Some possible explanations for the corporate sector surplus
What explanations have been offered for the UK’s large and long-standing corporate sector surplus, which seems at odds with the conventional economic view of corporations as borrowers not lenders/savers?
The higher surplus can be accounted for in terms of lower dividends and investment among non-financial companies and higher profits among financial ones . But the question of why this has happened remains. The few answers that have been put forward can be grouped under three headings, namely: the need to address the shortfall in company pension schemes; increased business instability including due to higher levels of debt; and the inability of the national accounts statistics to capture all the investment that is taking place. None can provide a complete answer but they do highlight some key issues.
The corporate surplus in international context
Before turning to these explanations, two statistical points from this literature are worth noting.
First, many countries in the OECD have developed large corporate sector surpluses. While the UK now looks like an extreme case, it is not unique. As the graph below shows, the UK corporate sector began to develop a surplus after 2001, following a period of deficits in the late 1990’s. Germany followed a similar pattern; however its surplus began to tail off in 2006, whereas the UK’s continued to grow. Japan’s corporate sector surplus is well known, although it had begun to shrink as the UK’s grew. Canada also has a large corporate sector surplus that emerged in the late 1990’s and persists today. The US dipped briefly into deficit in 2006 and 2007. Of the countries shown, the balances of France and the US have varied the least over the period while those of the UK and Japan have varied the most.
Chart 1: Corporate sector balance in six OECD Countries
Second, in identifying rising profits as the main driver of the surplus among financial corporations, the UK is not alone. The IMF confirmed this tendency across the developed world (with the exception of France, where a surplus didn’t emerge for financial corporations due to increased dividends) .
Pension scheme deficits?
The first explanation is that companies are building up a surplus in order to deal with deficits in defined benefit pension schemes ,  and . Many of these schemes were in deficit following the 2000 financial crash and companies are required by law to make up the difference or demonstrate how they are going to replenish the scheme fund over the next 10 years.
Estimates of pension fund deficits are erratic due to their dependence on current stock values, however the estimate of £160 billion made by the CBI in 2003 gives us a ballpark figure . Efforts to close a deficit of this size (some 14% of GDP) could certainly give rise to surpluses of the size seen in the UK in the early 2000s. Whether this is – or was- what the surplus was being used for would require evidence from corporate accounts.
The explanation has been challenged on the grounds that the logical response should be a reduction in dividends rather than investment which erode one’s capacity for future growth and future pension fund contribution. But investment has been cutback more than dividends, which only underwent a short fall early in the decade .
The pension deficit might therefore be responsible for the surplus, however further research is needed to provide clear evidence as to how it is having an effect. Particularly, if and how corporations are making additional contributions (or how they plan to do so) and where this lies in corporate accounts.
Greater instability arising in part from higher debt
A second group of explanations focuses on concerns over corporate debt levels which can also be seen as an aspect of a more general concern about instability, with being firms unsure of their future. Against this instability, cash holdings provide a buffer that can be used to fund investment or dividends in the event of low profits/high costs (1). There is some evidence that those companies with the greatest cash reserves have the most unstable income flows (1). But this does not explain why corporate savings should be high, for which these researchers sought country-specific explanations.
Non-financial companies did take on a large amount of debt in the years leading up to the IT bubble crash in 2000, financial liabilities growing from 197% of GDP in 1994 to a peak of 287% of GDP in 1999. It may be that this left a legacy of ‘debt phobia’ which made companies conservative about taking on debt. However, after dropping back sharply, both financial assets and financial liabilities increased fairly steadily after 2002, suggesting no lasting alarm about debt levels (see chart 2). One possibility is that companies are having to build up large surpluses in order to provide the cash needed to roll over the large debts they possess . An increasing share of companies’ assets are thus being held financially due to the surplus, which is in turn motivated by uncertainty about income stability.
Chart 2: Financial Liabilities and Assets of UK Private Non-Financial Corporations
Lower investment is the most interesting issue surrounding the surplus; it is the factor driving the high corporate savings in non-financial corporations. There are two possibilities, that companies are simply investing less or that the statistics are failing to capture the investment. In the case of the latter, it may be that investment is going towards capital not captured by the official statistics or that it is going overseas.
The shift in UK business towards services means, it is suggested, that an increasing amount of investment is in intangible assets that avoid detection by official statistics. For example a company training course is an investment, in that it provides a return in productivity but it is not counted as such on national accounts. Including such intangible investments in national accounts greatly increases the level of investment, although doesn’t reverse its recent decline .
Investment may also seem lower due to capital becoming relatively cheaper. But although evidence in support of the latter has been presented, , this would not necessarily lead to lower investment since firms could use this as an opportunity to undertake capital deepening .
It is also possible that British firms are investing overseas instead of at home. British companies are particularly outward-looking and the economic rise of Asia has triggered a re-balancing in investment towards these markets. It is difficult to determine without examining company accounts whether or not this is happening, again due to the paucity of statistics. However, since Britain (it is argued) had very attractive conditions for investment, the dearth in UK investment is still not explained .
The picture of corporate savings raises as many questions as it answers, each of the different explanations offered presents a partial explanation to the high corporate savings rate. Both the pension deficit and concerns about debt suggest that the surplus is a result of companies worrying about their financial position. Instability in income feeds into this and may suggest that corporations profits have become more unstable as of late, although this requires further investigation.
The second major issue is uncertainty about whether the statistics are capturing what’s going on. If and how additional transfers to pension funds are being made and if and how companies are investing in intangibles or overseas requires examination of the company accounts. Irrespective of this, under-investment in the UK persists – and remains a major issue for any government’s recovery plans.
1. IMF World Economic Outlook, April 2006 – Chapter IV. Awash With Cash: Why are Corporate Savings So High. http://www.imf.org/external/pubs/ft/weo/2006/01/pdf/c4.pdf
2. Economic and Labour Market Review, July 2008. Recent trends in corporate net lending – Graeme Chamberlin. http://www.statistics.gov.uk/elmr/07_08/downloads/elmr_jul08_chamberlin.pdf
3. OECD Economic Outlook 82, December 2007 – Chapter 3. Corporate saving and investment: recent trends and prospects. http://www.oecd.org/dataoecd/60/0/39727868.pdf
4. Bank of England Working Paper, Series No.276, October 2005, Corporate Expenditures and Pension Contributions: Evidence from UK Company Accounts. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=872687
5. The Economist, July 1st 2010. Companies cash piles. http://www.economist.com/node/16485673
6. Speech by Dr John Grieve, Deputy Governor, Bank of England at the University of West England, 26th September 2006. The Puzzle of UK Business Investment.