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News : Global Economy Last Updated: Jan 22, 2014 - 8:54 AM

Company cash hoards rise to $8tn; Taxes, squeezed labour and 'trapped' cash
By Michael Hennigan, Finfacts founder and editor
Jan 30, 2013 - 8:15 AM

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Company cash hoards in the main countries of the developed world are rising to an astounding $8tn -- the annual GDP (gross domestic product) of the United States was $15tn in 2011 - - as a three decade process of rising capital and falling labour shares in economies is coupled with massive tax avoidance. US companies are seeking a tax amnesty to 'repatriate' cash that is mainly already in the United States.

US worker pay has fallen to a 50-year low as a ratio of company sales and US GDP according to JP Morgan Chase, one of America's biggest financial firms, in 2011.

Profit margins were at their highest level in 2010 since the mid-1960s, according to Michael Cembalest, the chief investment officer of JP Morgan Chase.

Cembalest examined the rise in profit margins “from peak to peak” -- from their high point in 2000, just before the dot-com bust, to their high point in 2007, before the financial crisis. In that period, profit margins rose from just under 11% of the S&P 500’s revenue to just over 12% and rose further to 13% in 2010.

As to the reason for the rise, Cembalest wrote in the July 11 issue of the bank's 'Eye on the Market' (pdf) client newsletter: “There are a lot of moving parts in the margin equation,” but “reductions in wages and benefits explain the majority of the net improvement in margins.” This decline in wages and benefits, Cembalest calculated, is responsible for about 75% of the increase in major US corporations’ profit margins.

Harold Meyerson, Washington Post columnist, asked: "What’s behind this drop in the share of revenue going to wages? After all, the workforce of the S&P 500 companies contains many more college graduates today than it did in earlier decades. Cembalest cites high unemployment and the addition of 2bn Asians to the world’s labour force since 1980 as the reasons for workers’ declining ability to secure their former share of company revenue. He’s right, of course, but his list is hardly exhaustive. Surely the fact that the great majority of American employers no longer have to sit down and hammer out collective bargaining contracts with their workers has contributed to the increase in profits at wages’ expense. And many of those employers want to keep it that way."

Bill Gross, the billionaire founder of PIMCO
, the bond fund manager, wrote in October 2011 that there is a current imbalance is obvious from Chart 1, which shows before-tax corporate profits as a percentage of Gross National Income (GNI). It is obvious that “capital” as opposed to “labour” - - moving from 8 to 13% of GNI over the past three or even 30 years - - has been the cyclical and secular champion. Why one or the other should be policy and politically advantaged is not commonsensically clear. Granted, the return on capital as opposed to the return to labour should logically be higher if only to encourage savings. But once an historical midpoint or range has been established, a relative equilibrium should be observed. Even conservatives must acknowledge that return on capital investment, and the liquid stocks and bonds that mimic it, are ultimately dependent on returns to labour in the form of jobs and real wage gains. "If Main Street is unemployed and undercompensated, capital can only travel so far down Prosperity Road. Until recently, economic recovery has been relatively robust if one were a deployer of capital as opposed to the labourer who made that deployment possible. Near zero percent interest rates have allowed profit margins to widen even in the face of anemic end demand. As well, 'productivity' has remained high, but only because of layoffs and the production of goods and services with fewer people. While that is a benefit to capital, it obviously comes at a great cost to labour."

The bond fund manger added: "ultimately, however, both labour and capital suffer as a deleveraging household sector in the throes of a jobless recovery refuses - - if only through fear and consumptive exhaustion - - to play their historic role in the capitalistic system. This 'labour trap' phenomenon -- in which consumers stop spending out of fear of unemployment or perhaps negative real wages, shrinking home prices or an overall loss of faith in the American Dream - - is what markets or 'capital' should now begin to recognize. Long-term profits cannot ultimately grow unless they are partnered with near equal benefits for labour. Washington, London, Berlin and yes, even Beijing must accept this commonsensical reality alongside several other structural initiatives that seek to rebalance the global economy. The United States in particular requires an enhanced safety net of benefits for the unemployed unless and until it can produce enough jobs to return to our prior economic model which suggested opportunity for all who were willing to grab for the brass ring - - a ring that is now tarnished if not unavailable for the grasping. Policies promoting 'Buy American' goods and services - - which in turn would employ more Americans - - should also be reintroduced. China and Brazil do it. Why not us?"

Loukas Karabarbounis and Brent Neiman , economists at the University of Chicago, say in a paper that a "global decline in the cost of capital beginning around 1980 induced firms to shift away from labour and toward capital, financed in part with an increase in corporate saving. Whereas in 1975 a majority of global investment was funded by household saving, in recent years global investment is funded primarily from corporate saving. "

They document that the global labour share has significantly declined over the last 30 years. This decline was associated with a significant increase in the flow of corporate saving, which is generally the largest component of national saving. A global decline in the cost of capital beginning around 1980 induced firms to shift away from labour and toward capital, financed in part with an increase in corporate saving.
Of the 51 countries with more than 10 years of data between 1975 and 2007, 36 exhibited downward trends in their corporate labour share. Of the trend estimates that are statistically significant, 29 are negative while only 10 are positive.

Margaret Jacobson and Filippo Occhino of the Cleveland Fed said last September: "Labour income has declined as a share of total income earned in the United States. This decline was caused by several factors, including a change in the technology used to produce goods and services,  increased globalization and trade openness, and developments in labour market institutions and policies." (See figure 1)

The economists says that according to data from the Bureau of Economic Analysis, labour's share of gross national income fluctuated around 67% during the 1980s, 1990s, and early 2000s, but it has declined since then and now stands at 63.8%. According to the Bureau of Labour Statistics, the ratio of compensation to output for the nonfarm business sector fluctuated around 65% until the early 1980s and has declined steadily since, from 63% during the 1980s and 1990s to 58.2% most recently. Finally, a 2011 study of income tax returns and demographic data by the CBO (CBO 2011) finds that labour’s share of income decreased from 75% in 1979 to 67% in 2007.

In these times of recession, most workers have little bargaining power. So a rise in sales goes into profits rather than being recycled out as wages. Profits should finance investments and therefore ultimately boost economic activity. However, the low consumer demand is keeping business investment low.

The Wall Street Journal reported last month that the Bureau of Labour Statistics (BLS) estimates about 9.2m Americans are members of private or federal unions from a workforce in an employed nonfarm workforce of 143m.

"The median private-sector union member made $878 a week in 2011 compared to $716 for nonmembers, a nearly 23% premium. (The premium was somewhat smaller in the manufacturing sector: $836 per week for union members for $780 per week for nonmembers.) Such comparisons have limited value since there are numerous other variables that affect wages. But to the extent there is a union wage premium, the added cost of dues doesn’t appear to negate it.

Then there’s the question of benefits: 94% of private-sector union members have access to health-care benefits, versus 67% of nonunion members, according to BLS. And employers cover on average 83% of health insurance premiums for union members and their families versus 66% for nonunion members. Union members are also more likely to get paid vacation and sick time and retirement and life insurance benefits. BLS doesn’t put a dollar value on all those benefits, but worker benefits typically account for about 30% of employers’ compensation costs."

For most of the past century, a good job was a ticket to the middle class. Hitched to the locomotive of rapid economic growth, the wages of the typical worker  seemed to go in only one direction: up. From 1950 to 1970, the average earnings of  male workers increased by about 25 percent each decade. And these gains were not concentrated among some lucky few. Rather, earnings rose for most workers, and almost every prime-aged male (ages 25-64) worked...Over the past 40 years, a period in which US GDP per capita more than doubled after adjusting for inflation, the annual earnings of the median prime-aged male has actually fallen by 28%. 

The current recovery is clearly the weakest one in recent history.

Milken Institute Review, Trends article, Michael Greenstone, a professor of economics at MIT, a senior fellow at the Brookings Institution and the director of the Hamilton Project, and Adam Looney, a senior fellow at Brookings and the policy director of the Hamilton Project.

According to estimates from the Institute of International Finance, the Washington DC lobbying group for more than 400 global banks, corporations in the US, the Eurozone, the UK and Japan held some $7.75tn in cash, or near equivalents in January 2012.

In December 2009, Apple and Microsoft had cash and near equivalents of $79bn and three years later the sum had risen to $205bn - -  more than a third higher than Ireland's GDP.

In March 2012, Simon Tilford of the Centre for European Reform think-tank estimated that corporate cash holdings were at €2tn in the Eurozone and "an astonishing £750bn in the UK." He said the ratio of investment to GDP in Europe was at a 60-year low even as companies pile on cash.

American nonfinancial corporations held $1.74tn in cash and other liquid assets at the end of the third quarter, the Federal Reserve said last month in its flow of funds report. That is $44bn more than three months earlier and more than erases the prior quarter's slight decline.

The figure, which isn't adjusted for inflation, narrowly eclipsed the high set in the first quarter, but only because the Fed revised down its estimate of corporate cash holdings from earlier periods after receiving more data. The Wall Street Journal said after two downward revisions, the Fed now says US companies held less than $1.70tn in cash at the end of last year, down from an initial estimate of more than $2.23tn.

Nonfinancial companies now have about 5.6% of their assets in cash, down slightly from a peak of 6.3% in late 2009 but high compared with the 1980s, when companies kept less than 4% of their assets liquid.

The Canadian Labour Congress said yesterday that Statistics Canada data show that cash reserves held by private non-financial corporations in Canada jumped to C$575bn in the last quarter of 2011 from C$187bn in the first quarter of 2001 - - despite three of those years being deep in recessions.

Between 2010 and 2011, corporate cash reserves grew an extra C$72bn, while the federal government was reporting a C$33bn deficit.

European public companies have more than €750bn in cash - - close to a record level in the past two decades -- to boost low private investment which has plunged €354bn since 2007, four times the fall in real GDP and 20 times the plunge in private consumption, according to a report by McKinsey, the management consultancy. Download Full Report (PDF–2MB)

McKinsey says that although the decline in Europe’s level of private investment from 2007 to 2011 is rarely highlighted as a feature of the region’s financial crisis, it was unprecedented. In fact, during that period, private investment in the European Union’s 27 member states (the EU-27) plunged by a combined total of €354bn - - 20 and 4 times the fall in private consumption and real GDP, respectively according to a new report.

Research by the McKinsey Global Institute (MGI) finds that while private investment was the hardest-hit component of GDP, it is also vital for recovery. Even in the face of weak demand and high uncertainty, some investors would start spending again if governments took bold measures to remove barriers that now stand in the way. And companies need not rely exclusively on regulatory changes to take a more fine-grained look at their own investment approaches.

'Trapped cash'

In October 2010, in The Wall Street Journal, John Chambers, Cisco chairman and CEO, and Safra Catz, Oracle president, wrote an op-ed on the topic of repatriation of foreign earnings. Entitled, 'The Overseas Profits Elephant in the Room: There’s a trillion dollars waiting to be repatriated if tax policy is right,' (subscription required) Chambers and Catz stated: “One trillion dollars is roughly the amount of earnings that American companies have in their foreign operations - - and that they could repatriate to the United States. That money, in turn, could be invested in US jobs, capital assets, research and development, and more. But for US companies such repatriation of earnings carries a significant penalty: a federal tax of up to 35%.

This means that US companies can, without significant consequence, could use their foreign earnings to invest in any country in the world -- except here.” Chambers/ Catz said a foreign earnings at a low tax rate - - say, 5% - - would create a privately funded stimulus of up to a trillion dollars. However, of the $312bn  repatriated back to the United States in 2004/05 at a special rate of 5%, 92% of that money was returned to shareholders in the form of dividends and stock buybacks, according to a study by the nonpartisan National Bureau of Economic Research. However, this is a misleading debate as American companies' 'overseas/ trapped' cash is mainly held in the US.

It is estimated that the overseas portion of the $1.7tn in cash or near equivalents held by US subsidiaries overseas, that is technically overseas to avoid paying the 35% federal corporate tax rate, is mainly held in the United States.

The Wall Street Journal says some companies, including Internet giant Google, software maker Microsoft and data-storage specialist EMC, keep more than three-quarters of the cash owned by their foreign subsidiaries at US banks, held in US dollars or parked in US government and corporate securities, according to people familiar with the companies' cash positions.

The Journal says that in the eyes of the law, the Internal Revenue Service and company executives, however, this money is overseas. As long as it doesn't flow back to the US parent company, the US doesn't tax it. And as long as it sits in US bank accounts or in US Treasuries, it is safer than if it were invested into potentially risky foreign investments.

"One of the major reasons that US companies' foreign subsidiaries reinvest earnings in US-dollar-denominated investments is to avoid gains and losses from changes in foreign-exchange rates," EMC spokeswoman Lesley Ogrodnick wrote in an emailed response to questions about the company's cash holdings.

CBS 60 Minutes on tax havens

Check out our  subscription service, Finfacts Premium , at a low annual charge of €25 - - if you are a regular user of Finfacts, 50 euro cent a week is hardly a huge ask to support the service.

SEE also:

Irish Economy: Sustainable growth dependent on foreign firms since 1990; Now FDI has peaked

Irish Economy: Innovation, a failed enterprise policy and inconvenient facts for 2013

Irish Economy: Actual Individual Consumption per capita in Ireland at EU average; Germany at 20% above

Irish Economy: Pharmaceutical patent cliff no growth threat; High exports have low impact

Irish Economy: Export growth insufficient to pull domestic economy out of recession

Irish Economy 2012: At least a third of value of Irish services exports is overstated

Dell remains Ireland's biggest manufacturing exporter despite closing Limerick plant

Irish Economy 2012: Only 50,000 Irish direct workers responsible for 69% of annual Irish exports


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