Paul Krugman writes:
Another Economic Disconnect - New York Times: Edward Lazear... explained that what’s good for corporations is good for America. “Profits,” he declared, “provide the incentive for physical capital investment, and physical capital growth contributes to productivity growth. Thus profits are important not only for investors but also for the workers who benefit from the growth in productivity.”
In other words, ask not for whom the closing bell tolls; it tolls for thee.
Unfortunately... [i]n the Bush years high profits haven’t led to high investment, and rising productivity hasn’t led to rising wages. The second of those two disconnects has gotten a lot of attention.... Less attention... has been given to the first disconnect: the failure of high profits to produce an investment boom.... [W]ith corporate profits more than doubling since 2000... profits as a share of national income [in 2006] were at the highest level ever recorded. You might have expected this gusher... to produce a corresponding gusher of business investment. But the reality has been more of a trickle. Nonresidential investment — that is, investment other than housing construction — has grown very slowly by historical standards... remains far below its levels of the late 1990s, and it has been declining for the last two quarters.
Why aren’t corporations investing, and what does the lack of business investment mean for the economy?... Floyd Norris... [sees a] disturbing possibility. Instead of investing in physical capital, many companies are using profits to buy back their own stock. And cynics suggest that the purpose of these buybacks is to produce a temporary rise in stock prices that increases the value of executives’ stock options, even if it’s against the long-term interests of investors.... Researchers at the Federal Reserve have found evidence that company decisions about stock buybacks are strongly influenced by “agency conflicts,” a genteel term for self-dealing by corporate insiders....
Whatever the reasons, we now have an economy with incredibly high profits and surprisingly low investment. This raises some immediate, short-run concerns... optimistic projections for the economy depend on vigorous growth in business investment. And that doesn’t seem to be happening.
The bigger issue, however, may be longer term. Mr. Lazear was right... business investment plays an important role in raising productivity. High investment in equipment and software was one major reason for the productivity takeoff that began in the Clinton era, and continued in the early years of this decade. And low investment may be one reason productivity growth has slowed....
[N]ext time someone tells you... reduc[ing] corporate profits... will reduce business investment, bear in mind that today’s record profits aren’t being invested... [but] being used to enrich executives and a few lucky stock owners.