A chronic corporate sector surplus
The corporate sector surplus did not just emerge on the back of the recession but has instead been ever present since 2002. While a temporary surplus is quite normal, a persistent one is sign of something seriously amiss.
The starting point in more than the deficit was that economic policy needs to pay attention to a wider set of imbalances than just that of the public sector. Taken together with the household sector and the rest of the world (in its dealings with the UK), the four surpluses/deficits by definition cancel one-another out. Although the economic links between them are many and complex, accounting dictates that change in one will always be accommodated by changes in the other three.
At nearly 8 per cent of GDP in 2009, the corporate sector surplus is the public sector deficit’s alter ego. If one is to come down, then almost certainly so must the other. But while the former is subject to forensic scrutiny, the latter basks in obscurity. This third article is the series is a small correction to this usual bias.
Roughly speaking, the corporate sector balance can be thought as the difference between post-tax profits on the one hand, and the sum of dividends and interest paid plus investment expenditure in the UK on the other. If the difference is positive the corporate sector is a net saver. If it is negative it is a net borrower.
The graph depicts the annual values of three balances, expressed as a percentage of GDP, for each year from 1987 to 2009. The first is the private corporate sector balance in total. Excluding as it does public corporations, this is the proper counterpart to the public sector.
Annual UK corporate sub-sector balances (+net lending/-net borrowing) 1987 to 2009
Source data. Non-financial corporations net lending/borrowing (Blue Book table 3.1.7, updated 30/07/2010): EABO. Financial corporations net lending/borrowing (Blue Book table 4.1.7, updated 30/07/2010): NHCQ. Public non-financial and financial corporations net lending/borrowing (Blue Book table 3.2.7, updated 30/07/2010): CPCM. GDP (ONS Economic Accounts table A1, updated 22/12/2010t YBHA.
The other two are the balances for the non-financial and financial parts of the corporate sector. While it is immediately obvious from the graph that the two have moved in step with one-another over the period, they are in principle subject to different considerations. When we come to probe them further, we will probe each part separately. While these two do include public corporations, it is also clear from the graph that whether public corporations are included or not makes little difference to the overall picture.
By far the most striking feature of the graph is the contrast between the most recent years on the right-hand side and the earlier years on the left. In the earlier period, between 1987 and 2003, the overall balance varies between a deficit of 4 per cent and a surplus of 3 per cent. That 17 year period spans two cycles. In ten of those years, the sector as a whole was a net borrower. By contrast, although the surplus did decline a little after 2004, it was strongly positive, even before the recession struck.
Annual average UK corporate sub-sector balances (+net lending/-net borrowing)
Source data: as for graph.
The table showing annual averages over four groups of years sums this up. While the surpluses balloon in 2008 and 2009, the really significant point is that both sub-sectors ran surpluses in the five years from 2003 that were way in excess of anything seen in the earlier period. Since the sector went into surplus in 2002 and remained strongly in surplus in 2010, the surplus is now entering its tenth year.
There are three reasons why this matters.
First, it is a corrective to those economists and commentators who see in the fact of a surplus a sign that the corporate sector is in a strong position to invest. In The path to strong, sustainable and balanced growth, (HM Treasury and the Department for Business, Innovation and Skills, 2010), the government itself takes comfort in this. Yet while a surplus may be a necessary condition for an investment upturn, the fact that there has been one since 2002 proves it is not sufficient. The record on investment will be looked at more closely in the next article.
Second, the surplus – and especially the swing into surplus after 2001 – has to be taken into account in assessing what happened to the public sector deficit in the years prior to the 2008 recession. As the table shows, the average balance during 2003 and 2007 was four percentage points higher than between 1994 and 2002. By definition, the other three sector balances had to deteriorate by four percentage points. The graph in more than the deficit shows that the sectors that did so were the public and household sectors. Although the economic effects here are complex, it is implausible that an increase in spending relative to income by these two sectors should be the cause of the corporate sector’s increased saving. This implies that the public sector deficits of that period must be seen, at least in part, as consequences of problems elsewhere in the economy, rather than just as mistakes that that were freely made by the government of the day. This is another subject to be looked at more closely in due course.
Third, while the corporate sector can and does run surpluses from time to time, the whole point of companies is their capacity to identify and realise profitable opportunities. Limitations on finance would be expected to be one of the constraints on the rate at which companies could do that. Borrowing, particularly from the household sector, would be a way to ease that constraint. Yet for the best part of a decade now, the corporate sector as a whole has not been a borrower. Until this situation changes – that is, until the corporate sector balance reverts to a cyclical pattern in which period of surplus alternate with periods of deficit – economic normality will not have been restored.