Managerial Firms and Rentiers: How Corporate Behaviour is driving Inequality
One of the main elements of the Federal Government’s economic “plan” is to reduce taxes on corporations. In the Midyear Economic Forecast (MYEFO) delivered mid-December 2016 Treasurer Scott Morrison argued again for the corporate tax rate to be cut to 25 per cent – from the present 30 per cent – saying more needs to be done to encourage businesses to invest and employ more Australians, in order to stimulate economic growth.
Though the Coalition argues that the change would boost GDP by more than 1 per cent in the long-term, the net benefit, according to Grattan Institute economists, would more likely be half that and not appear for many years. The measure, which would cost an estimated $50 billion over 10 years, needs the approval of the Senate where it likely will be blocked.
Labor Opposition Treasury spokesman Chris Bowen, pointing to the long lead time and small impact, has repeatedly opposed the Coalition plan: the ALP advocates a tax cut for companies earning no more than $50 million. (Senator Nick Xenophon favours tax reductions for firms earning up to $10 millions.)
Donald Trump, President-elect of the United States, has also promised to reduce corporate taxes. The proposals include cutting the corporate tax rate from thirty-five per cent to fifteen per cent and allowing firms to pay a rate of just ten per cent if they repatriate profits. On Forbes, recent commentary pointed out, “First, tax cuts would have to be enormous to have any macroeconomic effect on a $16-18 trillion economy… Second, even if enhanced growth were achieved, it would not be evenly distributed. US income taxes are progressive. Spending is not, so the system as a whole is not redistributive. And as the individual discussion shows, it would not put a lot more money in the hands of people with a high marginal propensity to consume.”
In December Prime Minister Turnbull expressed the hope that the decision by President-elect Trump to press ahead with corporate tax cuts would strengthen governments’ hand in achieving the proposed cuts in Australia.
This essay advances the proposition, based on significant economic literature, that tax cuts will not achieve the purposes which are promoted because of tax minimisation and profit alienation or even non-existent. A significant number of large companies are in fact using retained earnings to buy back shares and increase dividends so restricting funds for growth and diversification. Thus the fundamental driver of increased economic activity, increased demand, is not there, very much because ordinary wages have been held back.
The increase in profits flowing from tax breaks to major corporations might give another boost to the stock market but the money won’t be spent on capital spending and growth. It will be spent on share repurchases. It is a consequence of the relatively recent view that the principal purpose of the corporation is to increase the wealth of shareholders.
The proposition that corporate tax cuts will not end up stimulating the economy is not based on economic theory but on experience. High corporate taxes are not holding back investment, short-term strategies and weak demand are.
The weak demand is a consequence of polices adopted by government at the behest of corporations to keep a cap on wages growth. The top one percent of earners take home more than 20 percent of the income, and their share has more than doubled in the last thirty-five years, as so many including Nobel Prizewinner Joseph Stiglitz, have pointed out. The gains for people in the top 0.1 percent, meanwhile, have been even greater. Yet over that same period, average wages and household incomes in the US have risen only slightly, and a number of demographic groups (like men with only a high school education) have actually seen their average wages decline.
Productive Achievement and Tax Cuts for Business
In an incisive article on The New Yorker for 22 December 2016, long-time staff writer John Cassidy observes, “One reason the U.S. economy has grown relatively slowly over the past eight years is that corporations have been sitting on their cash rather than investing it in things like factories, offices, and new equipment—a failure widely attributed to depressed animal spirits.
“It is the sort of Randian analysis [a reference to Russian-American novelist and philosopher Ayn Rand who considered productive achievement the noblest activity of man] long favored by many people on Wall Street, and recently promoted by some of Trump’s closest economic advisers: if you want capitalism to work more effectively, offer greater rewards to the capitalists. Cut taxes, rein in regulation, and create an environment that incentivizes financial risk-taking. The free market … will do the rest.” Indeed the view is that Trump’s proposals would generate “a tremendous movement, of capital and labor back to the United States, that’s in China and overseas.”
Cassidy quotes Ray Dalio, the founder and chief executive of American Investment Management firm Bridgewater Associates, “This new administration hates weak, unproductive, socialist people and policies, and it admires strong, can-do, profit makers. It wants to, and probably will, shift the environment from one that makes profit makers villains with limited power to one that makes them heroes with significant power.”
“Dalio claimed that the Trump era could be even more significant than the 1978-1982 shift to the right that saw Margaret Thatcher, Ronald Reagan, and Helmut Kohl elected—one of the big questions is whether the new policies being implemented will work. Dalio offered an upbeat prognosis. He argued that Trump’s proposals to slash corporate tax rates and give big businesses like Apple and Microsoft financial incentives to repatriate trillions of dollars in profits that they are holding abroad could “ignite animal spirits and attract productive capital” to the United States.”
Inequality, Shareholder Wealth and Corporate Power
Columbia University economist Jeffrey Sachs, in his 2012 book The Price of Civilisation reviewed by Ross Gittins, says the US economy is caught in a feedback loop: “’Corporate wealth translates into political power through campaign financing, corporate lobbying and the revolving door of jobs between government and industry; and political power translates into further wealth through tax cuts, deregulation and sweetheart contracts between government and industry. Wealth begets power, and power begets wealth.” The military-industrial, Wall Street-Washington and Big Oil-transport-military complexes and the healthcare industry all play their part.
Gittins’ more recent commentary on bad behaviour of business, stemming from current economic orthodoxy and its obsession with demanding measures of performance – Key Performance Indicators (KPIs) – without any concern for methods or process, is just one of many criticisms. The faddish translation of imagined business practice to government agencies has led to the latter adopting KPIs as a central part of forward planning as if they are the core of strategy, which they are not!
A series of research papers and articles elucidate these issues. Governments have ignored the behaviour of corporations and failed to address the consequences of continual cutbacks in government and slow wages growth.
Professor J. B. Foster of the University of Oregon & M. D. Yates, both researchers on inequality, in a review ‘Piketty and the Crisis of Neoclassical Economics‘ (Monthly Review October 2014) quote a recent paper by Economic Policy Institute economist Elise Gould which points out that between 1979 and 2013, productivity grew 64.9 percent, while hourly compensation of production and nonsupervisory workers, who comprise over 80 percent of the private-sector workforce, grew just 8.0 percent. Productivity thus grew eight times faster than typical worker compensation. Further, over roughly the same period, income and wealth levels, rather than converging, have diverged sharply—a divergence that cannot be attributed to differences in education and skill, nor to the contributions of capital relative to labor (as shown by Lawrence Mishel, “Education is Not the Cure for High Unemployment or for Income Inequality,” January 12, 2011 also quoted by Foster & Yates).
Ian McAuley, Centre for Policy Development Fellow, in a New Matilda article in August 2014, referred to the Australian economy as a Ponzi Scheme, one in which current income is diverted to paying earlier investors and not to new investment. He notes “As the profit reporting season runs its course, it is becoming clear that many companies have chosen to pay out high dividends, while keeping aside a smaller proportion of profits for re-investment. Of course it is quite legal for firms to pay high dividends and to make capital returns, but in many ways the results resemble those of Ponzi schemes. Higher dividends, higher share prices, and capital returns all favour corporate managers, who receive much of their pay in stocks or stock options. It’s not dissimilar to the early stages of a Ponzi scheme, where both the promoters and the investors do well.”
McAuley quotes the statement by then Reserve Bank Governor Glenn Stevens: “if reports are to believed, many businesses remain intent on sustaining a flow of dividends and returning capital to shareholders and are somewhat less focussed on implementing plans for growth”. Stevens was appearing before the House of Representatives Standing Committee on Economics. Giant telecommunications company Telstra was just one of the companies embarking on share buyback to inflate dividends.
Corporate Investment and Executive Risk: No Downside
In a review of changes in corporate investment strategy over the last four decades, J W Mason in ‘Disgorge the Cash’ (Roosevelt Institute, February 25, 2015) distinguishes the managerial firm as one in which managers make the major decisions on investment and stockholders are passive recipients of dividends and the rentier firm as one in which the stockholder are active and pursue management to increase the stock price and return higher dividends and the proceeds of stock buybacks. The thesis tested by Mason in his survey of the history of corporate governance is that up to the late 70s most firms were managerial ones but increasingly since the 1980s more and more firms have become rentiers.
Mason says, “the strong empirical relationship of corporate cash flow and borrowing to productive corporate investment has disappeared in the last 30 years and has been replaced with corporate funds and shareholder payouts. Whereas firms once borrowed to invest and improve their long-term performance, they now borrow to enrich their investors in the short-run. This is the result of legal, managerial, and structural changes that resulted from the shareholder revolution of the 1980s. Under the older, managerial, model, more money coming into a firm – from sales or from borrowing – typically meant more money spent on fixed investment. In the new rentier-dominated model, more money coming in means more money flowing out to shareholders in the form of dividends and stock buybacks.
“These results have important implications for macroeconomic policy. The shareholder revolution – and its implications for corporate financing decisions – may help explain why higher corporate profits in recent business cycles have generally failed to lead to high levels of investment. And under this new system, cheaper money from lower interest rates will fail to stimulate investment, growth, and wages because [as he shows] additional funds are funneled to shareholders through buybacks and dividends.”
Professor William Lazonick (University of Massachusetts’ Centre for Effective Public Management) in “Stock buybacks: From retain-and-reinvest to downsize-and-distribute” (April 2015) observed, “Over the decade 2004-2013, 454 companies in S&P 500 Index in March 2014 that were publicly listed over the ten years did $3.4 trillion in stock buybacks, representing 51 percent of net income. These companies expended an additional 35 percent of net income on dividends.5 And buybacks remain in vogue: According to data compiled by Factset, for the 12-month period ending December 2014, S&P 500 companies spent $565 billion on buybacks, up 18 percent from the previous 12-month period.”
Lazonick continues, “Under retain-and-reinvest, the corporation retains earnings and reinvests them in the productive capabilities embodied in its labor force. Under downsizeand- distribute, the corporation lays off experienced, and often more expensive, workers, and distributes corporate cash to shareholders.”
The pharmaceutical industry is renowned for charging high prices for its products and claiming that the prices reflect the high cost of research and development. However, many drugs developed by companies benefit from basic research conducted by or with funds from government. Lazonick, in Profits Without Prosperity (Harvard Business Review September 2014) says, “In response to complaints that U.S. drug prices are at least twice those in any other country, Pfizer and other U.S. pharmaceutical companies have argued that the profits from these high prices—enabled by a generous intellectual-property regime and lax price regulation—permit more R&D to be done in the United States than elsewhere. Yet from 2003 through 2012, Pfizer funneled an amount equal to 71% of its profits into buybacks, and an amount equal to 75% of its profits into dividends. In other words, it spent more on buybacks and dividends than it earned and tapped its capital reserves to help fund them. The reality is, Americans pay high drug prices so that major pharmaceutical companies can boost their stock prices and pad executive pay.”
In “Economic Hegemony and the Federal Reserve” (Counterpunch Feb 27–Mar 01) Rob Urie observes, “Theory has it that ownership stakes give executives vested interest in corporate well-being. By using company earnings or borrowed money to buy-back stock executives raise the stock price and with it, their own compensation. This comes at the expense of future production and a potentially destabilizing increase in leverage. The combined effect is a rigged stock market and a corporate class that is gutting the broad economy for its own self-enrichment.”
This behaviour is occurring also in Australia. Thus, in an article taken from Australian Economy, March 6, 2015 on the Macrobusiness website under the heading ‘Corporate greed is killing investment’ addresses the statement, “We all know that the RBA [Reserve Bank of Australia] has been pushing a line for years that the missing link in the Australian recovery is business investment owing to poor “confidence”.” The ‘Disgorge the Cash’ paper by Mason, referenced above, is quoted.
The article continues, “We are not immune. Recall this classic quote from Rodney Adler when interviewed by David James at BRW [Business Review Weekly] after the GFC:
“There has been a major change in the upper middle-management layer of most corporations. In the old days, which certainly I believe in, the standard organisation was that equity went into a company, and if you owned that equity after 20 years’ hard work you made a lot of money if you were successful. About 10 or 20 years ago this all changed. All of a sudden these people on good salaries who hadn’t taken the risk, who hadn’t built the corporation, they said to themselves: ‘I’d like to be rich. I’d like to have equity in the company but I don’t want to buy it.’ And a whole new set of instruments evolved out of America, which then infested the rest of the world, certainly the Western world, where executives became owners but with no risk. “[At that point] capitalism as we know it changed. It is not capitalism because the risk has gone. The executives have the upside and no down-side. That is the problem.”
The article concludes, “What does it mean when Rodney Adler makes more sense than the Reserve Bank.” In other words, it is not lack of confidence that is holding back investment but the behaviour of corporate executives and other shareholders in using companies as nothing more than a way to make money without any contribution to productivity!
In Kick the dividend addiction (ABC The Drum 28 August 2014) distinguished economic journalist Alan Kohler wrote, “the nation’s investors have become obsessed with harvesting dividends and the companies with supplying them. The share market has become a giant retiree ATM instead of a means of supplying capital for business investment. All of the return from the market since the beginning of 2007 – 35.1 per cent – has come from dividends.”
In ‘Australia’s addiction to dividends is killing us”, (Business Spectator 4 August 2014) Kohler focused on dividend imputation and the decline in non-mining capital stock since 1987. “Dividend imputation lowered the cost of equity for Australian companies and resulted in a structural decline in gearing, but it has also resulted in sustained pressure on companies to increase their dividend payout ratios and not retain earnings. The result is chronic under-investment by companies outside the mining industry, and especially in manufacturing.”
Where has Tax Revenue gone?
There has been a great deal of attention to the taxes actually paid by corporations in recent months especially. Cassidy notes that the complex tax code in the US, riddled as it is with loopholes, means that companies don’t pay anything like the 35 per cent intended. Between 2008 and 2012 it was on average about 14 per cent, from 2006 to 2012 two thirds of incorporated businesses didn’t pay anything.
The situation in Australia is similar, as has been revealed recently. Many large multinational companies are avoiding tax through profit alienation: among those companies are the well-known ones such as Amazon, Apple, Samsung, Google and Microsoft and pharmaceutical companies like Proctor & Gamble and Pfizer. Some 30 per cent of large private companies pay no tax. Then there are the astonishing avoidance of tax by the super-rich revealed by the Panama papers. One commentator asserted, “the Panama Papers confirm that the super-rich have effectively exited the economic system the rest of us have to live in. Thirty years of runaway incomes for those at the top, and the full armoury of expensive financial sophistication, mean they no longer play by the same rules the rest of us have to follow. Tax havens are simply one reflection of that reality.”
And what is the driver of investment anyway? Cassidy notes, “Surveys by the Federal Reserve Board and other organizations indicate that the main factor depressing corporate investment has been weak demand. As Keynes pointed out eighty years ago, when firms don’t see the appetite for their products growing, they have little incentive to build new capacity. He quotes Dominic Konstam, an analyst at Deutsche Bank, as saying “the logic is quite simple”. In the absence of strong (global) final demand there is unlikely to be an increase in investment.
The low level of demand is a major issue. Corporations in pursuit of neoclassical economic theory – private sector good, public sector bad – for decades have urged governments to reduce employment. Further, business has urged governments and statutory bodies charged with determining wage rates to limit wage rises and further, to control union demands for wage increases, the basic wage and remove provisions such as penalty rates for special circumstances.
The consequence in the US and in Australia and many other developed nations has been a plateauing or small increment of rates of increase in wages for the majority of the population. That has meant a decrease in the disposable incomes of that part of the population most likely to spend generally. The rich are much more likely to invest their money in various activities such as property and ones in which financial institutions specialise whereas the bulk of the population spend disposable income in consumer goods, entertainment, travel and similar activities.
In other words, to the extent that economic growth is a function of aggregate expenditure from disposable income, these campaigns of business and the super- rich defeat the push for growth. The influence of the super-rich is not to be discounted. Whilst the divergence has been less in Australia than in the US it is nevertheless significant. Government policies has particularly targeted social welfare spending from payments to general practitioners to pensions.
Who is causing the Great Divergence
In his analysis of the “Great Divergence”, the increase in inequality since the 1980s, Timothy Noah points to the actions of the super-rich as the principal factor, attributing 30% of the Great Divergence to their influence. (Noah attributes 30% of the decline to lack of educational attainment due to rising tuition costs leading to fewer graduates to meet demand, 20% to the downfall of union’s collective lower wages and 10% to trade; gender and race, single parenthood and computerisation were considered by Noah to not have contributed to the rise of inequality and 5% each to immigration and tax policy.)
And the growth of the financial sector has been identified as an important factor contributing to the growth in inequality over the past 30 years. David Rosnick and Dean Baker of the Center for Economic and Policy Research (CEPR) in Washington drew this conclusion in a July 2012 report, “Missing the Story The OECD’s Analysis of Inequality” critical of the OECD’s lengthy volume examining the causes of rising inequality in most wealthy countries over the last three decades. They found inequality to be driven by in large part by increasing income shares at the very top, higher than the 90th percentile; those earnings come at the expense of those outside the sector so contributing to their relative decline.
Cassidy concludes! “The final, and perhaps most important, point to note is that the Randian theory now being trumpeted was put to the test, not very long ago, and it failed. In 2004, the Bush Administration introduced a “tax holiday” for corporations that repatriated profits they were holding abroad, arguing much as … others are now, that it would spur capital investment and job growth. What actually happened, according to a Senate subcommittee that surveyed twenty leading multinational companies, was that “the 2004 repatriation tax provision was followed by an increase in dollars spent on stock repurchases and executive compensation.
”Of course, things could turn out differently this time, but even some analysts at … Goldman Sachs, doubt that will happen. In a recent research note to clients, Goldman predicted that three-quarters of the money that big corporations bring back to the United States next year under the Trump tax plan will end up being spent on stock buybacks. “We estimate that $150 billion out of $780 billion of S&P 500 buybacks in 2017 will be driven by repatriated overseas cash,” the Goldman research note said. “We forecast that S&P 500 companies will repatriate close to $200 billion of their $1 trillion of total overseas cash in 2017, which will be directed primarily toward share repurchases.”
Then there were the substantial reductions in corporate tax rates in the 1980s by both the Reagan and Thatcher administrations in the US and the UK respectively. Did that generate increased employment and economic activity generally? To what extent has there been increased activity which can be specifically attributable to the changes in the tax regime as opposed to other factors? Comparisons of tax regimes often fail to attend to the complexities in each country, in the case of the US the fact that there substantial state taxes in addition to federal taxes and taxes do not include provision for health insurance. And so on.
Whilst in Australia, the federal the Coalition government proclaims its concern about all Australians and the need for more jobs, business continues its rent-seeking, all the while campaigning for keeping strong control over wages and conditions, reduction of the budget deficit and cutting government expenditure. The impact of the resulting inequality is profound and the cost to government tax revenue significant.
In today’s climate it is also fair to say that curbing excessive corporate executive pay and increasing employment using the money saved would cost companies no more and not negatively affect productivity. There is no reason to believe that paying executives more than a million dollars increases productivity or innovation. Bonuses for performance are not being paid for superior performance but merely for average performance.
In other words the dictum that the board and executive should have as their primary task the encouragement of above average performance is ignored. The likelihood of this occurring is of course nil. Firms with a union presence have lower levels of total executive compensation. Paying lower salaries might well encourage persons to be engaged who genuinely want to advance the organisation rather than just enrich themselves.
Treasurer Morrison’s exhortations just Another Station along the way
The Government’s campaign on budget repair, the scare campaign on the possibility of a reduced credit rating by international agencies and the arguments about unsustainability of social welfare spending based on nonsensical 50 year projections is all of a piece with the rhetoric of tax cuts for business. These economic positions are resulting in a continuation of the risk averse approach to capital expenditure on infrastructure and the argument that future generations should not be saddled with debt as if failure to invest means that future generations would face no liability. The fact is that instead of a financial liability they face unsustainably crowded roads, grossly inadequate communication systems, poor educational and health infrastructure. All these are, on the other hand, hardly faced in the day to day experience of the executives and shareholders in receipt of their dividends. The proposal that tax cuts will assist economic activity is fraudulent.
Governments are not working for all the people but for those who have most influence. Treasurer Morrison’s exhortations are just another station along the way. It’s as if Frederick Hayek had been exhumed for the occasion.
Those who follow the behaviour of financial institutions and the workings of Neoliberalism will find very little that is new in the above.
Claims that tax cuts will benefit the community at large when in fact they will benefit only some of the super-rich are simply more of the same. There are many articles and books about Neoliberal economics. Last year, as those who follow George Monbiot will already be aware, Monbiot’s “How Did We Get into This Mess?” was published by Verso in April 2015. He summarised his book in The Guardian April 2015. Monbiot had an earlier article on the same theme in early 2013.
The following, an extract from Monbiot’s summary of his book, is key economic history:
But in the 1970s, when Keynesian policies began to fall apart and economic crises struck on both sides of the Atlantic, neoliberal ideas began to enter the mainstream. As Friedman remarked, “when the time came that you had to change … there was an alternative ready there to be picked up”. With the help of sympathetic journalists and political advisers, elements of neoliberalism, especially its prescriptions for monetary policy, were adopted by Jimmy Carter’s administration in the US and Jim Callaghan’s government in Britain.
After Margaret Thatcher and Ronald Reagan took power, the rest of the package soon followed: massive tax cuts for the rich, the crushing of trade unions, deregulation, privatisation, outsourcing and competition in public services. Through the IMF, the World Bank, the Maastricht treaty and the World Trade Organisation, neoliberal policies were imposed – often without democratic consent – on much of the world. Most remarkable was its adoption among parties that once belonged to the left: Labour and the Democrats, for example. As Stedman Jones notes, “it is hard to think of another utopia to have been as fully realised.”
It may seem strange that a doctrine promising choice and freedom should have been promoted with the slogan “there is no alternative”. But, as Hayek remarked on a visit to Pinochet’s Chile – one of the first nations in which the programme was comprehensively applied – “my personal preference leans toward a liberal dictatorship rather than toward a democratic government devoid of liberalism”. The freedom that neoliberalism offers, which sounds so beguiling when expressed in general terms, turns out to mean freedom for the pike, not for the minnows.
Numerous articles have appeared since 2008 about the Global Financial Crisis, not least by Michael Lewis: his book The Big Short was made into a film. The film Margin Call deals with the same themes. Both films are extremely high quality!
Many ask why none of the executives of the banks which benefitted from huge bailouts by government using taxpayer funds have ever gone to gaol.
Goldman Sachs director Greg Smith resigned in March 2012 after publishing an open letter in the New York Times accusing senior staff of being morally bankrupt and bent on extracting maximum fees from clients by offloading unsuitable investment products.
Matt Taibbi at Rolling Stone has been particularly active in covering this and the way government officials all the way to the US Attorney-General Eric Holder have managed to have next to nothing done about it all.
Taibbi’s stories show, amongst other things, how the SEC (Securities and Exchange Commission) “covered up Wall Street crimes” destroying records and whitewashing files (August 17 2011), how the biggest banks took part in a nationwide bid-rigging conspiracy until caught on tape (June 21 2012) and how HSBC “hooked up with drug traffickers and terrorists and got away with it” (February 14 2013) and much more.
Recent articles in the on line journal The Intercept deal with Holder’s behaviour. When Holder retired as Attorney-General he returned to the law firm for which he had been working when he was appointed to the Obama administration, a firm which actively lobbies on behalf of a number of the big banks.