Business Economists Are Strange Redux
The back-and-forth between Michael Mandel and others over the importance of saving was already strange. His rebuttal to PGL from Angry Bear, however, is even stranger. The criticism from PGL read as follows:
“An increase in government-sponsored R&D might be a very nice thing as Mandel suggests, but he seems to dodge the question as to how we pay for this extra expenditure. Do we cut some form of private or government consumption? If so, then I’d call this saving.”
Mandel’s response to this is again confused– he’s clear about his belief that saving is overrated, and that government should fund R&D, but his reasoning is the product of someone who has spent too much time away from his basic economics roots. He begins his argument by taking issue with the title of Angry Bear’s post, namely “More Free Lunch Economics from Michael Mandel”, and repeating his proposition that capital expenditure is not that important to growth:
“First, I like free lunch economics. The economic history of the past 200 years is basically one long free lunch, with productivity growth far outrunning anything which could be justified on the basis of physical capital investment alone. Since 1948 output per person has grown by 2.3% annually. Out of that, the contribution of physical capital is only 0.9% (see page 6 of this BLS release)”
His argument is accurate on its face, but ignores something I pointed out in my previous post.
A simplification of the table to which he refers:
| Average Annual Percent Growth in Output Per Hour, 1948-02 | |
| Contribution of capital intensity | 0.9 |
| Contribution of labor composition | 0.2 |
| Multifactor productivity | 1.2 |
| Total | 2.3 |
Mandel’s argument is that saving is overrated– and, from the table, it appears at first glance that he’s probably right. Saving appears most obviously in this table in the row titled “Contribution of capital intensity”. Increases in capital intensity are responsible for about 39% of the growth in output per hour we experienced between 1948 and 2002. Increases in output per hour due to the labor component are responsible for only about 9% of the total. The other component, “Multifactor productivity”, is responsible for the other 52% of growth in output per hour. Multifactor productivity is considered to be a measure of the effects of technological progress. Thus, Mandel’s prescription for increased government expenditure on R&D.
However, what we encounter with this table is another form of an error I pointed out before, when I stated that “traditional investment is always required to take advantage of new technologies.” Multifactor productivity is called what it is and not “Technological progress” because to take advantage of technological progress, we need to put those technologies into practice. In short, capital expenditure is a huge component of multifactor productivity. If there is exaggeration, it is on the part of Mandel, as he understates the importance of saving (and thus capital expenditure), not on the part of “capital fundamentalists” as he has claimed.
This does not mean that expenditure on R&D is a bad idea, however. It simply means that saving is also important. As I stated before, increased expenditure on basic research is likely a very good idea. Where Mandel and I differ in our policy prescriptions is on how to pay for it. Mandel argues,
“If R&D is an investment, then spending on R&D creates a long-lived asset with a rate of return. If that rate of return exceeds the interest rate on debt, then it is socially beneficial to borrow to fund R&D expenditures. I don’t need to find other cuts to fund it.
“To put it another way, suppose we were going to do the government budget the right way, and divide it into an operating budget and a capital budget. Then the right policy goal would be to hold down the deficit in the operating budget. R&D, however, would fall on the capital side of the ledger (because it’s a long-lived asset) and wouldn’t count against the operating budget deficit.”
In his post, Mandel asserts that PGL misunderstands the arithmetic of R&D. In fact, the error is Mandel’s. He’s committing one of two errors: he’s either conflating the fiscal and current accounts, or he’s overestimating the benefits of what would be a rather odd policy.
If we first assume that Mandel intends for the government to spend money on basic research, through NSF grants or some other mechanism, he’s conflating the fiscal and current accounts. If we assume that the product of such research would have a positive effect on overall growth (larger than the borrowing necessary to finance the research), we could consider, from a national account standpoint, that the initial “investment” would generate a return, and would thus justify the borrowing. What it would not do, however, is generate a return for the federal government. Thus, the government’s borrowing wouldn’t be offset (as the growth would have to be unrealistically high for increased tax revenues to cover the expenditure), and the government would still have to cut the budget or raise taxes to finance its expenditure– which is perfectly okay, it just happens to be what Mandel has argued is unnecessary.
If we instead assume that Mandel intends what is implied in the passage, that the R&D would be government-directed, presumably targeted (he mentioned energy in a previous post), and result in government-held patents that would be an asset generating a return, we find a different problem. In such a case, we’d be assuming that the government could generate a higher rate of return on its investments than the private sector. If the return on the investment would be worthwhile, why not cut that R&D from the budget, and let the private sector make the investment? It does tend to be a more efficient solution. Government borrowing, as I said before, tends to crowd out private investment. That crowding out effect does affect private-sector R&D expenditure as well as investments in physical capital, making this policy inadvisable.
In sum, Mandel’s a smart guy, and he has some useful thoughts, but it seems as though he’s unwilling to accept that, while major portions of his argument make a lot of sense, not all of his assertions are pure gold. It seems that that he’s jumped from trying to reach the best available knowledge on the subject to trying to win an argument– never a pretty sight. He’s right that savings doesn’t take into account all aspects of growth. He’s also right that encouraging basic research would be a beneficial move– if we assume that we can fund it through cuts elsewhere. He’s not right, however, that cutting the budget deficit isn’t necessary, nor is he right that the R&D can do all the things he wants it to do simultaneously.