The Investment Disconnect, Viewed By a Disconnected Brain

In The Investment Disconnect, Mark Thoma follows up on a Paul Krugman post buried behind the NYTimes Select Wall.

Boiled down to basics, it is believed that high corporate profits should lead to high corporate investment levels, and that the corporations are somehow immorally refraining from investment.

While this sounds superficially plausible, it is a fundamental confusion of cause and effect. High corporate profits are the result of previous investments. If a corporation judges that a worthwhile investment exists within its core competency, then it will not wait for actual cash profits to appear, but will borrow and invest immediately. There is little or nothing to be gained by waiting, as the opportunity cost of investing and not holding cash equivalents in the money market (or whatever) is little different from the interest costs of borrowing.

What high corporate profits actually do is attract investment from potential competitors.

The fundamental law for public corporations is to maximize shareholder value. To believe that the presence of large quantities of cash equivalents, municipal bonds, for example, on a corporation's balance sheet is necessarily a mistake, is naive.

High corporate profits are the result of a specific set of skills being applied to the production of a specific set of products and services for which there exists, or will exist, a substantial demand. Those high profits depend on and are limited by the finite level of demand and the inability of contemporary competitors to meet it. It is most certainly not true that additional profits will necessarily simply result from additional investment.

While investment opportunities always exist in the economy as a whole, that doesn't mean that every company always has highly profitable opportunities available to it. If just anyone can invest in a given area, then it is almost certain that enough companies will invest to compete away the profits.

It is absurd to say that just because a corporation is currently accumulating high levels of cash profits that it has not already fully taken advantage of the opportunities available to it.

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