Will corporate paralysis be unlocked?

by Rich Jeanneret, Vice Chair, Northeast Region Managing Partner, EY

A media outlet recently reached out to hear my thoughts on the new US tax policy’s impact on the world’s economy. As I prepared for the interview, I turned to data and recent discussions I’ve had with many Fortune 500 senior executives to validate the thesis that has been formulating in my mind since tax reform became a reality.

Across the globe in the past couple of years, we have been witnessing uneven growth and reduced capital deployment, including lower M&A as a result of inconsistent access to capital markets and hesitation by the C-suite to invest. Although we have seen overall GDP growth, I believe as a result of the certainty of the new tax laws and a better defined landscape, the conservative capital deployment posture of corporate America will be reduced, freeing up massive amounts of capital and fueling further growth in the US. I also believe that increasing consumer and economic confidence, accompanied by lower tax rates, will unleash an unprecedented amount of capital spending.

The World Bank forecasts global economic growth to edge up to 3.1% in 2018 after a much stronger than expected 2017. Considering the new tax laws are just now encouraging capital back into the economy, I believe most official estimates of economic growth are underestimating the lift that could be achieved as corporations come off the sidelines and aggressively reinvest.

The current optimism about the direction and certainty of the policy will begin to show — what I like to call “an unlocking of corporate paralysis— and we will begin to see accelerated growth in the upcoming years as more companies will deploy more-than-expected capital. The deleveraging of corporate America occurring since the 2008 financial crisis has enabled organizations to accumulate massive amounts of cash during a period of access to an abundance of capital. In recent years, a lack of US action on corporate tax reform, DC gridlock and broader geopolitical uncertainty contributed to hesitation to deploy this capital. Although geopolitical issues still exist and potential regulations are still yet to be issued, the increased clarity of tax reform paired with a pro-growth, pro-investment US administration, at a time when the EU has finally recovered from the great recession, makes for a prime environment for investing.

This deployment will impact everyone, and we should start seeing increased growth in the US from capital investments in areas such as:

* R&D, manufacturing and supply chain. Industries such as automotive, oil and gas, consumer products and life sciences will most likely allocate funds to further geographic expansion, invest in improvements in existing facilities and utilize state-of-the-art equipment.

A recent Ernst & Young LLP deployment survey polled over 500 C-suite executives on how they planned to spend the savings they expect to receive. Seventy-five percent of respondents stated they were likely to expand manufacturing efforts in the US specifically as a result of the tax savings from the recent tax reform legislation. 

Expect this investment not only from domestic organizations but with multinationals who still see the US as the most opportune marketplace. The EY Capital Confidence Barometer (CCB) reported that due to the positive outlook and established track record of innovation, the US still remains the most attractive investment destination to overseas buyers. 

* Employment. With the employment rate at its lowest in decades, companies will be encouraged to reinvest in their talent pool by creating jobs, increasing wages and formulating better compensation structures to attract and retain the best and the brightest. The EY deployment survey also reported that approximately 89 percent of respondents plan to enhance compensation due to the anticipated benefit of tax reform. This increased investment will also be applied to labor-saving technology as organizations seek solutions for a tighter labor market.

* Technology. Industry convergence driving massive disruption, combined with digital transformation, will continue to increase activity around M&A and IPOs. The EY CCB indicates that over 65% of senior executives are shifting their investment models to be able to respond quickly and positively as opportunities emerge. The increasing use of alliances and venture capital investments seen across sectors is an indication of this trend.

Organizations of all sizes will look to spend on tech-enabled solutions, such as AI, RPA and cybersecurity, in order to be more productive and effective in today’s complex world.

Some analysts will undoubtedly disagree with the degree of my positive outlook and many cite the Congressional Research Service report that examined the 2004 American Jobs Creation Act several years later, which concluded that the corporate tax cut did not increase domestic investment or employment but rather distributed the additional funds to shareholders. While repeating history is a possibility and a portion of capital can and possibly should be returned to shareholders, I think we are facing an unprecedented time in economic history.

We are living in the midst of the fourth industrial revolution, and never before have traditional business models been so transformed and remain at risk of disruption. With unparalleled availability of capital at competitive and reasonable terms, industries have no choice but to reinvest.

More so than any other time in recent history, global political leaders are predisposed to economic growth, so expect government to be an enabler. Of course, head winds will remain as they always have — and as mentioned, there are plenty of geopolitical risks to point to — but I firmly believe that investing in the economy has never been safer. We have been free of global warfare for almost 75 years, and it’s the optimal time for US industries to stand tall and galvanize around our economy in ways we haven’t witnessed in years.

Truth is, no one is certain how the continued changes coming out of the governments around the world will affect the long-term businesses climate. The activity within the next couple of years will be the true indicator of how the long-awaited tax reform will impact US and global economies. For the good that growth brings, I hope my intuition is right and the paralysis unlocks now and for years to come.

Compliments of EY, an EACCNY member company