Corporate sector behavior in the major industrial countries has undergone a sea change since the equity market bubble burst in 2000. Companies in many industrial countries have elected to use sharply higher profits, net of interest payments and taxes, to accumulate financial assets and repay debt rather than reinvest in their businesses or increase dividend payments. As a result, nonfinancial companies have, in effect, been lending resources to the household and government sectors rather than borrowing from them—a reversal of the pattern of behavior generally seen in past decades (see chart).
This corporate thriftiness is also likely to be a key factor behind the conundrum of persistently low long-term global interest rates alongside a U.S. current account deficit that has continued to balloon. In 2003-04, the Group of Seven countries’ $1.3 trillion of corporate excess saving (accumulated internal funds, after taking account of investment in physical assets) was more than twice the size of the cumulative current account surpluses of emerging market and developing countries during those two years. These are the surpluses labeled a global “savings glut” by U.S. Federal Reserve Board Chair Ben Bernanke.
The corporate puzzle
Why have corporations been saving so much? And is this a temporary or a more long-term phenomenon? Chapter IV of the April 2006 World Economic Outlook (WEO) takes up these questions. First, it examines the commonly held view that increased corporate saving has mainly been a reaction to the excess debt and physical capital that companies amassed in the 1990s. If this is so, then the recent level of saving is likely to be a passing phenomenon. Once these excesses are worked out, the corporate sector will again become a net borrower.
Why so thrifty?
In recent years, various uncertainties seem to have spurred corporations in major industrial countries to save rather than invest.
Data: IMF, World Economic Outlook, April 2006.
But has high corporate saving been primarily a reaction to past excesses? The WEO analysis suggests that the story is not that simple. Debt repayment accounts for only a small portion of companies’ excess saving. And, even if net borrowing has declined in all of the Group of Seven countries since the late 1990s, corporate leverage ratios remain close to their late 1990s levels, with the exception of those of Canada and Japan. The WEO finds that other factors—some cyclical and some structural—have played key roles, although their importance has differed across countries. It emphasizes these findings:
• Reduced interest payments (reflecting low interest rates) and reduced corporate tax payments are the primary reasons that corporate profits have been strong. Abnormally high operating profits have not been the driving factor behind the rise in net corporate profits. And, in Japan and the United States, where operating profits have accelerated sharply in recent years, the increase appears roughly in line with previous cyclical episodes.
• Subdued capital spending at least partly reflects lower relative prices of capital goods. Technological change has reduced the relative prices of capital goods and lowered the nominal spending needed to achieve a given volume of capital goods.
• Companies have been reallocating resources from domestic capital accumulation to the purchase of assets abroad. Rather than invest in physical capital at home, companies have been pursuing expansion strategies that involve acquiring existing or new physical assets abroad.
• Companies have been choosing to hold more cash. Why? There appear to be a number of considerations behind the preference for larger holdings of liquid assets, including companies’ perceptions that they now face a more uncertain operating environment; the increasing role of intangible assets, such as patents and goodwill (which require more internal financing); and, possibly, some uncertainties associated with how currently unfunded pension liabilities will be met.
Don’t count on it
Whatever the rationale for the excess corporate saving in recent years, the WEO finds little reason to expect record-high levels to be sustained for long. The turnaround may come soon, especially if the slack in advanced economies continues to narrow—thereby encouraging more investment spending—or if some factors driving recent net profits begin to wane.
The watchword for the future is caution. Policymakers will do well to avoid relying on high corporate saving to keep longer-term interest rates low. Without some increase in household and government saving in the coming years, changes in corporate behavior are likely to put upward pressure on interest rates.
IMF Research Department