Bill Dunkelberg, Chief Economist
National Federation of Independent Business
Talk at Aspen was cheap as it always is, with government officials, past and present, calling for more PUBLIC investment in infrastructure, education, training and the like and everyone looking for clues about the direction of monetary policy. The Fed has become the dominant factor driving financial markets, “follow the Fed”. So, PUBLIC investment is the key to raising productivity and stimulating the economy? The last attempt to do this with “shovel ready projects” (which didn’t exist) misfired badly.
“Roads and bridges”, yes, there is a great need to invest, some of this is federal (highways) but most of it is in the province of state and local governments whose resources have been drained by slow growth, lower tax revenues, increased welfare payments, unemployment benefits, pension shortfalls, rising public employee costs, and flight from efforts to tax consumers and private businesses to make up the deficiencies.
As a stimulus, this is a poor choice. Planning and permitting lags are long, and this is a capital intensive business, requiring massive amounts of heavy equipment, not of workers. Environmental regulations pose major barriers to progress in these area. We tried this before and it didn’t work.
“Education and training”, yes, education needs to keep pace with a fast changing job requirements. However, this is not well done by managing education from a large office building in Washington D.C. Innovation is stifled by local politicians and teachers unions and certainly isn’t taught or encouraged in public schools. Educational costs go up but results do not.
Short on revenues, governments at all levels are relying on debt to pay for what little they do. This will only have an unhappy ending as many of our cities have already discovered. Federal spending increases would also be funded by debt because the federal government always runs a deficit, so more spending means more debt (unless taxes are raised). In the late 1990s, surpluses were run and debt paid down under the control of a Republican Congress and a strong economy (which the Fed cannot produce).
The real source of productivity gains is the private sector, driven by private innovation and investment in real capital assets (snowplows vs shovels to move snow). This is not the province of Washington D.C. What Washington D.C. does do is tax away the earnings that private firms use to finance growth, and impose “redistributive” regulations on firms that waste private resources (including time) and lower the prospective return on investments. Compliance costs in financial and educational institutions for example impose large demonstrable costs but real benefits for consumers are less clear. “PC” has become expensive, colleges and universities have very expensive offices devoted daily to these issues, but benefits are less than clear. Meanwhile, tuition rises.
Hiring a worker has become increasingly expensive, paperwork, compliance, taxes, the minimum wage, mandatory health insurance, sick leave and family leave, legal liability, complexity in wage and salary administration, FLRB rulings on unionization etc. Employers are motivated to find a way to hire fewer workers by the government or prevented from hiring workers by the minimum wage.
Interest rates are historically low and large firms have billions in cash stashed away. Why won’t they spend it, particularly on new equipment and expansion? Investment in plant and equipment is all about the future, including the decision to “replace” worn out capacity. It is obvious, then, that business’ view of the future is not particularly positive. Cash has been used to repay debt, buy back shares, pay dividends, and acquire existing firms, but not much investment in new assets.
The process is simple, expected profits or cash flow from an investment are calculated and discounted by an appropriate discount rate which incorporates market interest rates and a risk premium related to the probability that the project will successfully produce the expected returns. Any stream of expected returns will look better if interest rates are lower. When market interest rates are so low, it is the risk premium that dominates. The higher the Discount rate, the lower the estimated value of the investment.
Discount Rate = Real rate of interest + Expected inflation + Risk premium.
The Risk premium (will the bond be repaid?) that financial markets place on a bond issued by a particular company for a certain maturity can be calculated from information about the price of the bond and the terms it offers using current market rates. For equities this is not the case, but implicitly the purchaser of stock makes this computation for expected profits. For greenfield investments (plant and equipment) the choice of the Risk premium is even more subjective. It depends on the expected course of the economy, regulations specific to the investment, the economic performance of customers, tax policy and the Fed. All uncertain.
The Fed has driven rates on risk free assets to near zero levels, inflation rates are below 2% and consumers expect them to stay low for a long time (University of Michigan). This leaves the Risk premium which must be very large to discourage investment with such low capital costs. Uncertainty, measured by the National Federation of Independent Business, is at its highest level in 40 years. Except for weak sales and the economy, “political climate” is the second most frequently cited reason for not expanding a business and is at a record high level. Uncertainty about the economy and Uncertainty over government actions ranked fourth and sixth out of 75 problems that small business owners were asked to prioritize in an NFIB survey this year.
The Fed laments the weakness in direct investment spending, but fails to understand that its policies have produced a major miss-allocation of funds and are one of the major sources of uncertainty that keep the Risk premium high, discouraging risk taking and investment.