Why ‘disgorging the cash’ can undermine economic growth

Photo of money by serp77, veer.com 

Two weeks ago, New York University economist Michael Spence and former Federal Reserve governor Kevin Warsh published an op-ed in the Wall Street Journal about U.S. monetary policy that provoked a spirited response. They argued that quantitative easing—the Federal Reserve’s program of buying long-term bonds and mortgage securities—actually depressed business investment instead of boosting it. (Former Treasury Secretary Larry Summers and our own Brad DeLong were, in a word, confused by this line of thinking.)

While Spence and Warsh’s logic does seem flawed, business investment growth has been quite weak over the course of this recovery. Why this investment recovery has been so weak, however, may have less to do with monetary policy and rather the functioning of the financial market.

Earlier this year, John Jay College economist and Roosevelt Institute fellow J.W. Mason published a paper called “Disgorge the Cash,” arguing that the U.S. financial system has become less about funneling money to companies who invest it and more about getting cash out of firms. The paper received quite a bit of attention, both positive and negative, so Mason released a new paper last Friday expanding on the topic and answering some criticism.

One such criticism is the idea that business investment was fine during the past two decades, so there’s no need to worry about this disgorgement. Mason shows, however, that business investment growth has actually been very weak during this recovery. In fact, not only is the current investment recovery is the weakest on record, but the second-weakest recovery was the one immediately prior starting in 2001.

This weak growth is especially confusing given the trends in factors we might think would boost investment. For one, investment growth was quite weak even though long-term interest rates were on the decline during the 2000s. And if we think investment is more related to profits, then the weakness of investment growth is also confusing as corporate profits were quite high during this time period.

Mason points at the financial sector as a big culprit. Some have argued that the share buybacks Mason and others have highlighted are merely the recycling of funds from mature companies to new, dynamic firms that will use the funds more productively. But if you look at the sheer amount of shareholder payouts in 2014 ($1.2 trillion), it dwarfs the amount of money going to new companies in the form of initial public offerings and venture capital ($200 billion). For every dollar the system invests in these newer firms, it takes out $6 from older public firms.

Mason’s research paints a grim picture. A well-functioning financial system is supposed to channel savings to their most productive use. Instead, the U.S. system, in total, seems to be more interested in getting money out of firms and into the accounts of wealthy shareholders. As a companion Roosevelt Institute report also released Friday points out, it will take pulling on multiple policy levers to reverse this kind of massive trend. It seems we need to find many levers in order to move the financial world.