Friday, June 7, 2013

The Cash and I

Martin Wolf in the FT the other day:
The third challenge is over the longer-term sources of demand. I look at this issue in terms of the sectoral financial balances – the balances between income and spending – in the household, business, external and government sectors. The question, then, is where expansion will come from. In the first quarter of this year the principal offset to fiscal contraction was the declining household surplus. 
What is needed, as well, is a big swing towards surplus in the US current account or a jump in corporate investment, relative to retained profits. Neither seems imminent, though the second seems more likely than the first. The worry is that the only way to balance the economy will be via big new bubbles. If so, this is not the fault of the Fed. It is the fault of structural features of the domestic and global economies...
This is a good point, which should be made more. If we compare aggregate expenditure today to expenditure just before the recession, it is clear that the lower level of demand today is all about lower  consumption. But maybe that's not the best comparison, because during the housing boom period, consumption was historically high. If we take a somewhat longer view, what's unusually low today is not household consumption, but business investment. Weak demand is about I, not C.

This is especially clear when we compare investment by businesses to what they are receiving in the form of profits, or, better cashflow from operations -- after-tax profits plus depreciation. [1] Here is the relationship over the past 40 years:

Corporate Investment and Cashflow from Operations as Fraction of Total Assets, 1970-2012

The graph shows annualized corporate investment and cashflow, normalized by total assets. Each dot is data from one quarter; to keep the thing legible, I've only labeled the fourth quarter of each year. As you can see, there used to be a  clear relationship between corporate profitability and corporate investment. For every additional $150, more or less, that a corporation took in from operations, it would increase capital expenditures by $100. This relationship held consistently through the 1960s (not shown), the 1970s, the 1980s and 1990s.

But now look at the past ten years, the period after 2001Q4.  Corporate investment rates are substantially lower throughout this period than at any earlier time (averaging around 3.5% of total assets, compared with 5% of assets for 1960-2001). And the relationship between aggregate profit and investment rates has simply disappeared.

Some people might say that the problem is in the financial system, that even profitable businesses can't borrow because of a breakdown in intermediation, a shortage of liquidity, an unwillingness of risk-averse investors to hold their debt, etc. I don't buy this story for a number of reasons, some of which I've laid out in recent posts here. But it at least has some certain prima facie plausibility for the period following the great financial crisis. Not for for the whole decade-plus since 2001. Saying that investment is low today because businesses can't find anyone to buy their bonds is merely wrong. Saying that's why investment was low in 2005 is absurd.

(And remember, these are aggregates, so they mainly reflect the largest corporations, the ones that should have the least problems borrowing.)

So what's a better story?

I am going to save my full answer for another post. But regular readers will not be surprised that I think the key is a shift in the relationship between corporations and shareholders. I think there's a sense in which the binding constraint on investment has changed from the terms on which management can get funds into the corporation, from profits or borrowing, to the terms are on which they can keep them from going out, to investors. But the specific story doesn't matter so much here. You can certainly imagine other explanations. Like, "the China price" -- even additional capacity that would be profitable today won't be added if it there's a danger of lower-cost imports entering that market.

The point of this post is just that corporate investment is historically low, both in absolute terms and relative to profitability. And because this has been true for a decade, it is hard to attribute this weakness to credit constraints, or believe that it will be responsive to monetary policy. (This is even more true when you recall that the link between corporate borrowing and investment has also essentially disappeared.) By contrast, household consumption remains high. I have the highest respect for Steve Fazzari, and agree that high income inequality is a key metric of the fucked-upness of our economy. But I don't think it makes sense to think of the current situation in terms of a story where high inequality reduces demand by holding down consumption.

Consumption is red, on the right scale; investment is blue, on the left. Both as shares of GDP.

As I say, I'll come back in a future post to my on preferred explanation for why a comparably profitable firm, facing comparable credit conditions, will invest less today than 20 or 30 years ago.

In the meantime, one other thing. That first graph is a nice tool for showing how a Marxist thinks about business cycles.

If you look at the graph carefully, you'll see the points follow counterclockwise loops. It's natural to see this as cycles. Like this:

Start from the bottom of a cycle, at a point like 1992. A rise in profits from whatever source leads to higher investment, mainly as a source of funds and but also because it raises expectations of future profitability. That's the lower right segment of the cycle. High investment eventually runs into supply constraints, typically in the form of a rising wage share.[1] At that point profits begin to fall. Investment, however, continues high for a while, as the credit system allows firms to bridge a growing financing gap. That's the upper right segment of the cycle. Eventually, though, if profits don't recover, investment will follow them downward. This turning point often involves a financial crisis and/or abrupt fall in asset values, like the collapse of tech stocks in 2000. This is the upper left segment of the cycle.  Finally, in the  lower left, both profits and investment are low. But after some time the conditions for profitability are restored, and we move toward the right and begin a new cycle. This last step is less reliable than the others. It's quite possible for the economy to come to rest at the lower left and wobble there for a while without any sustained change in either profits or investment. We see this in 2002-2003 and in 1988-1991.

(I think the investment boom of the late 70s and the persistent slump of the early 1990s are two of the more neglected episodes in recent economic history. The period around 1990, in particular, seems to have all the features that are supposed to be distinctive to the current macroeconomic conjuncture. At the time, people even called it a balance-sheet recession!)

For now, though, we're not interested in the general properties of cycles. We're interested in how flat and low the most recent two are, compared with earlier ones. That is the structural feature that Martin Wolf is pointing to. And it's not a new feature of the post financial crisis period, it's been the case for a dozen years at least, only temporarily obscured by the housing bubble.



UPDATE: In comments, Seth Ackerman asks if maybe using total assets to normalize investment and profits is distorting the picture. It's a good question, but the answer is no. Here's the same thing, with trend GDP in the denominator instead:


As you can see, the picture is basically the same. Investment in the 200s is still visibly depressed compared with earlier decades, and the relationship between profits and investment is much weaker. Of course, it's always possible that current high profits will lead an investment boom in the next few years...



[1] Cash from operations is better than profits for at least two reasons. First, from the point of view of aggregate demand, we are interested in gross not net investment. A dollar of investment stimulates demand just as much whether it's replacing old equipment or adding new. So our measure of income should also be gross of depreciation. Second, there are major practical and conceptual issues with measuring depreciation. Changes in accounting standards may result in very different official depreciation numbers in economically identical situations. By combining depreciation and profits, we avoid the problem of the fuzzy and shifting line between them, making it more likely that we are comparing equivalent quantities.

[2] A rising wage share need not, and often does not, take the form of rising real wages. In recent cycles especially, it's more likely to combine flat real wages with a rising relative cost of wage goods.




57 comments:

  1. I like that illustration of a Marxist narrative of business cycles.

    I'm a little skeptical about that chart, though. Couldn't those ratios (profits/assets, investment/assets) be distorted by the 2000s real estate bubble, given that much of corporate assets take the form of real estate?

    What would happen if you normalized using something else, like GDP? (Or just plotted log profit and investment, in dollars?)

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  2. It's so great that you asked that. My draft actually had a second figure with trend GDP in the denominator for exactly that reason. Then I figured, let's not anticipate objections that maybe nobody will make. Well, now you've made it, so I'll put it back.

    And then I will head over to the Verso party, where you are maybe heading too...

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  3. " But I don't think it makes sense to think of the current situation in terms of a story where high inequality reduces demand by holding down consumption."

    Yeah , we don't want to go there. That's a fast track to an exit from the mainstream country club. Krugman all but admits it. You're in good company.

    In time , of course , it will become so obvious that it will be impossible to ignore the fact that inequality is at the root of the current crisis , just like the debt bubble became impossible to ignore.

    No worries , though. The debt-deniers emerged with their status and reputations untarnished ( within "the club" , that is , which is all that matters to them ).

    As Michael Lewis said ( and similarly , long before Lewis , Upton Sinclair ) : "People see what they're incentivized to see. If you pay someone not to see the truth, they won't see the truth."

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    1. My one policy for comments here is, please use a handle of some kind. Pseudonyms are fine, just don't leave the name field blank.

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  4. The consumption share of U.S. GDP has been historically rising bit by bit. It used to be in the 62-64% range in the '60's and 70's. By the time, I first read an econ textbook in the early 1990's the commonplace had been fixated that it was 2/3 of GDP, but it rose to 68% during the stock market bubble of Clinton 2, after the collapse of which it increased to 70%, which is now a fallacious journalistic commonplace to cite a "natural" fact. But, of course, GDP figures by definition add up to 100%, and what occurred after the stock crash was a collapse pf investment, after an investment boom, in which there had been much misallocation, (which is the sort of thing that bubbles do), so, with encouragement from Fed policy, PCE filled in the gap. IOW it seems that rising consumption share is more an artifact of declining investment share, and the reasons for the latter should be examined.

    But then the U.S. economy is not closed and to be considered in isolation from RoW. And it would seem that declining domestic investment by MNCs would be counterbalanced by increasing foreign investment by them. At least that would seem to be suggested by the $4 trillion gap between cumulative U.S. CA deficits and the external debt attaching to the U.S. economy, as measured by the NIIP. IOW rents returned from arbitraging global FX markets far exceed returns from investment in domestic production, and thus the rise in the value of foreign assets counter-balanced the trade deficits (Bretton Woods 2!), until it didn't.

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  5. Hi J.W.,

    I agree that capital rental rates being too high is a key driver here. What is interesting is why they are too high even when short rates are at zero. Your argument -- that shareholders are more powerful now and demand higher rates -- is interesting, but are shareholders more powerful than in the 1960s, when business profits were huge? I think you are onto something, and will follow your further posts on this with interest.

    However I disagree with the argument that because PCE/GDP has gone up, that means that inequality is not driving down growth. The argument is that inequality reduces overall income. When people with a higher marginal propensity to consume get higher incomes, then more consumption is produced and businesses invest more as well.

    Really what the rising consumption shares are measuring is how much households are being squeezed. If I build a toll both and charge everyone $100 for passing, the BEA measures that as an increase in transportation services, just as it measures the spread between what banks charge and what they pauy depositors as consumption of financial intermediation services. In this case, consumption share of GDP goes up, but overall income goes down because these tolls reduce overall income.

    Similarly, all of the increase in consumption shares (and then some) can be attributed to increasing prices of heath-care, increasing land rents, and increasing financial sector fees (remember that you are comparing two nominal quantities in your ratio so no deflation is occurring. Higher health care costs show up as higher consumption of healthcare).

    Back those three out and you have disturbingly declining consumption shares just as you would with the toll-road example. Then start backing out rising education costs and things begin to look bleak, consumption-wise.



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  6. Since my earlier comment didn't seem to register, I'll try again:

    The consumption share of U.S. GDP has been historically rising bit by bit. It used to be in the 62-64% range in the '60's and 70's. By the time, I first read an econ textbook in the early 1990's the commonplace had been fixated that it was 2/3 of GDP, but it rose to 68% during the stock market bubble of Clinton 2, after the collapse of which it increased to 70%, which is now a fallacious journalistic commonplace to cite a "natural" fact. But, of course, GDP figures by definition add up to 100%, and what occurred after the stock crash was a collapse pf investment, after an investment boom, in which there had been much misallocation, (which is the sort of thing that bubbles do), so, with encouragement from Fed policy, PCE filled in the gap. IOW it seems that rising consumption share is more an artifact of declining investment share, and the reasons for the latter should be examined.

    But then the U.S. economy is not closed and to be considered in isolation from RoW. And it would seem that declining domestic investment by MNCs would be counterbalanced by increasing foreign investment by them. At least that would seem to be suggested by the $4 trillion gap between cumulative U.S. CA deficits and the external debt attaching to the U.S. economy, as measured by the NIIP. IOW rents returned from arbitraging global FX markets far exceed returns from investment in domestic production, and thus the rise in the value of foreign assets counter-balanced the trade deficits (Bretton Woods 2!), until it didn't.

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    1. Hey I'm late to the party, but I had a similar thought. Is your first graph strictly domestic? Also, I imagine given various types of outsourcing the picture may be a little distorted. To take a goofy example, if Foxconn is adding production capacity that won't show up anywhere in Apple's capital investment outlays.

      Obviously, this is a matter of degree, but the limit is an arrangement where the Apple corporation has no investment spending at all (except occasional computer upgrades and office space) since it's main function is creating/managing and not producing. I think the 90s is a useful comparison here because the 90s investment boom was about wiring up and computerizing actual physical space in the domestic economy even if some of it was wasteful. What drive is there for that now?

      Bear in mind that this is consistent with corporations holding a lot of cash since they no longer have to pay for investment "upfront" but now pay for it "as needed" in the sense that they rent instead of own productive capacity.

      To be incautious, you could even argue that the 90s tech boom is an interruption of the pattern that started after/during the 70s boom. Real estate aside, domestic investment may just not be as necessary as it once was in a % of GDP sense. In which case, consumption is too low.

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    2. Also, I imagine given various types of outsourcing the picture may be a little distorted. To take a goofy example, if Foxconn is adding production capacity that won't show up anywhere in Apple's capital investment outlays.

      Obviously, this is a matter of degree, but the limit is an arrangement where the Apple corporation has no investment spending at all (except occasional computer upgrades and office space) since it's main function is creating/managing and not producing


      This isn't even remotely true. Apple's capex outlays are very substantial indeed, and surge one quarter before product launches rather like Ford tooling-up in days of old, for the very good reason that they represent just that. Apple owns most of Foxconn's tooling, and actually has a policy of trying to lock up machine tool production in advance.

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    3. But do those machine tools get made in the US or in China?

      I've actually been thinking about this since I made my post, do you have anything suggestions for reading wrt apple's investment spending (Or anything more general)?.

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    4. The classic text is this November 2011 Businessweek piece: http://www.businessweek.com/magazine/apples-supplychain-secret-hoard-lasers-11032011.html

      Star Apple analyst Horace Dediu was early with this, too. The ur-text, from October 2011, is this post in which he highlighted the volume of spending on machinery, specifically, and demonstrated that it was a leading indicator of sales: http://www.asymco.com/2011/10/16/how-much-do-apples-factories-cost/

      The tools, like most machine tools, probably come from Germany unless they are semiconductor-related, in which case Applied Materials is still your best friend.

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  7. As you say, the early 90s are an illuminating term of comparison. The US escaped from that equilibrium with a boom in lending, starting in May 1993. Several months later long-term interest rates began to rise and the Fed immediately responded by raising policy rates. No similar process has unfolded this time. Lending expanded starting in March 2011, but to a derisory extent, and is slowing still further recently. Lack of supply, or lack of demand? That's the question, as you point out.

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  8. As rsj and jch point out, the consumption picture is quite a bit bleaker than red line on your 2nd graph would seem to suggest.

    Look at CPE on a log scale.

    http://research.stlouisfed.org/fredgraph.png?g=jiP

    Since 2010, an obviously lower slope than in the previous 2 decades.

    Ditto GDP, BTW.

    http://research.stlouisfed.org/fredgraph.png?g=jiQ

    PCE is at about 113.5, GDP under 112.5, each indexed to 100 on 1/1/2010.

    Time series CPE/GDP is slightly inflated by a low GDP growth rate.

    Besides these factors, the finance sector has captured an increasing slice of total profitability. Other than intermediation, finance does nothing for the productive economy, so this is a huge exercise in rent collection.

    Cheers!
    Jzb

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  9. I wonder if the missing piece of the story is the trade deficit?

    http://research.stlouisfed.org/fred2/graph/?g=jj6

    It does seem that excess consumption growth has been associated with foreign consumption, not domestic consumption. The more we import, the more demand the economy needs. And the less we expect to export, the less business invests.

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  10. A general point:

    It would be nice if people could be a little slower to translate positive claims about the economy into moral judgements. It is not, as far as I know, the case that capitalism is a God, doling out justice; it is perfectly possible for something to be morally awful and yet fully conducive to the steady growth of output.

    When I say that I think that rising inequality is perfectly compatible with rising aggregate demand, I mean just that. I don't mean that rising inequality is ok by me. It's tempting to argue that justice and equality are also the best conditions for the accumulation of capital, that there's no fundamental conflict between the owners of capital and the rest of us, it's all just a big misunderstanding. You should resist that temptation.

    When I say capitalism works well with inequality, I'm not saying keep inequality, I am saying scrap capitalism. But first you have to free yourself of the theodicy of GDP.

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    1. I'd agree with this to the extent that functional explanations should be kept distinct from normative claims and the first job of economics is to provide explanations of functional relationships, (though there is still a cognitive-normative dimension there, as to better or worse functional explanations).

      However, it doesn't seem correct to claim that distributional issues have little or no functional significance. (which isn't simply a matter of more or less equality, since differing shapes of unequal distributions could have different effects). And, of course, capitalism, as driven by the functional "imperative" to maintain the value of invested capital via the rate of profit, by hook or by crook, will always reproduce highly unequal distributions as a general tendency, since the selection from investment possibilities will always be primarily those that maintain the rate-of-profit before all else, or the investments simply won't be made. Such that a tendency toward under-consumption/excess production capacity, (which is Marxian terms are both symptoms of over-accumulation), would seem to be endemic to the system, however temporarily or cyclically averted. Which brings us to the issue of increasing rent-extraction and the stove-piping of such rents to the very top, as well as the increasing resort to fictitious capital based on increasing debt loads, to maintain the value of capital in the face of its ever increasing level of technical productivity. That's something that can't be read off of GDP figures alone, (which, whatever their faults, are good for some issues, but not for others).

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    2. I'm not quite sure what you mean by the "theodicy of GDP", but I sometimes get the impression that macro-economics, through its level of abstraction, is engaged in constructing a perpetual motion machine, especially when it takes GDP growth, which is a just a flow measure anyway, as the sine qua non of its policy prescriptions and functional orientation, (presumably, at best, because unemployed workers are being held hostage), when the quality and sustainability of such "growth" should be at issue. Inflating the implied land rents of housing lots through excess credit provision/debt accumulation or expanding the rents embedded in health care provision hardly seem like additions to productive "value" or social welfare, however much they might temporarily contribute to sustaining income flows and READ. (And, of course, if one tradables sectors are "uncompetitive", then, as a rule of thumb, investment will tend to flow into domestic non-tradables sectors, such as housing and health care: a version of the "Dutch disease"). That Keynes line about hiring workers to bury and dig up pots of money was a joke about the gold standard, not a prescription for structural re-balancing, which might not be possible if the illusion of increasing individual "utility" starts to lose its attraction.

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    3. My argument is that *industrial* capitalism does not, in fact, work well with inequality. It works very poorly. In the middle ages, we can say that there was an aristocracy that had all the (market) wealth, and consumed all the surplus, and the system was stable. But in an world of increasing returns in which productivity gains are dependent on mass markets, capitalism does not work well. An excellent case in point would be China. Is there something about american dollars that make them more desired than Chinese RMB? Why must the Chinese economy export so much in order to keep people employed? It is because they cannot sort out their domestic class conflicts and pay their workers a high enough wage so that Chinese firms can be profitable by selling goods to their own people. The only way that Chinese firms can gain a large enough market to be profitable is to sell to someone else. In a world in which the most precious resource is not oil, but aggregate demand, it's pretty clear that capitalism does not work well with inequality.

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  11. are shareholders more powerful than in the 1960s, when business profits were huge?

    Yes, absolutely. Have you read Doug Henwood's Wall Street? Highly recommend you check out chapter 6 -- most of my thinking on this is just a development of his arguments there.

    (Do not read the book from the beginning -- it's an intellectual tragedy that the brilliant later part of that books is buried under several really unfortunate early chapters.)

    all of the increase in consumption shares (and then some) can be attributed to increasing prices of heath-care, increasing land rents, and increasing financial sector fees

    There is definitely an element of truth to this. But I don't think it goes to the argument here. Suppose that yesterday there was a medical test that could be performed income day by a technician. But now today it takes two day's labor, one by the technician and one by a clerical worker to handle the billing. From the point of view of "real" output that doesn't add anything, but it does boost aggregate demand, just as much as if twice as many people who genuinely needed the test were getting it.

    The question is, why is aggregate demand falling so short of supply (or of trend)? For that question, all that matters is how many dollars people are spending, relative to their income. Whether they are getting more or less value for those dollars is a separate question.

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  12. I have some problem to understand this way of subdividing GDP:
    The share of GDP that is spent in capital investiment is spent in building factories, machinery etc.
    To build those things, you have to employ people and pay them wages, which they will likely spend in consumption. Thus the share of GDP spent in capital investiment should also be "double counted" inside the share of GDP spent on consumption:
    For example suppose that american workers who do not work in the production of capital assets spend all they gain in consumption, and this represents 50% of GDP; then investiment represents 15% of GDP, that goes in the wages of workers who produce capital stuff, who spend their wages in consumption, for an additional 15% of GDP. In the end, the numbers are 65% of GDP as consumption and 15% as investiment.
    Is this correct?

    If correct, how can it be that China spends more on investiment (40%) than on consumption (35%)? [yeah, those are crazy numbers, the sources are those:

    http://en.wikipedia.org/wiki/List_of_countries_by_gross_fixed_investment_as_percentage_of_GDP

    http://data.worldbank.org/indicator/NE.CON.PETC.ZS
    ]

    Also, if USA spends 11% of GDP on investiment and 71% as consumption, where does the remaining 18% go?

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    1. For example suppose that american workers who do not work in the production of capital assets spend all they gain in consumption, and this represents 50% of GDP; then investiment represents 15% of GDP, that goes in the wages of workers who produce capital stuff, who spend their wages in consumption, for an additional 15% of GDP. In the end, the numbers are 65% of GDP as consumption and 15% as investiment.
      Is this correct?


      Not as you've written it, no. If we are ignoring government and trade, then the consumption and investment shares have to total to 100%.

      If workers consume all their income and capitalists consume none of theirs, then the consumption share of GDP will be equal to the wage share, and the investment share will be equal to the profit share.

      Since you say investment is 15% of GDP, that means the profit share of income must also be 15%, and the wage share 85%. You also say that wages in consumption-goods industries total 50% of GDP. That would imply that total output of consumption goods = 50%/85% = ~59% of GDP, implying total output of investment goods of ~41% of GDP. So the numbers in your example are impossible.

      I think your mistake is that you are assuming all costs are wages, all wages are consumed, and there is positive investment. But those three things cannot all be true.

      how can it be that China spends more on investiment (40%) than on consumption (35%)?

      There is no reason I cannot be greater than C, though it's certainly unusual. It's a combination of a high profit share, a low propensity to consume out of income, and high desired investment by business. (Note that these are not three independently varying factors in any of the three perspectives I gave, but none of those perspectives is the "true" model of capitalist economies.)

      Also, if USA spends 11% of GDP on investiment and 71% as consumption, where does the remaining 18% go?

      Well, first, this is nonresidential investment, so part of the remainder is housing investment. There's also direct expenditure by government, and net exports. Altho since net exports are negative, that means that housing plus government final expenditure total more than 18%. See here.

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  13. RL-

    I'm not sure I can explain this a blog comment. But basically:

    Total output = total income = total expenditure.

    We measure the amount produced in the economy, by the amount spent on it. And every dollar spent is income for somebody.

    While these have to equal, they are divided up differently. Income consists of wages, profits, transfer payments from government, etc. Expenditure consists of consumption and investment.

    Some income is saved -- that is, not spent on currently produced goods and services, but used to acquire an asset of some kind, either an existing physical asset or an abstract claim on future output. The national income identity tells us that total savings = total investment. But it does not tell us how that equality is maintained, that is, what adjusts. There are basically three possible stories:

    1. In the neoclassical story, the adjustment mechanism is the relative price of investment vs consumption, that is, the interest rate. In this story, saving drives investment, in the sense that it is people's choice between present and future consumption that determines investment.

    We can write I = I(r), I' < 0; S = S(r), S' > 0. Then there is a unique value of r for which I=S.

    2. In the Keynesian story, the adjustment mechanism is total output. Consumption increases with income, but less than one for one; investment is either fixed or increases with income, but less strongly than consumption. So an increase in income increases saving relative to investment. In this story, investment drives saving. An increase in business investment increases total income by just enough to produce an equal increase in total saving. Note however that while total investment determines total saving, the investment share depends on the marginal propensity to save.

    We can write I = I*; S=S(Y), S' > 0. Then there is a unique value of Y for which S=I. If S(Y) is linear, S=sY, then Y = I/s. (This is the multiplier.)

    3. In the Marxian story, the balance between consumption and investment depends on the the distribution of income. All wages are spent on consumption, all profits are saved, and all savings are invested in new capital. So the mechanism that ensures that the total amount saved is equal to the total amount invested, is that both are equal to the total amount received as profits. In this case, we can't say that savings --> investment or that investment --> savings; instead, both are determined by the profit share.

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  14. "I think your mistake is that you are assuming all costs are wages, all wages are consumed, and there is positive investment. But those three things cannot all be true."

    Ouch !
    I was indeed assuming this.

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    1. This anonymous here is me.
      I sincerely hate this comment system.
      I'm Random Lurker and I approve this message.

      Delete
    2. Blogger just sucks across the board. I should switch to another platform, but I'm too lazy. Also, I don't know which one.

      Delete
    3. Wordpress is the least shitty, although that could change at any time. It's pretty easy to switch (you just create a new blog and then import the content). I'm against that, though, since my browser already has memorized the url with "blogspot" in it. Also, it would orphan all the comments you've made at other blogs that direct readers here (pretty sure that's how I found the site).

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  15. Suppose that yesterday there was a medical test that could be performed income day by a technician. But now today it takes two day's labor, one by the technician and one by a clerical worker to handle the billing. From the point of view of "real" output that doesn't add anything, but it does boost aggregate demand, just as much as if twice as many people who genuinely needed the test were getting it.

    This is not the situation we are facing with health care, land rents, or financial intermediation fees.

    Prices are going up in all three areas because of increasing economic rents, not declining labor productivity. Show me a decline in labor productivity in any of these areas

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  16. Ok. But for the argument here, why does that matter?

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  17. The larger issue being that changes in the ratio of PCE/GDP tells you absolutely nothing about aggregate demand. It could be increasing or decreasing, you just don't know and need to make the argument directly.

    Again, consider the case of rising land rents. Those who own their home "pay" this rent via imputation. Those who do not own their home pay this rent in fact. As land rents go up, the BEA will assume that all nationals are paying more in consumption of housing services, so all of the imputed rent is counted as consumption. As long as the higher rent payments do not 100% displace consumption, but displace a combination of consumption and investment, then expenditures (primarily imputed) on consumption increase but actual expenditures decline and so the ratio of consumption to GDP goes up.

    Economic rents are no different from taxes or tolls -- they reduce overall incomes, but because they are levied by private actors the payment of these tolls is counted by the BEA as consumption.

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  18. I don't think it makes sense to think of the current situation in terms of a story where high inequality reduces demand by holding down consumption.

    Could it be that high inequality reduces demand by holding down investment too? Steve Waldman had an interesting post to that effect:

    http://www.interfluidity.com/v2/4366.html

    If we compare aggregate expenditure today to expenditure just before the recession, it is clear that the lower level of demand today is all about lower consumption. But maybe that's not the best comparison, because during the housing boom period, consumption was historically high.

    Still seems like the best comparison to me, unless you expect negative consumption shocks to be accompanied by positive investment shocks. That consumption was such a large portion of demand in the 2000s is evidence that the goods consumed can be produced with little capital. I can think of plausible explanations for this shift that are consistent with it being a new normal rather than a historical aberration: technological improvements may mean capital is cheaper and more productive than it used to be, or the economy is increasingly service oriented and that may be the natural evolution of a wealthy economy.

    And anyway, what would drive a business to invest more than they already are absent an expectation of even more consumption? Even lower interest rates? Not plausible. I can think of some scenarios around supply shocks to raw materials that might trigger investment but you'd never describe that as something the economy needs. Technological disruption/obsolescence? Maybe over the short run but over the long run that would be as likely to make investment a smaller percentage of GDP.

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  19. JWM, I have a model to explain this using different natural rates of interest for labor (consumption market) and capital (means of production). The model is raw at the moment, but gives a rationale.
    http://effectivedemand.typepad.com/ed/2013/06/exchange-rate-between-capital-labor-a-wild-idea.html

    The graph shows that capital had a lower natural interest rate than labor in the 50's, 60's and 70's. Labor had a liquidity advantage due to its labor share being higher than optimal. This high labor share allowed inflation to be more easily created. Inflation was more volatile than now. Labor was able to demand faster than capital could meet that demand.
    Money was relatively more expensive for capital in the 60's and 70's, but the excess liquidity advantage of labor allowed for investment to grow and sales to be profitable.
    Then, in the 80's, the natural rate of interest of labor and capital were in balance after the Volcker recession. Inflation was tamed and labor share was brought down. Yet since the late 80's, there has been a switch. The natural rate of interest for capital owners has gone higher than that of labor. Now capital has the liquidity advantage. However, inflation has followed the lower natural rate of interest of labor (consumption). Makes sense since demand determines supply. Also, inflation lost its volatility when labor's natural rate of interest fell below capital's natural rate of interest. Capital can now produce much faster than labor can respond with demand.

    But now owners of capital enjoy very low interest rates relative to their natural rate. Capital has the liquidity, but labor's low natural rate reflects low liquidity and as such labor cannot purchase as much as capital is capable of producing.
    Capital has the liquidity to invest, but they know sales will be relatively sluggish. Thus, capital has accumulated large cash reserves and overseas investments. It is not profitable to invest in the US labor sector because there is relatively much less liquidity there.
    As long as labor's natural rate stays so much lower than capital's, inflation will stay low, and investment by owners of capital will be muted.

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  20. Could you comment more about what you found unfortunate about the early chapters of Henwood (recognizing that this might be a "where do I start..." question)? So far, I've just read chapters 1, 6, and 7, but I didn't see anything too far off about chapter 1, other than the obvious issues such as being written pre-Euro. He seems to be pretty well attuned to the systematic risks of all the derivatives and swaps running around the financial system at the time (post Orange County, but way pre-meltdown).

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    1. I would also like to hear JWMs criticism of the earlier chapters. I personally found them somewhat rambling and not particularly the most coherant. I suspect the sections on Keynes didn't really capture a lot of Keynes main points. Were there serious inaccuracies? Or was it a matter of the writing.

      John

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  21. The larger issue being that changes in the ratio of PCE/GDP tells you absolutely nothing about aggregate demand. It could be increasing or decreasing, you just don't know and need to make the argument directly.

    This is true as written. But my point is that *given* that aggregate demand growth has slowed, a rising ratio of PCE/GDP makes it unlikely that a downward shift in desired consumption is the main reason.

    Now, it is true that while in principle only currently-produced output should be counted under consumption (or any other category of final demand), in practice this is not strictly the case. You are certainly right that if an increasing share of measured consumption is actually expenditure on non-currently produced goods, such as land rent, then consumption demand will be less than measured consumption. I would be surprised if this effect is quantitatively important, but I could be wrong.

    Anyway, I'm sort of sorry I provoked this argument by framing my position as against the idea of a downward shift in the consumption function. That's not actually the point of the post. The point of the post is that there certainly has been a downward shift (and flattening) of the investment function. That is important even if the consumption function has also fallen, so there was no reason for me to set the issue up as either/or.

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    1. (I think the big factor here is more likely debt service than rent.)

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    2. But, to state something fairly obvious, if, e.g., one's house is 50% over-priced, the debt-service on that house is partly a financialized rent extraction. (The whole system of encouraging house ownership, the "American dream", is already a favor to the financial sector, since collateralized lending is much preferred by it, and much such lending bids up housing prices/implied rents for financial extraction). The extent to which economic rents figure in price levels and thus "standards of living" is something that I don't think can be extracted from GDP data, which is ultimately just based positivistically on nominal prices. But, given a) saturated consumer markets and b) the tendency of production to become "commoditized" over time and yield diminishing profit margins, the temptation to extract rents from sunk-cost prior investments and by other means might tend to prevail over the risks and uncertainties of undertaking newer, innovative investments. (And then the increasing level of technical productivity from newer investments would tend to reproduce the whole conundrum over again later).

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    3. You are certainly right that if an increasing share of measured consumption is actually expenditure on non-currently produced goods, such as land rent, then consumption demand will be less than measured consumption

      That's what you are saying when you argue that firms are more profitable today but are investing less. It means that a larger portion of the purchase price of goods counted as consumption is going to pay for rental of the in-place capital, but that less new investment occurs. This is isomorphic to a hike in land rents.

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  22. "That's what you are saying when you argue that firms are more profitable today but are investing less. It means that a larger portion of the purchase price of goods counted as consumption is going to pay for rental of the in-place capital"

    But then the "capitalists" have to spend the higer rents on something. If they don't invest in new capital they either buy old unelastic capital (thus increasing the price of things like land and creating bubbles) or spend for consumption themselves.

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    1. No. Income is not some incompressible fluid. Cash flows are, but that's a different story.

      For example, the person who receives a cash-flow can use it repay debt, or to purchase more land, etc. Neither of these expenditures generate revenue for anyone else in the economy.

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    2. In my unscientific imagination money is more like a gas than like a liquid, precisely because it's volume can be expanded or compressed by financial effects (with the velocity of money similar to the velocity of gas particles, cool! ). But this is specifically related to debt dynamics.
      I can understand how paying back debt doesn't create income for anyone, but when you buy land you create income for the guy who sell the land to you. Plus, if many people buy land this causes the price of land to soar; since land is often used indirectly as collateral for loans this increases the amount of loanable money and IMHO creates a wealth effect that should increase consumption.

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    3. I can understand how paying back debt doesn't create income for anyone, but when you buy land you create income for the guy who sell the land to you.

      No you don't. You don't create any income when you buy land, or shares of stock, or even bonds.

      Person A has $100 in their bank account, which are backed, say, by $100 worth of commercial paper. Person A then writes a check to Person B, who holds land. Now Person B holds $100 in their bank account, backed by $100 worth of commercial paper, and person A holds the land. Person A and Person B have swapped places.

      This transaction does not create income for anyone(*). It wouldn't create income if the Person A bought shares of stock, either.


      (*) There is a small amount of income generated by the commissions and fees paid to the broker of the transaction.

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    4. "Person A and Person B have swapped places."

      While this is true, the guy who sold the land presumably sold the land to buy something, so your reasoning IMHO works only as long as guy B either keeps the money in his bank account (i.e. he "buys" a financial asset) or buys another asset equivalent to land (i.e. something that can grant a rent but is not produced by labor).

      In my opinion, what happened is this:

      1) there are two kind of people: consumers (workers) and investors. Investors spend all their money in capital assets;

      2) As investors purchase capital assets, some workers get their wage by producing new capital assets;

      3) But at some point, for some reason still to be explained (let's say that the low hanging fruit of a previows technological revolution ends), the rate of profit that investors can expect from newly produced capital assets falls, so investors stop to pay for the production of new capital assets and start buying non-productable capital assets (like land or various forms of government concessions).

      4) Thus less people are employed in the production of new capital goods. In the meanwhile, the price of non-productable capital goods rises, but this doesn't produce new wages directly; indirectly, it produces collateral and thus stimulated demand through an increse of debt;

      5) from the point of view of the consumers/workers, real consumption really becomes stale (because real production isn't really growing), or at worst falls. When real wages fall, the crisis proper hits, since debt becomes non-manageable and financial assets disappears, while the value of non-productable capital assets also falls.

      I think that my point of view is compatible with what you say, so I'm not really disagreeing with you, but I think that many people today tend to attribute the fall in the wage share of income exclusively to cultural or political causes, whereas I believe that we are also experiencing the end of a technologic cycle and that the political and cultural situation is also to a certain degree caused by that cycle.

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    5. "While this is true, the guy who sold the land presumably sold the land to buy something, so your reasoning IMHO works only as long as guy B either keeps the money in his bank account (i.e. he "buys" a financial asset) or buys another asset equivalent to land (i.e. something that can grant a rent but is not produced by labor)."

      But this same reasoning should apply equally to earned income -- if I work and earn $100, I should either spend it or buy a financial asset, so that should generate $100 in income for someone else, which must in turn result in $100 in income for someone else, so GDP = infinity, right?

      You're describing a hot potato economy, and while at the micro level you can make a good argument for why an individual should behave the way you assume, at the macro level it is impossible for the economy to work this way. The cash must always be in somebody's hands, even though they shouldn't be saving in cash. Yes, the person who sells land probably has something in mind to do with his money (although he could have nothing in particular in mind -- he may just think it's a good time to sell and he's gotten an excellent offer), but wherever his money goes next, it won't happen instantaneously. And how long exactly the money stays in one place has enormous implications for the economy; you cannot approximate reality without getting the velocity of money right.

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    6. "You're describing a hot potato economy"

      I understand your point but we are arguing specifically about:

      - consumption;
      - investiment in production of new capital;
      - rents;
      - investiment in acquisition of old capital goods or non productable capital (like land).

      So there is a point where someone actually eats the potato (consumption).
      The OP point was that we know that consumption rose as a share of GDP, while investiment in the production of new capital fell.
      Other people (JCH above) noted that, since we are speaking of shares, if investiment in production of new capital falls, necessariously consumption has to rise as a share of the total even if in absolute term it isn't rising.
      RSJ made the different point that the stats for conumption are, in his opinion, inflated because american capitalism is in rent seeking mode, and this caused an increase in nominal price without a real increase in consumption.
      In RSJ opinion, the quantity of potatoes eaten (final consumption) didn't rise, but the price of those potatoes is inflated by increased rents of (in this example) landowners.
      My objection is that, as long as we speak of rents or investiment in non produced capital like land, we really are in a "hot potato" economy, since nobody is producing (or consuming) anything; we exit from the hot potato economy only when the potato is actually eaten, either in consumption or in the production of new capital goods, and as a consequence the increase in rents should be explained by the fall in investiment in production in capital goods.

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    7. Guys, financial transactions are not income. Buying and selling of land or shares of stock on the secondary markets does not produce income for anyone. There is no "hot potato" effect.

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    8. Yeah, there is some stock/flow confusion here. But perhaps it's endemic. Capital gains are not included in GDP, but they definitely figure in private incomes, eh? (And they can result from foreign, just as well as, domestic assets, and, as is partly the topic of this post perhaps, they can be engineered by corporate and financial managers). For that matter, the government statisticians aren't sure about just how to figure financial services into the GDP accounts, using a fairly obscure imputation method. (I would love to be a fly-on-the-wall 10 or 20 years hence, when the statisticians revise the GDP figures from the past dozen years).

      Which goes to the whole trickiness and difficulty of identifying and accounting for economic rents. (And if rents are a private tax on the rest of the economy, that does not automatically mean that they are bad or dysfunctional, any more than public taxes. That ambivalence of oligopoly rents is Bruce Wilder's favorite theme). It's not even the case that rents are excessive profits, since higher than average profits can be at least temporarily "justified" and rents can be quite small, (e.g., a "negative basis trade" on a banks books suing derivatives, which might only amount to a few bps.).

      But the thesis that an increase in rent extractions parallels a decline in new real productive investment, partly by raising the perceived relative "hurdle rate" required for investment decisions, is plausible, even if it's hard to know how that could be substantiated from available statistical evidence.

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    9. "So there is a point where someone actually eats the potato (consumption)."

      No. In my analogy, the potato is the money changing hands, not the goods/services/capital. The potato is not eaten as a result of consumption. When you purchase something for consumption, the money is now in someone else's hands, and they have the same choices for what to do with it next as they would if you had bought land from them. And one of those choices must be to do nothing for the moment; otherwise you are describing a game of hot potato.

      If we can agree that what happens to money after it is spent need not depend on whether or not that spending contributed to GDP, then we should agree that suggesting that any spending that does not create income will lead to spending that does makes no more sense than saying that any spending that creates income will lead to additional spending that creates income. Which is to say, it doesn't make much sense.

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    10. No, there is no hot potato, because if all households would rather hold more interest bearing bonds and fewer deposits, they will bid down the price of bonds creating an arbitrage opportunity for the banking system, which will sell more bonds, reducing the aggregate amount of deposits.

      The deposits, which are individually created when banks make loans, are also individually destroyed when banks sell bonds, so there is an equilibrium in which the amount of deposits being created is equal to the amount of deposits being destroyed. This equilibrium occurs when households are happy holding the current deposit/bond mix.

      There is no possibility of infinite GDP or infinite income generation anywhere in the above process, because incomes do not increase or decrease as a result of these adjustments between the financial sector and the household sector.

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    11. Apparently Krugman agrees with RSJ:
      http://www.nytimes.com/2013/06/21/opinion/krugman-profits-without-production.html?partner=rssnyt&emc=rss
      and
      http://krugman.blogs.nytimes.com/2013/06/21/rents-and-returns-a-sketch-of-a-model-very-wonkish/#more-34907

      I have two problems with Krugman's formulation:

      1) Is this really something new? I often read that interwar marxist authors made a big deal of monopoly capitalism, so maybe the predominance of rents on "profits" is more a cyclical aspect than a legal one;

      2) this sentence: "If household income and hence household spending is held down because labor gets an ever-smaller share of national income, while corporations, despite soaring profits, have little incentive to invest, you have a recipe for persistently depressed demand." expresses what I find dubious in this argument.
      The assumption is that all final demand comes from households whose income comes from wages. But, rentiers can contribute to final demand too, by buying yachts and cadillacs and decadent services! The idea that rents do not contribute to final demand can be justified only if we think that rentiers have an higer propensity to save than workers.
      But, how can those rentiers save? Since they cannot really put cash in they mattresses, they either buy financial products, or capital goods.
      If they buy capital goods, they either buy new capital goods (thus increasing investiment) or old goods.
      But in our story there is no (or few) new investiment, so they only buy old (or non reproductable, like land) capital goods, or they save financially. Why do they not buy new capital goods? Arguably because it is less profitable than the other two options; thus the idea that rents are strangling consumption rest on the assumption that the expected rate of profit for newly produced capital goods is very low.

      But why is it so low? If we say that the expected rate of profit for new capital goods is low because of low final demand we enter in a circular logic.
      Or maybe is it an actual circular causation?

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  23. Doc at the Radar StationJune 15, 2013 at 3:13 PM

    Chris Dillow has a convincing post up concerning our lost decade.

    http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2013/06/origins-of-the-crisis.html

    "I say all this as a corrective to a common view on the non-Marxist left - that our economic problems are due to greedy bankers and to austerity. But this is nothing like the whole story. This has been a crisis of real, and not just financial, capitalism - which is why it is so intractable."

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  24. Going back to your original observation about the changing relationship between shareholders and corporations (and its impact on corporate investment trends in the US since the 1990s), I believe this is a key factor - and exactly the same conclusion has been reached for quite some time by Bill Lazonick, whose work on stock repurchases is very interesting and relevant to what you're saying here.

    Check it out: http://www.uml.edu/centers/CIC/Lazonick%20Quest%20for%20Shareholder%20Value%2020080917.pdf

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  25. Yes, Lazonick's stuff on share repurchases is good. I believe I've linked to him in an earlier post on this topic.

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  26. JWM June 10 10:10 AM
    "Some income is saved -- that is, not spent on currently produced goods and services, but used to acquire an asset of some kind, either an existing physical asset or an abstract claim on future output. The national income identity tells us that total savings = total investment. But it does not tell us how that equality is maintained, that is, what adjusts. There are basically three possible stories: . . . "

    It is a minor, stickler's point, I suppose, and I know you know better, and were just grasping for a peg on which to hang a short comment, but macro reasoning is hard enough to get right, when we don't introduce basic confusion between the double-entry bookkeeping conventions of the national accounts and the stasis of an institutionalized system. Nothing has to adjust to make savings equal investment in the accounts (except the residual ;-)

    It is the three-way balance between consumption, investment and idle waste, which offers a challenge to systems of money and economic rent. This could be foundational for much of the rest of the discussion.

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  27. Hi Andy.

    Is your first graph strictly domestic? Also, I imagine given various types of outsourcing the picture may be a little distorted. To take a goofy example, if Foxconn is adding production capacity that won't show up anywhere in Apple's capital investment outlays.

    Yes, it's domestic. But there is actually a lot of domestic fixed investment in the industries we think of having the most outsourcing. Apple, as commenter Alex points out, actually is making huge direct capital expenditures -- from $1 billion in 2009, to $2 billion in 2010, $4 billion in 2011 and $8 billion last year. For the "computer systems design" sector as a whole, fixed investment is up 20% from the bottom of the recession, one of the biggest increases for any sector. Same with autos, another one where we think of a global assembly line -- Ford and GM both had fixed investment over $9 billion last year, and the auto sector as a whole, fixed investment is now well above where it was before the recession. Even Wal-Mart, which you think of as totally outsourced, has major fixed investment, $13 billion in 2012. (And I believe that excludes their foreign affiliates.) On the other hand, areas where investment remains really depressed include telecoms, transportation and of course construction -- all basically domestic sectors. So while I'm not totally against a globalization story of depressed investment demand, I don't think that's the main thing going on.

    Obviously, this is a matter of degree, but the limit is an arrangement where the Apple corporation has no investment spending at all (except occasional computer upgrades and office space) since it's main function is creating/managing and not producing.

    I think there is a possibly interesting story where a greater portion of the surplus is claimed via IP, brands and what we might call "coordination rents," and less via scarce physical capital. In a world like that, yes, fixed investment would be secularly lower. This might or might not be made up for by higher R&D and marketing expenses. But yes, as you say, full employment in that kind of world might require permanently higher consumption spending, either private or public.

    (You can actually find sort of this argument in Arrighi's Long 20th Century, applied to early-modern city states. Or in Baran and Sweezy I suppose.)

    Bear in mind that this is consistent with corporations holding a lot of cash since they no longer have to pay for investment "upfront" but now pay for it "as needed" in the sense that they rent instead of own productive capacity.

    I'm pretty sure this is wrong. You hold cash to deal with the problem of large, unpredictable variations in sources and or uses of funds. These are more likely when expenditure is lumpy, like fixed investment (and especially acquisitions) tend to be. If you rent capital your expenses should adjust more smoothly, so less need for cash.

    Real estate aside, domestic investment may just not be as necessary as it once was in a % of GDP sense. In which case, consumption is too low.

    As I said above, I think there may be something important here. (Altho people tend to underestimate just how much of investment is structures.) But I still think the main change isn't in technology, but in social relations: rentiers are stronger and greedier.

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    1. Not sure if I should have replied here or to Alex, but to address the investment thing. It is not so much a matter of "no domestic investment" or not, but rather the degree, which is an empirical issue that I'm not really able to answer.

      However, a not very serious, back of the envelope way of trying to make my point (and with all the usual disclaimers about how crude these measures are): GM has a market cap of about $50bill, so FI/Market-Cap is 9/50 or around lets say 20%. On the other hand Apple has a market cap of around $400 billion so 20/400=5%. Relative to the size of the firms, apple as a "new economy" firm invests significantly less than old timey industries.

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