Are low-interest rates contributing to low business investment?

Lower interest rates should boost business investment. By making money today cheaper today, companies have incentives to invest more in order to earn greater profits in the future. More credit equals more investment equals more economic growth now and in the future. But business investment growth hasn’t been particularly strong during the current era of zero and near-zero interest rates in the United States. And that’s particularly puzzling given how strong U.S. corporate profits have been over the same time period.

Maybe, just maybe, negative interest rates actually reduce businesses’ investment appetites– or so a new argument claims. This case, made by Jason Thomas of Carlyle Group and laid out by Greg Ip of the Wall Street Journal, starts from an important observation: Companies are increasing sending more money to shareholders in the form of dividends and stock buybacks, and spending relatively less money on investments in their businesses. According to Thomas’s calculations, since 2009–when interest rates were at zero percent–stock buybacks increased by 194 percent, dividends by 66.5 percent, and investment by only 43 percent. If companies have all these funds to send out to shareholders, why aren’t they using it to invest or borrowing money to do the same?

Thomas argues that it has to do with short-termism, or rather a specific kind of short-termism. One might expect that shareholders would welcome the chance for greater payouts in the future (as investing now would make dividends even greater in the future), but Thomas argues that there’s a group of shareholders that really want those dividends now: retirees. With low interest rates, retirees are particularly in need of cash flow now and will pay a premium for companies that buy back shares or increase dividends. Thomas’s argument, in effect, hinges on the idea that retirees have a higher risk tolerance than we think because it would make more sense for retirees to be investing in less-risky bonds than trying to pick specific stocks.

But many retirees, like many stock market investors, are passive investors, buying and selling through a variety of mutual funds and other retirement-investment vehicles. Their investment patterns reflect a broad index of stocks instead of specific companies.

What’s more, there are other explanations for the dearth of corporate investment today. Ip notes that companies may be investing less because they see fewer good investment opportunities, which is itself a reason why interest rates are low. Another problem with Thomas’s hypothesis is that declining corporate investment trend has been happening far longer than interest rates have been near zero. As John Jay College economist J.W. Mason points out in a report for the Roosevelt Institute, the shift away from investment and toward payouts to shareholders started in the 1980s, well before interest rates ever approached zero.

Low interest rates might possibly, in some small way, have an effect on the payout-investment decision for companies based on the demands of their elderly shareholders. But given the timing of the decline in corporate investment, the impact of low interest rates on retiree decision-making would seem to be nominal at best.