Do We Have Too Much Capital?

There’s been a lot of talk about the role of capital in the global economy lately, not least because of Thomas Piketty’s book of the same name. Capital is an essential ingredient in the creation of most manufactured goods and many services as well. But what if we have too much of it, and what would happen if we had less?

Economists think about capital as one of the main inputs — along with labor and technology — in the production of just about anything. Allowing each worker to use more capital can raise his or her productivity, which may in turn lead to higher wages, but there’s a limit to these benefits.

For example, imagine that you’re working an office job using a regular computer and monitor. Having an extra screen on your desktop might help you to edit documents and keep track of multiple tasks. A third screen might also help a little, but a fourth or fifth might not make much difference. At some point, more capital doesn’t make you more productive. The additional resources would be better used somewhere else in the economy.

You might think this sort of misallocation would be impossible in an economy growing at full speed, and that every bit of capital would be used efficiently. You’d be wrong. Only during wars has the Federal Reserve Board’s measure of the share of capital being actively used in manufacturing, mining, and utilities topped 90 percent, and not always even then. At the moment, the United States is operating at about 78 percent of capacity in these industries. In the European Union, every country is at 85 percent or below in manufacturing, for an average of less than 80 percent overall.

Certainly, capacity utilization in the service sector might differ. But right now, 20 percent of capital in the world’s two biggest economies may well be sitting idle. If distributed evenly, this would mean one out of every five computers, machines, and vehicles involved in production at every American and European business would be doing nothing. That’s a lot of stuff — with a global capital stock of close to $200 trillion just in regular financial markets, it could be worth $10 trillion or more. By comparison, the economy is much more efficient at using labor; an unemployment rate of 10 percent, which would be high by American standards and fairly normal in Europe, would suggest only 1 in 10 available workers was idle.

So why do companies have so much extra capital sitting around? For one thing, it’s probably not always the same capital. As the economy changes to produce different goods and services with new technologies, the composition of the capital in use changes as well; these days, 3-D printers are replacing many other kinds of machines. Also, some capital might be obsolete, just like workers with skills that are no longer needed. And just like workers and their employers, some capital might be mismatched with its owners.

Yet there are other, more worrying factors that are likely contributing to a true glut of productive stuff. For instance, corporate bosses may buy capital just to use up the cash flow inside their firms. Even if they have no profitable opportunities to increase production, they may prefer speculative purchases of capital to returning the cash to investors via dividends; they keep hold of the money by turning it into physical property. In fact, some executives may be trying to build empires within their companies through the acquisition of capital; a bigger capital stock under their control may make them appear more important.

Another factor in the decision to purchase capital is its price. Most big companies buy new capital by raising money from lenders and investors. When interest rates fall, capital becomes cheaper for reasons completely unrelated to the productive capacity of the capital itself. Managers and executives may buy more capital simply because it’s cheap; they may or may not use it in the future, but the risk attached to the purchase gets smaller when interest rates fall.

As anyone who follows the global economy knows, interest rates have been at or near all-time lows in advanced economies for several years. Central banks have been pouring money into the markets, in the hope that lenders would open their wallets, companies would make new investments, and more workers would get new jobs. Yet even in boom times, the capital stock is apparently overgrown; the utilization rate in the United States hasn’t hit 81 percent in the industries followed by the Federal Reserve since the third quarter of 2000.

Over the entire economic cycle, the capital glut depends on households offering their savings to companies by buying shares or making loans. Investors are always looking for a place to put their money, and companies — for whatever reason — are happy to take it. Even when the companies have no profitable investments, they have ways of paying the investors a return; they can dilute the return to existing investors or cut into workers’ share of revenue. An excess of capital is the result.

Basic economic models don’t account for the possibility that an excess of capital could persist for years at roughly the same level. They assume that diminishing returns would prevent the economy from generating enough income to maintain the bloated capital stock. Unless a 15 to 20 percent cushion really is either indispensable or unavoidable, this seems like a faulty assumption.

But what a powerful assumption it was. Years of economic policy have been devoted to accumulating more capital. Several of George W. Bush’s tax cuts were directed at increasing the return on saving, expanding the capital stock, and spurring a higher level of capital-based innovation. Today, pundits, professors, and politicians continue to argue for lower capital gains and corporate income taxes. What if they’re all wrong, and in fact we’re saving too much?

It’s not always easy to make people save less and spend more. Until recently, Japan was locked in a high-saving, low-spending, deflationary doldrums. Some of the reasons for high saving rates were likely demographic. But with prices dropping almost every year, money gained real value just by sitting under a mattress. Saving was a natural response.

In an economy that’s growing at a healthier pace, raising taxes on wealth might do the trick. As I’ve argued in this column before, such taxes might speed economic growth by helping to allocate opportunities more efficiently. Yet their effect on saving is far from obvious. Someone trying to build a nest egg of a certain size — perhaps for a college fund, retirement, or bequest — will have to save more if taxes rise. Moreover, the improvement in living standards resulting from shifting from saving t
o spending would be strongest among those who saved the most; in terms of consumption, the gap between rich and poor would widen, even if it closed in terms of wealth.

Perhaps I’m getting ahead of myself, though. The first step down this road is to verify whether the capital stock is indeed too large. Why is so much capital sitting unused? How much churn is there in the inventory of unused capital? Are the Fed and its counterparts around the world measuring the right thing? Once we know the answers to these questions, we’ll be able to confront what could be an enormous and yet broadly ignored inefficiency in the global economy.