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Corporations aren’t greedy enough Economists are divorced from reality

Joe Biden has the wrong fix for the US economy. Credit: Chris Kleponis/Abaca/Bloomberg/Getty

Joe Biden has the wrong fix for the US economy. Credit: Chris Kleponis/Abaca/Bloomberg/Getty


June 6, 2022   7 mins

American political debates over inflation have settled into predictable — and mostly unhelpful — patterns. On one side, “neoliberal” Democrats such as Lawrence Summers and Jason Furman argue that President Biden’s Covid stimulus bill was too aggressive, causing the economy to overheat and precipitating an inflationary wage-price spiral. On the other, progressives such as Elizabeth Warren and members of the Biden administration point to factors like idiosyncratic supply chain disruptions from the pandemic and later the Ukraine war, while increasingly leaning on explanations involving “corporate greed”. Republicans, meanwhile, are eager to blame Biden for inflation, but have added nothing of substance to discussions around either its causes or cures.

The conventional inflation narratives are both flawed, however, and are increasingly deployed to cover a retreat to the comfort of traditional ideological divides. Summers and Furman, for example, are aggressively pushing to eliminate tariffs to counter inflation, even though Trump’s 2018 tariffs cannot account for accelerating inflation in 2021, and their repeal would offer at best small and temporary relief. Likewise, Democratic rhetoric against “corporate greed” and “price gouging” mostly takes the form of moralistic posturing and only obscures more serious concerns about industry concentration and lack of competition.

Moreover, each side’s preferred explanations for inflation seem at odds with their perceptions of its severity and staying power. If, on the one hand, a one-time spending bill is the main culprit, then the Fed should easily be able to manage inflation through interest rate hikes (already underway), and there is little reason to fear an out-of-control inflationary spiral. In an April 2021 interview, Summers argued that a one-off stimulus would alter long-term expectations and lead to persistent inflation because it signaled the advent of  “a new era in progressive policy”. But a year later, any such progressive paradigm seems dead and buried, and unless Democrats pull off a miracle in the midterms, it is likely off the table through at least 2024.

On the other hand, if “corporate greed” — read charitably as underlying structural problems in the economy — is the main driver of inflation, then it seems unlikely that the Fed will be able to contain it, except perhaps at the cost of a severe recession. If that is the case, then any future progressive fiscal expansion would have to be ruled out, given its devastating inflationary consequences, unless those problems are addressed.

Indeed, the question going forward is whether there are structural issues — aside from idiosyncratic supply chain problems — that will cause inflation to remain elevated and lead to stagflation (high inflation and low growth). Here, there are reasons for concern, although they do not fit neatly into either conventional narrative and so have received relatively little attention.

The most intriguing and potentially alarming trends are visible in the oil market. In December 2019, before Covid, global oil consumption was about 100 million barrels per day, and the price of West Texas Intermediate (WTI) crude hovered around $50-$60 per barrel. At that time, the US operating rig count was around 800 (around 2,000 globally), according to Baker Hughes. After the pandemic hit, in 2020, global oil demand fell to about 90 million barrels per day, prices collapsed and briefly went negative, and the US rig count hit a low of around 250. Oil demand recovered about half the lost ground in 2021 and is expected to return to 2019 levels of 100 million barrels per day this year. In December of 2021, WTI spot prices were around $75, rose significantly after the Russian invasion of Ukraine, and currently sit around $110. Yet the US rig count is still around 700 (of 1,600 globally). The last time oil prices were above $100, before the crash of 2014, the rig count was over 1,800 (3,600 globally).

This trajectory is difficult to square with inflation accounts based on excessive demand. Oil demand has still not exceeded pre-pandemic levels; it is supply that has lagged. Meanwhile, far from being “too greedy”, companies seem to not be greedy enough — at least in the conventional sense of maximising profits. Instead of reinvesting their earnings in drilling new wells, even at profitable oil prices, companies have returned cash to shareholders.

Some have argued that oil companies are not drilling because of the Biden administration’s environmental regulations. As a critic of those policies, I am sympathetic, but they cannot account for the larger phenomenon, including international drilling. Others have suggested that ESG investing requirements have prevented the oil and gas industry from accessing capital. While there is no question that ESG as presently constructed is a disaster, this does not explain why companies are not reinvesting their own earnings. There are some time-lag issues — wells cannot be drilled overnight — but prices have now been elevated for months. Oil futures are also over $80 through most of 2024, meaning companies can hedge future production.

The best explanation is, therefore, the simplest one: shareholders prefer that companies return cash rather than invest, a preference widely discussed among industry participants and observers. Oil companies, to quote Bloomberg’s reporting on this issue, have “responded to investors’ persistent insistence that they return cash to shareholders and not spend their cash flow on capex. . . . That means that we have under-invested in oil, which helps to lead to a higher oil price, but it also means that those companies do have much more free cash flow.”

Any serious analysis of today’s inflation must recognise the different dynamics at play across various sectors. The oil industry is not the same as the housing market, semiconductors, shipping, and so forth. Nevertheless, across industries, the trend of shareholders preferring cash returns over investment has been prevalent in recent decades. Corporate share buybacks, which dropped from previous highs during the pandemic, returned to record pace in 2021 and 2022, according to Goldman Sachs.

The oil industry is actually a late adopter of this cash-return model. Previously, exploration and production companies were typically managed to maximise their “net asset value”. This meant that, in the American shale boom of the early 2010s, companies were investing in drilling at levels far above their operating cash flow, using debt financing to fill the gap. After the crash of 2014, however, Wall Street gained additional influence over the sector. Ever since, the industry has maintained “capital discipline” and avoided negative cash flows.

Economic theory assumes that companies are managed to maximise individual firm profits and, therefore, that they will invest to expand operations as long as expected returns exceed the cost of capital, and that they will compete with each other until profit margins approach zero. But economic theory has refused to grapple with the fact that maximising shareholder returns is not identical to maximising firm profits.

Financial market incentives may discourage competitive investment in favour of shareholder returns, as seen in the oil industry; indeed, the gap between firm hurdle rates and cost of capital is a distinguishing feature of recent economic history. In short, what economic theory presumes to be “rational” for a single firm may not be “rational” from the perspective of a diversified institutional portfolio manager. If anyone is too “greedy”, in other words, it is not corporations but shareholders. Or, more precisely, the incentives of financial managers may not be consistent with maximising overall output. This trend has led to an erosion of productive capacity and supply buffers, which has become painfully evident in recent years.

The same forces also encourage industry concentration through mergers and private equity “roll-ups” to preserve pricing power, as well as the separation of high-value intellectual property rents from capital and labour costs. The result is a bifurcated economy with high-margin “superstar” firms on one side and low-profit “commoditised” firms on the other. In an inflationary environment, this means that firms with large profit cushions, like superstar firms built on intellectual property rents, probably have the pricing power to maintain high margins. Firms without pricing power, like small-business restaurant franchisees, often have no profit cushions and must raise prices out of necessity.

Fears of stagflation have focused on a Seventies-style wage-price spiral, but the above considerations suggest that a greater concern today may be the threat of a “profit-price” spiral. In the Seventies, investment was discouraged by high taxes, strong unions (which directed profits to labour), and relatively robust antitrust enforcement. With low investment, increasing demand only led to more inflation rather than growth.

Today, we have low taxes, weak unions (although tight labour markets), and high industry concentration. These conditions, combined with shifts in corporate governance and financial management, have also discouraged investment — by facilitating extractive financial engineering, as in the case of the oil industry example. A scenario in which companies maintain returns in a stagnant economy by preserving margins while avoiding competitive investment is also more consistent with recent empirical findings. Corporate profit margins achieved a record in 2021 (though they seem poised to retreat somewhat in the coming quarters), and studies have found that rising corporate profits have contributed significantly more to inflation than labour costs. Employees may be able to manage some concessions in a tight labour market, but the data hardly suggest that is the dominant factor.

This sort of firm behaviour has a telling precedent: the modern tobacco industry. Since cigarette consumption began dropping in the Eighties, the basic model of tobacco companies has been to offset sales volume declines with price increases. This strategy works because tobacco companies face little competition due to industry concentration and regulations prohibiting advertising. Thus cigarette price inflation has averaged about 7% per year since 1997, while overall inflation during that time has been slightly above 2%.

The example is revealing because tobacco companies’ high cash returns and low capex requirements have historically made them attractive to financial investors, despite modest growth or innovation. Because of its dividend, Philip Morris was the highest performing stock of the 20th century, beating out far more technologically significant rivals. Guided by the incentives of financial markets, it would not be especially surprising to see more industries adopt the “stagflationary” behaviours of Big Tobacco.

To the extent that is the case, monetary policy alone will not be sufficient to heal the economy. Low rates since the financial crisis have supported asset bubbles but not high investment. Nor will demand-side policies work. As the last several months have shown, further stimulus payments are likely to allow companies to take profits without supporting sufficient investment or wage growth.

Given the immediate-term salience of monetary policy debates, it is often forgotten that escaping the stagflation of the Seventies required not only a sharp rise in interest rates but also the “supply-side” reforms of Ronald Reagan. In this respect, an overlooked element of Summers’s critique of the Biden stimulus bill — that it was not simply too large but too weighted toward transfer payments — is especially apt, as is his call for “a kind of progressive supply side economics that emphasizes . . . public investment.”

Conventional supply-side policies like tax cuts, typically associated with Republicans, fall prey to the same financial dynamics described above, and have led primarily to increased shareholder returns and asset bubbles rather than increased investment in recent years. New supply-side approaches are required, such as the proposed funding for manufacturing investment contemplated in the COMPETES/USICA conference bill. The administration has also proposed other supply-side measures in areas such as housing, but previous efforts along these lines were weighed down by unpopular progressive wish-list items. Rumours that the administration is considering a cancellation of some student debt — with no accompanying reforms to higher education policy — suggest progressives still remain trapped in old welfarist paradigms.

Contrary to neoliberal disdain for tariffs and “hipster antitrust”, however, prudent competition and trade policy reforms will be necessary to boost domestic investment in a highly concentrated economy whose industrial base has eroded. And although progressive proposals for a windfall tax on profits would do nothing to solve supply-side problems, a tax on “windfall buybacks” may make corporate earnings reinvestment more attractive.

Even if inflation subsides more rapidly than expected, a new policy focus on the supply side is necessary. Avoiding stagflation simply by returning to “secular stagnation”, as Summers would put it, would only lead to further decline and likely a repetition of the same cycle in the future. Also required is the recognition that fundamental assumptions of economic theory — and the ideological approaches they inspire — no longer match the realities of America’s financialised economy.


Julius Krein is the editor of American Affairs

JuliusKrein

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J Bryant
J Bryant
2 years ago

New supply-side approaches are required, such as the proposed funding for manufacturing investment contemplated in the COMPETES/USICA conference bill….prudent competition and trade policy reforms will be necessary to boost domestic investment in a highly concentrated economy whose industrial base has eroded.
Yes, reinvest in the productive economy (not the economy of Think Tanks, higher ed bureaucracy, and the like), especially high-tech manufacturing such as manufacture of pharmaceuticals and medical equipment. Not to mention computer chip manufacturing.
And there’s nothing wrong with a trade policy that favors your own nation and stimulates investment provided you can strike the difficult balance of avoiding outright protectionism.
Also invest in productive higher education, notably STEM, and make it easier for people to attend either technical college or university to study these subjects. Don’t write off student loans acquired by studying politicized subjects of no practical value. Subsidize the STEM students instead.
I hope we see these kinds of changes but so far national competitiveness, and job opportunities that pay ordinary people a living wage, have taken a distant back seat to corporate profits usually achieved by financial engineering.
Great essay from this author. Finally, Unherd has published a full length economics essay.

Luke I
Luke I
2 years ago
Reply to  J Bryant

A note of caution on overly subsidising STEM – creating more graduates with qualifications doesn’t automatically create jobs for them to work, or guarantee that the quality of their credentials makes the someone you’d want to employ.

A glut of unemployed graduates will likely start carving out their own niches, and we’d see an acceleration in the deterioration of science journalism and woke ideology sinking it’s claws in.

Garrett R
Garrett R
2 years ago

Excellent article. The Recession put the cash returns on steroid with labor’s share of income falling even more. For over a decade, companies have failed to invest in productivity-enhancing endeavors and we see the consequences of that today.

Another part of these trends is the global trade imbalances where persistent surplus countries like China, Japan, and Germany must dump their surpluses on persistent deficit countries like the US. Globalized finance without globalized trade results in these issues. For the most part, countries have competed on low wages rather than product quality, which is a race to the bottom. Hopefully we will reverse these trends.

Jeremy Bray
Jeremy Bray
2 years ago

At the risk of sounding like a hippy the premise of this article and some of the comments is that production of more goods is desirable and more should be invested to make this come about. The problem is that just as farmers can be ruined by a harvest glut that drives down prices below the usual cost of production so too many goods simply crushes returns. It may be paradoxical to suggest we are near peak demand for many goods given tales of poverty but the fact is that enthusiasm for decluttering and experiences over more stuff suggests that for the population with money peek demand is here. We have a problem with GP services because large numbers of GPs have accumulated all that they want and prefer to cut the time working or decide to retire early.
Those who are living on the streets contribute no effective demand and the poor are often simply relatively poor. You don’t see the poor in rags with their ribs protruding. In a world where the ecological and climate effects of productivity are continually emphasised the suggestion that expanded productivity might be a good thing ought surely to be questioned rather than more production being seen as desirable.

Last edited 2 years ago by Jeremy Bray
Billy Bob
Billy Bob
2 years ago

If we taxed high earners and dividends much more aggressively, and companies at a lower rate, do you think that would encourage investment in improving productivity? If shareholders would see large percentages of the money they take out simply handed over to the taxman would they be more inclined to reinvest it within the business?

Andy Moore
Andy Moore
2 years ago
Reply to  Billy Bob

The simple answer is yes, if combined with incentives on investments.

Laura Creighton
Laura Creighton
2 years ago
Reply to  Billy Bob

For many firms, the problem is that they have too much money to want to invest in the operations of the company, not too little.
Every company has 2 distinct businesses. The first one is the business that the company is famous for — providing the product or service associated with the company name. The second business is a financial business, for managing the money that the firms earns. It used to be that the second business was a very minor part of the whole, to the extent that some very successful firms had a financial strategy of ‘stick the profits in the bank and let it earn interest’ and nothing more was really needed.
But at some point, you may discover that the financials business is making more money than the core business. At this point they no longer care about investing in the core business to make it continuously competitive. Sometimes they sell the core business right off, or allow it to fail. But there are worse things that can happen. The profits as a financials business rarely translates into ‘increased dividends for the shareholder’, but rather into ‘increased price for the stock’, which can be realised only when you sell the stock.
So, the company does things that increases the price of the shares. The executives sell their shares and realise a great profit. Then the company goes into decline. The share price drops. The company buys back the stock at reduced prices. It then uses them for stock options for the next round of employees. And gets another big win when selling off or shutting down its non-competitive business to focus on its profitable real-estate arm causes the prices to jump again …
Usually, not always, but usually the people who want more dividend revenue are also the people who want more investment in the core business. They don’t care all that much if the stock price rises because they don’t want to sell their stocks. They just want enough investment in the business to keep it healthy and profitable — ideally forever. And spitting out nicer and nicer dividends for them. The people who are focused on making money through share price differentials desire a boom-and-bust in share prices. It’s easier to create a bust, or allow one through decreased competitiveness than it is to boom on your increased competitiveness. Besides, the big winners in the competitiveness game tend to be small, lean companies. Better to buy them than to try to compete with them ….
So if you want to use tax policy to make firms invest more, going after dividends seems to not be the way. What I think could work is to define a ‘financial services’ company and ‘financial services’ income and then tax the heck out of that. But this is just my theory. And to get it to work you will need a certain amount of international co-operation, or everybody will just relocate overseas. (Which is another thing I want to make laws against, but nevermind, this is too long already. ) Belling this particular cat, when what I want to do, aside from the belling, is out and out shave all the fur off the financial services industry, declaw it and leave it with very short whiskers seems impossibly hard to me.
Unless there is a violent and bloody revolution, or world war. Then all bets are off, but it’s not something to wish for.

Last edited 2 years ago by Laura Creighton
chris sullivan
chris sullivan
2 years ago

Great summary thanks Laura – at last we are getting more economics on Unherd – and you obviously have a handle on that !

Matthew Powell
Matthew Powell
2 years ago

So essentially the low interest environment, rather than encouraging investment, encourages inertia, as without any of the alternatives traditionally used for saving, investors incentivise companies to provide this service through favouring those that paid high dividends and engage in generous share buy backs. This distorts the market, as companies that do invest in the core business are penalised, as it diverts resources away from providing shareholder returns in the short term and capital seeking economic growth is crowded out by capital seeking immediate market returns.

This should come to an end with the FED raising interest rates but a lot will depend on what the political will there is to allow a Schumpeterian blood letting. America stock markets have been pumped up by cheap credit for over a decade and once bonds start to become a viable investment again, we may be about to find out just how big a bubble has been inflated.

However, given that political consensus is always to artificially extend the growth cycle and hope that the next administration are left holding the parcel when the music stops; I expect that nerves will fail before the boil has been lanced.

Hardee Hodges
Hardee Hodges
2 years ago
Reply to  Matthew Powell

When interest rates suggest capital has no value as we have experienced, the answer is to borrow as much as possible to buy whatever real assets you can. That leads to asset inflation and bubbles. Corporations then discover better income via engineering finance. This distortion of the value of capital has also allowed no consideration of debt service expense.
As you note somebody will soon be holding the bad news bag.

Sidney Mysterious
Sidney Mysterious
2 years ago

We are all impressed by the scholarly analysis of the current socio-economic conditions created by Tools and Fools in the US and worldwide.
Bravo.
How about the truth: Joe Biden and the ever-present band of elite “One Worlder control cadre” are upset that they don’t have the power and immunity of past Kings, Kaiser, Tsars, and potentates, because of tho pesky US constitution and some Forefather Fuddy-duddies. Ruminating about symptoms and pontificating about causes wastes ink, and does not lessen the stink.

David Jennings
David Jennings
2 years ago

Thanks for this essay. As others have noted, it is good for Unherd to publish more economic analysis.
One significant factor in corporate behaviour was not addressed: those shareholders seeking maximum cash back and dividends are often pension funds (or funds compared to pension funds) that have a duty to fund the retirements of those comprising the West’s demographic bomb (especially since governments have woefully underfunded public retirement plans). So corporations are feeling the tremendous stress to provide and increase dividends (which increases share prices as these shareholder funds chase returns) rather than invest in future and risky market growth. One only needs to see the composition of top US busiensses over time (only 25% of the top 30 in 1988 were still in the top 30 in 2017) to see that business is risky, even (or especially) for the successful. For many CEOs, giving the money to shareholders is a more popular and less risky way to achieve success. that does not make them “less greedy”, just rational.

N T
N T
2 years ago

So…more money should be thrown innto solve a problem that is fundamentally caused by too much money? Did I read that correctly?
I’m all for solving wage inflation by deeper investment in automation of all sorts. I don’t think the unwashed would agree.

Neven Curlin
Neven Curlin
2 years ago

This was a more interesting article than I expected from the title, which seems to harken back to the 80s.

Could a cap on wealth be a solution to this problem? Once people can’t get richer, there is no need for them to demand shareholder returns, which gives companies more leeway to invest.