Earn It!

Interesting article in the WSJ discussing "The Dark Side of Strong Corporate Earning." In the article the author Kelly Evans highlights that the uptick in corporate profits has not produced accelerating GDP growth. The reason, she argues, is that companies' earnings are increasingly driven by strength outside the U.S. She also points out that the capital stock in the U.S., things like factories, power plants and equipment, declined in 2009 for the first time in postwar history. The level of capital stock appears to have rebounded in 2010, but largely due to maintenance investments. In many ways the decline in capital stock is not surprising given the almost 15-year decline in capacity utilization. In light of capacity utilization, it is somewhat surprising a decline in one year has not happened sooner.

Increasing investment in capital stock is critical to a healthy and growing country. Simply put, no factories, no offices, and no power plants means a very limited economy. So why has capital stock growth leveled off? You could point to the rise of competitive products from emerging markets, offshore outsourcing of services, movement of U.S. manufacturing to cheaper labor regions, or even relatively high corporate tax rates in the U.S. To me, it boils down to declining returns on the capital stock, which encompasses all these macroeconomic issues and also over-investment during the past 15-20 years fueled by inexpensive debt. In other words, we have been "whistling past the graveyard" of our own weakening competitiveness for some time.

How has the U.S. responded to this problem? Some responses have been knee-jerk reactions with protectionist tariffs, laws and immigration restrictions that ultimately hurt the economy. Others have been semi-thoughtful efforts to improve the competitiveness of U.S. exports through exchange rates. These more thoughtful efforts range from obvious complaints leveled at intervention by other countries to more subtle dollar devaluation through expansionary monetary policies (wrapped in stimulative/ fend of the end of the world rhetoric).

The most effective, although the longest to implement and realize a return, are the efforts to encourage domestic investment in industries with potentially high growth products and services with high foreign demand. I emphasize high foreign demand to separate out companies like local casinos that draw from populations and provide little, if any, overall value add to society. Greater value comes from idea-generating industries with large global markets, manufacturing businesses that export products, and services that draw foreign dollars. The point is a basic one, America must return to increasing the value added to the world economy. We demand among the highest wages in the world. President Obama hit on it in 2009 when he referenced the old Smith Barney ad "earn it."