In our last post we alluded to the possibility that the technology-driven Fourth Industrial Revolution, for which many economists hope, will not be a panacea for enhancing productivity, in contrast to with earlier U.S. post-1870 industrial revolutions. Moreover, we addressed a complex structural factor, the slowing rate of increase in educational attainment, that insidiously depresses productivity growth.
What Is Constraining Investment Spending?
Today we turn first to the growth in the capital assets of businesses, i.e. capital stock. That growth is investment in such non-residential goods as offices, factories, computers, machinery, trucks, software, research and development, and a thousand other essentials that make businesses run. At the margin, it enhances the productivity of labor.
Our preferred metric for that growth is dividing net investment (gross investment less depreciation) by capital stock so we can judge the rate of growth in the capital stock outstanding. This ratio of growth exhibited a steady decline from an average of 3.45% from 1950 to 1986, to 2.6% from 1987 to 2007, and 1.5% from 2010 to 2015.[1]
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In a surprise to many, the ratio has continued to languish, even after the Tax Cuts and Jobs Act of 2017 which was effective January 1, 2018. Both the lowering of the corporate tax rate from 35% to 21%, along with a 100% bonus depreciation of short-lived assets, should have encouraged a proportionate increase in capital formation.
In fact, the stated objective of Republican officeholders who pushed the $1 trillion tax cut through was to get companies to invest more. They said letting companies keep more of their profits would lead to a surge in capital spending that would, in turn, boost productivity and amp up GDP growth to 3% or more.
Admittedly, it’s too early to draw definitive conclusions about the tax cuts’ effect on forward capex intentions. But only three-quarters into the new tax regime it seems that corporations are doing what most economists predicted: shrinking their capital base through share buybacks and increasing per-share dividends by reducing the share count. There also seems to be little correlation between the size of tax cuts and capital spending, the plans for many projects having been on the drawing boards before the tax cut. Most importantly, averages can be misleading. Two-thirds of first-quarter capex was accounted for by 10 companies: Alphabet, Amazon, AT&T, Charter Communications, General Motors, Intel, Micron, Microsoft, Verizon, and Walmart.[2]
Could Low Productivity Growth Be Tied to a Low Savings Rate?
There is a circularity in the flow of funds in all economies: What is produced equals what is spent, which in turn equals what is earned (i.e., GDP equals income), which is then either spent or saved. In national-income accounting the amount saved in an economy will be the amount available for investing in new plants, equipment, and inventories (S = I). We know that investment is crucial to the growth of productivity and, parenthetically, that productivity plus labor-force growth determines potential economic-growth rates.
Herein may lie the cause and the dilemma that S = I presents. If investment spending is to grow—suspending, for sake of this argument, Robert Gordon’s contention that it’s GDP growth that drives investment spending, which is likely true, ceteris paribus—greater national savings is required.[3] Government deficits are not saving, but “dissaving,” reducing the total savings available for investment. Since 1929, the personal savings rate has remained fairly constant, an average of 6.4%. Government deficits (dissaving), however, have continually increased since 1969. The brief reprieve in 1999 was courtesy of capital gains taxes on the dot-com bubble. Today, the net national savings rate is half of what it was fifty years ago. With burgeoning deficits, it could well be headed toward zero. Should that occur, investment would be forced further downward, continuing to erode productivity, unless, of course, consumer savings were to rise. But, if consumer saving rise, this would reduce consumer spending and economic growth, undermining the incentive for more investment.
Perhaps the Problem Is Nothing More Than Mismeasurement?
There are those who argue that the slowdown in U.S. productivity growth after 2006 is an illusion due to faulty measurement. Controversy, and perhaps misunderstanding, has resulted in evaluating the role of recent inventions that create consumer surpluses. For example, a finance firm and a household may buy the same Internet at the same price, but the former most likely derives a greater economic surplus from the purchase. Such products could skew our productivity measurements. Proponents of mismeasurement argue that official statistics have failed to place any surplus value on smartphones and tablets, which have become ubiquitous over the last decade. The counterargument is that many such examples are primarily used by consumers, not as a tool to boost business productivity.
This line of reasoning contends that social networking on Facebook and other sites, game playing, watching YouTube videos, and trading digital photos don’t generate business output that allows firms to create jobs or raise wages in proportion to innovations from the past. To be sure, there are growing uses for smartphones and tablets in business settings, including the smartphones of Uber drivers, the tablets carried by home-repair workers and airline pilots, and as devices for ordering and payment in some fast-food and casual restaurants. But mainly the smartphone produces consumer surplus that is not included in GDP calculations or in productivity statistics. This is nothing new. Consumer-oriented inventions have always created benefits to consumers that haven’t been included in GDP, including many of the great inventions of the 1870–1970 era.
Separating Wheat from Chaff
In the current political environment, administrative interference with free markets has drawn attention away from, if not thrown off, the economic reality. Whether it’s ad hoc trade or immigration policies that command the headlines, there is no denying that “Productivity is the most important determinant of the growth and living standards over the long run, and its growth has been weak since 2004 and dismal since 2010.”[4]
[1] Robert J. Gordon, “Why Growth Is So Slow When Innovation Is Accelerating?” NBER Working Paper No. 24552 (April 2018), 20.
[2] Equity strategist Jonathan Golub of Credit Suisse.
[3] While declining net investment is also a cause of slowing productivity growth, there is a concurrent channel of reverse causation in which declining population growth and labor-force participation, together with the dampened impact of innovation, erode the extent of profitable investment opportunities. Thus, low net investment is both a cause and a result of the overall slowdown in GDP growth.
[4] Martin Neil Baily & Nicholas Montalbano. The Brookings Institution. “Why Is U.S. Productivity Growth So Slow?”