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Wed Jun 20, 2018, 06:41 AM


OECD Meets Piketty: An Alternative Economic Narrative

Today’s Profits Are Not Tomorrow’s Investments


A picture can say more than a thousand words. This is certainly true for the set of graphs (see below) that the OECD published in its latest Economic Outlook and that show the rate of return on fixed assets – a proxy measure for the rate of profitability on capital investment.

A quick glance reveals high rates of return in OECD countries. Indeed, across the body as a whole, the rate of return on fixed assets is back at its pre-crisis level and as high as 10 percent. While in the US and the UK the rate is higher (12 percent), Germany and the Netherlands have hit record highs of 13 to 14 percent profitability. Moreover, these rates only reflect returns before any financial leverage effect operates when companies take out loans and pay a lower interest rate cost than the return on assets. This indeed implies that returns on equity would be even higher and a multiple of the returns shown below.

With returns on investment this high and the return on risk-free financial investment at historic lows, business investment should be booming as management can realise a much higher return on investment compared to the financial cost of such investment. This, however, is not the case. According to the OECD Outlook, investment spending in 2018-2019 is expected to be around 12 percent below the level required for capital stock to rise at the same pace as in the decade prior to the crisis. Firms are not making the marginal but profitable investments that low interest rates should encourage. Interestingly, the OECD refers here to sticky corporate hurdle rates that are as high as 14-15 percent as an explanation. In other words, management, when deciding to invest or not, still requires high and rigid nominal profitability thresholds, even though the cost of finance or alternative risk free investment has gone down substantially. In fact, the OECD takes this argument one step further by claiming that corporations, particularly in the US, are using their profits and resources to merge with or acquire competing companies instead of adding new capital to the aggregate stock.

All of this brings into question the validity of a traditional structural reform agenda that showers business with all sorts of incentives and “treats” in the hope that investment and jobs will follow in return. An alternative narrative for economic policy is necessary, some of whose contours are sketched out below.

A Stronger Role For Fiscal Policy............


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