May 7, 2018

Stock Buybacks Grease the Wheels of Future Economic Growth

Michael Farren Research Fellow, Study of American Capitalism

Apple announced last week that it would repurchase an additional $100 billion in stock, on top of the $23.5 billion stock buyback from the first quarter of 2018. Predictably, this has led politicians and pundits to argue that companies are doing the “wrong” thing with the savings gained from tax reform, rather than reinvest in their own business or raise worker wages. My colleagues Veronique de Rugy, Jason Fichtner, and I have addressed these complaints—which generally reflect a misunderstanding of the market process—in recent articles. Here’s what a lot of pundits miss when they discuss these stock buybacks:

  • The funds used for stock buybacks don’t simply vanish—they instead flow to the investors who owned the stock and sold it back because they’ve observed a better investment opportunity elsewhere.
  • This increased availability of investment capital assists other companies who are looking to expand, but didn’t have the resources to do so. This means that we should be looking for economic growth in different companies than the ones doing the stock buybacks.
  • In doing this investors are serving as entrepreneurs who, alert to new opportunities, facilitate the flow of resources through an economy. This is the lifeblood of economic growth. Without the assistance that entrepreneurs provide, producers of goods and services would face greater constraints in trying to serve customers, leading to decreased production and a lower quality of life.
  • Without stock repurchases, Apple (and the many other companies buying back their stock) would have to find a way to invest their profits in their own operations—which apparently is what many pundits think they should do. But this limitation on investment possibilities would lead to lower economic growth over time by preventing the funds from being re-invested in the best opportunity. In economists’ terms, forcing companies to reinvest in themselves would lead to economic inefficiency.
  • Similarly, those who argue that companies should increase wages instead of repurchasing stock fail to understand that wages are determined in a market setting—through the interplay of supply and demand—and that an influx of new funding doesn’t necessarily change the current market mathematics which determine how much employers are willing and able to pay workers (because it doesn’t directly affect the competition between workers for jobs). However, the increased future revenue available to companies because of tax reform will relax their cash constraint, which could allow them to compete more aggressively to hire the best workers or to hire more workers for business expansion. This increased demand for workers might then lead to rising wages over time.

Although the size of Apple’s stock buyback is astonishing, the deeper economic understanding of these repurchases is that Apple is returning around $125 billion for investment in other companies. The increased availability of investment capital will then assist growth in general throughout the economy.

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