Why Asia is in Trouble: Corporate Savings Under Assault

For the government and the mainstream, the only thing that matters for the political economy is spend, spend, spend to infinity and beyond, regardless of the quality and financing of such activities.

So they endorse almost any policies that assails on savings--which is seen as a scourge.

This Keynesian myth has practically been embraced by Asian governments to the point that some of have directly imposed penalties on corporate cash hoard.

From the Wall Street Journal Real Times Economics Blog

Investors have long criticized many of Asia’s corporate giants for hoarding billions of dollars. Now those cash piles are under attack from governments that want them put to better use driving economic growth.

Last month, Korea announced that as part of a $40 billion economic stimulus package, it would impose a tax on companies that keep piling up savings instead of paying them out to workers or shareholders.

In Japan, Prime Minister Shinzo Abe has pushed companies to raise payouts to shareholders and workers, and Beijing has ordered state-owned behemoths to boost their dividends to the government to help pay for expanded social-welfare programs.

The International Monetary Fund took aim at the issue this month in its latest report on Japan, calling on Friday for better corporate governance to help “unstash Japan’s corporate cash.” The IMF estimates Japanese companies are sitting on record amounts of cash, equivalent to more than 9% of gross domestic product.

The idea is that by unleashing these corporate cash lodes onto shareholders and employees, they will either invest it more profitably in other parts of the economy, or simply spend it – either of which is better for growth than having it sit in the bank.

While such policies may temporarily be a boost to shareholders and employees these will have nasty side effects over the long run that has been unseen or neglected by the consensus. 

[Note: I exclude China's State Owned Enterprises in the discussion below]

One major reason why corporations hold cash is due to “uncertainty” (perhaps in reaction to social policies, to changes in the risk environment or to changes in profit opportunities) and or in relation this, the possible waiting for the right opportunities to deploy these surplus reserves. 

Yet by forcing companies to spend, such incentivize companies to wade into or speculate on unproductive ventures that risks financial losses. This would hardly be a boost to shareholders and employees. 

In addition, if many companies engage in politically induced 'forced' speculation such will lead to massive mis-allocation of capital, thus poses as a systemic risk. Combined with easy money policies, such will compound on bubble formation.

By forcing companies to pay employees more than what the company sees as their marginal productivity contribution to the company’s product/s, such increases business costs (decreases productivity) that could lead to a scrimp in profits or even to financial losses.

By forcing companies to shell out dividends, the opportunity cost of such actions will be investment opportunities when they emerge. These companies won’t have the resources to invest without recourse to debt. Subsequently, this also means that forcing companies to reduce cash reserves would increase balance sheet risks via debt accumulation.

This obsession with the crucifixion of savings and spending as panacea signals trouble ahead. 

As Austrian economist Gerald Jackson recently wrote: (bold mine)

Unfortunately economic thinking has now deteriorated to the point that one of the major economic fallacies the classical economists refuted is now presented on a daily basis in universities, colleges and the media as an irrefutable fact. The result is that governments the world over are implementing policies that direct economic activity to increased consumption at the expense of gross investment. As the Austrians are forever pointing out, it is gross investment, expenditure on all future-goods factors, that maintain the capital structure: not net investment or consumer spending

We are thus left with the conclusion that fighting a recession by encouraging consumption will prolong and perhaps even deepen it. One thing is certain from an Austrian perspective: if the critical point is reached where increased consumption spending continues to drive down gross investment then real wages must eventually fall if the phenomenon of permanent widespread unemployment is to be avoided.

Overall, the spending nostrum is all about temporary gratification at the expense of the future. This signifies what politics has been all about: Get votes today, voters be damned after.