If a stock market investor wishes to instruct a CEO to invest more aggressively, there is a very simple way to do it: buy shares.
When investors buy shares, the share price goes up. When the share price goes up, the company gets more money from investors for issuing a given amount of new shares. In MBA terms, the company’s cost of capital goes down.
Every company has a list of projects it’s considering. It ranks the projects and does the most promising ones first. The most promising ones have the highest expected return on capital.
The cost of capital is a hurdle all projects have to overcome. The company will keep doing projects until their forecasted return on capital is lower than the cost of capital.
That’s how stock prices feed through to concrete in the ground. Higher stock prices lower the cost of capital, which lowers the hurdle rate, and results in more projects going ahead.
The share price communicates how stock market investors think the CEO should be investing. And the CEO who ignores the stock market for long enough will eventually find themselves out of a job.
There are two ways to go wrong: over-investment and under-investment.
Over-investment is easy to get your head around because it’s concrete. When WeWork builds more offices than there are people to go in them, that’s over-investment. You can see it and point at it.
Under-investment is harder to spot. It’s a factory that wasn’t built. It doesn’t result in a WeWork-style implosion. What happens instead is that the company fades away. The company loses market share. Five years later, the company is smaller than it otherwise would have been.
When I moved to London in 2010, the traditional taxi market was being disrupted by a company called Addison Lee. Addison Lee is a hackney cab company. In 2012, 4,500 of their sleek black vans prowled all over the city. They were more modern than taxis, and were easy to book over the phone. In 2012, the company made more than £90 million in revenue.
By 2015, Addison Lee had been completely usurped in London by Uber. Uber took the same idea as Addison Lee — a big fleet of modern hackney cabs — and added a mobile app. Though Addison Lee had a huge head start, it lost to Uber because it failed to make one big, important investment.
Uber’s first London employee, Richard Howard, said in The Guardian: “We were worried that Addison Lee would get smart, spend £1m – which isn’t a lot of money for them – and make a really nice, seamless app that copied Uber’s. But they never did.”
Addison Lee had been bought by Carlyle, a big private equity firm, in 2013. Private equity is sometimes accused of short-termism. It’s said that PE firms under-invest in projects that would bring long-term growth, since they aim to sell their target companies within five years. That seems to have happened in this instance.
The stock price provides public companies with a flashing red signal. It gives them a steer on how aggressively they should be growing. Privately-owned companies, like Addison Lee, don’t have that. And neither do governments.
What happens when a nation under-invests? Look to the UK to find out. The UK is a giant experiment in what happens when the government, and the private sector, slam the brakes on capital investment for 12 years.
The following chart from John Burn-Murdoch in the Financial Times shows public sector investment as a share of GDP. The red line represents Labour government, and the blue line represents Conservative government. The grey lines represent Austria, Germany, France, the US, Canada, Denmark, Germany, Finland, the Netherlands, Norway, Sweden and Switzerland.
It’s not just happening in the public sector. Gross fixed capital formation, both public and private has declined. Between 1970 and 1989 it averaged 23 per cent of GDP per year. Since 2009 it has averaged 17 per cent.
What happens when a country stops pouring concrete? Predictably enough, things start falling apart. In a June report, the UK's National Audit Office said: "Following years of under-investment, the estate's overall condition is declining and around 700,000 pupils are learning in a school that the responsible body or DfE believes needs major rebuilding or refurbishment."
On healthcare, UK capital spending has gone from being typical of rich countries to being the smallest by a distance. In that time the proportion of unoccupied hospital beds has gone down by half, and the number of beds per 1,000 people has gone down by almost half.
What happened in the UK is that, during the austerity years, the government prioritised current spending over capital spending. You can get away with that for a few years, but in time it catches up to you.
At the same time, the uncertainty over Brexit caused businesses to pause their investment plans. The business investment index is now 30 per cent off its pre-Brexit trend line.
Poor healthcare and crumbling schools are bad in their own right. Underinvestment is also bad because, gradually, it inhibits the economy. Congestion doesn't just stress people out, it makes the nation poorer.
Ireland is a small bit like the UK in that the government slammed the brakes on capital expenditure after the Global Financial Crisis. But it's not like the UK in that the government has been trying to catch up since then.
The UK is on a path towards decline that's hard to get off. Its failure to invest in the past means a) it needs even more investment now and b) it's even harder to finance said investment.
That's not where Ireland is. We have the economy to fund it, and our government hasn't been as stingy as the UK, and our private sector has invested like mad.
With Ireland, it's less about decline and more about fulfilling our potential. A lot of people want to live here, and a lot of companies want to operate here. Our investment needs to match our growth. If we stick to the middle of the pack — among a bunch of much older, slower-growing countries — we'll be perennially congested and our housing crisis won't go away.
In London, it’s still possible to book an Addison Lee cab. But it's a tenth as popular and important as Uber.