Wrong Diagnosis

An unsigned editorial in today’s NYT diagnosed the economy’s problem’s thusly:

The economy’s central problem is not lack of money to hire workers or make loans or rates that are too high. It is lack of hiring and lack of lending, despite cash cushions at many corporations and big banks and rates that are already very low.

Hmmm….that’s like saying the problem with the poor is that they don’t have enough money.

I’d say the economy’s central problem is a lack of innovation (with the exception of  the communication sector), combined with an increasingly oppressive regulatory structure.  Both of these combine to lower the expected rate of return from domestic investments, both for big and small businesses.

To solve these problems, we have to go beyond  monetary and fiscal policy, which have served their purpose of blunting the downturn. We have to develop regulatory policies that protect the vulnerable, while still leaving the room and incentives for innovation and growth.  We need to use the capabilities provided by our information society to better focus the regulatory apparatus, and turn it from a hammer, which it is today,  into a fine-edged scalpel.


  1. Good luck with that! It’s like saying you’re going to turn hobos from worthless drunks into finely-tuned social drinkers! 😉

  2. I’d like to see a post and/or essay of yours (apologies if I’ve missed it) about which regulations you have in mind (and how you’d change them if you were dictator for a day.)

    • Mike Mandel says:

      I’ve addressed this in the limited case of the communications sector, where I proposed countercyclical regulatory policy (more permissive in the downturn, then aggressively tighter in the good times). But I will write a broader post soon.

  3. Putting a cutting and a smashing implement in the same metaphor is an interesting choice. It keeps me from saying something inane like that people use hammers because scalpels are too expensive. 🙂

    But yes, “innovation” is the creative side of the creative and destructive force of capitalism, and with slack in the labor market, we surely need more of it.

  4. Well, I would agree that corporations are sat on huge piles of cash, that they actually don’t know what to do with. They don’t see any investments they can make with that money to give a good return. Even if you take Google, they have piles of cash and are trying to innovate, but just about everything they have done in the past year with the exception of Android has been a bust. So you could argue they are over-innovating – wasting that pile of cash on stuff that is unlikely to work.

    Facts are, corporations have now finally pulled the trigger on all the excess capacity they had; at least as far as workers they didn’t really need. Their profits are huge and growing.

    Banks, meanwhile, are still desparate to repair their balance sheets. They know they have massive losses on their books. The only way they can replenish their funds is to have interest rates at zero. But this is a complete and utter disaster for the economy at large, and only Hoenig has the balls to say so. In protecting the banks, they are undercutting everything else. Banks won’t lend, because they can’t afford to. And, corporations are also making enough money that they don’t need to borrow. Sadly, that same issue isn’t true of the small businesses; they have to have loans. The logical place for them to go, is the smaller regional banks, but those are the ones being left to go under by the FDIC, and they’re the ones most exposed to the commercial real estate crash, which is probably even worse than the consumer/home one. Thus, the companies most likely to innovate, the small businesses, can’t expand. Further, in order to expand, they’d likely have to agree to be gobbled up by a bigger corporation long before that shoudl really be an issue. The corporations love that.

    I dont’ think more regulation or taxes have much to do with anything, even for small businesses. If they are candidates for huge growth, taxes aren’t what si going to put them under. If they are marginal or likely to remain small, then taxes and regulation might be enough to make them non-viable. But they aren’t going to be drivers of big growth anyway, so can be ignored.

    • Konstantyn says:

      I think you are essentially right. The problem is that most people look at the issue as if economy were a solid body with universal characteristics across all localities. It is not. So the problem is structural, but isn’t treated as such.

      First, one needs to admit the innovation is invented in startups. Big corps carry the burden of economical prove that is done by scaling inventions and adding the money value to it. the Android hasn’t been started at Google too.

      Second, startups ecosystem has different demands than corporate one. While the entire economy is growing, startups can get a share of the pie. Though, the innovation feeding isn’t optimal in this case too. One can use the hype hight in the Gartner Cycle as a metric (startups need to cheat on the time-performance in order to be sufficiently attractive and get food). When economy tanks startup risks as first to cut off.

      Third, to nurture startup ecosystem, two things could happen (better both). 1. Money force feeding, 2. Educate population to enable seeing through the inventions. The first point means resolving the structural problem. The second point means the notion “innovation should actually happen”. The later is harder to achieve.

  5. Oh and BTW, the stock market now is not a place where an investor goes to invest for long term returns. Its a trader’s game now. I actually am coming to believe Joe Public should have nothing to do with the stock market at all, because they are just there to be fleeced/used as liquidity by the traders to make money for themselves.

  6. This means to say: Free Money via interest rates at zero aren’t driving anything in the economy right now. The sooner the Fed start to realize their policies on that aren’t havign any impact, and abandon zero interest rates, the sooner we can start employing policies that WILL have an impact on growth and economic well-being.

  7. Something from the gold bug community that might be interesting:

    As an aside, I think it may be wrong to conflate innovation and high tech. I think it could be argued that the higher the degree of knowledge required to innovate, the less innovation you will actually get. The US now has XX million unemployed, presumably waiting for someone to tell them how to be usefully employed. This is a vast pool of potentially very motivated talent. Encouraging them to look at their environment (especially in terms of the systems they operate in) and think of how it could be different and better may well produce innovation. In my view western societies are full of cultural artefacts that make little practical sense (schools, malls, suburbs, transport systems – all fundamentally mad!). Get an incentive structure in place for low energy, internet enabled living (or is that a carbon trading scheme?).

  8. I would also appreciate a broader post on regulations. I have looked, but have had trouble finding studies quantifying regulations and/or looking at them in a qualitative sense. If you could compare this with regulations pre-1970 that would help. It has been my general sense that there were fewer, but blunter and tighter regulations post WWII until the 70s. My current theory, but with little real data is that we probably over regulate smaller businesses, but under regulate finance.


  9. Rycoka, I read that guy Long’s piece and must say I’m befuddled at how he can rightfully bash Obamacare and the govt looting of Social Security and still think the govt can somehow fund innovation. They can’t even come up with good rules on medical payments, yet they’re somehow going to have the insight to fund the next great technical innovations? As John Stossel would say, give me a break! 🙂 These things will work themselves out, they always do and it always comes out better. There’s no guarantee of course, but I have not heard a compelling argument for why this time it’s different, so the presumption must be that this time will be the same. 🙂

  10. Those high profits are the result of a lack of competition. Many of our intellectual property laws are guided not to encourage innovation but to prevent it. Competition would lower prices increasing the real income of consumers allowing growth in the economy.

    The fields of innovation do become less productive at times though. Often only basic research is capable of breaking new ground and the risk is seen as too great. Eventually these high profits will make even risky plays be seen as necessities.

  11. ” They can’t even come up with good rules on medical payments, yet they’re somehow going to have the insight to fund the next great technical innovations?”

    O, the irony as he typed that out on the internet.


  12. Mike Reardon says:

    A Google saying: constraints help to define what you can do in the real world. –

    Something like that.

    If the economy still is de-leveraging towards long term deflation, out five years, pulling down every bottom line, or if we get into a depreciation of the dollar and restrictive buying capacity for business.

    US business will still do what its formed as a pattern over the last decade. That find the cheapest products and services and import new innovation from more robust producers.

    Our innovation will not be invested in, if long-term constraints are in place, and a cheaper foreign import can still gain a greater return.

    Nothing has change in the tax code or is in the debate on the tax codes rewards. Its still for American business, feed the bottom line with the most inexpensive products you can find and take profits with financial and asset manipulation. Is it.

  13. Mike Reardon has a point. Which may not obviously be tied to my point, but I think it is. I can only reiterate what I have pointed out earlier – there is no dearth of innovation or innovation potential (where developing the innovation requires nontrivial investment). But much of that innovation, under current accounting paradigms, does not have sufficient ROI prospects, accounting for risk and opportunity costs. In many cases milking the existing cash cows seems better. This also has to do with diminishing returns to technology. Just look at how features and prices of computers and computer accessories have evolved over the past few decades. What more do you want? In fact I’m of the opinion that price competition already leads to a reduction in quality as margins have dropped too low.

    Maybe by innovation you mean “new paradigms” (well we have mobile now so you can send/follow tweets/updates and engage in other inanities if you are into all that). What innovations will substantially improve on current computer technology, just to stay in the field. I suspect fields I know less about show similar effects.

    Maybe we need some innovation in how to run a sustainable society. If nobody has noticed, things may well be going down the toilet if recent trends persist.

    • In other words, gambling in the Wall Street casino seems like a better bet than developing new capacity. After all, the casino can be rigged, while new research and development is fundamentally risky.

      • umm, where did cm mention Wall Street or casinos? He was droning on with the same nonsense about how those greedy managers are just pumping out inferior products and reaping the fat profit margins, as though consumers would be dumb enough to fall for that. Hilarious how he dismisses mobile by referring to twitter, ignoring how you now have the internet at your fingertips anywhere and everywhere you go, through your web browser on your smartphone. I realize you guys are engineers so you want management to fund your risky R&D boondoggles, but that doesn’t happen when the money isn’t rolling in. And without micropayments, the floodgates stay shut, so enjoy the trickle from ads. 🙂

      • I’ll grant that cm didn’t say anything more about Wall Street casinos than I complained about companies not funding my pet R&D projects.
        I’m more ittirated, for example, that certain large companies aim only to be a fixed percentage ahead of the existing competition in existing markets because being further ahead doesn’t pay and knocking out the competition is verbotten.

      • Ajay, as dismissive and stereotyping as ever;

        ComgEng, it was in the later 90’s when I and my coworkers were told (by our head of engineering) the now well known parable of the wanderers and the bear (you don’t have to be faster than the bear, only faster than the other guy). And to make sure we had gotten it, the follow-up explanation was pretty much what you mentioned. But then consolidation and high barriers to entry have probably always led to risk aversion and a slowdown in R&D/innovation as well as rolling out new products that could cannibalize the existing cash cows. Of course that applies largely only where there is a profit motive, but in the private sector that’s the case.

      • In related news, let’s say I know a workplace that is heavily skewed towards cash cows and maintenance, and where incidentally there has been an IMO unhealthy growth in management hierarchies. Of course innovation is not deliberately suppressed, but in a maintenance focused organization it is crowded out by the day-to-day stuff and generally not funded. The top management has recognized the innovation deficit, and has started a grassroots initiative. The general idea is that you submit your idea to an evaluation board which will assign a high-ranking “partner” to “work with you” to develop the idea further. As far as I can tell, the program has not met with an eager response, and why would it. I’m not familiar with the details, but I suppose you get to work on this “on your own time” (no Google 20%), and if it goes somewhere much of the credit goes to the “partner” and you get an honorable mention or maybe a group lunch/dinner with other “innovators” and one of the dignitaries, and possibly a token cash award worth a few days of your salary. This kid of stuff has to be funded as part of your job and not as an “initiative” where the upfront funding comes from your own time and you don’t partake in any gains (but then also not failures to be fair).

      • cm ,
        Good examples. It would be nice if that weren’t the case, but yeah, it’s really frustrating to see engineers and management pacing investment only relative to the competition.

  14. “Oh, the hilarity of another dummy who thinks Al Gore invented the internet. ”

    Darpanet, not that it will mean anything to you.


    • Do AppleTalk or DECnet mean anything to you? Proprietary protocols that were arguably superior to trivially simple TCP/IP, but that lost out only because they weren’t free. Anyway, the protocol is a trivial matter compared to all the private hardware scaling and innovations like fiber optics that was put into building the internet, but let me guess, that won’t mean anything to you. 😉

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