The latest issue of the Cambridge Journal of Economics carries an interesting article on what the author, Özgür Orhangazi, calls the ‘investment-profit’ puzzle. He focuses his analysis on the US economy, and tries to account for the slowdown in investment and growth there since the early 2000s, and particularly since the crisis of 2008, despite a rise in the rate of profit.
The puzzle in question is the disconnect between rising profits and sluggish or falling rates of investment. It contributes to the literature blaming factors such as globalisation and financialisation for the disconnect. In particular, ‘investment’ in intangible assets in the high technology, healthcare, telecoms and non-durables sectors has risen relative to investment in tangible capital assets, cementing monopoly power and reducing some of the competitive stimulus for increasing investment in tangibles, thereby slowing economic growth.
Intangibles can take the form of patents which grant temporary monopoly, spending on branding, trademarks, design and licenses for production, increasing the artificial scarcity of products such as software, whose reproduction costs tend to fall to zero, and increasing barriers to market entry which can arise from ‘winner-take-all’ and network effects.
All such factors are ways of increasing monopoly power, and can give rise to monopoly rents, over and above the rate of profit that would be established in a more competitive market.
There is a case for a form of temporary monopoly rent, sometimes called Schumpeterian rent, if it is likely to encourage innovation. The prospect of a guaranteed monopoly in the production of a new product and the ability to charge higher prices and gain a higher rate of profit than in a more competitive market can incentivise sometimes costly research and development into new technologies, products and processes. The resultant rent, part of the higher profit on the new product, can incentivise the innovation and ultimately produce positive net social benefits that raise productivity firstly for the firm in question and subsequently for the economy as a whole.
Rents for innovation need to be temporary. After a time they can otherwise become unproductive monopoly rents, which can stifle competition by preventing new entrants into the market and the diffusion of the innovation throughout the economy, preventing output prices from falling and reducing social welfare.
Policies that encourage innovation without giving rise to excessive monopolistic market structures can be difficult to get right and require careful judgement. In the US in recent years, the granting of patents has risen and in many cases they now last longer than in the past. This could well be reducing competition and increasing monopoly in the relevant sectors.
Orhangazi finds that for the US economy in general the ratio of intangibles has increased relative to the capital stock, and that this trend has been highest in the sectors mentioned above. Industries with higher intangible asset ratios have tended to have lower ratios of investment to profit, as well as higher markups and profitability.
In recent decades, the composition of the non-financial corporate sector has changed significantly, with an increased weight of high technology and healthcare in overall output. However, these sectors’ investment share in the total has not risen.
He also finds that for intangible-intensive industries, the profit share has increased more than the investment share or the share of total assets.
All forms of spending on intangibles are partly ways of increasing monopoly power, which as already mentioned may be part of the explanation for the investment-profit puzzle.
These trends could also be a partial explanation for increased inequality in the US, and overlap with theories of the impact of financialisation. Higher profits which do not give rise to higher investment in growth-generating new capacity leave funds which can flow to richer households in the form of shareholder income, rather than wage income which typically forms the majority of the income of poorer households.
This explanation for the investment-profit puzzle, aside from the impact of financialisation and globalisation, is not the only one. Some Marxists critique theories of monopoly rent, holding that they are based on neoclassical theories of perfect competition, and that in reality, competition and monopoly are part of the same process. Competition gives rise to pressure for firms to become larger and more able to engage in large-scale new investment, allowing them to cut costs and prices and compete more aggressively in the market. However while this negates the idea of monopoly necessarily being an obstacle to competition, it does not really explain the fall in investment relative to profitability.
Alternatively, a savings glut driven in many economies by forces, institutions and policies which have restrained the share of household income and wages in overall GDP has led to a structural weakness in demand despite stable or rising profits in the last few decades. This weakness and its effect on output growth has been hidden for a time either by rising public or private debt, or by a trade surplus. At the global level these outcomes interacted to sustain a degree of growth for some time, but came to a head with the crisis of 2008 and have begun to be resolved since, giving rise to stagnant or slowing growth and the threat of further crises.
In the US, a faster growth of household income and wages would allow consumption demand to rise without it relying on rising household debt, at some point stimulating investment, even if the rising household income puts downward pressure on profits. Since a portion of these profits are currently not funding investment, it should not be a problem if they fell somewhat, as long as investment in new capacity rose. Stronger demand from net exports would also help to sustain growth without unsustainable rises in debt, an outcome which would be supported by a weaker dollar and stronger global growth in demand.
Of course this need not fully negate the role of intangible assets in sluggish investment. If Orhangazi is right, targeted competition policies which reduce monopoly power could help to stimulate higher investment and a faster diffusion of new technologies across the economy. This should raise growth in output and productivity, making room for wages to rise as long as the labour market continues to tighten. However, a significant rise in wages is not guaranteed, as stagnant wage growth for a vast number of Americans has been a problem for much of the past forty years. Strengthening labour relative to capital is therefore also necessary, which could encompass stronger trade unions, redistribution, a more generous welfare state and greater funding for public goods and services. This would require significant political change.