Companies are pessimistic but households are optimistic. This is one possible inference from official figures due to be released next Friday.
These are likely to show that non-financial companies are big net savers, as retained profits far exceed capital spending. In the first quarter (Q1) their net savings were £15bn, or 3 per cent of GDP and the second quarter’s data is unlikely to be much different. Households, on the other hand, are big net borrowers: they borrowed £17.5bn in Q1.
One natural interpretation of this is that companies are so gloomy about the economic future that they are reluctant to invest, while households are so confident that they are willing to borrow. How can we reconcile these contrasting moods?
It could be that they are both right. A shift in incomes from profits to wages would vindicate both groups. Not that this would necessarily be a disaster for companies. If the propensity to spend out of wages is higher than the propensity to spend out of profits such a shift would raise aggregate demand, offsetting at least some of the initial drop in profits.
A nastier possibility, though, is that households are wrong and that as reality dawns they will rein in their spending and their bad debts will mount.
I’m not sure about this. It’s impossible to know what is the right level of aggregate household debt, as it depends on the distribution of both that debt and of the economic surprises households will get in coming months. What we do know, though, is that aggregate households’ spending has in the past been a good economic forecaster. The idea that ordinary people are irrational know-nothings owes more to ideology and the self-love of self-proclaimed experts than it does to the evidence.
Another possibility is that it is companies that are wrong and that their investment will rise as their pessimism dissipates. I’m sceptical of this too. Corporate net savings aren’t simply a product of Brexit or even a legacy of the financial crisis. We’ve seen them since the early 2000s. Fifteen years is a long time to be wrong. More likely, there are structural reasons for corporate savings.
One of these is that the relative price of investment goods has fallen, which means companies need to spend fewer pounds to get the same volume of capital. And because the price elasticity of demand for such goods is low, this hasn’t led to much greater demand for such goods.
Another factor is that firms now use cash as a means of managing shocks. Years ago, companies had underemployed staff and warehouses full of goods and responded to higher demand by emptying those warehouses and using their workers more intensively. Today, they hold cash so they can buy in goods and workers if necessary.
Also, companies’ assets have changed. They used to consist of buildings and machinery, which could serve as collateral. Today, assets are more likely to be intangible items such as goodwill or ideas, which can’t be used as collateral. Such companies need cash because they are less able to borrow.
Perhaps, therefore, there are benign reasons for the juxtaposition of high corporate savings and households’ dis-saving. Even if this is the case, though, there’s something odd here. We used to think that the financial system was a way of shifting savings from households to companies who needed to invest. Today, however, the opposite is the case: net, the financial system transfers savings from companies to households. How well it does so, of course, is another matter.
