Monday, September 12, 2011

The Three Components of Investment Demand – How Barro & Mankiw Are Talking Past Baker and DeLong

Dean Baker is not happy with something Greg Mankiw wrote:

The most volatile component of G.D.P. over the business cycle is spending on investment goods. This spending category includes equipment, software, inventory accumulation, and residential and nonresidential construction. And the recent economic downturn offers this case in point about the problem: From the economy’s peak in the fourth quarter of 2007 to the recession’s official end, G.D.P. fell by only 5.1 percent, while investment spending fell by a whopping 34 percent.

Mankiw then uses this observation to promote a pro-business agenda as if restoring investment demand was the key to having a vigorous economic recovery. Robert Barro is making a similar argument (something we’ll come back to shortly):

The administration’s $800 billion stimulus program raised government demand for goods and services and was also intended to stimulate consumer demand. These interventions are usually described as Keynesian, but as John Maynard Keynes understood in his 1936 masterwork, “The General Theory of Employment, Interest and Money” (the first economics book I read), the main driver of business cycles is investment. As is typical, the main decline in G.D.P. during the recession showed up in the form of reduced investment by businesses and households. What drives investment? Stable expectations of a sound economic environment, including the long-run path of tax rates, regulations and so on. And employment is akin to investment in that hiring decisions take into account the long-run economic climate. The lesson is that effective incentives for investment and employment require permanence and transparency. Measures that are transient or uncertain will be ineffective

Dean objects making a point that Brad DeLong also made:

American businesses are not scared and are not pulling in their horns--rather, they are investing for the future at a furious rate. Business investment in equipment and software is back to its pre-recession peak--it is investment in residential construction that is depressed

To be fair to Dr. Mankiw – he knows the part about depressed residential investment and he argued that non-residential investment is also lower than it was pre-recession. Then again: non-residential investment includes both business investment in equipment and software which has recovered and nonresidential construction, which has not recovered as well.

Paul Krugman is not at all pleased with this Barro-Mankiw argument noting:

investment is high when demand is strong and firms see a good reason to expand capacity. So the best thing we could do to spur business investment would be to get a recovery going by whatever means necessary, including fiscal stimulus.

In a way, the fact that business investment is equipment and software has recovered even though the economy has not is amazing. And I wish these debaters would focus on what is going on with respect to nonresidential construction. But I have a separate question for Dr. Barro who writes:

I propose a consumption tax, an idea that offends many conservatives, and elimination of the corporate income tax, a proposal that outrages many liberals.

This proposal strikes me as one that would be useful if the problem were too little nationals savings but my read of the current macroeconomy is that we have more national savings than investment even at very low interest rates. Is Dr. Barro really saying that if we save more we magically invest more? If so, I’m wondering how carefully he actually read the General Theory.


Suzan said...

Kudos on your analysis!

I have feared for a long while now that Mankiw's public views have been formed not by his views on economics but on his politics.

And although the same can be said of many of us, these public figures should be very sure before publishing that their formulations are as close to pristine as possible.

Because the reviews are vigorous.


ProGrowthLiberal said...

Suzan - exactly. I think they call this behavior drinking the Kool Aid. And it seems Barro has started guzzling the stuff!

Shag from Brookline said...

Is Mankiw a Romney advisor?

paine said...

The investment in soft ware and equipment
Is at a rate normal at this stage of a recovery ?

The investment rate over the cycle ned's to be
super imposed here

Yes it's doubtless changed shape and size over the b cycles since say 1950

But comparing to expected rate at this stage however loosely defined that may have together looks like the correct move here

The ridiculous conflation of construction with durables
Has two sides
Business and household

The suggestion is

Residential purchases of new housing is bogus
And similarly with new business structure purchases

Okay we get to believe buying equipment and soft ware is


What do household durable purchases look like?

The credit drought factor here ?

ProGrowthLiberal said...

Mankiw is a Romney advisor - along with Glenn Hubbard. Yes - the Bush CEA chair has decided to become economists for Romney. After all - they did such a great job with economic growth and bringing down the public debt!

TheTrucker said...

The most egregious lie in the remarks is:

"What drives investment? Stable expectations of a sound economic environment, including the long-run path of tax rates, regulations and so on."

Horse crap.

What drives investment is the inflation monster eating the rich person's pile of money. Inflation moves the money out of the bank vault and into REAL CAPITAL DEVELOPMENT. Of course, the creator of money must provide a destination for all that money. That is what taxes are for.