Capitalism, Upside Down

Yesterday’s GDP numbers were worse than they seemed.  And they highlighted a curious feature of modern capitalism.  Nowadays, non-financial businesses have become major net lenders to the rest of the economy.  Instead of borrowing money (in various forms: debt, equity, etc.) from other sectors to finance real investment, non-financial businesses are not even reinvesting their own cash flow.  The surplus cash is channeled back into financial markets.

At a moment deleveraging is holding back growth, and  both governments and consumers are cutting back spending, this upside-down behaviour by the business sector makes things far worse.  Canada’s non-financial businesses have saved almost $100 billion during the current recession.  That almost perfectly offsets the $100 billion increase in debt taken on by Canadian governments in the same period.

Below is my full G&M column on this.  Mario Seccarreccia has also raised this point in analyzing Canadian flow-of-funds data.  Michael Hlinka (CBC Toronto) called this argument nonsense on Metro Morning today — so then I must be on to something!

Tepid GDP numbers released yesterday by Statistics Canada confirm that Canada’s economic recovery, such as it was, is sliding completely into the ditch.  We’re clearly heading for stagnation at best, and quite possibly another “double dip” downturn.

The headline number was disappointing, to say the least.  Real GDP grew just 2 percent (annualized) in the spring quarter.  That’s just a hair faster than the U.S. economy (which everyone knows is still deeply in the soup).  Two percent doesn’t keep up with population and productivity – implying higher unemployment ahead, not lower.  Typically, at this stage of recovery, the economy should be growing 3 times faster.

Dig a little deeper, and the picture looks even worse.  Half the growth reported yesterday was a statistical “shadow” of the faster expansion experienced in the first quarter (earlier growth which automatically boosted the second-quarter numbers, whether GDP kept growing or not).  From March through June, actual growth was weaker: about 1 percent annualized.

Moreover, that growth which did occur was due solely to inventory accumulation, as businesses began restocking the shelves in hopes of stronger market conditions.  Strip out new inventories, and real GDP actually declined.  But consumer spending is already slowing down, and now those inventories will drag down future growth.

Another worrisome sign is the continuing deceleration of inflation, as measured by Statistics Canada’s broad GDP deflator.  Inflation fell to less than 1 percent in the spring – and in the consumer sector, prices were falling (deflation).  That further erodes confidence, and increases real debt burdens for consumers and governments.

Yesterday’s data confirm another curious and worrisome trend.  Every economic recovery needs somebody to borrow and spend.  That’s where new purchasing power comes from.  So far, this recovery has been precariously dependent on households and governments to do all the borrowing and spending.  The spirit of growth has yet to infuse the private sector, and consequently Canada’s recovery remains both narrow and precarious.

Debt-happy consumers accounted for much of last year’s rebound.  Their spending was largely channelled into Canada’s short-lived housing bubble (which popped audibly last spring).  With total personal debt now equal to 150 percent of disposable income, we know that consumers must retrench.  Indeed, they’re already cutting back, as evidenced by a big uptick in the saving rate.

Governments, of course, have been the other key source of spending power, through deficit-financed stimulus programs.  Those injections will also start to ebb, as governments at all levels pull back (hopefully not too quickly, or else the threatened double dip will become a sure thing).  So with both consumers and governments tightening their belts, who will lead the next phase of recovery?  It should be business.  But so far, the private sector is still sitting firmly on the bench.

Despite a few signs of life (mostly in the oil and gas industry), overall business investment spending has not bounced back at all.  Business capital investment is only 6 percent higher than in the trough of the recession a year ago.  Yes, profits shrank during the downturn, but are recovering.  And businesses aren’t even re-investing what they get, let alone taking on new debt.  Cash flow (profits plus depreciation) continues to outstrip new capital investment by almost two-to-one.

The odd result of this private-sector passivity is that non-financial firms have actually saved close to $100 billion since the recession began.  That almost perfectly offsets the $100 billion in new debt taken on by our governments over the same period.  In other words, governments (and the taxpayers who fund them) are taking on debt to try to restart a sick economy.  But for every dollar they put in, private firms take a dollar out – in the form of idle, uninvested cash flow, used to pay down their own debt or (worse yet) speculate in the paper markets.

Business should be leading economic recovery, borrowing money (from households and banks) to fund new investments and jobs.  That’s how capitalism is supposed to work.  In today’s lean-and-mean world, however, business is free-riding on the spending efforts of others.  Despite tax cuts and other business-friendly policies, the private sector isn’t taking on the risks, and taking on the debt, necessary to fuel broader recovery.

That longer-run imbalance, not just the weakness evident in the shorter-run economic data, will hold back Canada’s economy for years to come.  Governments clearly need to keep stimulating through budget deficits and low interest rates (rather than choking off recovery with premature tightening).  But in the absence of business leadership, they’ll also have to take on a bigger task: finding ways to directly expand output and create work, filling the vacuum left by the private sector’s continuing failure to borrow and spend.


  • Stanford in today’s Globe and Mail: “. . . quite possibly another ‘double dip’ downturn.”

    Weir in today’s Toronto Star: “I’m not predicting a double dip.”

    The makings of a PEF debate?

  • You both seem to be talking about a hockey stick recovery. Not an L but close enough from an employment point of view. So double dip or no is not really the point.

    Jim, I am not sure that the bubble has been pricked. Y/Y is running 15.5% and M/M at 1.5% (see the teranet data). Neither rent data, nor income data, nor the inflation rate support this type of price rise.

  • One could argue this has been going on for quite a few years.

    However I do understand the frame of reference and our current mess.

    I think one of the signs to me that somethings was seriously getting out of whack occurred construction sector employment started exhibiting some strange correlation with that of manufacturing employment. It was a sign to me of the credit steriods that the economy was pumping itself up on trying to overcome misguided business investment into non-productive activities.

    I have a chart here, it needs an update but the key areas seems to be just after the dotcom crash in I would say from the chart early 2001. this to me is around when the housing bubble started. (yikes 4 years since I did that chart)

    The point is though- where to next with anemic investment- deleveraging consumers and potentially deficit wary governments instigated by leaders trumpeting austerity at the summer time austerity meeting.

    A time for serious reflection in terms of economic philosophy. And I do agree with Travis- I do not think we ever made much headway in terms of recovery to actually signify the personification. However, again I will give you the pandering to the presser point.

  • Travis, I completely agree that the GDP recovery’s insufficiency for employment is the real issue.

  • Great column Jim. I’d go a bit further in the last para. If private capital is not going to step up to the plate and invest, then public investment will have to drive the recovery. That means more than “stimulus” – or rather a shift from mainstream Keynesianism to the Keynes who wanted to socialize the investment process.

  • An excellent analysis! Anyone, who is not blind can see that a lot of things are going terribly wrong with the way the private business is operating these days and this is one of a very usefull angles to look at the problem. Obviously a more active leadership role from the government is needed in the absence of such in the private sector.

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