Corporate surpluses, savings, and economic growth
Shaking hands by avava, veer.com
While business investment in the United States is growing at a historically weak rate, corporate profits continue to make up a remarkably large share of the economy. The result: Net savings by the U.S. corporate sector has increased significantly since the turn of the century, going from negative to close to 2 percent of our gross domestic product.
This trend isn’t restricted to the United States, however—it’s also happening in the other large developed economies such as Japan, the United Kingdom, and Germany, as Martin Wolf aptly describes in a column for the Financial Times. For those concerned about the pace of future economic growth and perhaps economic stability, the rise of corporate savings has important implications.
As Wolf points out in his column, the increase in corporate savings has significant ramifications for economic growth in two ways. The first effect is that declining corporate investment will reduce the potential growth rate of the economy, as investment is thought to have a strong relationship with productivity growth. The rise of corporate savings surpluses, however, has an effect on “the shape of aggregate demand.”
With all its excess savings, the corporate sector has turned into a net financer of the economy in recent years. These savings have to go somewhere, but government borrowing seems to be an unlikely destination with many governments shooting for balanced budgets. The remaining targets are then the household sector and the rest of the global economy.
It might be a positive development for the United States if the savings are reinvested in the global economy. The United States has long run a trade deficit with the rest of the world, so an increase in savings going abroad would help balance the trade deficit. In a traditional neoclassical model, we might expect this capital to flow from high-income countries to low-income countries where the return on capital is higher. In fact, we’ve seen the opposite of this happen in recent years. The strong U.S. dollar seems to have been an impediment to this process in the past.
When it comes to the household sector, we have to ask which households would end up borrowing these loaned funds. As research from University of California, Berkeley economists Emmanuel Saez and Gabriel Zucman shows, the savings rate is much higher for higher-income Americans than for those further down the income ladder. With savings rates hovering around 0 percent for the bottom 90 percent, do we really want to have them save even less? Experience shows that funneling debt toward those particular households poses a big risk.
To return to the question of business investment, Wolf suggests that the government should consider taxing corporations’ retained earnings at a higher rate while allowing for the deductibility of investment and dividends. Given the research on how cutting dividend taxes would affect corporate decision making, it seems likely that deductibility would not boost business investment as intended. Instead, it would increase payouts to high-income shareholders.
This leaves us with two broad options. Either we figure out a way to induce more investment from the corporate sector, or we consider the best use of these savings for the broader economy. In an era of potential secular stagnation, it’s a knotty topic we have to unravel.