[A-List] Contradictions of capitalism: falling rate of profit

["Keaney Michael" <Michael.Keaney@xxxxxx>]

This sort of drivel shows why most economists are exactly the last
people to expect to get any clear insight from. Even when they identify
an important trend or phenomenon, they completely misunderstand,
misinterpret, misrepresent it. In this case, this clown buys into the
great US "productivity miracle" of the last decade, which, thanks to
Enron and the unravelling of the financial regulatory apparatus, we know
is based on a lot of technocratic smoke and mirrors that altogether
effectively constitutes a share support operation that transcends any
notion of legality. Similarly, the idea that the fruits of this
"miracle" have not been translated into profits, but have instead been
eaten up by "workers rather than shareholders" is utterly false. Unless,
by "workers" he means those executives who lined their own pockets with
their employees' pensions, etc.  Nevertheless there is a fundamental
truth beneath all this crap, and that is the diminishing returns to be
reaped from continued investment, given the glut of IT in the system and
the increasing evidence (charted in the "new economy bull" thread) that
it contributed negligibly to productivity growth (8% according to PA
Group). King also very nicely shows what sort of criteria he employs
when judging economic "success" -- not full employment, but rather
corporate profitability. The Third Way's "social inclusion" agenda
depends upon an approximation of full employment, achieved by
state-subsidised low paid menial and unskilled jobs ("workfare") that
would otherwise not exist/be filled, etc. Market purists are, as usual,
appalled, and would prefer to see the market clear naturally -- poverty,
destitution, starvation, etc., being unfortunate "externalities", if not
"choices" made by rational, informed masochists.


A rise in business investment is not always good
'Numerical ambitions for investment spending have to be buttressed by
notions of quality and sustainability'
Stephen King
The Independent, 11 March 2002

"So this is the challenge for this Budget and for the future: by our tax
and fiscal decisions, to secure rising levels of business investment and
rewards for entrepreneurship." Last year's Budget was focused on the
whole issue of raising investment in the UK economy. Indeed, Gordon
Brown was keen to stress one particular measure of success, namely the
share of investment within national income. "Business investment has
grown by 2 per cent as we lock in a higher level of investment as a
share of our economy, over 14 per cent, higher than at any time in forty
years."

Is a high investment share of GDP really a useful measure of economic
success? Intuitively, the concept seems to be appealing. The more
investment you have, the more you are likely to have a decent underlying
rate of growth. Putting away a few pennies today should provide a useful
nest-egg for tomorrow. Investing in the future of your economy is,
surely, a better bet than consuming today without any regard for levels
of prosperity in the years ahead.

All of this may be true but the idea that a higher share of investment
in GDP is somehow a good thing is, in reality, a fairly odd conclusion.
It is clear that the attractions of this particular measure come from
the US experience over the last few years: in the second half of the
1990s, the investment share within US GDP rose dramatically, associated
with the emergence of the New Economy. If that increase in investment
could be emulated elsewhere, then the New Economy could be for everyone,
not just for dynamic, entrepreneurial Americans.

We can live in hope. In my view, there are big problems with using the
investment share of GDP as a measure of economic success. It is true
that the US has enjoyed a rising share of investment in GDP and it is
equally true that the US has overtaken the eurozone on this particular
measure during the course of the 1990s. On that basis, there might be a
case for suggesting that the eurozone's lack of growth recently may have
something to do with a lack of capital spending. However, the argument
begins to break down when you start looking either within the eurozone
or elsewhere. Chart one tells an interesting story. Remarkably,
America's investment share within GDP last year was little different
from either the UK or Germany. Even more remarkable, all three countries
had a lower investment share within GDP than Japan.

Given these facts, little comfort can be gained by focusing on the
investment share within GDP. In truth, the measure says absolutely
nothing about the long-term sustainable rate of economic growth. Indeed,
on some occasions, a rapidly rising investment share within GDP could be
regarded as a bad sign, an indication of corporate hubris, whereby
excessive gains in the capital stock choke off profits and future
investment. Indeed, looking at the experience of Japan, the UK, Spain or
Sweden in the late 1980s, a rapidly rising investment share of GDP could
be regarded as a source of subsequent economic instability. All four
countries ended up in recession - or economic stagnation - in the first
half of the 1990s and eventually saw their investment share of GDP
falling from dizzy heights.

One problem with these measures is that they do not deal adequately with
the life expectancy of a given lump of investment or, to put it another
way, they don't capture the rate of depreciation of capital goods.
Capital spending can, theoretically, be split up into replacement
investment and net new investment. In practice, however, these
distinctions are difficult to make. After all, if you have to replace
worn out machinery, you are likely to use an updated, more productive
and more efficient model. In other words, the new investment will partly
be a replacement story and partly be a net new story.

One of the justifications used for the rapid gain in the investment
share within US GDP has been the impact of rapid technological progress.
The argument is straight-forward. Rapid technological change enhances
profits in the short term - because of faster productivity growth - but,
at the same time implies that capital becomes obsolete more quickly than
in the past (after all, would you bother to buy an IBM 286 these days?).
This greater obsolescence implies an increase in the amount of
replacement investment that has to be carried out each year, thereby
boosting the share of capital spending within GDP.

This is a neat argument but there are problems with it. Two underlying
assumptions are being made, both of which may be wrong. First, it is
assumed that the productivity gains stemming from the new investment
will benefit company profits and shareholders. This assumption is
important because it provides the incentive for investment to carry on
at an elevated level. Yet the experience of the US over the last couple
of years has been that many of the rewards of faster productivity have
gone to workers rather than shareholders, thus reducing the incentive
for even more investment in the future. Second, it is assumed that rapid
technological change must imply a heightened rate of capital
depreciation. This, however, does not seem quite right. You are only
likely to replace your investment if you believe there is money to be
made. If your expected future returns come down you may decide to
"stretch out" the lifespan of your existing capital stock. By doing so,
the replacement investment rate falls as does the share of investment
within GDP even if technological progress continues apace.

Even worse, of course, it may be that the productivity gains that should
accrue from investment in new technologies may simply not materialise.
It is odd, for example, that the UK has seen a similar capital spending
pattern to the US but has yet to reap the rewards of this
entrepreneurial activity in the form of sharply higher productivity
growth (chart two). Of course, it may simply be the case the higher
capital spending in the UK has brought other benefits along instead -
greater job opportunities and, hence, a lower unemployment rate - but
there are also signs that British workplaces have not been flexible
enough to extract the full benefits of the new technologies.

Whatever the case, it is clear that numerical ambitions for investment
spending - whether they be for the economy as a whole or within the
public sector - have to be buttressed by notions of quality and
sustainability. The experience of the major industrialised countries
suggests that simple rules of thumb along the lines of investment shares
within GDP are fairly misleading. Yes, investment for the future is a
desirable aim in theory. But not all investment is ultimately good.
Unless something can be said about the quality of investment, its impact
on productivity and profits and on jobs, it is a good idea to hold off
from making sweeping generalisations. The rise in investment within the
US economy has looked good because productivity growth has been so
strong (although the story may still be undermined by weak profits). The
same cannot be said - yet - for the rise in investment in the UK.

Stephen King is managing director of economics at HSBC.

Full article at:
http://news.independent.co.uk/business/news_analysis/story.jsp?story=273
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Michael Keaney
Mercuria Business School
Martinlaaksontie 36
01620 Vantaa
Finland

michael.keaney@xxxxxx