corporation can superintend the organization of vast capital stock that puts hundreds of thousands of people into gainful employment – thereby making the firm seem productive. But the very same corporation can also engage in asset-stripping, divestment and mass layoffs to boost short-term returns to shareholders – thereby making it seem predatory. This distinction has been emphasized in the literature on firm-level financialization (see Lazonick and O’Sullivan 2000). To cut a very long story short, according to this literature, from the 1980s onwards, there was a shift from a model of corporate governance from retaining and reinvesting corporate earnings, to one of downsizing workforces and distributing earnings to shareholders.
But is this oft-told narrative of firm-level financialization reflected in corporate metrics? In an initial attempt to answer this question, I have drawn on Compustat to compute the total nominal net income, net interest expenses, capital expenditure, dividends and share repurchases data for the 500 largest ‘non-financial’ firms, ranked by income, for each year from 1950 to 2016 (series codes: ni, xint, capx, dvt and prstkc, respectively). Here non-financial firms are all those firms incorporated in the US with SIC numbers from 0100-5999 and 7000-9729. In other words, all but the finance, insurance, real estate and non-classifiable firms are included in the dataset. Figure 1 plots the resulting findings for the ‘non-financial 500’ (NFC 500) on a log scale to facilitate comparison between the different series and to highlight rates of change. By ‘distributions to shareholders’ I mean the sum of dividends and share repurchases for any given year.
As you can see in the figure, there were steep rises in capital expenditure and net interest expenses for the NFC 500 from the 1950s to 1970s. However, from the 1980s onwards the upward slopes for both series become less steep. In contrast, over the long haul, distributions to shareholders grow at a steadier rate and surpassed the level of capital expenditure in the years immediately leading up to the global financial crisis and in some of the years that have followed it. The reason why I have included data on net interest expenses in the chart will be revealed later. But for now, the most important thing to note is that the ‘financialization’ thesis sketched above seems to be supported by the data.
The next figure uses the very same data but presents it in a different way. Rather than looking at absolute levels on a logarithmic scale, this second chart looks at relative levels on a linear scale. Specifically, it shows how many dollars are channelled into fixed investment, interest payments, and shareholder returns, respectively, for each dollar of profit generated by the NFC 500. According to these metrics, relative capital expenditure reached a peak in the early 1980s and subsequently declined until the 2000s, from which point it has flat-lined. Similarly, relative net interest expenses reached a peak in the 1980s, and then followed the same trajectory as relative capital expenditure. Finally, relative distributions to shareholders ratchet up first in the 1980s, and then in the 2000s, falling sharply during the global financial crisis but only to recover again to levels reached immediately before the crisis. Taken together, these data also affirm the financialization thesis: in the 1980s and 1990s relative capital expenditure levels fell significantly, and have subsequently reached a low plateau; and in the same four-decade period, relative distributions to shareholders have risen albeit in staggered fashion.
The next chart foregrounds the changing levels of shareholder distributions relative to capital expenditure, by dividing the former by the latter to produce a metric for rentier power. The greater the rentier power, the more firms move away from ‘retain and reinvest’ model of corporate governance toward a ‘downsize and distribute’ model. The picture provided by the chart is clear: in the three decades following the Second World War, rentier power was in retreat as US business were enjoined in a social compact with labour. This social compact was based on the overarching goal of full employment, massively expanded economic output, and wages growing roughly in line with productivity (Maier 1977, Blyth 2002).
By the 1970s, however, the ‘retain and reinvest’ model was under severe strain. American corporate amalgamation in the 1960s led to over-centralization. And the competitiveness of US firms was particularly threatened by the rapid ascendance of Japanese industries. While US firms were increasingly hampered by fractious labour relations, Japanese corporations were propelled by the successful enactment of keiretsu (partial firm-level disintegration), kanban (minimization of idle labour and inventories), and kaizen (continuous improvement of production process by multiskilled workers) (Schwartz 2010). Meanwhile, the removal of restrictions on the capacity of pension funds and life insurance companies’ capacity to invest in equity markets led to a dramatic rise in the importance of institutional investors. Similarly, the deregulation of banking, as emblematized by the phasing out of Regulation Q from 1981 onward, meant that Wall St firms were questing evermore assiduously for higher returns on investment (Lazonick and O’Sullivan 2000).
In terms of industrial relations, the sustained attack on organized labour by the Reagan government in the 1980s all but ended the ‘politics of productivity’ that bound privileged segments of the American working-class to big business in the post-war period (Maier 1977). With the restoration of ‘sound finance’ as official state ideology, international capital account liberalization, and the coeval outsourcing of the least profitable aspects of US manufacturing to East Asia and elsewhere, rentier power was resurgent.
One aspect of this story that I have yet to mention relates to interest expenses. From 1979-1982, the Federal Reserve, under the leadership of Volcker radically curtailed the US money supply, with the result that interest rates rose to double digits, hitting a zenith of 20% in 1980. The interest rate hikes were designed to tame the inflationary spiral precipitated by ever growing wage demands from US workers amid the unravelling of the post-war social compact between capital and labour. In so doing, global confidence in the US dollar would be assured, thus strengthening the dollar’s position as the international reserve currency. The interest rate hikes also had profound domestic consequences: dollar appreciation made US manufactured goods less competitive in export markets, and thus undermined the sectors in which labour unions had the strongest presence (Van Arnum and Naples 2013). Concomitantly, the interest rate hikes also inaugurated a Third World debt crisis, which paved the way for the wholesale restructuring of social formations throughout the Global South along lines conducive to capital accumulation for firms headquartered in the US and elsewhere (Panitch and Gindin 2013).
As the figure below shows, the unprecedently high interest rates in much of the 1980s coincided with elevated levels of net interest expenses for the NFC 500. Furthermore, as the first chart shows, in the same period the NFC 500’s total nominal capital expenditure flatlined in absolute terms. The successful realignment in class power within the US, and the consolidation of the US dollar’s status as the international reserve currency in the 1980s, has been followed by a stuttering decline in interest rates. This stuttering decline continued until the fed rate hit the zero mark in the immediate aftermath of the global financial crisis.
The general downward movement in interest rates is arguably integral to the macroeconomic regime that has emerged from the 1980s onward. There are three key aspects to the political economy of interest rates worth mentioning here. First, amid chronically stagnant median wages in the US, low interest rates allowed US households to continue spending through access to cheap consumer debt.
Second, long-term falling interest rates were partly underwritten by massive purchases of US public debt by China and other countries pursuing an export-led model of economic growth. These countries’ growing trade surpluses have been continually recycled into US treasury securities, thus helping maintain consumer demand from US households for their exports. A particularly important conduit for this process was the US housing market, as low interest rates facilitated lower mortgage rates, and lower mortgage rates led to expanding demand for housing. This expansion in demand, in turn, led to higher property prices, and against rising property prices, US homeowners could release evermore equity to finance continued consumption (Schwartz 2009).
Third, due to falling interest rates and capital market liberalization, interest rate spreads fell, and in consequence banks increasingly jacked up their leverage. The leveraging of debt, or ‘gearing’, meant banks developed huge asset bases relative to the global political economy at large. Furthermore, it also resulted in the emergence of unregulated areas of finance, such as repo markets, and other forms of shadow banking. Meanwhile, the ever-growing volume household debt was pooled, sliced and repackaged into mortgage backed securities, and the risk associated with holding these securities was ostensibly managed through the use of rapidly expanding, but weakly regulated, derivatives markets (Wolf 2013). From this perspective, falling interest rates from 1980 onward was intertwined with rising inequality in the US, growing international current account balances, and an ever-more fragile global financial system, which of course imploded in the crisis of 2007-08.
This story has been well told by economists and political economists, particularly those of a post-Keynesian persuasion. What has been less discussed is the role that falling interest rates have played in terms of capital expenditure. To return to the literature on the financialization of non-financial firms, the growth in shareholder value norms has led to corporations moving away from fixed investment toward maximizing shareholder returns through dividend pay-outs and stock buybacks. Interestingly, in a rare dissenting view of the ‘financialization thesis’, Andrew Kliman and Shannon Williams (2015) have argued that there is not a necessary trade-off between fixed investment, on the one hand, and shareholder payments through dividends and buybacks, on the other, as both fixed investment and shareholder payments need not come out of current profits alone, but also from borrowed funds. The argument and data that they put forward seems somewhat convincing.
However, what appears to be missed is the possible intervening role played by interest rates in shaping business strategies. When interest rates are at low levels, there may not be any trade-off between shareholder payments and fixed investment, as Kliman and Williams argue. But when interest rates are at higher levels, there may be increased strains over how corporations’ resources are allocated, as higher interest rates will lead to higher interest payments, and higher interest payments will eat further into profits.
Figure 5 presents an initial attempt at testing this hypothesis by presenting the annual changes in the capital expenditure/net income ratio and the shareholder distributions/net income ratio of the NFC 500. The data are charted as 5 year moving averages. Furthermore, the insert of the figure presents the 10-year moving correlation of the raw data of the two series. The figure suggests that changes in capital expenditures and distribution to shareholders appear to be unrelated, or perhaps negatively related, in the early post-war period through to the Volcker Shock. But the macroeconomic regime of declining interest rates that emerged after the Volcker Shock led to a closer alignment in changes in capital expenditures and shareholder distributions.
It would be too hasty to attribute an essential harmony of interests between those generally benefiting from capital expenditure (presumably ‘stakeholders’) and those benefiting from increased dividends and buybacks (most definitely shareholders), just because annual changes in capital expenditure and shareholder distributions have become more synchronized. Indeed, remember that from the 1980s, we also witness a massive increase in shareholder distributions relative to capital expenditure (Figure 3). Nonetheless the data do suggest that a regime of falling interest rates has made the growth in rentier power more tolerable for those who do not directly garner any income from dividend pay-outs and stock buybacks. If this is the case, higher interest rates tend to make the trade-off between shareholder value and capital expenditure more acute, and lower interest rates tend to make this trade-off less acute. However, econometric analysis and detailed qualitative investigation are required to test these claims more rigorously.
The Dilemmas of Economic Policymaking
We can now begin to draw out tentative implications of this exploratory analysis for contemporary US economic policymaking. Trump’s ‘Make America Great Again’ rhetoric hinges on his promise to cajole US-headquartered firms into boosting their capital expenditure in ways that would deliver job growth and rising income for working and middle-class American families. Crucially, he hasn’t sought to do this through challenging the financialized mode of corporate governance that prioritizes shareholder returns above all else. Rather he has sought to ignite a bonfire of corporate regulations, and earlier this month, he successfully pushed through a historic cut in corporation tax from 35% to 22%. Trump’s apparent hope is that these deregulatory and tax-cutting measures will deliver increased profits for US corporations, and at least some of these income gains will be channeled into increased capital expenditure in the US. The danger here is that these corporate tax cuts will lead to a ballooning US budget deficit, which arguably will put the US government in a less sound position to fight the next crisis through bailouts and fiscal stimulus. Furthermore, US corporations may respond to a reduction in their tax liabilities by paying more out to shareholders via dividends and stock buy-backs, or by engaging in fixed investment abroad, thus leaving the average American family in the same position or an even worse position than before.
And this brings us to interest rates. In all likelihood, if interest rates for the last decade were not at their zero-lower bound, then capital expenditure wouldn’t just be flat-lining, it would be falling. Through increasing interest rates, the Fed will likely not only impinge on rentier interests, but also undermine the prospects of increased fixed investment. However, this puts the Federal Reserve in a bind. Increasing interest rates can be seen as an insurance policy for the next crisis: the higher interest rates go, the more the Fed can subsequently cut in the event of another market rout. Conversely, so long as interest rates are at low-levels, and so long as ‘tapering’ remains only tentative, the Fed will have scant resources to thwart the next financial meltdown. In short, then, the use of fiscal and monetary policy tools to cater to the pathologies of financialized corporate governance in the present blunt the effectiveness of these tools for more severe challenges in the future.
There is no easy way around these fiscal and monetary dilemmas. In order to counter financial fragility, the problem of domestic inequality has to be addressed. But in order to address the problem of domestic inequality, global current account imbalances – especially between the US and China - have to be reduced. And in order to reduce these current account imbalances, vested interests which have benefited disproportionately from export-oriented growth in China and debt-oriented growth in the US have to be countered. Needless to say, neither President Trump nor President Xi appear willing or able to take up the challenge at hand.