Stocks are too expensive.
This
is not a market forecast. I wouldn’t be particularly surprised if the
Dow shrugged off its recent turbulence and continued its long upward
thrust. What I contend is that if the American economy behaved in the
way that most economists say market economies should, stocks would in
all likelihood be cheaper.
It
is a grim proposition. Wall Street’s titans might welcome the fact that
equity prices have grossly exceeded what a well-functioning,
competitive economy should deliver. But for almost everybody else, it
amounts to a disaster. From wage stagnation to the depressed investment
rates that are holding back long-term economic growth, many of the fault
lines running through the American economy can be traced back to the
same root cause powering the rise of America’s overpriced stocks.
Consider
a few facts. The average financial wealth of American households — the
market value of housing, stocks, bonds, business assets and the like,
beyond their liabilities — has grown much faster than the nation’s income over the last half-century.
This
would not be weird were American households saving more and investing
their savings in productive ventures. They are not. The personal savings
rate has declined sharply.
The ratio of the capital stock — the value of factories, machines and
such — to the nation’s economic output has actually declined a little
since the 1970s.
What
has enhanced wealth in recent years is the huge rise in stock prices.
The Standard & Poor’s 500-stock index increased 8 percent per year
from 1970 to 2015, on average. According to an analysis
by Germán Gutiérrez and Thomas Philippon of New York University, the
ratio of the market value of American corporations to the replacement
value of their capital stock has roughly tripled since the 1970s.
What
makes this particularly puzzling for scholars reared on the classical
models of competitive economies is that all this happened despite a
persistent decline in real interest rates. In a more orthodox economy,
declining rates on corporate bonds would encourage a surge in corporate
investment. As companies invested more and more capital, the returns on
investments would gradually decline until companies’ returns matched
their cost of capital: the interest rate they pay to borrow.
The Stock Market Isn’t the Economy. Here’s How They Can Shape Each Other
Stock markets have recently fallen over fears that
economic growth is too strong. Here’s why, and one way how steep,
sustained sell-offs could end up hurting the economy.
In the United States, neither has occurred. Investment has been stuck at stubbornly low rates. And even as interest rates have fallen, the average return on productive capital has stayed roughly constant.
In
a nutshell, the United States has built an economy where businesses
don’t invest even though it has rarely been cheaper to finance
investment. Still, they reap spectacular profits that warrant runaway
share prices.
“These are not your father’s growth facts,” wrote Gauti Eggertsson, Jacob A. Robbins and Ella Getz Wold of Brown University in an analysis
published this week by the Washington Center for Equitable Growth. The
puzzling facts of contemporary America suggest an economy poised to
fail.
What
happened? It turns out that there is one straightforward reason for the
American economy’s unorthodox behavior. As Mr. Eggertsson and his
colleagues argue, the standard economic theory based on competitive
markets cannot apply when markets are not competitive. And competition,
in the United States, is shriveling.
The
scholars argue that the American economy is afflicted by “rents” —
returns in excess of what investments would yield in a competitive
economy, where fat margins are quickly whittled away by competition.
These
rents don’t fall from the sky. Companies free of competitive pressures,
with the power to set prices more or less at will, squeeze them from
their customers and their workers. They pad corporate profits and send
stock prices sky high.
Graphic
It’s an Unequal World. It Doesn’t Have to Be.
Global inequality, after widening for decades, has
stabilized. The share of the world’s income captured by the top 1
percent has shrunk since its peak on the eve of the financial crisis.
Executives love it. The critical question is what these rents hold in store for the rest of us.
This
doesn’t necessarily mean, by the way, that the corporate landscape has
been taken over by evil monopolists that resort to illegal tricks to
keep competitors out. High-tech titans like Google and Facebook may just
have the ability and the deep pockets to out-innovate everybody —
delivering wonderful new experiences to consumers along the way, and
maintaining monopoly control over their latest innovations. One
intriguing theory is that the globalized economy is reorganizing the
business landscape, encouraging the rise of corporate superstars.
Not
everybody agrees that competition is waning. Hal Varian, Google’s chief
economist, argues plausibly in a recent study that the case to worry
about market concentration across the economy is weak. Even as
concentration has increased in many sectors, there is plenty of
competition in most industries and markets. Carl Shapiro, an antitrust
scholar from the University of California, Berkeley, who served in
President Barack Obama’s Justice Department, worries that the new
populism infecting American politics could prompt antitrust policy to take aim at all big successful companies.
Still,
there are good reasons to worry about rising rents, no matter where
they come from. Mr. Shapiro argues that while some measures of market
concentration may not be meaningful, persistently high profits are of
themselves a cause for concern.
Profits
as a share of output have risen by half over the last 30 years.
Combined with evidence that large corporations are accounting for an
increasing share of revenue and employment, Mr. Shapiro writes, “it
certainly appears that many large U.S. corporations are earning
substantial incumbency rents, and have been doing so for at least 10
years, apart from during the depths of the Great Recession.”
This
is particularly true in the tech sector, where a handful of dominant
companies — you know the ones I’m talking about — have sustained
spectacular profits for years. Their sky-high stock prices suggest that
investors expect high profits to continue as well.
“They
probably are geniuses; what they are doing is wonderful,” Mr. Shapiro
told me. “Still, you would expect competition to erode away the excess
profits over time.”
Here is why we should worry.
Mr.
Eggertsson and his colleagues built an alternative model of the
American economy by doing away with the assumption of perfect
competition. They contend that there are barriers to entry that stop
competitors and allow rents to persist.
In
this economy, stock prices don’t just reflect the future stream of
normal economic returns that would accrue to a company’s capital
investment. They also include a claim to a stream of rents that generate
“pure profits.” These profits can’t be replicated by another company’s
capital investment. They are owned by a specific company.
So
what features might an economy like this possess? Wages are unlikely to
rise much in a job market dominated by a few big employers. As I
speculated last week, markets dominated by a few businesses will most likely deter start-ups from appearing on the scene.
Rising
rents will take larger shares of the nation’s income. That will bolster
the proportion of income that goes to corporate profits but squeeze the share
that flows to workers — in wages and benefits — and to productive
capital. This will discourage both work and capital investment. It will weigh on overall economic growth.
Rents
interfere with incentives in a big way. Companies will spend more time
and effort trying to preserve those rents — often by working to block
rivals from their markets. Rivals will fight to grab a share of those
rents for themselves, perhaps through lobbying. Amid all this jockeying,
investment in productive capabilities will most likely be neglected as a
secondary consideration.
And
inevitably, inequality will rise: The owners of the shares in the
powerful corporations capturing the economy’s growing monopoly rents
will peel further and further away from the average Jane and Joe, who
own little but their labor.
This
is not the kind of economy proposed by classical economic theory. It is
not the kind of country portrayed by evangelists of the American dream.
But it looks as if we are stuck with it, regardless of what the stock
market does tomorrow.
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