One of these, say Kenza Benhima and Baptiste Massenot at the University of Lausanne, is that we might have fallen into a “safety trap.” The idea here is that low interest rates, far from encouraging spending and investment, actually deter it. This is because if firms or households are risk-averse, they’ll want a higher cushion of safe assets such as cash. When interest rates are high, they can build up such a cushion simply by letting the interest accumulate. But when rates are low, they must actively add to their cash balances, which they do by cutting investment in riskier assets.
In this sense, low interest rates can have a perverse effect upon investment; far from stimulating it by reducing the cost of capital, it can retard it by making it harder for people to build up sufficient safe assets in any other way. Such a view isn’t quite as radical as it seems. It’s consistent with the idea that low interest rates have an income effect as well as a substitution effect, and with a famous paper by John Leahy and Andrew Caplin, which showed that low interest rates might deter capital spending, if they signal to firms that future economic prospects are bleak.
There are, say Messrs Benhima and Massenot, two possible equilibrium paths for the economy – a high investment, high risk-tolerance, high-interest rate path on the one hand, and a low investment, risk-averse, low-interest rate path on the other. They believe that Japan fell into this trap in the 1990s, and still hasn’t escaped from it. It’s possible the UK has suffered the same fate.
Alex Edmans at the London Business School suggests another reason for low investment – investors’ requirement that companies be more transparent and disclose more information.
The problem here, he says, is that there are two types of information. There’s hard data such as “we made £200m of revenues in Q2”, but there’s also softer, less quantifiable or verifiable information such as “we have a healthy corporate culture” or “this is a good investment project”. Such information is often what Michael Polanyi called “tacit” knowledge. It comprises hunches and feelings which can’t be proven correct but which are nevertheless vital to a business’s success.
If firms are asked to be transparent, says Dr Edmans, managers will naturally emphasize the “hard” information to the detriment of the soft. They’ll prefer to announce good near-term earnings even if doing so means cutting worthwhile investment projects or cutting costs so far as to jeopardize employees’ goodwill. The upshot is that transparency and disclosure, far from being in the interests of shareholders, merely cuts investment and growth.
This is consistent with an important finding by John Asker at New York University – that stock market-listed firms (which have more disclosure obligations) invest “substantially less” than comparable private firms.
These two papers are very different in most respects. But they have a similar message. It’s that our low capital spending might not be wholly due to merely temporary cyclical forces, but instead could prove more long-lasting.
