World Economy

OECD Warns of Global Investment Puzzle

OECD Warns of Global  Investment PuzzleOECD Warns of Global  Investment Puzzle

The dangers posed to the global economy and the entire financial system by the growth of financial parasitism, in which investment in productive capacity is increasingly replaced by various forms of speculation, have been highlighted in a report issued by the Organization for Economic Cooperation and Development.

The inaugural Business and Finance Outlook published on Wednesday involved a detailed study of some 10,000 companies whose output amounts to around 30% of global gross domestic product, World Socialist Web Site reported Friday.

The report probed what has been called a “global investment puzzle,” that is, why at a time of the lowest interest rates in history, there is so little investment by firms in productive capacity. Corporations are sitting on large amounts of cash, which are being employed in financial operations such as share buybacks.

The study also pointed to the dangers building up in the financial system because of the low-interest-rate regime created by the world’s major central banks, leading investors to undertake ever riskier investments in order to obtain a sufficient return. The low return on assets such as government bonds meant that life insurance companies and pension funds are facing a funding gap or potential insolvency.

Relative Punishment

Launching the report, OECD secretary-general, Angel Gurria, pointed to the perverse situation in advanced economies where companies which carry out high capital expenditure (capex) are punished by stock markets while those that organize share buybacks and other such operations do much better.

“Over the 2009–2014 period buying shares in companies with low capex, while selling those with high capex, would have added 12% to the value of your portfolio in Japan, 21% in emerging countries, 47% in Europe and a whopping 50% in the United States,” he said. “Clearly the incentives are badly skewed.”

In an interview with the Australian Financial Review the principal author of the report Adrian Blundell-Wignall, the special financial adviser on financial markets to the OECD secretary-general, said that in the current environment any company wanting to invest over the next 15 years gets “relatively punished.”

One of the key reasons, he said, was the development of global value chains which meant that investment was less likely to be carried out in the home country of many corporations but in emerging markets. However there was not enough demand being generated in these countries because governments were engaged in “financial repression” aimed at keeping their currencies at a low value in order to maintain export competitiveness.

Mounting Dangers

Another key finding of the report was that there are mounting dangers to the global financial system because traditional safe investments, including government bonds targeted by insurance companies and pension funds, are bringing such a low rate of return that they have to pursue riskier ventures.

“Increasingly pension funds and life insurers are feeling the pressure to chase yield themselves, and to pursue higher-risk investment strategies that could ultimately undermine their solvency. This not only poses financial sector risks, but potentially jeopardizes the secure retirement of our citizens,” Gurria said.

Over the next five years pension funds are expected to grow by 26% from an estimated $28.4 trillion in 2014 to $35.8 trillion in 2019, while insurance companies’ assets will expand by 33% over the same period from $28.2 trillion to $37.7 trillion.

Insolvency Crisis

Blundell-Wignall warned that many long-term pension funds with defined benefit schemes, especially in Europe, were “coming up to an insolvency crisis of some form.” This warning follows a similar assessment by the International Monetary Fund three months ago in which it said that European life insurance companies were facing “severe challenges.”

He also noted that the expanding global market for high yield bonds had produced a dangerous surge of money flowing into risky alternative investments. “There’s a big bubble in private equity, absolute return fund, synthetic exchange traded funds and hedge funds,” he said.

The OECD report listed a potential series of triggers for another financial crisis, including a return of interest rates to more normal levels, a more than expected escalation in the value of the US dollar, a crisis in emerging markets, the failure of the quantitative easing program of the European Central Bank, a crisis sparked by a Greek exit from the eurozone and a further sudden plunge in oil prices.