Harry Geels: Companies are swimming in money, governments are swimming in debt
Harry Geels: Companies are swimming in money, governments are swimming in debt
This column was originally written in Dutch. This is an English translation.
By Harry Geels
Most large companies hold a lot of cash, while most governments have a lot of debt. This paradox can be explained by five factors, which lead to an ironic conclusion about how our system works.
It is one of the strangest paradoxes of the modern economy: large companies have never had so much cash on their balance sheets, while governments have never run such large deficits. Google now has $95 billion in liquid assets, and Microsoft, Amazon and Berkshire Hathaway also hold enormous cash reserves. Strikingly, many large European industrial companies, for example in the automotive or energy industries, also hold billions in cash (equivalents).
Figure 1
Source: Wolf Financial
At the same time, many governments have large deficits, with the US even having a budget deficit of more than 7%. In a classic capitalist system, you would expect the opposite: that companies reinvest their profits in growth and innovation, and that governments keep their budgets more or less in balance. But today, it is the other way around. There are roughly five reasons why companies are hoarding money on a massive scale. And these lead to a remarkable conclusion about the current system.
1) Less competition, less need to invest
The first and perhaps most fundamental cause is the lack of competition. In many sectors, the dynamics of “creative destruction”, the constant pressure from rivals to be better, cheaper or more innovative, have weakened. Large companies dominate markets as oligopolists, sometimes even as monopolists, thanks to network effects, economies of scale and high barriers to entry. New players are often bought out early on, before they can pose a threat.
When market share and profitability are assured even without major investment, the incentive to take big risks every year disappears. The result: rising profit margins, high cash flows and a reduced need to reinvest those cash flows productively. There is even compelling evidence that oligopolistic structures in the energy sector, which defend easy current fossil fuel cash cows, contribute to slowing down the sustainability transition.
2) Lack of profitable investment opportunities
Even where companies are willing to invest, opportunities are often limited. Many modern business models, especially in the technology sector, are not capital-intensive. An extra billion dollars in cloud software or algorithmic research does not necessarily yield a higher return. As a result, the return on investment of new projects is often lower than the return on simply doing nothing. Many growth markets have already been largely exploited, and the remaining niches are too small or too risky for large companies.
3) Strategic flexibility: cash as a weapon
Cash is not only a sign of stagnation, but also of power. Large companies see liquidity as a strategic tool: a war chest for acquisitions (of new, innovative players), share buybacks, or fending off activist shareholders. In a world of geopolitical uncertainty and technological disruption, financial flexibility is a value in itself. The larger the reserves, the smaller the dependence on banks or capital markets and the greater the room for manoeuvre in times of crisis.
4) Tax and accounting incentives
A more technical, but not insignificant factor is tax and accounting incentives. Until a few years ago, it was disadvantageous for American companies to repatriate foreign profits due to the tax burden, which meant that these reserves often remained “offshore” in tax havens. That disadvantage has now largely disappeared, but companies still prefer to return money to shareholders through share buybacks rather than dividends, because it is more tax-efficient and often drives up share prices, which is good for the bonuses of top executives.
5) Shareholder preferences and risk perception
Finally, the psychology of the financial markets also plays a role. Institutional investors value stability, predictability and liquidity. CFOs are rarely penalised for having too much cash, but they are penalised for liquidity problems. The 2008 financial crisis left a deep mark in this regard: better to have a large buffer than a small one. In addition, bonus structures encourage “certain” short-term profits from existing activities more than “uncertain” profits from long-term investments.
Governments, on the other hand, have deficits
The five factors described above mean that large companies are no longer the dynamic investors they once were. They have turned into cash machines. And that brings us to the second part of the paradox: structural government deficits. From a macroeconomic perspective, the surplus of one sector is the deficit of another. If companies and households save more than they invest, then another party – usually the government – must borrow to maintain demand.
Remarkably, this situation is also forcing governments to play a role that they had largely left to the market for decades: that of investor. Programmes such as the American Inflation Reduction Act, the European Green Deal, the new German government's plans to invest $500 billion in infrastructure and the new agreements on higher defence spending are essentially attempts to fill the gap left by the business community. To pay for this, the “Schuldenbremse” (debt brake) must be removed.
Irony
The irony is that this government spending often flows back to the same companies that are hoarding their cash surpluses: in the form of subsidies, contracts or tax breaks. And so the “corporatocracy” – a system in which large companies and governments work together – is further shaped. The market power of large players is publicly facilitated at the expense of the taxpayer. Let's please stop calling this free markets. It is a fine example of corporate socialism.
This article contains the personal opinion of Harry Geels