It's the shortness of his knowledge that matters - Public Domain

We have it on good authority, from an eminence no less grise than Paul Krugman, that Robert Reich doesn’t know his economics. Even with that forewarning it’s possible to luxuriate in the rich ignorance on show in Reich’s current complaint about stock buybacks.

Trump and Republicans branded their huge corporate tax cut as a way to make American corporations more profitable so they’d invest in more and better jobs.

No, that’s not the argument at all. Rather, that if American corporations are more profitable then more people will invest more money in American corporations. More widely, that if investment is more profitable by the returns from investment being taxed less then there will be more investment. It absolutely isn’t true and isn’t part of the argument – whatever politicians on either side might say – that extant corporations must or should become more profitable so that extant corporations invest more.

And forget about investing in more jobs. Jobs are a cost of doing something, not a benefit of having it done. We’re interested in the output from processes, we want to increase that. We also want to decrease the inputs to any process. Starting with using 100 people to build 100 cars, getting to building 100 cars with 50 people, or 200 cars with 100, either is success. More jobs, building 100 cars with 120 people, that is economic failure, something that makes us all poorer.

But they’re buying back their stock instead. Now that the new corporate tax cut is pumping up profits, buybacks are on track to hit a record $800 billion this year.

Well, OK, so they are.

For years, corporations have spent most of their profits on buying back their own shares of stock, instead of increasing the wages of their employees, whose hard work creates these profits.

Drivel, abject nonsense. No corporation ever spends profits on increasing the wages of their workers. Profits are what’s left over after you’ve paid the workers. We simply cannot, given this linguistic fact, pay the profits in wages. They’re mutually exclusive, profits and wages.

Stock buybacks should be illegal, as they were before 1983.

They weren’t. They were more difficult, true, they were very much less common, but they weren’t illegal. And yes, the legal system did change to make them easier and more common. But they still weren’t illegal.

Stock buybacks are artificial efforts to interfere in the so-called “free market” to prop up stock prices. Because they create an artificial demand, they force stock prices above their natural level. With fewer shares in circulation, each remaining share is worth more.

It appears that simple mathematics is beyond our Professor. There’s nothing artificial about a price rising if there’s fewer of something and nothing about stock buybacks which forces prices above their natural level. Imagine a stylised company “worth” $100. There are 100 shares out there. Each one is worth $1 therefore. Now we buy in and cancel 50 of those shares. The company is still worth $100, there are only 50 shares, each share is worth $2.

Now, to do that might be wise, might not be. But there’s nothing at all artificial about that price, nor have we forced anything. Well, as long as you’re not going to get confused about nominal and real prices and of course a Professor is never going to do something that stupid.

Buybacks don’t create more or better jobs. Money spent on buybacks isn’t invested in new equipment, or research and development, or factories, or wages. It doesn’t build a company. Buybacks don’t grow the American economy.

Well, consider what does grow the American economy. More consumer demand grows the economy, we know that. More investment grows the economy, we know that also. So, the money coming out of companies in buybacks goes where? Well, there’re only two things you can do with money, spend it or invest it. Even if you just “save” it then whoever you’re saving it with is investing or spending it. So, whether the money stays inside a corporation or goes outside it, there are still only two things that can be done with it, spend or invest, either of which grows the American economy.

Buybacks were illegal until Ronald Reagan made them legal in 1982, just about the same time wages stopped rising for most Americans. Before then, a bigger percentage corporate profits went into increasing workers’ wages.

Buybacks weren’t illegal and profits never do go into workers’ wages. For by definition if they do they’re not profits.

But OK, let’s imagine that you too have been educated at Berkeley (and have managed to miss Brad Delong’s rather good classes on economic history) and so know nothing of the subject, you believe Reich’s arguments – but then I repeat myself. Why is this all being done then?

Because a bigger and bigger portion of CEO pay has been in stocks and stock options, rather than cash. So when share prices go up, executives reap a bonanza. The value of their pay from previous years also rises – in what amounts to a retroactive (and off the books) pay increase on top of their already outrageous compensation.

Cue Twilight Zone music as we ponder the evil of those capitalistic running dogs. What’s the solution?

But since corporations were already using their profits for stock buybacks, there is no reason to believe they’ll use their tax windfall on anything other than more stock buybacks.

Let’s not compound the error. Make stock buybacks illegal, as they were before 1982.

OK, let’s do it, what happens now? That free cash flow is still returned to investors just as dividends instead of stock buybacks. Prices still go up, the CEOs still get ever more money, the cash doesn’t stay in the companies to raise wages and, well – see what happens? We do exactly what Reich says we should and we manage to change bugger all. The capitalists still get their return to capital, the workers still get the return to labour and we’ve screwed the pooch of the economy a little bit more according to the misunderstandings of Robert Reich. And all of it flowing from the manner in which Reich simply doesn’t grasp the basics of the subject under discussion.

Well done there Robert, well done.

 

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Spike
Member

But corporations are also paying bonuses, increasing contributions to employee retirement accounts, and increasing wages, in some cases across-the-board. Not, as Adam Smith would say, from compassion but from necessity, in the realization that their competitors also compete to have skilled and contented workers, and that they ought to make the first move, which they are suddenly more able to do. On the assertion in question, indeed there is no harm if corporations buy back their own stock. It improves investors’ equity without placing cash in the investors’ pockets, on which investors would have to pay taxes. Granting that corporations… Read more »

Spike
Member

Postscripts on my middle paragraph above: (1) Buybacks tend to make investors liable for more capital gains tax, but the investor can choose when to pay the tax. (2) These investors are mostly not initial investors but buyers of “used shares,” but the corporation knows its ability to attract new capital depends on how it treats existing owners.

Quentin Vole
Member
Quentin Vole

It’s worth noting that if senior management have millions of share options that are currently under water, sufficient amounts of stock buyback can make them quite valuable. But I’m sure that won’t influence anyone’s decision, no sirree Bob …

Spike
Member

Who cares if it does? If management makes a decision that favors managers-as-investors, it also favors all other investors. Most think it is a good thing if members of the Board own shares because it is one more way to focus members on the well-being of investors. Even better if the Board pressures members to buy shares with their own money; granting share options in the first place dilutes investors’ stake while giving the member a free stake. It’s here where the conflict of interest lies.

Spike
Member

PS – I’d be especially delighted if the Board had options that were underwater. They’d know they wouldn’t get a penny unless they cancelled that champagne fountain in the HQ atrium and did stuff that made my shares go up.

Hallowed Be
Member
Hallowed Be

A companywide employee share schemes are likely to have far more effect in terms of shifting demand for the shares. And before I actually believe anything to do about it I hope someone has quantified it.

James in NZ
Guest
James in NZ

Not sure about the incompetence of your HR and Remuneration team but my share options aren’t based on a change in share price but on a change in company value plus dividends paid out. So in the same way that we aren’t penalised for the diminishing in company value through paying a dividend, we don’t benefit from movement in share prices as a result of having fewer shares on issue.

Spike
Member

James, your share options are certainly dependent (if not “based”) on the meaning of a “share”: On what percentage of the corporation it represents. Fewer shares on issue will tend to push share prices upward, though your contract with your employer has not changed. Dividends are rightly paid from new money (earnings) and not taken out of the corporation’s capital.

Felipe Grey
Member
Felipe Grey

An expert is supposed to be ‘experienced’. Most Professors of economics only have theoretical experience, as in ‘those that can, do, and those that can’t, teach’.

Thus we get guff like the Stern report. Good on theory, but practically useless, except as a vehicle for the Morgan Stanleys and Gores of this world to get wealthier and increase their ‘carbon footprints’ at the expense of ‘hard working’ electricity bill-payers, courtesy of the ignoramuses in the HoC.

Southerner
Member

At the end of the month, if I haven’t pissed all my money down the drain, I might consider paying down some of my debt. I’ve got money I can’t use profitably so I find a productive use for it. Why has Reich got a problem with that?

I lean socialist. Reich is a profound embarrassment to the cause. His entire website is full of crap like this, the ten point plan to end inequality being one of the worst. I often wonder if he’s not a false-flag fifth-columnist.

Wack
Member
Wack

The article contains an error.

“Imagine a stylised company “worth” $100. There are 100 shares out there. Each one is worth $1 therefore. Now we buy in and cancel 50 of those shares. The company is still worth $100, there are only 50 shares, each share is worth $2.”

The company is no longer worth $100 as it has spent $50 buying the shares and so is only worth $50 and the remaining shares are still only worth $1.

Spike
Member

No; more typically (to use your numbers even though the result is extreme), the company earns $50 and contemplates how best to return that new money to its owners. It buys half the shares outstanding. The company is now worth $100 again, but its shares have risen to $2. The remaining owners get the new $50 as their investment doubles in value, and they don’t have any “income” on which tax is due until they sell the shares. (In fact, the operation would not come off this neatly, as the shares would start rising before the company had finished its… Read more »

Diogenes
Member
Diogenes

only true, wack, if the company is trading at NAV. One reason for buybacks is to control the level of discount or premium to NAV at which the shares are trading. Most companies other than closed-end funds, trade way above NAV. If they are below NAV then either you are looking at a dog or a real recovery situation.

Spike
Member

And management is extremely likely to view a dog as a recovery situation! They don’t buy back to control the price, but to take advantage of a price they view as too cheap, given their opinion of their own likelihood of success.

Another case where a company trades below Net Asset Value is during an Obama Economic Malaise, or even the original under Jimmy Carter, where the Assets (desks, pencils) are worth more than the future business prospects of the company.

Bloke in North Dorset
Member

Slightly OT but the Spotify listing is quite interesting. They haven’t gone down the usual route of an IPO to raise money they’re just listing on the NYSE so that their current shareholders, investors, owners and staff, will have a marke to sell in to. As there’s no investment bank involved nobody has set an initial price so the market will have to discover the price. As a lot of tech firms aren’t capital intensive if this works it could see a few more tech firms choosing this route, pissinging the IPO industry no end. Perhaps all of a sudden… Read more »

Spike
Member

In avoiding the IPO industry, does the company avoid rigorous analysis by people with reputations to protect, as Theranos did when it avoided the Venture Capital industry?

Bloke in North Dorset
Member

Yes, that was part of the point, it saved all those costs. I can’t remember the details but it was something like IPOs going from 33 pages 25 years ago to 100s now, mostly around risks.

Spike
Member

I am all for saving costs imposed by Sarbanes-Oxley, Dodd-Frank, and the rest. Modern disclosure documents are mind-numbing, as regulations force it to state the same facts many different times in different ways. My question, though, was whether this route to market avoids analysis by experienced investors who might be able to see through a brand-new con job?

Diogenes
Member
Diogenes

Spike, have you ever read a full prospectus and concluded that you were getting a full account of risks etc? Even when BT was floated in 1985?, there was no disclosure that the pension fund was larger than the company

Spike
Member

I have never even gotten more than halfway through a modern Annual Report. I agree that one can satisfy regulations for writing a “disclosure” and omit all the important stuff.