These charts were compiled by Pimco via data collected from the Federal Reserve and Credit Suisse. They show that U.S. companies are earning record amounts of money but are not re-investing it. Instead, companies are hoarding cash.
Why are companies hoarding so much cash? Many believe it is out of fear as liquidity issues during the financial crisis have caused companies to focus on reducing debt and raising cash.
But the lack of capital investment is having a negative impact on job growth, causing the recovery to stall. Regarding investment and hiring decisions, Arnold Kling writes:
In a textbook competitive market, there is no excess supply. When an excess supply threatens to appear, the price falls, increasing demand and reducing supply in order to restore balance.
Unemployment can be viewed as an excess supply of labor. Evidently, the labor market does not act like a textbook competitive market. Macroeconomists are tempted to ask why the labor market does not act as a textbook competitive market and whether it would be better if the labor market were more like a textbook competitive market.
One question is why an individual firm chooses to dismiss workers rather than reduce wages…
If the financial condition of a firm takes a turn for the worse, it needs to hold down or reduce its labor compensation. If all of its workers were equally valuable and interchangeable, then it might make sense to reduce labor costs by cutting wages, leaving it up to employees to decide when the wage is too low to warrant staying on. However, when managers believe that some workers are particularly valuable, they would rather make the choice themselves. Managers choose which workers to retain and which workers to let go.
After a cutback in staff, the workers that are retained by the firm are less likely to have their pay cut. The firm needs its remaining staff to maintain their productivity–indeed, it may require additional effort to make up for the workers who were let go. A pay cut would send workers a very adverse signal about the prospects for the firm, leading the firm’s best workers to seek jobs in other firms.
This is one reason that wages in aggregate may be sticky and labour markets don’t clear. When analysts tell you that all we need is to decrease wages to the market-clearing level in order to reduce unemployment, they are taking a stylized view of competitive markets that is not necessarily applicable to real world labour markets. In the real world, workers think in nominal money terms and perceive pay cuts as a negative signalling effect.
Possible remedies:
- Payroll tax cut
- Governed-sponsored industry investment
- Tax-break on re-investment
Of course, every government-supplied remedy will have unforeseen consequences. A Japanese-style MITI directing resource allocation smacks of central planning and could misallocate scarce real resources. I would suggest treading lightly. Of course, re-investing in R&D will not necessarily add to GDP in the near-term according to a recent BEA article on R&D and GDP.
Nevertheless, it can have an appreciable longer-term impact. Moreover, with underemployment in the high teens, the government is not crowding out the public sector on the hiring front. I do not think we should wait for the private sector to re-invest and hire when millions of workers are losing skills due to long-term unemployment and we lose hundreds of billions in output each quarter.
Sources:
- Macroeconomics Doubtbook, Installment 3 – Arnold Kling
- All Eyes on Washington – Mark Kiesel, PIMCO