When Lord John Maynard Keynes wrote “In the long run we are all dead”, he was not just expressing his frustration at mainstream economists who blindly believed in self-adjusting markets.
I am convinced that he was trying to do something much more important. He was alerting the economics profession against the danger of a subtle enemy: Father Time. Yes, because time in economics is a troublemaker and it causes all sorts of problems.
When time enters the picture, individuals and firms suddenly become either too impatient or too patient. The result destroys resource allocation and fosters inter-generational conflicts. Private and public agents start developing expectations that inevitably turn out to be wrong. The government is revealed to be “dynamically inefficient”, which is just a fancy way to say that it will break its promises and cheat individuals.
No wonder that in economics, time is a big challenge.
Repurchasing stocks, neglecting the future
Lord Keynes was certainly not inviting us to just forget about the future. Yet, our human nature is to be more concerned with today than tomorrow, to focus on the short-term more than the long-term.
The problem is that sometimes what one does in the short-term is bad for the long-term. Also, what can make the long-term better may make the short-term worse.
When this conflict arises, usually the short-term wins. Ask those governments who cancel a carbon tax because it might hurt manufacturing competitiveness in the short term. Or those other governments that sell public assets in a frenzy to get rid of a debt problem that does not really exist.
But myopia and short-termism are not just the prerogative of governments. We find examples everywhere in the economy.
One example is the Australian investor’s preference for dividend returns. A new report by Boston Consulting Group finds Australia’s top 200 listed companies pay nearly double the proportion of earnings in dividends as their global peers. This is despite lagging them in earnings per share growth. According to the report, this push for dividend payouts is causing Australian companies to risk investment opportunities and is leading to a “growth crisis”.
Another example that is particularly subtle and still potentially very damaging relates to a new fashion in corporate finance: stock repurchasing.
In the United States, corporates started to buyback considerable amounts of their own shares in the 1990s. This practice has now reached massive proportions since the global financial crisis.
According to the Wall Street Journal, in the first six months of 2014, US corporates repurchased US$338.3 billion of their stocks. This is the largest volume of buybacks for any semester since 2007. In Australia, A$3.7 billion of buybacks were announced in the latest reporting season.
There may be a variety of reasons why corporates do this. Buybacks can be used to sustain the market value of shares when they are under-priced, to return cash to shareholders in a more tax efficient way than paying cash dividends, and to increase earnings per share in the presence of large amounts of employees’ stock options. This latter practice is particularly popular among chief executives because their incentive pay is often linked to earnings per share.
To some extent, the market seems to be rewarding companies that repurchase their stock. Analysis at Barclays shows that companies with the largest buyback programs by dollar value have outperformed the market by 20%.
But this apparent short-term benefit comes with large long-term costs for both shareholders and the economy.
When firms repurchase their stock, they divert cash away from investment. This has two implications.
First, less investment means lower long-term earnings. Hence buybacks do not really increase the value of the firm for shareholders: those who keep a stake in the firm are likely to see the performance of the firm deteriorate in the long-term.
Second, in an economy where the private sector is the engine of economic activity, less corporate investment means lower future growth. This in turn means poorer labour market outcomes, such as increased unemployment.
Furthermore, buybacks may increase earnings per share above actual profit. When this happens, markets receive a distorted price signal and resources or savings are less efficiently allocated.
Visionary entrepreneurs needed
One could argue this is a case where ill-designed CEO payment schemes and accounting practices have a real negative impact on the long-run economic performance of the country.
The problem is deeper and more general. Corporate short-termism, of which buybacks are a symptom, arises from a lack of “entrepreneurial spirit”.
What contributes to the economic fortunes of a country is not a short-sighted corporate executive who takes excessively risky behaviour in response to the myopic preferences of shareholders. Neither is the executive who cuts company research and development to increase current earnings expectations.
Economically advanced countries achieved their current living standards thanks to generations of entrepreneurs that were willing to innovate, invest and produce value. They did this not because they were good Samaritans serving the community, but because they understood the very interest of their company and shareholders extended beyond the present.
If economic growth is not to become a thing of the past, we cannot just rely on government policy and reforms. We need entrepreneurs that combine “greed” (Gordon Gekko’s copyright) with a vision that does not just end with the current reporting period.
However the question remains, do they still exist?