The Curse of Middle-Aged Capitalism for Trump, Rest of Us
A persisting puzzle about the U.S. economy is how it can seem both strong and weak. On the one hand, it remains a citadel of innovation, producing new companies like Uber. On the other, the economy is expanding at a snail's pace of 2% annually since 2010. How could both be true? Why isn't innovation translating into faster growth? The answer — or part of the answer — is that American businesses are running on two separate tracks. Call them the "youthful" and "middle-aged" tracks.
You can't miss youthful capitalism. The Googles of the world dazzle with their rapid innovation. Their dynamism is reassuring. Meanwhile, many less visible but more numerous older firms are treading water. They're struggling to generate higher revenues and profits from mature markets, while facing new competitive threats. It is arguably the firms running on the second track — middle-aged capitalism — that have dominated the economy since the Great Recession.
To be sure, America's business aristocracy has shifted. In 1995, the largest five firms by market "capitalization" (the value of a company's shares) were old-line businesses: Exxon, AT&T (T), Coca-Cola (KO), General Electric (GE) and Merck (MRK). By 2015, only Exxon (now Exxon Mobil (XOM)) remained. The others were replaced by Apple(AAPL), Google (GOOGL), Microsoft (MSFT) and Amazon (AMZN). (Note: Jeff Bezos, Amazon's CEO, owns The Washington Post.) Still, middle-aged capitalism has slowed the recovery.
Bolstering the case is a new study, published in the Journal of Economic Perspectives by Kathleen Kahle of the University of Arizona and Rene Stulz of Ohio State University. The scholars examined all U.S. public companies over a 40-year period, from 1975 to 2015, and found pervasive evidence of a two-tiered capitalism. Companies are sorting themselves into the strong and the weak.
(Recall: A public company has shares that are traded, typically on a stock exchange. Private firms, including most small and family businesses, are not publicly traded.)
Profits became more concentrated, especially among large tech firms. In 2015, Apple, Google, Microsoft and Amazon had combined profits of $82 billion, fully 10% of all profits of publicly traded companies. In 1975, 109 firms accounted for half the profits; by 2015, 30 companies did. More disturbing, companies below the top 200 reported negative earnings as a whole; many of these firms had significant losses.
A similar story applies to corporate investment in buildings and machinery (computers, vehicles). From 1975 to 2015, this capital investment has dropped from 8% of corporate assets to 4%. Interestingly, this decline in investment was mostly offset by increases in corporate research and development (R&D) — reflecting the need to develop new digital products and programs, say Kahle and Stulz. But the R&D spending was heavily skewed toward bigger firms. Half of publicly traded firms showed no R&D.
Middle-aged capitalism prevails. Consider:
* Companies have gotten older. In 1975, the average publicly traded business was 10.9 years old. In 2015, the average was 18 years. The implication is that surviving firms either are more efficient or have stronger market positions in their industries.
* One reason companies have gotten older is that the number of publicly traded companies has dropped sharply, from 7,002 in 1995 to 3,766 in 2015. The main cause, say Kahle and Stulz, is not bankruptcy but mergers. Small and medium-sized firms — many of them younger — prefer to sell out to larger corporations rather than compete as free-standing firms. The result is that fewer younger companies are becoming publicly traded firms.
* Companies are paying out record amounts to their shareholders, either as dividends or share buybacks. In 2015, nearly half of corporate profits (47%) were returned to shareholders, almost double the rate in 1975 (27%). This suggests that companies either lack attractive investment opportunities or are too risk-averse to take them.
All this is troublesome for President Trump or anyone wanting a stronger economy. If the primary forces holding it back are ill-considered government policies, then the remedy is obvious. Get rid of the policies. The economy will improve. This is the administration's position.
But what if the weaknesses go deeper? For example: It's hard to argue that cuts in corporate taxes will accelerate economic growth if many companies are already suffering losses — and don't benefit from tax cuts. Similarly, large, very profitable firms, with huge piles of cash but few appealing investment projects, won't suddenly find new projects if their taxes are cut.
Kahle and Stulz worry that the trends they outline may mean "less investment, less growth, and less dynamism." Companies will remain highly cautious. Entrepreneurship will further weaken. These hazards are hardly hypothetical.
