Second estimate of 1Q 2015 GDP and worrisome R&D data

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As expected, the second estimate of 1st quarter GDP from BEA shows the economy actually declined by 0.7% (rather than rising by 0.2% as earlier estimated - see earlier posting). Part of the revision was a downgrading of investments in intellectual property products (IPP) - which grew by only 3.6% as opposed to 7.8% in the earlier estimate. The biggest revisions was that R&D investment was almost flat in the 1st quarter -- up by only 1.1% instead of the 12.3% growth estimated earlier. Given that today's estimate is based on the latest R&D data, this is a very worrisome trend.

Of course, this figure could get revised again next month. Stay tuned.

IPP parts 1Q15 - 2nd.png

Senator Hirono (D-HI) gets it

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Earlier this month, Senator Mazie K. Hirono (D-HI) introduced S.1262: The Small Business Start-up Savings Accounts Act of 2015. The bill would allow entrepreneurs to establish a business savings account similar to an individual retirement account to pay for start-up expenses. Qualified distributions explicitly include "purchase of equipment or facilities, marketing, training, incorporation, and accounting fees." In other words, the intangible investments needed to start and grow a business.

This is one of the few pieces of legislation that explicitly includes such intangibles. Senator Hirono clearly gets it.

(See also her press release)

Earlier this year, Andrew Haldane, Chief Economist at the Bank of England, gave a fascinating speech on "Growing, fast and slow." In it he succinctly sums up the history of economic growth. As he notes, "If the history of growth were a 24-hour clock, 99% would have come in the last 20 seconds." Given that economic growth is a very new phenomenon, he goes on to look at where growth comes from. Specifically, he outlines the difference between the Neo-Classical exogenous growth model (where innovation is an outside random factor - "manna from heaven") and the "New Growth Theory" endogenous growth model (where innovation is a function of internal factors). [See my paper on Technology and Economic Growth: A Review for Policymakers for a somewhat dated discussion of exogenous versus endogenous growth theories.]

The Neo-Classical model sees the Industrial Revolution as sparked by successive waves of general purpose technologies (GPTs):

During the first industrial revolution, these GPTs included the steam engine, cotton spinning and railways; during the second, electricity, the internal combustion engine and internal water supply and sanitation; and in the third, the personal computer and the internet.
The endogenous capitals model takes a more complex view. As Haldane says, "On this interpretation, sociological transformation supported, perhaps preceded, technological transformation."

What I found of great interest was how Haldane ties the endogenous theory to the intangible capital model:

The factors driving growth [in the endogenous model] are multiple, not singular. They are as much sociological as technological - skills and education, culture and cooperation, institutions and infrastructure. These factors are mutually-supporting, not exogenous and idiosyncratic. And they build in a cumulative, evolutionary fashion, rather than spontaneously combusting.

One way of accommodating these broader factors is to widen the definition of "capital": physical capital (such as plant and machinery); human capital (such as skills and expertise); social capital (such as cooperation and trust); intellectual capital (such as ideas and technologies); and infrastructural capital (such as transport networks and legal systems). Growth results from the cumulative accretion of multiple sources of capital.

To take a simple example, the success of the railways relied not just on the invention of the steam engine (intellectual capital), but on the materials (physical capital) and skills (human capital) to build locomotives and track. And to become a GPT, railways needed in addition a network (infrastructure capital) and the cooperation and trust of the general public (social capital).

He uses the "capitals" model to provide what he calls a sociological view of the rapid economic growth in during the Industrial Revolution.

The first driver of faster economic growth was the development of human capital. Sometime in the 16th Century literacy rates began to dramatically rise, providing a human capital foundation for innovation process that fueled the Industrial Revolution. Education levels also rose continuing the accumulation of human capital (both widening and deepening) needed to keep the innovation process moving.

The second driver was an increase in social capital:

Violent crime fell dramatically between the 15th and 18th centuries, by a factor of around five. By the time of the Industrial Revolution, it had levelled-off.
This helped support the trust and co-operation that facilitate commerce and economic growth.

Likewise institutional and infrastructure capital developed earlier provided a foundation for future growth:

England was the birth place of the Industrial Revolution. Its parents, arguably, were English institutions well into adolescence at the dawn of the Industrial Revolution: a parliamentary system from the 11th and 12th centuries; a legal and judicial system from the 12th and 13th centuries; a central bank, the Bank of England, from the end of 17th century.

Finally, the innovation during the Industrial Revolution was built on the existing stock of intellectual capital:

From the windmill in the 12th century, the mechanical clock in the 13th, the cannon in the 14th, the printing press in the 15th, the postal service in the 16th and the telescope and microscope in the 17th, the innovation escalator was in service well before the Industrial Revolution, albeit stepped and sticky.

All of this historical analysis becomes especially important when Haldane turns his attention to the current debate over economic growth. He characterizes this as secular innovation versus secular stagnation. The Neo-Classical model, he argues, leads one to an optimist secular innovation point of view. He sees a new wave of GPTs re-igniting growth:

it is only recently that the digital revolution may have reached critical velocity. Perhaps consistent with that, a number of transformative technologies have arrived on the scene recently, including in the fields of robotics, genetics, 3D printing, Big Data and the "internet of things". These are not new. What is new is their widening application, as they have moved from inventions to GPTs.

On the other hand, the endogenous capitals model points out the headwinds that leads to a more pessimistic secular stagnation view. Inequality is eroding both social and human capital (see also my earlier postings). As Haldane notes, "Inequality may retard growth because it damps investment in education, in particular by poorer households." Lower levels of education and social trust and cohesion are a recipe for lower growth. Levels of investment in infrastructure capital are also eroding (which may be, I would argue, another result of the decline in social capital due to inequality leading to a lower willingness to invest in projects for the common good).

Other factor eroding the intangible capitals is increased short-termism and impatience. Haldane argues that social patience has been a key ingredient in economic growth:

In the run-up to the Industrial Revolution, society became more willing to wait than in the past. That, in turn, enabled saving, investment and ultimately growth. Patience was a virtue.

The reasons he gives for this shift are multiple. One is rising incomes:
During the Malthusian era, much of the population operated at close to subsistence income levels. If experimental evidence is any guide, that is likely to have generated an acute sense of societal short-termism. This may have manifested itself in, for example, a failure to invest in physical and human capital, retarding growth. Poverty and impatience would have been self-reinforcing, in a Malthusian poverty trap.

The raising of incomes above subsistence levels which occurred after 1800 will have reversed that cycle. It will have boosted patience and laid the foundations for higher saving and investment and, ultimately, growth. In other words, after the Industrial Revolution patience may have created its own virtuous reward, endogenous growth style.

Another is the technology itself:

Technological innovation has also been found to influence patience. The invention of the printing press by Guttenberg in around 1450 led to an explosion in book production. It is estimated that there were more books produced in the 50 years after Guttenberg than in the preceding 1000 years. What followed was much more than a technological transformation.

Books contributed to a great leap forward in literacy levels, boosting human capital. More speculatively, they may also have re-wired our brains. Nicholas Carr argues that the changes brought about by the printing press, and other information media, may have re-shaped our minds. Books laid the foundations for "deep reading" and, through that, deeper and wider thinking. Technology was, quite literally, mind-bending.

It has been argued that this re-wiring stimulated the slow-thinking, reflective, patient part of the brain identified by psychologists such as Daniel Kahneman. If so, it will have supported the accumulation of intellectual capital - creativity, ideas, innovation. Technology will have first shaped neurology and then neurology technology, in a virtuous loop. Slow thought will have made for fast growth.

He worries that technology might now be undermining patience resulting in slow growth:

We are clearly in the midst of an information revolution, with close to 99% of the entire stock of information ever created having been generated this century. This has had real benefits. But it may also have had cognitive costs. One of those potential costs is shorter attention spans. As information theorist Herbert Simon said, an information-rich society may be attention-poor. The information revolution could lead to patience wearing thin.

Some societal trends are consistent with that. The tenure of jobs and relationships is declining. The average tenure of Premiership football managers has fallen by one month per year since 1994. On those trends, it will fall below one season by 2020. And what is true of football is true of finance. Average holding periods of assets have fallen tenfold since 1950. The rising incidence of attention deficit disorders, and the rising prominence of Twitter, may be further evidence of shortening attention spans.

If so, that would tend to make for shorter-term decision-making. Using Daniel Kahneman's classification, it may cause the fast-thinking, reflexive, impatient part of the brain to expand its influence. If so, that would tend to raise societal levels of impatience and slow the accumulation of all types of capital. This could harm medium-term growth. Fast thought could make for slow growth.

As much as I like Haldane's analysis using the endogenous capitals model, I have to argue with his conclusions. Specifically I disagree with the conclusion that the endogenous capitals model leads to a pessimistic secular stagnation view while the Neo-Classical exogenous models supports an optimistic secular innovation view.

First, much of the argument of the techno-pessimists is grounded in the Neo-Classical exogenous growth model. Their entire point is that the manna has stopped falling. The low hanging fruit has been picked, to paraphrase Tyler Cowen. [In fairness to Cowen he does include human capital - in the form of education - as one of the factors powering past growth.]

Second, the capitals model provides as much a direction as it does a forecast. By laying out the factors that foster economic growth, the endogenous capitals model provides a blueprint for what needs to be done (for example see my posting on the State of the Union). Human capital can be strengthened though both formal education and informal training based on the principle of live-long learning. Social capital can be improved through various means. Institutional and infrastructure capital can be re-built. Intellectual capital can be expanded, in part by recognizing that the model of innovation has shifted.

More importantly, the endogenous capitals model indicates that something can be done. As Haldane says of the Industrial Revolution, "Innovation was an earthly creation, not manna from heaven." Our task is to continues that creation.



The intangible capital case for equality

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Last week, the Brooking Institution held a symposium on the 40th anniversary of Arthur Okun's classic essay Equality and Efficiency: The Big Tradeoff (see also Brad DeLong's posting on the event). While the event celebrated Okun's economic insights, the speakers debated the relevance of the essay's central argument. Many pointed out that the context of 1975 is very different than today. One of the speakers, Heather Boushey, went as far as to state (in her blog) that

Rereading Okun in 2015, however, feels about as relevant to my work as an economist as does reading Hilary Mantel's "Wolf Hall," about 16th century Britain. Both are interesting and enjoyable swings through the historical past-and I highly recommend them-but neither should be used as a roadmap for today's policymakers.
Robert Samuelson echoed this theme in his look at the traditional argument for an equality/efficiency trade off in the Washington Post (Poof goes the big tradeoff). Even the keynote speaker, Larry Summers, while praising the book made this point:
In my forward to the reprinting of Equality and Efficiency I describe the major changes in the economy, and speculate about what Art would be recommending if he were with us today. Rather than reprising that discussion here, let me conclude by noting how in areas relating to equity and efficiency my thinking has changed in response to a changing economy over the last 40 years. This is not I believe because my values have changed but is rather because of changes in the economy and our understanding of it.

One of the ways that the economy (and our understanding of it) has changed is the nature of work. The speakers touched on this
lightly, mostly in the context of new technology and the role of education. I would argue that there is a fundamental difference in how we view the workforce compared with 40 years ago.

In 1975, standard view of labor was a mind-hand split. Most workers were "doers" (physical labor) not "thinkers." This is the classic Taylorist vision of the economy. It even translates into the "post-industrial" vision of the economy which highlighted the leading role of the knowledge class and the centrality of formalized knowledge. The "thinkers" contribute more to economic growth and need to be groomed (through elite education) and valued (paid more). They need to be rewarded for the risks they take, otherwise they would not take those risks. The result is this group of risk takers are rewarded more -- i.e. unequally. The natural result is some level of inequality.

We have since come to understand the importance of the "doer" class. It turns out that the human capital of those other workers is huge. Both tacit and experiential knowledge, not just codified and science-based knowledge, are important. A decade ago, I noted in a posting that the changing nature of the economy made tacit knowledge more important:

The ability to innovate and to "design a compelling experience" are the important intangible assets. Routine activities -- no matter how technically sophisticated or important -- will gravitate to the cheapest workforce or be automated. Key to non-routine activities is a person's tacit knowledge as well as problem solving abilities.
In order to put those skills and knowledge to proper use, organizational structure comes into play. The old hierarchical systems of the industrial age are no longer adequate or appropriate. New adaptive organizations which encourage innovation are needed. What we use to be called "High Performance Work Organizations" are needed to effectively utilize worker skills and knowledge. In other words, we need all forms of intangible capital for economic growth.

As I've noted in earlier postings, inequality undermines the development of various forms of intangible capital that are needed to sustain economic growth. Inequality undermines human capital development by limiting education and the ability of all to contribute. Inequality undercuts strategic capital by weakening opportunity for entrepreneurship. It destroys relationship capital by undermining trust. Finally, inequality undercuts social capital through political instability and uncertainly.

Thus, let us acknowledge to contributions of great scholars such as Arthur Okun. But let us also understand how their work fits into the context of today. In this case, we need to understand the new relationship between equality and growth. Otherwise, we are trapped on Keynes' famous warning about being "slaves of some defunct economist."



April's employment data from BLS shows steady growth of 223,000 job with the unemployment rate ticking down slightly to 5.4%. This is about what economists had forecast (an increase of 228,000 jobs).

Employment in tangible producing industries grew by 106,000 in March led by growth in Accommodation & Food Service, Tangible Business Services and Tangible Education & Health Services. Intangible producing industries added 116,000 jobs with most of that gain in Professional & Business Services and Educational & Health Services. (See tables below.)

As the charts below shows, U.S. employment in tangible producing industries and intangible producing industries is just about equal. Up until March, employment in tangible producing industries had been growing slightly faster than in intangible producing industries.

For more background on this data, see my earlier posting.

Apr 2015 tangible & intangible employment.png

Apr 2015 parts.png
Apr 2015 pie.png



    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


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