Negative Re-Investment Rates

When the cost of equity capital is low, then the re-investment rate is high. This is dangerous for firms because the market is fickle, and periods of complacency quickly turn into panics, at which point the capital is re-priced, and now higher returns are demanded. Companies respond to this by trying to defend their dividends and thus end up liquidating a portion of their capital stock in the form of layoffs, shutdowns, and other asset sales.

You can see a historic negative re-investment rate in this graph, corresponding to capital liquidation for the market as a whole.

Note that this is different from lowering the re-investment rate as you would expect in a regular recession. As long as the re-investment rate is positive, then productive capacity is still being increased, but at a lower rate. I.e., the growth of productive capacity is "slowing down" as opposed to shrinking.

Layoffs are always occuring as is hiring, but when the market as a whole has a negative re-investment rate, then productive capacity as a whole is decreasing. You can think of the difference as that between laying off a few workers versus closing a factory. It is harder for employment in the latter case to recover because it requires a greater investment commitment on the part of management as they emerge from the recession. But this is exactly when management is still skittish. This is not to say that employment can't or wont recover -- but the hurdle will be higher.

Moreover, the graph suggests that the current market downturn is fundamentally different from the crashes and recessions in earlier periods. You have to go back to Great Depression, the 1921 recession, or the Long Depression (1893-1898) to find such periods of negative re-investment, and all of those periods were dwarfed by the negative re-investment that we see today. Note that all three of the historical precedents were deflationary recessions.