Investment Heroes: Top Companies for Domestic Capital Spending.

As we know, the U.S. is still stuck in a capital spending drought. According to my calculations, nonresidential business investment in the first quarter of 2011 was still 23% below its long-term trend.   By contrast, nonfarm employment is about 8% below its long-term trend.

But there are some companies that are still investing in the U.S.  As part of a new paper for the Progressive Policy Institute,  I identified America’s “investment heroes”: The companies which are the leaders in domestic capital spending. Here’s the table from the paper:

In 2010 AT&T was the domestic capital spending leader, by a wide margin.  Verizon was next, followed by Wal-Mart. These are companies that invested  huge sums into the domestic economy, at a time when many other companies were still holding back.  Out of the top seven “investment heroes,” 3 were telecom companies, 3 were energy companies, and 1 was a retailer.  [Before you ask, I'm not ready to release the rest of the list yet. Some companies break out their U.S. vs non U.S. capital spending, but many don't,  so it takes time to estimate and verify the breakdown based on other financial data  ].

Why is this important? We at PPI see long-term economic prosperity as resting on a three-legged stool: Investment in physical capital, human capital, and knowledge capital.  Higher levels of  investment improve the productivity of U.S. workers, which in turn should show up as higher real wages and greater international competitiveness.  Or to put it another way: Without strong  capital spending at home, the U.S. economy will sink into irrelevance. * 

 The overarching aim of economic policy should be to encourage all three types of investment, since all are essential for long-term prosperity.  In particular, those companies which continue to invest in the U.S. need to be acknowledged for their contributions to the domestic economy, especially when other companies of equal size  are investing much less at home.  I wouldn’t go as far as to give them a medal, but let’s give them their due.  Rather than resorting to financial trickery, these investment heroes are making money the old-fashioned way–by spending on productive long-lived assets which will generate economic benefits for years to come.

*Some might argue that the U.S. has been able to generate good productivity gains since 2007 without capital spending.  But as regular readers of this blog know,  I am skeptical of the stunning productivity gains that the official statistics seem to report for many industries in 2007-09, the middle of the financial crisis (see this post here, for example).

How much of the productivity surge of 2007-2009 was real?

[This post just grew and grew and grew, until it turned into something  ridiculously long. Sorry about that--I'm probably guilty of blog abuse.   If you want, here's a PDF version. I look forward to comments ]


In the 2007-2009 period, the U.S. economy experienced its worst recession since the Great Depression. Nevertheless, despite this deep downturn,  the near-collapse of the financial system and unprecedented global economic turmoil,  U.S. productivity growth actually seemed to accelerate in the 2007-2009 period, or at least maintain its previous pace.

The 2007-2009 productivity gain had a major impact on both economic policy and political discourse. First,  it gave the Fed a free hand to feed mammoth amounts of liquidity into the system without worrying about inflation.  Second, it convinced the economists of the Obama Administration that the economy was basically sound, and that the big problem was a demand shortfall. That’s why they expected things to get back to normal after the fiscal stimulus.

However, I’m going to show in this post that the  productivity gain of 2007-2009 is highly suspect.  Using BEA statistics,  I identify the industries that contributed the most to the apparent productivity gain, including primary metals, mining, agriculture, and computers and electronic products. Then I analyze  these high-productivity growth industries in detail using physical measures such as barrels of oil and tons of steel. I conclude  these ‘high-productivity’ industries did not deliver the gains that the official numbers show.

Based on my analysis, I estimate that the actual productivity gains in 2007-2009 may have been very close to zero.  In addition, the drop in real GDP in this period was probably significantly larger than the numbers showed.  I then explore some implications for economic policy.


I start by giving several  data points.

*From 2007 to 2009,  business productivity rose at a 2.4% rate, according to the official data. By comparison, the productivity growth rate was only 1.2% over the previous two years (2005-2007).

*If you like your numbers quarterly, business productivity grew at a 1.8% annual rate from the peak in 07IV to the trough in 09II.  That’s somewhat faster than the  1.6% growth rate of the previous 3 years.

*Looking at  total economy productivity–real GDP divided by full-time equivalents (FTE)–we see that productivity growth in 2007-2009, at 1.6% per year,  was double that of the previous two years (0.8% per year).

This chart breaks down productivity growth by business cycle, using the official statistics. You can see that the productivity growth of the 2007-2009 period–the worst recession in 70 years–appeared to be basically a continuation of the productivity gains during the boom. You can’t tell from this chart that anything bad happened to the economy.

The strong measured productivity growth during the crisis years reflects a steep drop in employment (-5.7%) combined with an apparently mild two-year decline in real GDP (-2.6%).  Of course, ‘apparently mild’ is still nastier than any post-war U.S. recession, but a 2.6% decline in real GDP translates into a 4.4% decline in per capita GDP, which puts the U.S. at the low end of  financial crises described by Reinhart and Rogoff.

What’s more, the 2007-2009 productivity gain had a major impact on both economic policy and political discourse. First,  it gave the Fed a free hand to feed mammoth amounts of liquidity into the system without worrying about inflation. 

Second, the productivity gains convinced the economists of the Obama Administration that the economy was basically sound and there was nothing wrong with  the ‘supply-side of the economy.  Instead, the Obama Administration concluded that the big problem was a demand shortfall, which is why they expected things to get back to normal after the fiscal stimulus.

Consider this April 2010 speech from Christina Romer, then head of the CEA. She said:

The high unemployment that the United States is experiencing reflects a severe shortfall of aggregate demand. Despite three quarters of growth, real GDP is approximately 6 percent below its trend path. Unemployment is high fundamentally because the economy is producing dramatically below its capacity. That is, far from being “the new normal,” it is “the old cyclical.”

Perhaps more important from a political perspective, the productivity surge  helped convince the Obama economists that the job loss was ‘normal’ in some sense. That is, the rise in productivity suggests that the financial crisis apparently just accelerated the normal process of  making U.S. businesses leaner and more competitive, and there was no structural problem. In fact, that’s what Romer said in her speech:

In short, in my view the overwhelming weight of the evidence is that the current very high — and very disturbing — levels of overall and long-term unemployment are not a separate, structural problem, but largely a cyclical one. It reflects the fact that we are still feeling the effects of the collapse of demand caused by the crisis. Indeed, at one point I had tentatively titled my talk “It’s Aggregate Demand, Stupid”; but my chief of staff suggested that I find something a tad more dignified.

If productivity was rising, then the job loss was due to a demand shortfall and could be dealt with by stimulating aggregate demand. That, in turn, helps explain why the “job problem”  didn’t seem so urgent to the Obama administration, and why they spent more time on other policy issues such as healthcare and regulation.

[Read more...]

The End of Japan as an Industrial Power?

I don’t mean to be apocalyptic here,  in the face of the terrible tragedy hitting the Japanese people.  But I think the current crisis is going to accelerate the aging of Japanese society, especially if the nuclear disaster gets worse.  And  I’m wondering whether we are seeing the beginning of the end of Japan as an industrial power. 

Think about this from the perspective of an executive running a major Japanese manufacturer.  In the short-term, when you are facing all the problems at home,  you may find it appealing, wherever possible, to ‘temporarily’ switch over much of your production to either China or the U.S., your two major markets.  This can be justified, patriotically, as the need to keep up profits to help fund the reconstruction of Japan.

But you may not want to move that  production  back again. In the medium-term,  as you consider how much to invest in rebuilding your factories and infrastructure in Japan,  you will face a demographic problem–the coming collapse of the working-age population. Take a look at this chart:

Basically,  Japan’s working-age population is anticipated to drop by 20% over the next 20 years. And that actually understates the problem in the rural areas, which have felt a youth drain to the big cities. ( see here and here   ). 

That makes it much more attractive to invest in China and the U.S., of all places, which have more desirable demographics for both the workforce and consumption. Ten years from now, much of what is made in Japan today will be made elsewhere.  

When Did the Innovation Shortfall Start?

I’m responding to the posts by Arnold Kling and Bryan Kaplan critiquing  Tyler’s The Great Stagnation. Let me just throw out some thoughts, from the perspective of someone who thinks that The Great Stagnation is a terrific book.

1. I agree wholeheartedly with Tyler that the current crisis is a supply-side rather than a demand-side problem. That explains why the economy has responded relatively weakly to demand-side intervention.

2. From my perspective,  the innovation slowdown started in 1998 or 2000, rather than 1973–sorry, Tyler.  The slowdown was mainly concentrated in the biosciences, reflected in statistics like a slowdown in new drug approvals, slow or no gains in death rates for many age groups (see my post here),  and low or negative productivity in healthcare (see David Cutler on this and my post here).  This is a chart I ran in January 2010 (the 2007 death rate has been revised up a bit since then)–it shows a steady decline in the death rate for Americans aged 45-54 until the late 1990s.

The innovation slowdown was also reflected in the slow job growth in innovative industries, and the sharp decline in real wages for young college graduates (see my post here). (Young college grads, because they have no investment in legacy sectors, inevitably flock to the dynamic and innovative industries in the economy. If their real wages are falling, it’s because the innovative industries are few and far between).

3. The apparent productivity gains over the past ten years have been a statistical fluke caused in large part by the inability of our statistical system to cope with globalization, including: The lack of any direct price comparisons between imported and comparable domestic goods and services; systematic biases in the import price statistics (see Houseman et al  here, for example); and no tracking of knowledge capital flows. I’ve got several posts coming on this soon.

4. I agree with Tyler that regulation of innovation is a big problem.  That’s why I’ve suggested a new process, a Regulatory Improvement Commission,  for reforming selected regulations.

5. I’m of the view that we may be close to another wave of innovation, centered in the biosciences, that will drive growth and job creation over the medium run.  If we want growth and rising living standards, we need to avoid adding on well-meaning regulations that drive up the cost of innovation.

My Review of Tyler Cowen’s New Book

Tyler Cowen’s new book, The Great Stagnation, is terrific. If you want to understand what’s going on with the economy, you should buy it right now. In fact, buy two.

Oh, oh, I’m supposed to write more? Ok.

I should start by saying that if I was still writing for BusinessWeek, I would never be allowed to review Tyler’s book, because he cites me copiously and even graciously dedicates it to “Michael Mandel  and Peter Theil, who have blazed the way.”  (Thank you!) But the fact is, The Great Stagnation is so important and so readable that I’m going to violate every possible  conflict of interest rule.

Since 2009, I’ve been arguing that there’s an innovation slowdown which is the root cause of many of our current economics ills (See here for the  June 2009 BusinessWeek cover story, “Innovation Interrupted”)*.  Since then I’ve been writing and blogging about the  innovation shortfall thesis. (For example, in March 2010 I wrote a policy memo for the Progressive Policy Institute titled “Why the Jobs Crisis is Actually an Innovation Crisis”)

That’s why I was so pleased to see Tyler’s new book. He incorporates my original innovation shortfall thesis–which mainly focuses on technological change over the past decade–into a much broader argument that stretches back forty years. What’s more, he does a great job of making his case in clear terms (readable!). Tyler argues:

…the American economy has enjoyed lots of low-hanging fruit since at least the seventeenth century, whether it be free land, lots of immigrant labor, or powerful new technologies. Yet during the last forty years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognize that we are at a technological plateau and the trees are more bare than we would like to think. That’s it that is what has gone wrong….there are periodic technological plateaus, and right now we are sitting on top of one, waiting for the next major growth revolution.

Why is Tyler’s “technological plateau”  so important? It gives you a coherent explanation of how we got into this mess. Tyler writes:

In essence, we’ve been making plans—whether consciously or not—as if we would have ongoing productivity growth of 3 percent or more, along with the asset prices that would accompany such a boom. When you combine plans based on 3 percent gains with a reality of much inferior performance, sooner or later you get a crash.

In other words, it was a collective misperception of current growth rates.

We were all, more or less, overconfident. It gets increasingly harder for me to escape the conclusion that many millions of people were complicit, whether intentionally or not.

Going forward, Tyler raises several important questions.  How do we encourage technological progress? How do we manage slow growth? And if and when we get a new round of technological breakthroughs, how do we manage those?  These are his suggestions

  • Raise the social status of scientists
  • Be part of the solution to the current rancor, not part of the problem. Don’t demonize those you disagree with.
  • Have realistic expectations.
  • Be ready for when more low-hanging fruit actually arrives because sometimes low-hanging fruit is dangerous
  • Be prepared for a recession that could last longer than we are used to.

Let me comment on two of these. First, the point about raising the social status of scientists. In his state of the union address, President Obama made a big deal about innovation. But he did not highlight a single current scientist. Instead, he featured two brothers,  Robert and Gary Allen, who own a  Michigan roofing company.  Good politics–but perhaps not the right message to kids.  

Second, don’t demonize those you disagree with. The point Tyler is making that politics becomes a lot harder in a slow-growth economy, where expectations have to be ratcheted down.  The center has a real purpose.

Finally, Tyler wrote this book in a short Kindle e-book format. It’s worth getting a Kindle just to read his book –I did!

One View of State Budgets and Higher Education

I start out with the belief that investment in higher education is in general a good thing. However, I’ve been worried by the decline in real college grad wages.

 I came upon this 2009 Brookings paper, “The Causal Impact of Education on Economic Growth:Evidence from U.S.”, by P. Aghion , L. Boustan , C. Hoxby, and J. Vandenbussche. Let me take two excerpts from the beginning and end of the paper: 

Should countries or regions (generically, “states”) invest more in education to promote economic growth? Policy makers often assert that if their state spends more on educating its population, incomes will grow sufficiently to more than recover the investment.

 //giant snip//

We find support for the hypothesis that some investments in education raise growth. For the U.S., where all states are fairly close to the world’s technological frontier, we find positive growth effects of exogenous shocks to investments in four-year college education, for all states. We do not find that exogenous shocks to investment in two-year college education increase growth.

This suggests that the money would used equally productively elsewhere. We find that exogenous shocks to research-type education have positive growth effects only in states fairly close to the technological frontier. In part, this is because research-type investment shocks induce the beneficiaries of such education to migrate to close-to-the frontier states from far-from-the-frontier states. Put another way, Massachusetts, California, or New Jersey may benefit more from an investment in Mississippi’s research universities than Mississippi does. Finally, we show that innovation is a very plausible channel for externalities from research and four-year college type education. Exogenous investments in both types of education increase patenting of inventions.

What conclusion should I draw from this paper?  Should we put more money into research-related education spending and four-year schools, and less into two-year colleges? Or are we missing something important here?

Really? Ireland/Iceland/Greece Outperform Germany?

Is it true that the three basket-case countries of Europe–Greece, Ireland, and Iceland–have outperformed Germany on real GDP and productivity growth? Or do the implausible official numbers demonstrate the bankruptcy of the global economic statistical system?

I was nosing through the just-released OECD Economic Outlook (top secret project, don’t ask), and I noticed something very interesting.  The Outlook includes forecasts through 2012 for all sorts of macroeconomic variables,  so we can now look at a 15-year time period (1997-2012) which includes the ten years of  tech+housing boom (1997-2007) and the five years of the financial bust. Here are two charts comparing the strongest economy in Europe, Germany, with the three basket cases, Greece, Ireland, and Iceland. We’re looking at real gdp growth and total economy labor productivity growth:


These charts show that the three basket-case countries of Europe–Greece, Ireland, and Iceland–substantially outperform Germany during the boom years, which is to be expected (blue bars).  For example, Greece had productivity growth averaging 2.4% per year from 1997 to 2007, compared to only 1% per year for Germany.

What is more surprising is that  Greece, Ireland, and Iceland continue to outperform Germany, even when we factor in  the 5 years of the bust, including forecasts through 2012 (the red bar).  For  example, average real GDP growth in Iceland is projected to be 2.7% annually over the 1997-2012 time period, almost double the 1.4% growth rate of Germany.

What can we make of these disparities? After all, we economists have been trained to believe that productivity growth is an essential measure of the health of an economy. Here are four possible explanations:

  1. OECD forecasters have drunk too many bottles of wine, leading to overoptimistic forecasts
  2. Five years post-bust is too short: The basket-case countries will be suffering for many years.
  3. Boom-and-bust beats slow-and-steady in the long-run.
  4. The usual way of measuring Gross Domestic Product overestimates  both debt-fueled growth (Iceland, Greece) and growth fueled by supply chains (Ireland).

As anyone who has been reading me for a while knows, I lean towards #4.  I think there’s a first-order problem with the way we measure GDP growth, because trade–including flows of knowledge capital–is being incorrectly counted, or not counted at all.*   That’s a big gotcha, since bad macro data have and will distort decision-making by policymakers,corporate leaders, and investors.  

*I will recap the full set of statistical issues in a post soon. If anyone wants to be on my “alternative system of global economic statistics” mailing list, just drop me a note.

A Massive Writedown of U.S. Knowledge Capital

In his column this morning, Paul Krugman gets it half-right:

America’s economy isn’t a stalled car, nor is it an invalid who will soon return to health if he gets a bit more rest. Our problems are longer-term than either metaphor implies….The idea that the economic engine is going to catch or the patient rise from his sickbed any day now encourages policy makers to settle for sloppy, short-term measures when the economy really needs well-designed, sustained support.

So far, so good.  But then Krugman goes off the rails:

The root of our current troubles lies in the debt American families ran up during the Bush-era housing bubble…What we’ve been dealing with ever since is a painful process of “deleveraging”: highly indebted Americans not only can’t spend the way they used to, they’re having to pay down the debts they ran up in the bubble years.

No, no, no. The build-up of debt was a symptom of  the real underlying problem:  A massive write-down of U.S. knowledge capital over the past 10-15 years, combined with anti-innovation policies on the part of the government.

U.S. prosperity has always depended far more on our accumulated store of knowledge capital than on our physical investments. Knowledge capital includes accumulated education, research and development, and business-knowhow–all the intangibles that underly a modern economy.

The value of knowledge capital depends, in part, on how rare it is. The more companies or countries that possess the same knowledge (say, about how to make a commercial airliner), the less valuable that knowledge is.  This is just Economics 101, applied to intangibles.

Over the past 10-15 years, the strengthening of information flows into developing countries meant that knowledge capital was being distributed much more quickly around the world.  As a result, the normal process of knowledge capital depreciation greatly accelerated in the U.S. and Europe–beneath the radar screen, because no statistical agency constructs a set of knowledge capital accounts.

What we should have been doing is boosting our investment in knowledge capital creation–education, R&D, business innovation.   Instead, we borrowed to support consumption.  Instead, we got Republican and Democratics administrations that  were more concerned with punishing innovative industries and ladling on additional security and economic regulations.

We still have some major knowledge capital advantages–in communications, in the biosciences, in the rapidly growing area of digital education–that we can build on for the future.   But this is the moment where we should be focusing on rebuilding our knowledge capital base rather than supporting debt-led consumption.

Added 12/15: Tyler Cowen agrees that knowledge capital may be depreciating more rapidly, but disagrees on the cause.

I agree with the conclusion but I am not sure that globalization was the mechanism.  I sometimes think of an imaginary economy with two sectors: music and bathtubs.  I believe that my bathtub is over thirty years old, yet for me it works fine and I have no desire to buy a new one.  When it comes to music, most people want to listen to what is new and hot, not Bach’s B Minor Mass.

Growth Upgrade for 2010

From a Bloomberg article by Rich Miller:

Pimco, which manages the world’s biggest bond fund, raised its forecast for growth next year in response to the stimulus, [Mohamed El-Erian, chief executive officer of Pacific Investment Management Co] said. It now sees the economy growing 3 percent to 3.5 percent in the fourth quarter of next year from the same period of this year. That compares with its previous estimate for 2 percent to 2.5 percent growth and the 2.2 percent gain forecast for this year by the International Monetary Fund.

Time for hiring to pick up as well.

Does regulatory backlash explain the midterm elections?

On the front page of the NYT this morning

Mr. Obama, having just cut a painful deal with Republicans intended to stimulate the economy, can ill afford to be seen as simultaneously throttling the fragile recovery by imposing a sheaf of expensive new environmental regulations that critics say will cost jobs.

The delays represent a marked departure from the first two years of the Obama presidency, when the E.P.A. moved quickly to reverse one Bush environmental policy after another. Administration officials now face the question of whether in their zeal to undo the Bush agenda they reached too far and provoked an unmanageable political backlash.

Finally! The light dawns. As I showed in my recent PPI policy memo, the regulatory burden actually rose under George Bush, with most but not all of the increase concentrated in homeland security. The Obama Administration then ladled another hefty layer of regulation on top of the Bush regulatory burden. Let me reproduce a chart from the memo.

The problem is that adding more regulations in a period of weak economic and job growth is precisely the wrong thing to do, and people know it in their hearts. If Obama really wants to support jobs and innovation now, he can’t be regulating willy-nilly.

That suggests the correct middle ground is pro-growth, pro-fairness, and sane regulation.



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