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.


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