Corporate Canada’s Recovery: More Cash, Less Investment

There has been a persistent drumbeat in the American business press about corporations accumulating cash. The argument is that, while corporations are making solid profits now, they are not investing in the US for fear of anti-business policies in the future. Obama has allegedly spooked corporate America into hoarding cash rather than investing.

To test that story, I looked at the Canadian data. There is little threat of anti-business policy from our Conservative federal government. Our public deficit and debt are proportionally very low compared to the US. Our federal and provincial corporate tax rates have been slashed since 2000 and are legislated to fall further in the next few years.

But corporations are not investing here. Fixed investment by private non-financial corporations peaked in the third quarter of 2008 and has fallen since then. By the first quarter of this year, investment was one-third below the pre-crisis peak.

Corporate Canada is hoarding cash. The Canadian-dollar deposits of private non-financial corporations shrank during the first two quarters of the financial crisis, but then grew during the next four quarters, reaching an all-time record high in the first quarter of this year.

This trend becomes a little less clear if you include corporate Canada’s deposits of foreign currency. However, the Canadian-dollar value of these deposits reflects exchange-rate fluctuations as much as business decisions.

Private Non-Financial Corporations in Canada ($ billions)

Although we have a Conservative government, low deficits and tax cuts, corporations are hoarding cash rather than investing in Canada. So, maybe the Obama administration is not to blame for corporations behaving the same way in the US.

Four months ago, I suggested that low capacity utilization explains sluggish investment. If corporations already have a lot of idle capacity, why invest in adding more capacity? A week ago, Paul Krugman presented the same interpretation for the US.

Corporate tax cuts will be especially ineffective at promoting investment given the overhang of excess capacity. As I argued, it would be better for the government to retain the money and invest it directly.

Krugman recently made a similar point, although he advocated borrowing the idle cash from corporations rather than taxing it away from them. (Perhaps he is insufficiently radical.)

In economics textbooks, businesses issue stocks and bonds to finance investment in excess of current profits. A dollar of corporate tax cuts could arguably produce more than a dollar of additional investment. But in a world where corporations hoard cash instead of investing it, each dollar of corporate tax cuts likely just means an extra dollar sitting in corporate coffers.

A note on my numbers:

“Fixed I” is the flow of fixed investment whereas “Deposits” are accumulated balances. The investment figures in GDP generally include banks and government enterprises. Banks are expected to hold cash rather than make fixed investments. Government enterprises may invest for different reasons and generally do not pay corporate taxes.

To focus on private non-financial corporations, I used Statistics Canada’s Financial Flow Accounts and National Balance Sheet Accounts. Currently, the first quarter of 2010 is the most recent data in both series.