Tuesday, January 29, 2013

The Financialization Of The US Economy And Unemployment

This is a fascinating article which shows how the US economy has changed since 1980.  Non-financial corporate payouts to shareholders, prior to 1980, was around 40% of after tax profits.  The remainder was available to fund investments.  That pattern shifted dramatically in the 1980's, and it continues today.  In 2008 corporate payouts to shareholders, through dividends and net stock repurchases, exceeded the profits of non-financial corporations.  Many corporations were borrowing money in order to provide payouts to shareholders with dividends, or stock repurchases that have the effect of increasing the value of the outstanding stock shares. 

This pattern was consistent with the concept that purpose of the corporation was to increase shareholder value.  Management compensation also moved in that direction.  Executive compensation was linked to increases in the stock price.  This aligned the incentives of executives with that of shareholders. 

This also shifted the investment function from corporate executives to Wall Street firms that owned, or managed stocks for individuals and other investors.  Wall Street was put in the position of allocating funds to firms or industries that would provide the best returns to investors.  Many argued that Wall Street would be better at allocating capital to its most productive uses than corporate executives.  Wall Street has been critical of firms, like Apple, which retains earnings so that it can allocate profits to innovations that will allow it to grow. They want Apple to use its cash to payout dividends to shareholders, or to repurchase its stock.  The financial industry also favors firms that set higher targets for internal investment projects.  That encourages firms to make fewer riskier investments and to focus on cost cutting to increase profits.  The end result is decreased innovation, and less expenditure on R&D.  It also encourages corporations to lobby government for tax reductions, or other favors that might contribute to corporate profits, and returns to shareholders.

The financialization of the economy leads to unemployment by lowering the level of internal corporate investment on new projects.  Corporate investments focus on increasing internal efficiency, and reducing the cost of labor.  Firms that are not successful in increasing returns to shareholders are subject to attack by private equity firms.  Their mode of operation is to produce a quick return to their investors by borrowing money in order to pay dividends to the private equity company, along with high fees for consulting services.  The private equity firms make money even if the company fails. It also makes money if it can increase profits through cost cutting, and sell the business to a third party.

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