The Something’s-Not-Quite-Right Economy
(Bloomberg Opinion) -- Economists like puzzles, and recent economic data have generated a fair share of them. For instance, the U.S. labor market recovery has been underway for years, yet growth in inflation-adjusted wages remains weak. More broadly, the male median wage still is in the general range of where it was in 1973. There is an investment drought, and yet corporate profits are relatively high. Some measures of monopoly power are up, even as the internet and the rise in foreign competition retain their potential to foster greater competition.
How do all these data points fit together? It’s an admittedly speculative exercise, but I’d like to offer a relatively simple unified hypothesis — namely, greater capital mobility.
Capital today can cross borders more easily than it could a few generations ago. That might keep real wages down in the U.S. If wages threaten to rise during an economic recovery, for instance, it is then profitable to invest more capital abroad, where wages usually are lower. The end result resembles what economists call a “Malthusian” equilibrium. That means there is an upper limit to returns to labor: They cannot exceed the cost of bringing more labor to market, for instance by investing abroad (or perhaps building robots). Even a long recovery won’t help wages rise above that limit.
This same hypothesis can help explain both the U.S. investment drought and supercharged growth in many emerging economies. If capital is flowing overseas, that will boost growth abroad and worsen a shortfall of investment at home. Too much foreign capital flowing into the U.S. is absorbed by Treasury securities, rather than the private sector.
What about the high rates of return measured for capital investment in the U.S.? It seems strange to have high profits but low investment. Why not invest more to earn more money, thereby leading to an investment glut until the profits are competed away?
One hypothesis is that investors now expect a higher rate of return for domestic investments, a possibility suggested by economists Loukas Karabarbounis and Brent Neiman in a recent paper. Let’s say that entrepreneurs used to be willing to make domestic investments for an expected 7 percent return but now they demand at least 10 percent. Entrepreneurs will cut back on investment, but the remaining projects will have higher returns on average, more closely bunched around 10 percent than 7.
What accounts for this increased reluctance? Karabarbounis and Neiman consider factors such as greater risk aversion. A simpler alternative explanation, consistent with my capital mobility hypothesis, is that newly available rates of return in other countries are high, and that means competing investments in the U.S. will need to offer higher returns too. Maybe opening up another Starbucks in Singapore is more attractive than opening one in Akron, Ohio. In that case there can be higher profits at home, due to a kind of capital starvation, without having to believe monopoly power has gone up very much.
So that’s one story, based on an intuitive idea of greater capital mobility, which helps account for a number of the facts surrounding the U.S. economy. (If you are wondering about your portfolio, it implies that a lot of the higher investment returns will be found in multinationals rather than smaller stocks.) But what is this story leaving out?
At least two central issues. First, the mobility of capital is exaggerated; many people simply prefer to invest in their home countries, whether or not that is a rational decision. So, for this story to hold, true capital mobility would have to be higher than measured capital mobility. That might be the case if the highest quality capital projects were going overseas, in a way that is undervalued by the current numbers on investment expenditures. Another possibility is that the mere threat of investing overseas affects the domestic market, whether or not the capital actually moves. These hypotheses are, as promised, speculative.
A second potential issue is that economists tend to look at the last 15 years and see a “savings glut,” whereas this account treats savings and investment as relatively scarce. Perhaps “investment bundled with the right talent” is the correct scarce variable, and that is harder to come by than the aggregate numbers indicate.
To be sure, the rise of capital mobility cannot completely explain the recent puzzles in economic data. But it may be bringing the jigsaw closer to completion than any of the alternatives.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Tyler Cowen is a Bloomberg Opinion columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “The Complacent Class: The Self-Defeating Quest for the American Dream.”
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