Cash and Investments: Corporate Savings Glut in USA

Cash and Investments: Corporate Savings Glut in USA

 

Profits/Retained Earnings of a firm can be used in number of ways:

  • Capital Investments
  • Debt Repayment
  • Dividends
  • Cash and Short Term Investments
  • Long Term Investments
  • Share Buybacks
  • M&A Investments

Please see three quarterly reports from FACTSET on trends in

  • Dividents
  • Buybacks
  • Cash and Investments

Share buybacks are very common for several years.

Please see my related posts

Why do Firms buyback their Shares? Causes and Consequences.

Low Interest Rates and Business Investments : Update August 2017

Short term Thinking in Investment Decisions of Businesses and Financial Markets

Mergers and Acquisitions – Long Term Trends and Waves

Business Investments and Low Interest Rates

 

From The Corporate Saving Glut in the Aftermath of the Global Financial Crisis

cash

From Why Are Corporations Holding So Much Cash?

cash 2cash3

 

From FACTSET Cash and Investment Quarterly

cash4

Companies are holding on to the large sum of cash.  Rather than capital investments (CAPEX), cash is being used for share buybacks, dividend payouts, mergers and acquisitions, and cash investments (short and long term).

 

From FACTSET Cash and Investment Quarterly

cash5

Key Sources of Research:

 

The Corporate Saving Glut in the Aftermath of the Global Financial Crisis

Joseph W. Gruber
Steven B. Kamin

This Draft: June 2015

https://www.imf.org/external/np/seminars/eng/2015/secularstag/pdf/Gruber.pdf

 

The global corporate saving glut: Long-term evidence

Peter Chen, Loukas Karabarbounis, Brent Neiman

05 April 2017

http://voxeu.org/article/global-corporate-saving-glut

 

 

 

Declining Labor Shares and the Global Rise of Corporate Saving

Loukas Karabarbounis

Brent Neiman

October 2012

http://faculty.chicagobooth.edu/brent.neiman/research/labshare.pdf

 

The Global Rise of Corporate Saving

Peter Chen

Loukas Karabarbounis

Brent Neiman

March 2017

http://faculty.chicagobooth.edu/brent.neiman/research/CKN.pdf

http://www.nber.org/papers/w23133.pdf

 

FACTSET Dividend Quarterly

https://www.factset.com/websitefiles/PDFs/dividend

 

FACTSET Buyback Quarterly

https://www.factset.com/websitefiles/PDFs/buyback

FACTSET Cash and Investment Quarterly

https://www.factset.com/websitefiles/PDFs/cashinvestment

https://insight.factset.com/hubfs/Cash%20and%20Investment%20Quarterly/Cash%20and%20Investment%20Quarterly%20Q3%202016_12.21.16_v2.pdf

 

 

 

Why Are Corporations Holding So Much Cash?

By Juan M. Sanchez and Emircan Yurdagul

2013

 

https://www.stlouisfed.org/~/media/Files/PDFs/publications/pub_assets/pdf/re/2013/a/RE_Jan_2013.pdf

 

 

Why Do Companies Hold Cash?

Gianni La Cava and Callan Windsor

RDP 2016-03

 

https://www.rba.gov.au/publications/rdp/2016/pdf/rdp2016-03.pdf

 

 

MULTINATIONALS AND THE HIGH CASH HOLDINGS PUZZLE

Lee Pinkowitz

René M. Stulz Rohan Williamson

June 2012

 

http://www.nber.org/papers/w18120.pdf?new_window=1

 

 

 

The Determinants and Implications of Corporate Cash Holdings

Tim Opler, Lee Pinkowitz, Rene Stulz, Rohan Williamson

Issued in October 1997

http://www.nber.org/papers/w6234.pdf

 

 

WHY DO U.S. FIRMS HOLD SO MUCH MORE CASH THAN THEY USED TO?

Thomas W. Bates Kathleen M. Kahle Rene M. Stulz

September 2006

 

http://www.nber.org/papers/w12534.pdf

 

 

Why do firms hold so much cash? A tax-based explanation

C. Fritz Foley, Jay C. Hartzell, Sheridan Titman, and Garry Twite

October 2006

 

http://www.nber.org/papers/w12649.pdf

 

 

It’s Alive! Corporate Cash and Business Investment

Finn Poschmann

 

https://www.cdhowe.org/sites/default/files/attachments/research_papers/mixed/e-brief_181.pdf

 

 

Dead money

There are good reasons for hoarding cash.

John Lorinc

 

http://www.canadianbusiness.com/economy/dead-money/

 

 

IS “DEAD” MONEY ALIVE? A FIRM-LEVEL ANALYSIS OF CANADIAN NON-FINANCIAL LISTED CORPORATIONS CASH HOLDING AND CAPITAL EXPENDITURE BEHAVIOR

2014

IMF

 

https://www.imf.org/external/pubs/ft/scr/2014/cr1428.pdf

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Understanding Trade in Intermediate Goods

Understanding Trade in Intermediate Goods

 

One of the key source of International Trade statistics is a document published by the UNCTAD since 2013:

Key Statistics and Trends in International Trade

Please see references below to access reports for 2015 and 2016.

 

In 2014, out of USD 18.5 trillion in global trade, about USD 8 trillion was in intermediate goods.

 

From TRADE IN INTERMEDIATE GOODS AND SERVICES

Introduction: the international dimension of the exchange of intermediate inputs

1. Trade in intermediate inputs has been steadily growing over the last decade. However, despite the internationalisation of production and the increasing importance of outsourcing and foreign investment, some studies have found little rise in intermediate goods trade as a share of total trade1. More than half of goods trade is however made up of intermediate inputs and trade in services is even more of an intermediate type with about three quarters of trade flows being comprised of intermediate services. Trade in intermediate goods and services thus deserves special attention from trade policymakers and so far few studies have investigated how it differs from trade in consumption goods or services.

2. An intermediate good can be defined as an input to the production process that has itself been produced and, unlike capital, is used up in production3. The difference between intermediate and capital goods lies in the latter entering as a fixed asset in the production process. Like any primary factor (such as labour, land, or natural resources) capital is used but not used up in the production process4. On the contrary, an intermediate good is used, often transformed, and incorporated in the final output. As an input, an intermediate good has itself been produced and is hence defined in contrast to a primary input. As an output, an intermediate good is used to produce other goods (or services) contrary to a final good which is consumed and can be referred to as a “consumption good”.

3. Intermediate inputs are not restricted to material goods; they can also consist of services. Thelatter can be potentially used as an input to any sector of the economy; that is for the production of the same, or other services, as well as manufacturing goods. Symmetrically, manufacturing goods can be potentially used to produce the same, or other manufacturing goods, as well as services.

4. An important question we can ask is how to identify inputs among all goods and services produced in an economy. Many types of goods can be easily distinguished as inputs, when their use excludes them from final consumption. Notable examples include chemical substances, construction materials, or business services. The exact same type of good used as an input to some production process can however be destined to consumption. For instance, oranges can be sold to households as a final good, as well as to a factory as an input for food preparation. Telecommunication services can be sold to individuals or to business services firms as an intermediate input for their output. The United Nations distinguish commodities in each basic heading on the basis of the main end-use (United Nations, 2007). It is however recognized that many commodities that are traded internationally may be put to a variety of uses. Other methodologies involve the use of input-output (I-O) tables to distinguish between intermediate and consumption goods.

5. The importance of intermediate goods and services in the economy and trade is associated with a number of developments in the last decades. Growth and increased sophistication of production has given birth to strategies involving fragmentation and reorganisation of firm’s activities, both in terms of ownership boundaries, as in terms of the location for production. In what follows, the international dimension of the exchange of intermediate goods and services is explored by clarifying terms and concepts as well as the links between trade in intermediate inputs and FDI.

From Key Statistics and Trends in International Trade 2015

inter8

 

From Key Statistics and Trends in International Trade 2015

inter2

 From Key Statistics and Trends in International Trade 2015

inter3

From Key Statistics and Trends in International Trade 2015

inter4

From Key Statistics and Trends in International Trade 2015

inter

From Key Statistics and Trends in International Trade 2015

inter5

From Key Statistics and Trends in International Trade 2015

inter6

From Key Statistics and Trends in International Trade 2015

inter7

From Key Statistics and Trends in International Trade 2015

Trade networks relating to global value chains have evolved during the last 10 years. In 2004, the East Asian production network was still in its infancy. Most trade flows of parts and components concerned the USA and the European Union, with a number of other countries loosely connected with these two main hubs. As of 2014 trade of parts and components was much more developed. The current state is characterized not only by the prominent role of China, but also by a much more tightly integrated network with a much larger number of countries many of which have multiple connections to different hubs.

From Mapping Global Value Chains: Intermediate Goods Trade and Structural Change in the World Economy

inter10inter11inter12

Key sources of Research:

 

TRADE IN INTERMEDIATE GOODS AND SERVICES

OECD Trade Policy Working Paper No. 93
by Sébastien Miroudot, Rainer Lanz and Alexandros Ragoussis

2009

https://www.oecd.org/trade/its/44056524.pdf

 

 

An Essay on Intra-Industry Trade in Intermediate Goods

Rosanna Pittiglio

2014

http://file.scirp.org/pdf/ME_2014051916452646.pdf

 

 

The Rise of International Supply Chains: Implications for Global Trade

http://www3.weforum.org/docs/GETR/2012/GETR_Chapter1.2.pdf

 

 

 

Growing Trade in Intermediate Goods: Outsourcing, Global Sourcing or Increasing
Importance of MNE Networks?

by
Jörn Kleinert
October 2000

https://www.ifw-kiel.de/ifw_members/publications/growing-trade-in-intermediate-goods-outsourcing-global-sourcing-or-increasing-importance-of-mne-networks/kap1006.pdf

 

 

 

Imported Inputs and the Gains from Trade

Ananth Ramanarayanan
University of Western Ontario
September, 2014

https://www.economics.utoronto.ca/index.php/index/research/downloadSeminarPaper/49816

 

 

 

Key Statistics and Trends in International Trade 2015

Division on International Trade in Goods and Services, and Commodities
United Nations Conference on Trade and Development

http://unctad.org/en/PublicationsLibrary/ditctab2015d1_en.pdf

 

 

 

Key Statistics and Trends in International Trade 2016

Division on International Trade in Goods and Services, and Commodities
United Nations Conference on Trade and Development

http://unctad.org/en/PublicationsLibrary/ditctab2016d3_en.pdf

 

 

Integration of Trade and Disintegration of Production in the Global Economy

Robert C. Feenstra
Revised, April 1998

http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.39.7178&rep=rep1&type=pdf

 

 

 

GLOBAL VALUE CHAINS: CHALLENGES, OPPORTUNITIES, AND IMPLICATIONS FOR POLICY

OECD, WTO and World Bank Group
Report prepared for submission to the G20 Trade Ministers Meeting Sydney, Australia, 19 July 2014

https://www.oecd.org/tad/gvc_report_g20_july_2014.pdf

 

 

Trade in Value Added: Concepts, Estimation and Analysis

Marko Javorsek* and Ignacio Camacho

20015

http://www.unescap.org/sites/default/files/AWP150Trade%20in%20Value%20Added.pdf

 

 

The Similarities and Differences among Three Major Inter-Country Input-Output Databases and their Implications for Trade in Value-Added Estimates

Lin Jones and Zhi Wang, United States International Trade Commission Li Xin, Beijing Normal University and Peking University Christophe Degain, World Trade Organization

December, 2014

https://www.usitc.gov/publications/332/ec201412b.pdf

 

 

Advanced Topics in Trade
Lecture 9 – Multinational Firms and Foreign Direct Investment

Heiwai Tang – SAIS
April 8, 2015

http://www.hwtang.com/uploads/3/0/7/2/3072318/lecture_8_new.pdf

 

 

Efforts to Measure Trade in Value-Added and Map Global Value Chains: A Guide

Andrew Reamer

May 29, 2014

https://gwipp.gwu.edu/files/downloads/Reamer_ISA_Trade_in_Value_Added_05-29-2014.pdf

 

 

 

Global Value Chains for Value Added and Intermediate Goods in Asia

N Shrestha

20015

http://www.econ.ynu.ac.jp/cessa/publication/pdf/CESSA%20WP%202015-07.pdf

 

 

 

Global Value Chains: The New Reality of International Trade

Sherry Stephenson
December 2013

http://e15initiative.org/wp-content/uploads/2015/09/E15-GVCs-Stephenson-Final.pdf

 

 

Asia and Global Production Networks Implications for Trade, Incomes and Economic Vulnerability

Benno Ferrarini

David Hummels

20014

https://www.adb.org/sites/default/files/publication/149221/asia-and-global-production-networks.pdf

 

 

Participation of Developing Countries in Global Value Chains:
Implications for Trade and Trade-Related Policies

by
Przemyslaw Kowalski, Javier Lopez Gonzalez, Alexandros Ragoussis
and Cristian Ugarte

https://www.die-gdi.de/uploads/media/OECD_Trade_Policy_Papers_179.pdf

 

 

GLOBAL VALUE CHAINS: SURVEYING DRIVERS, MEASURES AND IMPACTS

João Amador
Sónia Cabral

2014

https://www.bportugal.pt/sites/default/files/anexos/papers/wp20143.pdf

 

World Intermediate goods Exports By Country and Region

2014

WITS World International Trade Statistics

http://wits.worldbank.org/CountryProfile/en/Country/WLD/Year/2014/TradeFlow/Export/Partner/all/Product/UNCTAD-SoP2

 

 

Trade in global value chains

2013

WTO

https://www.wto.org/english/res_e/statis_e/its2013_e/its13_highlights4_e.pdf

 

 

The Rise of Trade in Intermediates: Policy Implications

  • February 10, 2011

http://carnegieendowment.org/2011/02/10/rise-of-trade-in-intermediates-policy-implications-pub-42578

 

 

International trade with intermediate and final goods under economic crisis

Elżbieta Czarny, Warsaw School of Economics
Paweł Folfas, Warsaw School of Economics
Katarzyna Śledziewska, Warsaw University

http://www.etsg.org/ETSG2012/Programme/Papers/375.pdf

 

 

 

Trade in Intermediate Goods: Implications for Productivity and Welfare in Korea

Young Gui Kim

Hak K. PYO

Date Written: December 30, 2016

 

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2929118

 

 

Growing Together: Economic Ties between the United States and Mexico

BY CHRISTOPHER WILSON

https://www.wilsoncenter.org/sites/default/files/growing_together_economic_ties_between_the_united_states_and_mexico.pdf

 

 

Mapping Global Value Chains: Intermediate Goods Trade and Structural Change in the World Economy

Timothy J. Sturgeon
Olga Memedovic

https://www.unido.org/fileadmin/user_media/Publications/Research_and_statistics/Branch_publications/Research_and_Policy/Files/Working_Papers/2010/WP%2005%20Mapping%20Glocal%20Value%20Chains.pdf

 

India’s Intermediate Goods Trade in the Inter Regional Value Chain:
An examination based on Trade data and Input Output Analysis

Simi Thambi

https://www.jsie.jp/Annual_Meeting/2013f_Yokohoma_n_Univ/pdf/10_2%20fp.pdf

 

Global Supply Chains

https://www.usitc.gov/publications/332/pub4253_2.pdf

 

 

Global value chains in a changing world

Edited by Deborah K. Elms and Patrick Low

https://www.wto.org/english/res_e/booksp_e/aid4tradeglobalvalue13_e.pdf

 

Slowdown in Global Investment (FDI) Flows

Slowdown in Global Investment (FDI) Flows

 

 

From Determinants of Foreign Direct Investment (FDI)

Foreign direct investment (FDI) is a major component of globalization, together with international trade. Its operation is made possible by movements of factors across countries, in particular, capital. By definition, FDI involves long-term cross-country commitments. According to International Monetary Fund (IMF), FDI entails the establishment of a “lasting interest” by a resident entity of one economy in an enterprise located in another economy (International Monetary Fund, 1993). Lasting interest implies a long-term relationship between the foreign investor and the overseas enterprise where the said investor holds significant influence over management. The IMF defines a direct investment enterprise as one in which a foreign investor holds at least 10% of the ordinary shares or voting power (International Monetary Fund, 1993). The Organization for Economic Cooperation and Development (OECD, 1996, p. 10) classifies enterprises of direct foreign investors into three groups: subsidiaries, in which a nonresident investor holds more than 50% of the ownership; associates, in which a nonresident investor’s shares range between 10 and 50%; and branches, which are unincorporated enterprises owned by a nonresident investor, wholly or jointly. Obviously, such definitions and the resultant measurements leave ambiguities and imprecisions. However, they do help maintain relative consistency in cross-country comparisons.

From 1995 to 2015, the world saw a dramatic increase in FDI. The FDI inflows in 2015 were 8.6 times those in 1995, an increase from about 0.2 trillion USD in 1995 to about 1.8 trillion USD in 2015. While FDI inflows to developed countries increased 8.6-fold, those to developing countries and transitional economies increased 23 times. In 1995, FDI inflows to developing and transitional economies were 17% of the world total, and in 2015 they accounted for 45%. FDI flows to OECD countries peaked in 2007, at about 1.3 trillion USD. Between 2013 and 2014, for the first time, developing countries received more FDI than developed countries (UNCTAD, 2016), though the developed world recaptured the position as the largest FDI recipient in 2015 (see Figure 1).

There is an ever-growing body of literature on FDI. As Markusen (2008) demonstrated, three strands of relevant literature exist:

  • the international business approach that is oriented toward the rationale of individual firms,
  • the macroeconomic approach that focuses on aggregate flows of FDI without making a distinction between direct and portfolio investments,
  • and the international trade theory approach, which increasingly moves closer to the international business approach, combining firm-level FDI analysis with aggregate analysis of capital flows.

 

 

From UNCTAD World Investment Report 2017

FDI2

 

 

Key Sources of Research:

 

2017 AT Kearney FDI Confidence Index

http://www.iberglobal.com/files/2017/fdi_index_atkearney.pdf

 

UNCTAD World Investment Report 2017

http://unctad.org/en/PublicationsLibrary/wir2017_en.pdf

 

 

Recent Developments in Trade and Investment

Pierre Sauvé
Trade and Competitiveness Global Practice
World Bank Group
MIKTA Workshop on Trade and Investment
Session 2
Geneva, 20 March 2017

https://www.wto.org/english/forums_e/business_e/pierre_sauve_world_bank.pdf

 

 

OECD FDI Data

https://data.oecd.org/fdi/fdi-flows.htm

 

 

UNCTAD FDI Data

http://unctad.org/en/Pages/DIAE/FDI%20Statistics/Interactive-database.aspx

 

 

GLOBAL FDI FLOWS SLIP IN 2016, MODEST RECOVERY EXPECTED IN 2017

http://unctad.org/en/PublicationsLibrary/webdiaeia2017d1_en.pdf

 

 

Cross border mergers make India favoured FDI route: UNCTAD

June 2017

 

http://www.deccanchronicle.com/business/economy/080617/cross-border-mergers-make-india-favoured-fdi-route-unctad.html

 

 

Cross-border M&As push global FDI flows to $1.76 trillion

June 2016

http://economictimes.indiatimes.com/news/international/business/cross-border-mas-push-global-fdi-flows-to-1-76-trillion/articleshow/52860326.cms

 

 

OECD Bilateral FDI Data

http://stats.oecd.org/index.aspx?DataSetCode=FDI_FLOW_PARTNER

 

 

UNCTAD Bilateral FDI Data

http://unctad.org/en/Pages/DIAE/FDI%20Statistics/FDI-Statistics-Bilateral.aspx

 

 

World Bank FDI Database

https://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD

 

 

FDI Markets

https://www.fdimarkets.com

 

 

FDI Reports

http://www.fdireports.com/home/index.cfm?CFID=16605395&CFTOKEN=534deb8f9bfff240-CA8D9CBD-9042-6C79-7D3F0DD68E9B6616&jsessionid=2030aa76f30310567d2372163935674e554c

 

 

Determinants of Foreign Direct Investment (FDI)

Yi Feng

Online Publication Date: Jun 2017

http://politics.oxfordre.com/view/10.1093/acrefore/9780190228637.001.0001/acrefore-9780190228637-e-559?print=pdf

Why are Macro-economic Growth Forecasts so wrong?

Why are Macro-economic Growth Forecasts so wrong?

 

There are several institutions which publish economic forecasts annually/quarterly.

  • IMF
  • OECD
  • EC

Central Banks of Nations also publish economic Forecasts.  For Example:

  • Federal Reserve Bank of USA
  • Bank of England
  • Bank of Canada
  • Riksbank of Sweden
  • European Central Bank

 

There are several surveys of professional forecasters which create consensus forecasts to improve the accuracy of forecasts.

  • US Fed Reserve Survey of Professional Forecasters
  • ECB Survey of Professional Forecasters
  • Consensus Forecasts by Consensus Forecasts
  • Federal Reserve Blue Book
  • Federal Reserve Livingston Survey
  • Blue Chip Economic Forecasts by Wolters Kluwers

 

International Forecasting organizations (Private and Government)

  • IMF, “World Economic Outlook”;
  • EC, “European Economic Forecast”;
  • OECD, “OECD Economic Outlook”;
  • Consensus Economics, “Consensus Forecasts”;
  • The Economist, “The Economist pool of forecasters”.

 

USA Private and Government Economic Forecasters

  • Fed Reserve Survey of Professional Forecasters
  • Blue Chip Economic Indicators ( Wolters Kluwer)
  • Green Book
  • Livingston Survey
  • CBO
  • FOMC
  • Office of Management and Budget (OMB)
  • Western Blue Chip Economic Forecast

 

From Swiss Re Report May 2017

imfforecast

From Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach

RMSE GDP

 

Surveys of Economic Forecasters:

list

 

USA Private Economic Forecasters

There are many private forecasters who also publish forecasts.  For Example:

  • The Conference Board
  • Wells Fargo Bank
  • Goldman Sachs
  • Citi Group
  • Haver Analytics
  • RSQE Forecasts at University of Michigan

 

See the lists below for almost all of professional forecasters.

private forecasters USA

 

From Blue Chip Economic Forecast:

bluechip2bluechip

From Social Learning, Strategic Incentives and Collective Wisdom: An Analysis of the Blue Chip Forecasting Group

forecastersforecasters2

 

There is also in UK:

  • NIESR ( National Institute of Economic and Social Research)

 

From time to time many of these organizations review quality of their forecasts.  Results of these studies are published in papers many of which are listed in references below.

After the global financial Crisis of 2008-2009, many institutions have taken another look at their models used for forecasting economic variables.

See recent papers by

  • Bank of Canada
  • IMF
  • OECD
  • Fed Reserve
  • Bank of England
  • Riksbank of Sweden
  • US CBO
  • Bank of Portugal
  • European Commission

 

From Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach

Since late 2007, the Federal Open Market Committee (FOMC) of the U.S. Federal Reserve has regularly published assessments of the uncertainty associated with the projections of key macroeconomic variables made by individual Committee participants.1 These assessments, which are reported in the Summary of Economic Projections (SEP) that accompanies the FOMC minutes once a quarter, provide two types of information about forecast uncertainty. The first is qualitative in nature and summarizes the answers of participants to two questions: Is the uncertainty associated with his or her own projections of real activity and inflation higher, lower or about the same as the historical average? And are the risks to his or her own projections weighted to the upside, broadly balanced, or weighted to the downside? The second type of information is quantitative and provides the historical basis for answering the first qualitative question. Specifically, the SEP reports the root mean squared errors (RMSEs) of real-time forecasts over the past 20 years made by a group of leading private and public sector forecasters.

 

Some have blamed the entire economics profession.  Several attempts are being made to improve economic analysis.  Examples include work being done at

  • INET ( Institute for New Economic Thinking)
  • NAEC  at OECD

Heterodox schools of economics are making claims to accuracy of their approach after failure of main stream orthodox New Classical economics in predicting the Global Financial Crisis.

I will create another post later for some of these issues.

  • GDP forecasts errors have been attributed to errors in GDP components of business investments and exports.
  • Variability of GDP forecasts from short term to long term
  • Variability of GDP forecasts between forecasters – private and governments

 

Key Sources of Research:

 

The Case of Serial Disappointment

Justin‐Damien Guénette, Nicholas Labelle St‐Pierre, Martin Leduc and
Lori Rennison

Bank of Canada Staff Analytical Note 2016-10
July 2016

The Case of Serial Disappointment

 

ToTEM: The Bank of Canada’s New Quarterly Projection Model

Stephen Murchison and Andrew Rennison

Research Department
Bank of Canada

2006

ToTEM: The Bank of Canada’s New Quarterly Projection Model

 

 

ToTEM II: An Updated Version of the Bank of Canada’s Quarterly Projection Model

José Dorich, Michael Johnston, Rhys Mendes, Stephen Murchison and Yang Zhang

Canadian Economic Analysis Department
Bank of Canada

2013

ToTEM II: An Updated Version of the Bank of Canada’s Quarterly Projection Model

 

 

Introducing the Bank of Canada’s Projection Model for the Global Economy

Jeannine Bailliu, Patrick Blagrave, and James Rossiter

International Economic Analysis Department
Bank of Canada

2010

Introducing the Bank of Canada’s Projection Model for the Global Economy

Introducing the Bank of Canada’s Projection Model for the Global Economy

 

 

BoC-GEM: Modelling the World Economy

René Lalonde, International Economic Analysis Department

Dirk Muir, International Monetary Fund

BANK OF CANADA REVIEW SUMMER 2009

BoC-GEM: Modelling the World Economy

 

 

MUSE: The Bank of Canada’s New Projection Model of the U.S. Economy

Marc-André Gosselin and René Lalonde
International Department
Bank of Canada

2005

MUSE: The Bank of Canada’s New Projection Model of the U.S. Economy

 

 

OECD FORECASTS DURING AND AFTER THE FINANCIAL CRISIS: A POST MORTEM

OECD Economics Department
Policy Note no. 23
February 2014

OECD FORECASTS DURING AND AFTER THE FINANCIAL CRISIS: A POST MORTEM

 

 

THE USE OF MODELS IN PRODUCING OECD MACROECONOMIC FORECASTS

OECD ECONOMICS DEPARTMENT WORKING PAPERS NO. 1336
By David Turner

2016

THE USE OF MODELS IN PRODUCING OECD MACROECONOMIC FORECASTS

 

 

Lessons from OECD forecasts during and after the financial crisis

Christine Lewis and Nigel Pain

OECD Journal: Economic Studies
Volume 2014

Lessons from OECD forecasts during and after the financial crisis

 

 

How accurate are OECD forecasts?

12 February 2014
by Brian Keeley

 

Home Glossary About Contact Disclaimer How accurate are OECD forecasts?

 

 

Debate the Issues: Complexity and Policy making

OECD

Edited By:Patrick Love, Julia Stockdale-Otárola

06 June 2017

Debate the Issues: Complexity and Policy making

 

 

We need an empowering narrative

OECD Insights
23 June 2017
Gabriela Ramos

 

 

Final NAEC Synthesis : New Approaches to Economic Challenges

OECD

2015

Final NAEC Synthesis New Approaches to Economic Challenges

 

Debate the Issues: New Approaches to Economic Challenges

OECD

2016

Debate the Issues: New Approaches to Economic Challenges

 

OECD Forecasts During and After the Financial Crisis

A Post Mortem

Nigel Pain, Christine Lewis, Thai-Thanh Dang, Yosuke Jin, Pete Richardson

17 Mar 2014

OECD Forecasts During and After the Financial Crisis A Post Mortem

 

 Outlook for the Budget and the Economy

CBO USA

Outlook for the Budget and the Economy

 

CBO’s Economic Forecasting Record: 2015 Update

US CBO

CBO’s Economic Forecasting Record: 2015 Update

 

“Gauging the Uncertainty of the Economic
Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach,”

Finance and Economics Discussion Series 2017-020.

Washington: Board of Governors of the Federal Reserve System

“Gauging the Uncertainty of the Economic Outlook Using Historical Forecasting Errors: The Federal Reserve’s Approach

 

 The FRB/US Model: A Tool for Macroeconomic Policy Analysis

lint Brayton, Thomas Laubach, and David Reifschneider

2014

The FRB/US Model: A Tool for Macroeconomic Policy Analysis

 

 

 Gauging the Uncertainty of the Economic Outlook from Historical Forecasting Errors

David Reifschneider and Peter Tulip

federal Reserve

2007-60

Gauging the Uncertainty of the Economic Outlook from Historical Forecasting Errors

 

The IMF/WEO Forecast Process

Hans Genberg, Andrew Martinez, and Michael Salemi

IMF

2014

The IMF/WEO Forecast Process

 

 

On the Accuracy and Efficiency of IMF Forecasts: A Survey and Some Extensions

Hans Genberg and Andrew Martinez

IMF

2014

On the Accuracy and Efficiency of IMF Forecasts: A Survey and Some Extensions

 

 

An Evaluation of Commissioned Studies : Assessing the Accuracy of IMF Forecasts

Prepared by Charles Freedman
February 12, 2014

IMF

An Evaluation of Commissioned Studies : Assessing the Accuracy of IMF Forecasts

 

 

An Assessment of IMF Medium-Term Forecasts of GDP Growth

Carlos de Resende

2014

IMF

An Assessment of IMF Medium-Term Forecasts of GDP Growth

 

 

THE POLITICS OF IMF FORECASTS

AXEL DREHER
SILVIA MARCHESI
JAMES RAYMOND VREELAND

CESIFO WORKING PAPER NO. 2129

OCTOBER 2007

THE POLITICS OF IMF FORECASTS

 

 

Macroeconomic Forecasting: A Survey

K Wallis

1989

Macroeconomic Forecasting: A Survey

 

 

INTERNATIONAL ORGANISATIONS’ VS. PRIVATE ANALYSTS’ FORECASTS:

AN EVALUATION

Ildeberta Abreu

Banco de Portugal
July 2011

International organisations’ vs. private analysts’ forecasts: an evaluation

https://www.bportugal.pt/sites/default/files/anexos/papers/ab201105_e.pdf

 

 

On Macroeconomic Forecasting

Simon Wren-Lewis

2014

On Macroeconomic Forecasting

 

Why central banks use models to forecast

Simon Wren-Lewis

2014

Why central banks use models to forecast

USA Survey of Economic Professional Forecasters

ECB Survey of Economic Professional Forecasters

 

Trading Economics

 

Oxford Economics

 

Consensus Economics

IHS Markit

 

Evaluating forecast performance

Bank of England

Independent Evaluation Office | November 2015

Evaluating forecast performance

 

 

 Does the FederaL Reserve Staff Still beat Private Forecasters?

Makram El-Shagi, Sebastian Giesen and Alexander Jung

2014

 

DoeS THe FeDeraL reSerVe STaFF STiLL beaT PriVaTe ForeCaSTerS?

 

 

Modern Forecasting Models in Action: Improving Macroeconomic Analyses at
Central Banks

Malin Adolfson, Michael K. Andersson, Jesper Lind´e,
Mattias Villani, and Anders Vredina

Sveriges Riksbank
CEPR
Stockholm University

Modern Forecasting Models in Action: Improving Macroeconomic Analyses at Central Banks

 

 

Updated Historical Forecast Errors (4/9/2014)

Federal Reserve

Updated Historical Forecast Errors (4/9/2014)

 

 

How good is the forecasting performance of major institutions?

Riksbank of Sweden

Monetary Policy Department.

How good is the forecasting performance of major institutions?

 

 

Best Economic Forecaster Awards

Focus Economics

Best Economic Forecaster Awards

 

Has Output Become More Predictable? Changes in Greenbook Forecast Accuracy

Federal Reserve

Has Output Become More Predictable? Changes in Greenbook Forecast Accuracy

 

Green Book

Federal Reserve Bank of Philadelphia

Green Book

 

US Federal Reserve Livingston Survey

Federal Reserve Bank of Philadelphia

Livingston Survey

 

 

The IMF and OECD versus Consensus Forecasts

by
Roy Batchelor
City University Business School, London
August 2000

The IMF and OECD versus Consensus Forecasts

 

 

CBO’s January 2017 Budget and Economic Outlook

CRFB

CBO’s January 2017 Budget and Economic Outlook

 

 

Growth Forecast Errors and Fiscal Multipliers

Prepared by Olivier Blanchard and Daniel Leigh

January 2013

IMF

http://www.nber.org/papers/w18779

Central Bank Macroeconomic Forecasting during the global Financial Crisis: the European Central Bank and Federal Reserve Bank of New York experiences

no 1688 / july 2014

 

 

Economic Forecasting and its Role in Making Monetary Policy

RB Australia

1999

 

https://www.rba.gov.au/publications/bulletin/1999/sep/pdf/bu-0999-1.pdf

 

Are Forecasting Models Usable for Policy Analysis?

1986

Chris Sims

Minneapolis Federal Reserve

 

https://www.minneapolisfed.org/research/QR/QR1011.pdf

 

Persistent Overoptimism about Economic Growth

BY KEVIN J. LANSING AND BENJAMIN PYLE

2015

 

http://www.frbsf.org/economic-research/files/el2015-03.pdf

 

 

Federal Reserve economic projections: What are they good for?

Ben S. Bernanke

Monday, November 28, 2016

https://www.brookings.edu/blog/ben-bernanke/2016/11/28/federal-reserve-economic-projections/

 

Reassessing Longer-Run U.S. Growth: How Low?

John G. Fernald
Federal Reserve Bank of San Francisco

August 2016

 

http://www.frbsf.org/economic-research/files/wp2016-18.pdf

 

 

Recent declines in the Fed’s longer-run economic projections

by Jonas D. M. Fisher,

Christopher Russo,

2017

https://www.chicagofed.org/publications/chicago-fed-letter/2017/375

 

 

“How Accurate Are Private Sector Forecasts? Cross-Country Evidence from Consensus Forecasts of Output Growth.”

Prakash Loungani

2000

IMF

https://www.imf.org/external/pubs/ft/wp/2000/wp0077.pdf

 

The Failure to Forecast the Great Recession

Simon Potter

 

Liberty Street Economics / New York Federal Reserve Bank

http://libertystreeteconomics.newyorkfed.org/2011/11/the-failure-to-forecast-the-great-recession.html

 

 

Social Learning, Strategic Incentives and Collective Wisdom: An Analysis of the Blue Chip Forecasting Group

J. Peter Ferderer Department of Economics Macalester College
St. Paul, MN 55105 ferderer@macalester.edu

Adam Freedman Chicago, IL 60601 freedman.adamj@gmail.com

July 22, 2015

 

http://muse.union.edu/lamacroworkshop2015/files/2015/01/34-Ferderer-Blue-Chip-Collective-Wisdom.pdf

 

 

CBO’s Economic Forecasting Record 2013 Update

 

https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/43846-ForecastingRecord.pdf

 

CBO’s Economic Forecasting Record 2015 Update

https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/49891-Forecasting_Record_2015.pdf

 

CBO Recurring reports

https://www.cbo.gov/about/products/major-recurring-reports#7

 

European Commission’s Forecasts Accuracy Revisited: Statistical Properties and Possible Causes of Forecast Errors

Marco Fioramanti, Laura González Cabanillas, Bjorn Roelstraete and Salvador Adrian Ferrandis Vallterra

2016

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2753854

 

 

Western Blue Chip Economic Forecast

Arizona State University

JPMorgan Chase Economic Outlook Center

https://research.wpcarey.asu.edu/economic-outlook/western-blue-chip/state-forecasts-archive-download?type=pdf&year=2017&month=08&state=Summary

Low Interest Rates and Monetary Policy Effectiveness

Low Interest Rates and Monetary Policy Effectiveness

 

World economy is stuck in low interest rates environment.   Euro area, japan have even negative interest rates.  US Fed Reserve since December 2016 has started raising interest rates.

Attempts by Central Banks have not been effective in increasing economic growth.  Many Economists now are presenting counter intuitive reasons for low growth.

 

Please see my earlier related posts.

Business Investments and Low Interest Rates

Mergers and Acquisitions – Long Term Trends and Waves

 

Since 2016, there are several new studies published exploring effectiveness of monetary policy in low interest rates environment.

 

Is monetary policy less effective when interest rates are persistently low?

by Claudio Borio and Boris Hofmann

April 2017

Is Monetary Policy Less Effective When Interest Rates are Persistently Low?

 

In March 2017, Brookings Institution published the following study by the economists of the US Federal Reserve.

Monetary policy in a low interest rate world

 

Fed Reserve of Chicago published speech given by Charles Evans in 2016.

Monetary Policy in a Lower Interest Rate Environment

 

Lecture by Vítor Constâncio, Vice-President of the ECB, Macroeconomics Symposium at Utrecht School of Economics, 15 June 2016

The challenge of low real interest rates for monetary policy

 

Journal of Policy Modeling published a paper by Ken Rogoff.  Paper was presented at American Economic Association, 2017.

Monetary policy in a low interest rate world

 

Eight BIS CCA Research Conference on “Low interest rates, monetary policy and international spillovers”, hosted by the Board of Governors of the Federal Reserve System, Washington DC, 25-26 May 2017

Low interest rates, monetary policy and international spillovers

 

Economist Magazine published an article on views of Bill Gross and others.

November 2015

Do ultra-low interest rates really damage growth?

 

Bloomberg Business Week published an article describing views of Charles Calomiris and others.

June 2017

Is the World Overdoing Low Interest Rates?

 

Claudio Borio and Boris Hofmann

The Paper was prepared for the Reserve Bank of Australia conference
“Monetary Policy and Financial Stability in a World of Low Interest Rates”,

16-17 March 2017, Sydney

Is monetary policy less effective when interest rates are persistently low?

 

Monetary policy and bank lending in a low interest rate environment: diminishing effectiveness?

Claudio Borio and Leonardo Gambacorta

February 2017

Monetary policy and bank lending in a low interest rate environment: diminishing effectiveness?

 

Negative Interest Rate Policy (NIRP):
Implications for Monetary Transmission and Bank Profitability in the Euro Area

Prepared by Andreas (Andy) Jobst and Huidan Lin

IMF

August 2016

Negative Interest Rate Policy (NIRP): Implications for Monetary Transmission and Bank Profitability in the Euro Area

 

James Bullard, President and CEO of Federal Reserve Bank of St. Louis

March 24, 2009

The Henry Thornton Lecture, Cass Business School, London

Effective Monetary Policy in a Low Interest Rate Environment

 

Federal Reserve Bank of New York

Monetary Policy, Financial Conditions, and Financial Stability

Tobias Adrian
Nellie Liang

Monetary Policy, Financial Conditions, and Financial Stability

 

Monetary policy, the financial cycle and ultra-low interest rates

Mikael Juselius of Bank of Finland

DNB Workshop on “Estimating and Interpreting Financial Cycles”

Amsterdam, 2 September 2016

Monetary policy, the financial cycle and ultra-low interest rates

BIS Paper

Monetary policy, the financial cycle and ultra-low interest rates

 

The dynamics of real interest rates, monetary policy and its limits

Philippe d’Arvisenet

May 2016

The dynamics of real interest rates, monetary policy and its limits

 

Output Gaps and Monetary Policy at Low Interest Rates

By Roberto M. Billi

Output Gaps and Monetary Policy at Low Interest Rates

 

The insensitivity of investment to interest rates: Evidence from a survey of CFOs

Steve A. Sharpe and Gustavo A. Suarez

2014-02

The insensitivity of investment to interest rates: Evidence from a survey of CFOs

 

Does Prolonged Monetary Policy Easing Increase Financial Vulnerability?

Prepared by Stephen Cecchetti, Tommaso Mancini-Griffoli, and Machiko Narita

February 2017

Does Prolonged Monetary Policy Easing Increase Financial Vulnerability?

 

The Microeconomic Perils of Monetary Policy Experiments

Charles W. Calomiris

Cato Institute

The Microeconomic Perils of Monetary Policy Experiments

 

Why Have the Fed’s Policies Failed to Stimulate the Economy?

Mickey D. Levy

Cato Institute

Why Have the Fed’s Policies Failed to Stimulate the Economy?

Short term Thinking in Investment Decisions of Businesses and Financial Markets

Short term Thinking in Investment Decisions of Businesses and Financial Markets

 

When companies buyback shares and pay dividends rather than investing in new capacity, it leads to low economic growth and low aggregate demand.

Central Banks respond by cutting interest rates.  Yet Businesses do not invest in new capacity.

Many studies attribute this to short term thinking dominant in corporate investment decisions.  Pressures from shareholders push corporate managers to be short term oriented.

Many economists and thinkers have criticized this recently as advanced economies are suffering from anemic growth.

Larry Summers has invoked Secular Stagnation.  He says one of the reason for Secular Stagnation is short term thinking.

Andy Haldane of Bank of England has criticized short term thinking as it prevents investments and causes low economic growth.

Key Terms:

  • Quarterly Capitalism
  • Secular Stagnation
  • Short Term Thinking
  • Low Economic Growth
  • Business Investments
  • Real Interest Rates
  • Monetary Policy
  • Income and Wealth Inequality
  • Aggregate Demand
  • Productive Capacity
  • Productivity growth
  • Long Term Investments
  • Share Buybacks
  • Dividends
  • Corporate Cash Pools

 

Capitalism for the Long Term

The near meltdown of the financial system and the ensuing Great Recession have been, and will remain, the defining issue for the current generation of executives. Now that the worst seems to be behind us, it’s tempting to feel deep relief—and a strong desire to return to the comfort of business as usual. But that is simply not an option. In the past three years we’ve already seen a dramatic acceleration in the shifting balance of power between the developed West and the emerging East, a rise in populist politics and social stresses in a number of countries, and significant strains on global governance systems. As the fallout from the crisis continues, we’re likely to see increased geopolitical rivalries, new international security challenges, and rising tensions from trade, migration, and resource competition. For business leaders, however, the most consequential outcome of the crisis is the challenge to capitalism itself.

That challenge did not just arise in the wake of the Great Recession. Recall that trust in business hit historically low levels more than a decade ago. But the crisis and the surge in public antagonism it unleashed have exacerbated the friction between business and society. On top of anxiety about persistent problems such as rising income inequality, we now confront understandable anger over high unemployment, spiraling budget deficits, and a host of other issues. Governments feel pressure to reach ever deeper inside businesses to exert control and prevent another system-shattering event.

My goal here is not to offer yet another assessment of the actions policymakers have taken or will take as they try to help restart global growth. The audience I want to engage is my fellow business leaders. After all, much of what went awry before and after the crisis stemmed from failures of governance, decision making, and leadership within companies. These are failures we can and should address ourselves.

In an ongoing effort that started 18 months ago, I’ve met with more than 400 business and government leaders across the globe. Those conversations have reinforced my strong sense that, despite a certain amount of frustration on each side, the two groups share the belief that capitalism has been and can continue to be the greatest engine of prosperity ever devised—and that we will need it to be at the top of its job-creating, wealth-generating game in the years to come. At the same time, there is growing concern that if the fundamental issues revealed in the crisis remain unaddressed and the system fails again, the social contract between the capitalist system and the citizenry may truly rupture, with unpredictable but severely damaging results.

Most important, the dialogue has clarified for me the nature of the deep reform that I believe business must lead—nothing less than a shift from what I call quarterly capitalism to what might be referred to as long-term capitalism. (For a rough definition of “long term,” think of the time required to invest in and build a profitable new business, which McKinsey research suggests is at least five to seven years.) This shift is not just about persistently thinking and acting with a next-generation view—although that’s a key part of it. It’s about rewiring the fundamental ways we govern, manage, and lead corporations. It’s also about changing how we view business’s value and its role in society.

There are three essential elements of the shift. First, business and finance must jettison their short-term orientation and revamp incentives and structures in order to focus their organizations on the long term. Second, executives must infuse their organizations with the perspective that serving the interests of all major stakeholders—employees, suppliers, customers, creditors, communities, the environment—is not at odds with the goal of maximizing corporate value; on the contrary, it’s essential to achieving that goal. Third, public companies must cure the ills stemming from dispersed and disengaged ownership by bolstering boards’ ability to govern like owners.

When making major decisions, Asians typically think in terms of at least 10 to 15 years. In the U.S. and Europe, nearsightedness is the norm.

None of these ideas, or the specific proposals that follow, are new. What is new is the urgency of the challenge. Business leaders today face a choice: We can reform capitalism, or we can let capitalism be reformed for us, through political measures and the pressures of an angry public. The good news is that the reforms will not only increase trust in the system; they will also strengthen the system itself. They will unleash the innovation needed to tackle the world’s grand challenges, pave the way for a new era of shared prosperity, and restore public faith in business.

1. Fight the Tyranny of Short-Termism

As a Canadian who for 25 years has counseled business, public sector, and nonprofit leaders across the globe (I’ve lived in Toronto, Sydney, Seoul, Shanghai, and now London), I’ve had a privileged glimpse into different societies’ values and how leaders in various cultures think. In my view, the most striking difference between East and West is the time frame leaders consider when making major decisions. Asians typically think in terms of at least 10 to 15 years. For example, in my discussions with the South Korean president Lee Myung-bak shortly after his election in 2008, he asked us to help come up with a 60-year view of his country’s future (though we settled for producing a study called National Vision 2020.) In the U.S. and Europe, nearsightedness is the norm. I believe that having a long-term perspective is the competitive advantage of many Asian economies and businesses today.

Myopia plagues Western institutions in every sector. In business, the mania over quarterly earnings consumes extraordinary amounts of senior time and attention. Average CEO tenure has dropped from 10 to six years since 1995, even as the complexity and scale of firms have grown. In politics, democracies lurch from election to election, with candidates proffering dubious short-term panaceas while letting long-term woes in areas such as economic competitiveness, health, and education fester. Even philanthropy often exhibits a fetish for the short term and the new, with grantees expected to become self-sustaining in just a few years.

Lost in the frenzy is the notion that long-term thinking is essential for long-term success. Consider Toyota, whose journey to world-class manufacturing excellence was years in the making. Throughout the 1950s and 1960s it endured low to nonexistent sales in the U.S.—and it even stopped exporting altogether for one bleak four-year period—before finally emerging in the following decades as a global leader. Think of Hyundai, which experienced quality problems in the late 1990s but made a comeback by reengineering its cars for long-term value—a strategy exemplified by its unprecedented introduction, in 1999, of a 10-year car warranty. That radical move, viewed by some observers as a formula for disaster, helped Hyundai quadruple U.S. sales in three years and paved the way for its surprising entry into the luxury market.

To be sure, long-term perspectives can be found in the West as well. For example, in 1985, in the face of fierce Japanese competition, Intel famously decided to abandon its core business, memory chips, and focus on the then-emerging business of microprocessors. This “wrenching” decision was “nearly inconceivable” at the time, says Andy Grove, who was then the company’s president. Yet by making it, Intel emerged in a few years on top of a new multi-billion-dollar industry. Apple represents another case in point. The iPod, released in 2001, sold just 400,000 units in its first year, during which Apple’s share price fell by roughly 25%. But the board took the long view. By late 2009 the company had sold 220 million iPods—and revolutionized the music business.

It’s fair to say, however, that such stories are countercultural. In the 1970s the average holding period for U.S. equities was about seven years; now it’s more like seven months. According to a recent paper by Andrew Haldane, of the Bank of England, such churning has made markets far more volatile and produced yawning gaps between corporations’ market price and their actual value. Then there are the “hyperspeed” traders (some of whom hold stocks for only a few seconds), who now account for 70% of all U.S. equities trading, by one estimate. In response to these trends, executives must do a better job of filtering input, and should give more weight to the views of investors with a longer-term, buy-and-hold orientation.

If they don’t, short-term capital will beget short-term management through a natural chain of incentives and influence. If CEOs miss their quarterly earnings targets, some big investors agitate for their removal. As a result, CEOs and their top teams work overtime to meet those targets. The unintended upshot is that they manage for only a small portion of their firm’s value. When McKinsey’s finance experts deconstruct the value expectations embedded in share prices, we typically find that 70% to 90% of a company’s value is related to cash flows expected three or more years out. If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem.

Roughly 70% of all U.S. equities trading is now done by “hyperspeed” traders—some of whom hold stocks for only a few seconds.

Some rightly resist playing this game. Unilever, Coca-Cola, and Ford, to name just a few, have stopped issuing earnings guidance altogether. Google never did. IBM has created five-year road maps to encourage investors to focus more on whether it will reach its long-term earnings targets than on whether it exceeds or misses this quarter’s target by a few pennies. “I can easily make my numbers by cutting SG&A or R&D, but then we wouldn’t get the innovations we need,” IBM’s CEO, Sam Palmisano, told us recently. Mark Wiseman, executive vice president at the Canada Pension Plan Investment Board, advocates investing “for the next quarter century,” not the next quarter. And Warren Buffett has quipped that his ideal holding period is “forever.” Still, these remain admirable exceptions.

To break free of the tyranny of short-termism, we must start with those who provide capital. Taken together, pension funds, insurance companies, mutual funds, and sovereign wealth funds hold $65 trillion, or roughly 35% of the world’s financial assets. If these players focus too much attention on the short term, capitalism as a whole will, too.

In theory they shouldn’t, because the beneficiaries of these funds have an obvious interest in long-term value creation. But although today’s standard practices arose from the desire to have a defensible, measurable approach to portfolio management, they have ended up encouraging shortsightedness. Fund trustees, often advised by investment consultants, assess their money managers’ performance relative to benchmark indices and offer only short-term contracts. Those managers’ compensation is linked to the amount of assets they manage, which typically rises when short-term performance is strong. Not surprisingly, then, money managers focus on such performance—and pass this emphasis along to the companies in which they invest. And so it goes, on down the line.

Only 45% of those surveyed in the U.S. and the UK expressed trust in business. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil.

As the stewardship advocate Simon Wong points out, under the current system pension funds deem an asset manager who returns 10% to have underperformed if the relevant benchmark index rises by 12%. Would it be unthinkable for institutional investors instead to live with absolute gains on the (perfectly healthy) order of 10%—especially if they like the approach that delivered those gains—and review performance every three or five years, instead of dropping the 10-percenter? Might these big funds set targets for the number of holdings and rates of turnover, at least within the “fundamental investing” portion of their portfolios, and more aggressively monitor those targets? More radically, might they end the practice of holding thousands of stocks and achieve the benefits of diversification with fewer than a hundred—thereby increasing their capacity to effectively engage with the businesses they own and improve long-term performance? Finally, could institutional investors beef up their internal skills and staff to better execute such an agenda? These are the kinds of questions we need to address if we want to align capital’s interests more closely with capitalism’s.

2. Serve Stakeholders, Enrich Shareholders

The second imperative for renewing capitalism is disseminating the idea that serving stakeholders is essential to maximizing corporate value. Too often these aims are presented as being in tension: You’re either a champion of shareholder value or you’re a fan of the stakeholders. This is a false choice.

The inspiration for shareholder-value maximization, an idea that took hold in the 1970s and 1980s, was reasonable: Without some overarching financial goal with which to guide and gauge a firm’s performance, critics feared, managers could divert corporate resources to serve their own interests rather than the owners’. In fact, in the absence of concrete targets, management might become an exercise in politics and stakeholder engagement an excuse for inefficiency. Although this thinking was quickly caricatured in popular culture as the doctrine of “greed is good,” and was further tarnished by some companies’ destructive practices in its name, in truth there was never any inherent tension between creating value and serving the interests of employees, suppliers, customers, creditors, communities, and the environment. Indeed, thoughtful advocates of value maximization have always insisted that it is long-term value that has to be maximized.

Capitalism’s founding philosopher voiced an even bolder aspiration. “All the members of human society stand in need of each others assistance, and are likewise exposed to mutual injuries,” Adam Smith wrote in his 1759 work, The Theory of Moral Sentiments. “The wise and virtuous man,” he added, “is at all times willing that his own private interest should be sacrificed to the public interest,” should circumstances so demand.

Smith’s insight into the profound interdependence between business and society, and how that interdependence relates to long-term value creation, still reverberates. In 2008 and again in 2010, McKinsey surveyed nearly 2,000 executives and investors; more than 75% said that environmental, social, and governance (ESG) initiatives create corporate value in the long term. Companies that bring a real stakeholder perspective into corporate strategy can generate tangible value even sooner. (See the sidebar “Who’s Getting It Right?”)

Creating direct business value, however, is not the only or even the strongest argument for taking a societal perspective. Capitalism depends on public trust for its legitimacy and its very survival. According to the Edelman public relations agency’s just-released 2011 Trust Barometer, trust in business in the U.S. and the UK (although up from mid-crisis record lows) is only in the vicinity of 45%. This stands in stark contrast to developing countries: For example, the figure is 61% in China, 70% in India, and 81% in Brazil. The picture is equally bleak for individual corporations in the Anglo-American world, “which saw their trust rankings drop again last year to near-crisis lows,” says Richard Edelman.

How can business leaders restore the public’s trust? Many Western executives find that nothing in their careers has prepared them for this new challenge. Lee Scott, Walmart’s former CEO, has been refreshingly candid about arriving in the top job with a serious blind spot. He was plenty busy minding the store, he says, and had little feel for the need to engage as a statesman with groups that expected something more from the world’s largest company. Fortunately, Scott was a fast learner, and Walmart has become a leader in environmental and health care issues.

Tomorrow’s CEOs will have to be, in Joseph Nye’s apt phrase, “tri-sector athletes”: able and experienced in business, government, and the social sector. But the pervading mind-set gets in the way of building those leadership and management muscles. “Analysts and investors are focused on the short term,” one executive told me recently. “They believe social initiatives don’t create value in the near term.” In other words, although a large majority of executives believe that social initiatives create value in the long term, they don’t act on this belief, out of fear that financial markets might frown. Getting capital more aligned with capitalism should help businesses enrich shareholders by better serving stakeholders.

3. Act Like You Own the Place

As the financial sector’s troubles vividly exposed, when ownership is broadly fragmented, no one acts like he’s in charge. Boards, as they currently operate, don’t begin to serve as a sufficient proxy. All the Devils Are Here, by Bethany McLean and Joe Nocera, describes how little awareness Merrill Lynch’s board had of the firm’s soaring exposure to subprime mortgage instruments until it was too late. “I actually don’t think risk management failed,” Larry Fink, the CEO of the investment firm BlackRock, said during a 2009 debate about the future of capitalism, sponsored by the Financial Times. “I think corporate governance failed, because…the boards didn’t ask the right questions.”

What McKinsey has learned from studying successful family-owned companies suggests a way forward: The most effective ownership structure tends to combine some exposure in the public markets (for the discipline and capital access that exposure helps provide) with a significant, committed, long-term owner. Most large public companies, however, have extremely dispersed ownership, and boards rarely perform the single-owner-proxy role. As a result, CEOs too often listen to the investors (and members of the media) who make the most noise. Unfortunately, those parties tend to be the most nearsighted ones. And so the tyranny of the short term is reinforced.

The answer is to renew corporate governance by rooting it in committed owners and by giving those owners effective mechanisms with which to influence management. We call this ownership-based governance, and it requires three things:

Just 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles.

More-effective boards.

In the absence of a dominant shareholder (and many times when there is one), the board must represent a firm’s owners and serve as the agent of long-term value creation. Even among family firms, the executives of the top-performing companies wield their influence through the board. But only 43% of the nonexecutive directors of public companies believe they significantly influence strategy. For this to change, board members must devote much more time to their roles. A government-commissioned review of the governance of British banks last year recommended an enormous increase in the time required of nonexecutive directors of banks—from the current average, between 12 and 20 days annually, to between 30 and 36 days annually. What’s especially needed is an increase in the informal time board members spend with investors and executives. The nonexecutive board directors of companies owned by private equity firms spend 54 days a year, on average, attending to the company’s business, and 70% of that time consists of informal meetings and conversations. Four to five days a month obviously give a board member much greater understanding and impact than the three days a quarter (of which two may be spent in transit) devoted by the typical board member of a public company.

Boards also need much more relevant experience. Industry knowledge—which four of five nonexecutive directors of big companies lack—helps boards identify immediate opportunities and reduce risk. Contextual knowledge about the development path of an industry—for example, whether the industry is facing consolidation, disruption from new technologies, or increased regulation—is highly valuable, too. Such insight is often obtained from experience with other industries that have undergone a similar evolution.

In addition, boards need more-effective committee structures—obtainable through, for example, the establishment of a strategy committee or of dedicated committees for large business units. Directors also need the resources to allow them to form independent views on strategy, risk, and performance (perhaps by having a small analytical staff that reports only to them). This agenda implies a certain professionalization of nonexecutive directorships and a more meaningful strategic partnership between boards and top management. It may not please some executive teams accustomed to boards they can easily “manage.” But given the failures of governance to date, it is a necessary change.

More-sensible CEO pay.

An important task of governance is setting executive compensation. Although 70% of board directors say that pay should be tied more closely to performance, CEO pay is too often structured to reward a leader simply for having made it to the top, not for what he or she does once there. Meanwhile, polls show that the disconnect between pay and performance is contributing to the decline in public esteem for business.

Companies should create real risk for executives.Some experts privately suggest mandating that new executives invest a year’s salary in the company.

CEOs and other executives should be paid to act like owners. Once upon a time we thought that stock options would achieve this result, but stock-option- based compensation schemes have largely incentivized the wrong behavior. When short-dated, options lead to a focus on meeting quarterly earnings estimates; even when long-dated (those that vest after three years or more), they can reward managers for simply surfing industry- or economy-wide trends (although reviewing performance against an appropriate peer index can help minimize free rides). Moreover, few compensation schemes carry consequences for failure—something that became clear during the financial crisis, when many of the leaders of failed institutions retired as wealthy people.

There will never be a one-size-fits-all solution to this complex issue, but companies should push for change in three key areas:

• They should link compensation to the fundamental drivers of long-term value, such as innovation and efficiency, not just to share price.

• They should extend the time frame for executive evaluations—for example, using rolling three-year performance evaluations, or requiring five-year plans and tracking performance relative to plan. This would, of course, require an effective board that is engaged in strategy formation.

• They should create real downside risk for executives, perhaps by requiring them to put some skin in the game. Some experts we’ve surveyed have privately suggested mandating that new executives invest a year’s salary in the company.

Redefined shareholder “democracy.”

The huge increase in equity churn in recent decades has spawned an anomaly of governance: At any annual meeting, a large number of those voting may soon no longer be shareholders. The advent of high-frequency trading will only worsen this trend. High churn rates, short holding periods, and vote-buying practices may mean the demise of the “one share, one vote” principle of governance, at least in some circumstances. Indeed, many large, top-performing companies, such as Google, have never adhered to it. Maybe it’s time for new rules that would give greater weight to long-term owners, like the rule in some French companies that gives two votes to shares held longer than a year. Or maybe it would make sense to assign voting rights based on the average turnover of an investor’s portfolio. If we want capitalism to focus on the long term, updating our notions of shareholder democracy in such ways will soon seem less like heresy and more like common sense.

While I remain convinced that capitalism is the economic system best suited to advancing the human condition, I’m equally persuaded that it must be renewed, both to deal with the stresses and volatility ahead and to restore business’s standing as a force for good, worthy of the public’s trust. The deficiencies of the quarterly capitalism of the past few decades were not deficiencies in capitalism itself—just in that particular variant. By rebuilding capitalism for the long term, we can make it stronger, more resilient, more equitable, and better able to deliver the sustainable growth the world needs. The three imperatives outlined above can be a start along this path and, I hope, a way to launch the conversation; others will have their own ideas to add.

The kind of deep-seated, systemic changes I’m calling for can be achieved only if boards, business executives, and investors around the world take responsibility for bettering the system they lead. Such changes will not be easy; they are bound to encounter resistance, and business leaders today have more than enough to do just to keep their companies running well. We must make the effort regardless. If capitalism emerges from the crisis vibrant and renewed, future generations will thank us. But if we merely paper over the cracks and return to our precrisis views, we will not want to read what the historians of the future will write. The time to reflect—and to act—is now.

 

Please see my other related posts.

Business Investments and Low Interest Rates

Mergers and Acquisitions – Long Term Trends and Waves

 

 

Key sources of Research:

Secular stagnation and low investment: Breaking the vicious cycle—a discussion paper

McKinsey

http://www.mckinsey.com/global-themes/europe/secular-stagnation-and-low-investment-breaking-the-vicious-cycle

Case Still Out on Whether Corporate Short-Termism Is a Problem

Larry Summers

http://larrysummers.com/2017/02/09/case-still-out-on-whether-corporate-short-termism-is-a-problem/

Where companies with a long-term view outperform their peers

McKinsey

http://www.mckinsey.com/global-themes/long-term-capitalism/where-companies-with-a-long-term-view-outperform-their-peers

How short-term thinking hampers long-term economic growth

FT

https://www.ft.com/content/8c868a98-b821-11e4-b6a5-00144feab7de

Anthony Hilton: Short-term thinking hits nations as a whole, not just big business

http://www.standard.co.uk/comment/comment/anthony-hilton-short-term-thinking-hits-nations-as-a-whole-not-just-big-business-10427294.html

Short-termism in business: causes, mechanisms and consequences

EY Poland Report

http://www.ey.com/Publication/vwLUAssets/EY_Poland_Report/$FILE/Short-termism_raport_EY.pdf

Overcoming the Barriers to Long-term Thinking in Financial Markets

Ruth Curran and Alice Chapple
Forum for the Future

https://www.forumforthefuture.org/sites/default/files/project/downloads/long-term-thinking-fpf-report-july-11.pdf

Understanding Short-Termism: Questions and Consequences

http://rooseveltinstitute.org/wp-content/uploads/2015/11/Understanding-Short-Termism.pdf

Ending Short-Termism : An Investment Agenda for Growth

http://rooseveltinstitute.org/wp-content/uploads/2015/11/Ending-Short-Termism.pdf

The Short Long

Speech by
Andrew G Haldane, Executive Director, Financial Stability, and Richard Davies

Brussels May 2011

http://www.bankofengland.co.uk/archive/Documents/historicpubs/speeches/2011/speech495.pdf

Capitalism for the Long Term

Dominic Barton

From the March 2011 Issue

https://hbr.org/2011/03/capitalism-for-the-long-term

Quarterly capitalism: The pervasive effects of short-termism and austerity

https://currentlyunderdevelopment.wordpress.com/2016/05/10/quarterly-capitalism-the-pervasive-effects-of-short-termism-and-austerity/

Is Short-Term Behavior Jeopardizing the Future Prosperity of Business?

http://www.wlrk.com/docs/IsShortTermBehaviorJeopardizingTheFutureProsperityOfBusiness_CEOStrategicimplications.pdf

Andrew G Haldane: The short long

Speech by Mr Andrew Haldane, Executive Director, Financial Stability, and Mr Richard
Davies, Economist, Financial Institutions Division, Bank of England,
at the 29th Société
Universitaire Européene de Recherches Financières Colloquium,
Brussels, 11 May 2011

http://www.bis.org/review/r110511e.pdf

THE UNEASY CASE FOR FAVORING LONG-TERM SHAREHOLDERS

Jesse M. Fried

https://dash.harvard.edu/bitstream/handle/1/17985223/Fried_795.pdf?sequence=1

The fringe economic theory that might get traction in the 2016 campaign

https://www.washingtonpost.com/news/wonk/wp/2015/03/02/the-fringe-economic-theory-that-might-get-traction-in-the-2016-campaign/?utm_term=.932bc0b97758

FCLT Global:  Focusing Capital on the Long Term

Publications

http://www.fcltglobal.org/insights/publications

Finally, Evidence That Managing for the Long Term Pays Off

Dominic Barton

James Manyika

Sarah Keohane Williamson

February 07, 2017 UPDATED February 09, 2017

https://hbr.org/2017/02/finally-proof-that-managing-for-the-long-term-pays-off

Focusing Capital on the Long Term

Dominic Barton

Mark Wiseman

From the January–February 2014 Issue

Is Corporate Short-Termism Really a Problem? The Jury’s Still Out

Lawrence H. Summers

February 16, 2017

Yes, Short-Termism Really Is a Problem

Roger L. Martin

October 09, 2015

Long-Termism or Lemons

The Role of Public Policy in Promoting Long-Term Investments

By Marc Jarsulic, Brendan V. Duke, and Michael Madowitz October 2015

Center for American Progress

https://cdn.americanprogress.org/wp-content/uploads/2015/10/21060054/LongTermism-reportB.pdf

 

Overcoming Short-termism: A Call for A More Responsible Approach to Investment and Business Management

https://corpgov.law.harvard.edu/2009/09/11/overcoming-short-termism-a-call-for-a-more-responsible-approach-to-investment-and-business-management/

 

 

Focusing capital on the Long Term

Jean-Hugues Monier – Senior Parter – McKinsey & Company

Princeton University – November 2016

http://jrc.princeton.edu/sites/jrc/files/jean-hugues_j._monier_slides_final.pdf