Marco Rubio: Welcome to the resistance.

It’s encouraging to see the conservative senator from Florida break with Republican economic orthodoxy to examine what’s really wrong with the American economy. (Spoiler: tax cuts alone won’t fix it.)

In a new report released last week, Rubio almost sounds like Democrat, but that’s only because it’s so rare to see an elected Republican politician think so clearly and critically about how blind faith in the workings of markets has led us into a stagnant economy that is no longer building an prosperous society like it once did.

“ Rubio argues that the prevailing business model of shareholder value — the idea that the only goal of a corporation is to return the maximum value to its owners — is ruining us. ”

Rubio’s critique of the economy can’t be dismissed as “socialism.” He’s more concerned about how value is created than with who gets the rewards. Rubio is a flag-waving capitalist who worries that the American economy is no longer living up to its potential because American businesses are no longer investing in the future. The economic anxiety felt by most Americans today is the direct result of this failure.

His exhaustively researched report released last week, “American Investment in the 21st Century,” puts the blame squarely on institutional changes in corporate management and capital markets that demand a single-minded emphasis on short-term financial results over sustainable growth.

“Short-term economic growth does not guarantee a strong and prosperous nation, “ he says in an op-ed in the Washington Examiner.

Rubio argues that the prevailing business model of shareholder value — the idea that the only goal of a corporation is to return the maximum value to its owners — is ruining us.

The main task required of a successful economy, Rubio argues, is “developing productive, long-life capital assets.” In America, that task has always fallen upon the business sector, but American businesses aren’t even trying anymore.

And if the business sector can’t do it, Rubio warns, then it will fall upon the only other sector with the ability to do it — the federal government.

He contrasts the not-too-distant past with our current failures. “The American tradition is a story of the prosperity that can be created when the private business sector is the allocator of capital investment, training society’s wealth and resources into the growth of new products and technologies.”

He looks back at the American giants, such as Ford F, +0.30% , General Motors GM, -0.78% , General Electric GE, -0.81% , Exxon XOM, -0.20% and DuPont US:DWDP , who created American industrial capacity not only by building factories but by building an adaptable and skilled organization.

Profits soaring, investment collapsing

How can it be, Rubio wonders along with everyone else, that profits can be so high and yet investment can be so low?

Since 2000, net investment by American businesses has been only twice as weak as it was in the 1960s and 1970s.

Net investment by the nonfinancial business sector has collapsed since 2000. The companies that use to make the products and provide the services now look more like banks, with an increasing share of profits coming from financial assets. Ford went from a company that earned its money making cars to a company that earns its money making car loans.

Instead of taking savings from households and investing them in innovative or productive assets, the nonfinancial sector has become a net lender, turning the usual story about how our capital markets work on its head.

“ Shareholders are siphoning capital out of corporations at a breathtaking pace. ”

The nonfinancial business sector invests more in financial assets than in physical ones, and it returns almost all of its profits to shareholders instead of ploughing them back into the business. It’s no wonder productivity growth is so slow — innovation is being starved.

It’s not primarily a problem of too much government, Rubio concludes. Rather, it’s an institutional shift within the free enterprise system that’s pushing corporations to think more about what the stock market wants today than it does about building a sustainable, innovative corporation.

We’ve gone from a free enterprise system to one that’s “enterprise-free,” he says.

He puts a lot of blame for our anemia on the ascendancy of the shareholder primacy paradigm of corporate governance since the mid-1970s.

Three big takeaways

There are three main implications of giving shareholders’ interests primacy, Rubio says.

First, “shareholder primacy theory has tilted business decision-making toward delivering returns quickly and predictably to investors, rather than building long-term capabilities through investment and production.”

One upshot of this shift in focus has been the financialization of the economy and an intense desire at the management level to deliver short-term results, even at the cost of hollowing out the corporation over the longer term.

The emphasis on short-term payouts to shareholders “diverts resources away from investments whose payoff lies beyond the immediate horizon,” and “creates a systematic bias against innovation,” in the words of Clayton M. Christensen, Stephen P. Kaufman, and Willy C. Shih in their Harvard Business Review article, “Innovation Killers: How Financial Tools Destroy Your Capacity to Do New Things.”

Second, “shareholder primacy theory does not properly understand how businesses invest in innovation,” Rubio writes.

According to theory, these companies ought to invest whenever the expected return is greater than their cost of capital. But managers who are tied to short-term results are risk-averse, and require much higher expected returns — a hurdle rate — before pulling the trigger on investments. These managers would rather return profits to shareholders than invest, even in projects with expected positive returns to the corporation.

Contrary to myth, corporations don’t channel savings from households into productive investments; they mostly serve to channel profits to shareholders.

But what do shareholders do with the proceeds of the buyback or dividend? They buy shares in another company, whose managers are also risk-averse. The cash returned to shareholders never goes into a productive investment; it just goes into pushing stock prices higher, even for firms that don’t have high profits.

Since 1996, there hasn’t been one year in which nonfinancial corporations raised any net capital in the stock market. Over that period, these corporations funneled $1.8 trillion via the stock market to the household sector. Shareholders are siphoning capital out of corporations at a breathtaking pace.

Retreat from research

“It should not be surprising then, that the U.S. private sector is in retreat from investment in basic science,” Rubio writes. “While large corporations historically invested in basic research as the precondition of value-creating innovation, this is decreasingly the case.” Nobody is doing today what Bell Labs did decades ago when it invented the science underpinning our modern electronics and communications systems.

R&D spending by companies is growing rapidly, but it is “increasingly weighted towards development rather than research, toward the marginal innovations related to the commercialization of old research than the longer-term pursuit of new discoveries,” Rubio says. Unfortunately, federal spending on basic research has also plunged.

Third, “shareholder primacy theory has resulted in a diminished understanding of the role workers play and the risk they undertake in the value creation process,” Rubio says.

It’s assumed by the theory that “shareholders bear the risk, and therefore appropriately reap the reward of any profits,” Rubio says. “This obscures the reality that shareholders are not the only stakeholders in the value-creation process who take on risk.”

Rubio’s report is short on solutions, it is true. But he pushes back against the easy solutions offered by the orthodox Republican business and political leadership.

“There is no utopia waiting in the real world in which the right combination of policies, or the right deregulation of markets, by some internally consistent law of ideology inevitably unleashes new technologies and enhances the standing of American companies and workers,” Rubio says.

“The decline of business investment in the U.S. is not due to inexplicable secular shifts in the economy, nor a lack of capital available for investment, but a misallocation of productive resources,” he concludes. “This misallocation is driven by the choices of political and social institutions that do not properly prioritize the obligation of the American economy to reproduce itself.”