Investment and Retained Earnings

A simple empirical fact: in the decades before 2002 about 50% of US investment spending was financed by retained earnings, and about 50% by debt and new equity issues (Moore 2002: 147). Historically, investment from retained earnings was probably more important than in more recent times.

Business retained earnings – when not re-invested in real capital or other real assets – are often held in the form of financial assets, like stocks, shares, bonds, bank accounts (such as corporate demand deposits and savings accounts), or fixed term deposits. In other words, these are monetary savings. Yet these “savings” can be held over long periods of time before being drawn on.

A rise in business spending on these secondary financial assets (from their monetary profits) does not induce employment, and when this happens the corresponding fall in real capital investment is an important factor in recessions and periods of insufficient investment and high involuntary unemployment.

The changing liquidity preferences of businesses thwart Say’s law-like equalisation of investment and monetary saving.

Furthermore, the importance of retained earnings is an even more important blow to the idea that investment is a simple function of interest rates: that is, the idea that a flexible interest rate that allegedly moves towards a Wicksellian natural rate can clear all capital goods markets.

Even though interest rates do have a real and significant effect on investment, the process is variable and depends on the state of business expectations and demand signals, and many businesses do not rely on money loans to fund new investment.

For the business that funds its investment through retained earnings, it is, above all, sales volume, demand, expected demand and expectations that influence capital investment and hiring decisions.

BIBLIOGRAPHY
Moore, B. J. 2002. “Saving and Investment: The Theoretical Case for Lower Interest Rates,” in Paul Davidson (ed.), A Post Keynesian Perspective on 21st Century Economic Problems. Edward Elgar, Cheltenham. 137–157.