Mohamed El-Erian Has A Fascinating Theory For Why Companies Aren't Spending More Money

Why aren't businesses investing more?

It's a question people have been asking for years, as profits keep pushing towards record levels, and corporate cash keeps piling up, while yielding very little.

In a piece at Project Syndicate, Mohamed El-Erian offers 5 possible reasons why this is the case. Most of them are fairly standard. The economic outlook remains uncertain. The Chinese financial system casts a dark cloud over the entire global economy. There's uncertainty about budgets and monetary policy. But one answer is particularly intriguing:

Third, while companies recognize that innovation is a key comparative advantage in today's global economy, they are also humbled by its increasingly winner-take-all nature. Successful innovation today is a lot less about financing and much more about finding the "killer app." As a result, many companies, less convinced that "normal" innovation yields big payoffs, end up investing less overall than they did before.

The most obvious example to point to here is Microsoft vs. Apple.

This chart is a couple years old, but the point is still totally valid; Microsoft has long obliterated Apple in terms of the amount it spends on R&D.

But everyone knows that for basically the last decade, Apple has been unmatched in terms of innovations that lead to commercial successes. And in part it's the winner-take-all nature of the economy. Regardless of how strong Microsoft's mobile products have been technically, they just haven't been able to gain traction

El-Erian's statement echoes something similar that Larry Summers said just this week when talking about the Facebook acquisition of WhatsApp, the 4-year old messaging company that was worth shelling out $19 billion for.

Ponder for example that the leading technological companies of this age, I think for example of Apple and Google, find themselves swimming in cash and facing the challenge of what to do with a very large cash hoard. Ponder the fact that WhatsApp has a greater market value than Sony with next to no capital investment required to achieve it. Ponder the fact that it used to require tens of millions of dollars to start a significant new venture. Significance new ventures today are seeded with hundreds of thousands of dollars in the information technology era. All of this means reduced demand for investment with consequences for the flow of - with consequences for equilibrium levels of interest rates.

In a winner-take-all economy, the relationship between investment spending and outcomes becomes less direct. When a company that's taken in almost no cash becomes a $19 billion behemoth, it's hard to draw any line between how much you spend on investment and innovation and payoff. So much of it is luck and network effects, and having, as El-Erian puts it, that "killer app" that takes over the world. Obviously this analysis doesn't apply to all firms, but this is a powerful trend that may explain a lot.