Categories: Business Politics

The Problem With Warren’s Accountable Capitalism Act – Warren’s Not Very Bright

Clearly the Accountable Capitalism Act is the opening shot in Senator Elizabeth Warren’s run for the Democratic nomination for 2020. It’s just politics, not anything more substantial than that. Sadly though the bill itself, the purpose of it, shows the underlying reality. Warren’s just not very bright. She’s not managed to grasp the basics of how financial markets or the economy work.

She really does seem to believe that money paid out to shareholders somehow vanishes. Disappears off into the night or something. Whereas the truth is that we can, anyone can, do only one of two things with money. We can spend it or we can invest it. This is true whether the money is inside a company or outside it, it can only be spent or invested. Barring lock boxes under the bed there simply isn’t anything else that can be done with it.

It is upon that factual rock that the entire enterprise shatters itself.

Vox tries to take us through some of the evidence:

And a range of scholars believe shareholder capitalism is to blame. Dong Wook Lee, Hyun-Han Shin, and René Stulz find that firms enjoying high Q now invest in share buybacks rather than reinvesting in business. Heitor Almeida, Vyacheslav Kos, and Mathias Kronlund find that companies strategically time buybacks to manage earnings per share metrics in line with Wall Street expectations and that “EPS-motivated repurchases are associated with reductions in employment and investment, and a decrease in cash holdings.”

Germán Gutiérrez and Thomas Philippon empirically test seven possible causes of decreased business investment, and find that changes in corporate governance (along with reduced competition and a shift to intangible goods becoming more important) is a major factor.

The heterodox economist William Lazonick of the University of Massachusetts puts the thesis very squarely, arguing that “from the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations.” But since the Reagan era, business has followed “a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders.”

The point being that all of this matters not a damn. Because the critique is making that incorrect assumption. That once the money leaves the company then it is in some manner wasted. Instead of being either spent or invested just like any money that stays within the company.

The Guardian picks up on the same point:

Large companies dedicated 93% of their earnings to shareholders between 2007 and 2016 – a shift from the early 1980s, when they sent less than half their revenue to shareholders and spent the rest on employees and other priorities, Warren said.

So what? is the correct answer. This isn’t actually the newspapers just getting it wrong, from Warren’s own explainer:

This shift is a root cause of many of America’s fundamental economic problems. In the early 1980s, America’s biggest
companies dedicated less than half of their profits to shareholders and reinvested the rest in the company. But over the last
decade, big American companies have dedicated 93% of their earnings to shareholders.
That has redirected trillions of dollars that might have otherwise gone to workers or long-term investments, with
predictable results. Since the advent of shareholder value maximization, worker productivity has risen steadily but real
wages for the median worker have been basically flat and the share of national income that goes to workers has dropped
markedly. Big American companies have chronically under-invested, opening the door to foreign competitors.

That is all to assume that the money which leaves the company – dividends or buybacks – somehow now vanishes from the economy. But it doesn’t, it’s now in the hands of the stockholders and they then invest or spend it. Because that’s all they can do with it.

Now, there has actually been a change in the economy over these decades. Financial markets have become much more efficient. It is now much easier to raise money, investment capital, than it used to be. That’s actually what more efficient financial markets means. So, what has changed as this has changed?

Correct, a company that is making good profits doesn’t need to save them up to invest in a project. It can go out to the market and borrow or capital raise for that project nicely and cheaply. It is also true that good projects don’t have to be within a corporate giant in order to gain financing. Because it is possible to gain investment funding from those more efficient markets rather than paying for it out of retained earnings.

What happens then? Quite, the companies making profits send the cash out to shareholders, the stockholders then allocating those capital returns as they see fit. Across the investment and consumption decision, and across the whole panoply of investment opportunities the economy offers, not just those apparent to one subsidiary or another of an extant corporate giant.

We can – and I would – make the argument that paying out earnings to stockholders is a more efficient manner of making those investments in future projects. But the criticism of Warren’s idea doesn’t depend upon that at all, it’s something much more basic. She is believing that money paid out just vanishes. A ludicrous idea, it’s invested or spent.

Warren believes that payments to stockholders disappear from the economy. But those payments, dividends and stock buybacks, will be either spent or invested into the economy by those stockholders. What the heck else are they going to do? There’re only two things you can do with money, spend or invest it. Thus Warren’s Accountable Capitalism Act is wrong simply because Warren’s not very bright.

Tim Worstall

Tim has written for most of the British newspapers. The Times, Daily Telegraph, Express, Independent, Guardian and even, as a ghostwriter, for the Daily Sport. That last being the real badge of honour of course. He's also written for a number of American papers, The WSJ, NYT, Philadelphia Inquirer, Washington Post, Washington Examiner. Magazine work includes some years at Forbes Online and The Register. Takimag, PandoDaily, CapX, Adam Smith Institute, and there is more out there available to the dedicated searcher.

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Tim Worstall