Capital depreciation as stimulus?

Let’s say the U.S. becomes another Japan or for that matter let’s say Japan has become Japan.  Still, we all know that capital depreciates.  That raises the return on replenishing and rebuilding the capital stock.  Even though wealth is falling, it raises the marginal rate of return on investment.  Which in turn should spur aggregate demand and also credit creation.  At some point you have to get the roof fixed.  If alien invasion can work, what about a slower rotting away of the same output?

That’s a slow, ugly and painful way to end a downturn, but the deeper question is whether it will work at all.  It doesn’t seem to have worked in Japan and they’ve had enough time for a lot of capital to rot away. This paper measures depreciation rates (for America) and estimates that physical capital, without repair, has an average survival time of thirteen to sixteen years.

Why has it not worked in Japan?  I see (at least) two options:

1. The boost to aggregate demand has to be based on sustainable increases in real wealth, rather than deteriorations in wealth.  Maybe so, but then monetary and fiscal policy won’t work either, or more accurately the fiscal policy will work only if the resulting outputs are fairly valuable.  Keynesian pyramids won’t do the trick.  Of course, people who stress “the broken window fallacy” will likely side with this response.

2. As the capital stock depreciates, it is repaired slowly but steadily, enough to keep the MP of K from rising very much and thus there is enough capital replacement to thwart recovery.  (People who stress “the broken window fallacy fallacy” may prefer this option!)  That sounds plausible, but if I think about it long enough my worries multiply.

The argument implies that the real problem is low and enduring real rates of return, and not simply that a monetary trick is distorting those rates of return.  The marginal real rate of return keeps on creeping up and the decisions of investors keep on pushing it back down, but only so much; apparently the economy wants to stay in this low output, low rate of return corridor.  That’s closer to a TGS story than to a “we can fix this with AD” story.  (Alternatively, do you wish to argue that there is a collective action problem with the slow accretion of the “investment of repair” and that we should tax it and save it all up for one big bang of recovery?  I can see the model but does anyone actually believe this?)

Does the argument imply a funny non-linearity?  It implies that, say, a stimulus of $2 trillion will be more than twice as effective as a stimulus of $1 trillion.  Bombs falling are better than slow rot, and so on.  That could be true, but I see a lot of hand-waving on the issue.  It would seem to boil down to psychology and multiple equilibria (“the confidence fairy”?) and thus I am suspicious of very definite predictions along this particular dimension.  Of course, sometimes bombs really wreck a place; ever been to Bosnia?

It is worth pondering our views on capital depreciation and whether they are consistent with our other beliefs about macroeconomics and also about Japan and why it has remained in its downturn so long.

By the way, measured private investment has not really risen since 1998.


Watchmen 2: The economy stinks, so the heroes fake an alien invasion to boost demand.

We have been putting our finger on the scales, through our tax code, in favoring capital investment over employment, through accelerated depreciation and investment tax credits. We don't have a similar tax credit for employment, in fact, we penalize employment relative to capital substitution.

If it were the case that we were a creditor nation, and not a debtor nation, and if it were true that we made machines rather than imported them, then accelerated depreciation and investment tax credits might make sense, as they did in the 60's. But, times change.

What happens today is that human capital depreciates faster than physical capital, yet we do not invest enough in human capital, the kind that displaces or does not compete against the human capital in other countries. China can purchase the same piece of equipment as we can, but it might have more difficulty in making a nano technologist, electrical engineer capable of designing a wireless transmission protocol for monitoring a pacemaker, or a person to fix or repair in the US a wind farm.

If interest rates are stuck at the ZLB, an investment subsidy is a very cheap way to promote recovery, push rates above zero and restore full employment. You're right that this would distort the capital-labor margin in normal times, but this matters little when the economy is in recession, since the equilibrium rates would be negative anyway. But yes, to avoid further distortion one would want to subsidize all investment equally, including human capital and public projects.

Why does it matter little if in a recession? If one subsidy creates 20 jobs and another a net 3, which would you choose. Of course, that's begging the question, but if equipment displaces people, why subsidize equipment when you could directly subsidize the hiring of people or the retooling of their skills?

I could understand this back in the 60's. We were a capital exporter; now we import capital and thereby create foreign debt obligations with equipment purchases. I could also understand if there is a labor shortage. I certainly understand if adding new equipment improves effciency relative to foreign manufacturers, but the market would handle that, even if there is a recession, because a competitive firm competing in the world marketplace would try to be more efficient with or without the subsidy.

But, why do we continue to subsidize worker displacement. Just because it is good for short term corporate profits?

Because (broadly speaking) equipment does not displace labor in a recession. The economy is demand-constrained and unemployment is mostly due to cyclical factors (prices and wages are too sticky to adjust downwards), so the real choice is not labor vs. equipment, but rather spending on workers/equipment vs. keeping money in the mattresses/bank reserves.

"equipment does not displace labor in a recession." ???

Can you give me a cite.

Also, when you say the "real choice is not labor vs. equipment, but rather spending on workers/equipment", I would spend on workers, ie, improving human capital and not equipment, which, last time I checked, did not have a marginal propensity to consume.

Along the same lines, why do we not mention Japan's anemic birth rate and restrictive attitudes towards immigration as one cause of their stagnation? Fundamentally, every economy is based on speculation on future growth and the base of that growth is population growth.

Who is supposed to be "investing in human capital?" Short of rounding up construction workers and forcing them to learn Sharepoint at gunpoint, human investment is going to be a individual choice. We're already throwing truly massive subsidies at education, and it's not clear that's doing anything more than inflate tuition and fund wasteful academic spending.

Also, unless things changed have changed dramatically in the past few years, the U.S. is still one of the top five makers of specialized machinery. China isn't even close.

Well, dah, Tall Dave,

to use your own words,

"who is going to be forcing business to invest in equipement capital. Short of rounding up CEOs and forcing them to buy equipment at gunpoint, capital investment is going to be individual choice. We are already throwing massive subsidies at capital with investment tax credits and accelerated depreciation, and it clear that that's not doing anything more than displacing people with equipment.

Also, unless things have changed dramaticially in the past few years, the US is still the only top maker of US employees. China isn't even close." (Also, note, specialized machinery EXPORTS link you cite is not relevant; what you export is not by definition consumed in the US and is unaffected, in terms of stimulated demand, for US consumption--but, the subsidie does stimulate US imports of machinery from the 4 other countries who are larger exporters than us.)

Funny how silly the comment sounds when you frame it the other way and place the same hyperbole on the other foot.


1. No one forces anybody to do anything, not even rounding them up. We do use the tax code to incent businesses to displace people with equipment and put our thumb on the scale through the tax incentives, peversely during a recession.
2. Educational subsidies are for the young, before the enter the workforce. Actually, I would argue we do not do enough to retrain workers, because we are eager to get them off of unemployment and back to work.
3. Take away investment tax credits and accelerated depreciation and what you get is parity. But, it doesn't make sense during a recession to subsidize worker displacement.

It sounds silly because you're not making any sense. CEOs buy and make equipment, they don't buy or make electrical engineers. The only way you get more EEs is more people deciding to become EEs (which is why we're still, even with today's employment market, hiring lots of high-skill workers from other countries). There is an element of choice there that a new kind of extruding machine doesn't have.

Sounds silly to think CEOs don't buy--er, hire--employees? The idea here, which you choose to ignore, is that we favor capital over labor. Ever here of the Cobb-Douglas function?

The difference between hiring and buying is the element of choice. A specialized machine doesn't have to decide to be a specialized machine.

I agree we have been creating lots of unhelpful disincentives to labor (such as PPACA, and the high perceived MTR for the unemployed) but the larger problem is that here in the U.S. we're actually better at making specialized machines than we are at getting people to become specialized laborers.

TallDave, re PACCA, getting everyone in a pool reduces costs for everyone, including those who currently purchase insurance who subsidize the free riders who do not.

Paying for your own health care does not make you a "free rider." The only "free riders" are the people who are so poor they cannot afford to pay for their health care, and PPACA will not change that. In fact, PPACA will make this problem much worse because now they will be directly subsidized.

More relevantly, the immediate effect of PPACA has been to increase the cost of employment because of the sundry requirements within the 3,000 pages of legislation and the 10,000 administrative decisions, many of which are still not made. Companies are not besieging HHS for waiver requests to avoid lower costs.

Tall, I guess you weren't in class when they explained insurance pooling and separating equilibria--compelled pooling which eliminates adverse selection and separating equilibria, which explains why your insurance will continue to skyrocket if there were no compelled purchase, as prices would rise and people would choose not to purchase, leading to ....--. I suggest you listen to Prof. Shillers lectures on social insurance at Bascially, with compelled pooling, you can underwrite health insurance as you would something that is very, very predictable and controlled by the law of large numbers.

I guess you weren't paying attention when HHS revealed this year that the adverse selection market is virtually nonexistent: their estimates for the high-risk pools were fifty times too large. The savings to be had there are infinitesimal at best. This argument is no better than your "free riders" error.

Besides the fact forcing people to buy anything as a consequence of living is unconstitutional, difficult to enforce, and a gross infringement on liberty, there's no reason to think it's going to reduce costs.

Also, some states already have compelled purchase, and their results contradict your claim of lowered costs.

If we want to lower health care costs, we need to dismantle the insulation between decision-makers and prices, not create giant new subsidies. The other option is rationing, which PPACA proponents still alternate between claiming is a right-wing myth and a really good idea.

I can't think there is anything more explosive than having insurance companies compete for insuring a pool.

Bill and people like him really need to pick one of A) the mandate is to pay for the uninsurable B) the mandate is to stop free riding.

Btw, this was the funniest Bill since "this graph is accurate and well labeled, but I wish it showed something else!" Bill

Careless needs to decide 1) whether he likes to pay for others healthcare when they show up at the emergency room for an ailment that could have been averted or mitigated with earlier intervention; B) face the fact that in the real world he currently is paying for other people's healthcare, inefficiently; 3) recognize that when everyone is in a pool, adverse selection disappears, so there is the elimination of an externality that benefits him and 4) recognize that having everyone in does eliminate or minimize free riding and associated externalities and you still pay for the uninsurable, today, or in the future, but at less cost to them and to yourself.

Market competition between insurers would be great. To do that, we need to end the employer health insurance tax deduction and allow interstate competition (which means no more state mandates on what insurers must cover, which has become largely a tool to politicians to wield on behalf of special interests).

Preventative care is (somewhat counterintuitively, I admit) not a money saver; it actually costs more for virtually all care. This is because the number of diseases which become much more expensive over time when untreated, have cheap enough tests, are asymptomatic enough that people would delay treatment, and have a high enough prevalence in the population at any given time for testing to be cost-effective, is very small. In fact, this is one of the major reasons why U.S. health care is so expensive -- we do a LOT more diagnostics here, including twice as many MRIs as the OECD average.

You're still rambling about adverse selection and free riders, so you apparently still don't understand that pools don't really address the latter and the former barely exists.

Do you really not understand that anyone who is today getting free health care by skipping on the bill today is almost certainly going to subsidized under PPACA? And you don't get less of something by subsidizing it, so the "free rider" problem is just going to get bigger once it's become a deliberate government welfare function.

You seem even more confused about the exports. You should check the link more carefully.

First, by clicking on "Imports" at the bottom, you can see we export about as much as we import, so your assertion that we would probably be importing the equipment is wrong.

Second, you will see China -- a country with a massive trade surplus -- is a large net importer of specialized machinery -- by nearly three to one. Specialized machinery is a U.S. export strength in our relationship with them. So yes, China can buy the same equipment we can, but we're far more likely to have made that equipment. Advantage: U.S.

Finally, "one of the top five" is not a synonym for "fifth" -- there aren't four other countries there are that bigger exporters than us in that list, there is one. I qualify it that way because it only goes to 2005 and it bounces around bit.

Tall, I am sorry, but thee way you compute markets shares is to go to census data, determine the appropriate naifs codes, determine domestic production by establishments under these codes, to commerce data re exports and imports. I don't have the time or interest in doing this as anyone who has any knowledge of US equipment manufacturing knows that we primarily import from Germany and Japan, the beneficiaries of equipment stimulus. We still have advantages in chip equipment and some computer fields,
but not enough to justify a stimulus claim or effect.

That's one way, but not the only way.

What you claim might be true in some industries, but the numbers say you're wrong in the aggregate, "anyone who has any knowledge of US equipment manufacturing" notwithstanding.

It seems like market forecasts of low real yields 30 years into the future support TGS. How long does it take for long-run money neutrality to win out? If the yield curve showed low yields 100 years out, would that dissuade those looking for a monetary solution?

Perhaps this belongs in Sumner's comment section.

> That’s a slow, ugly and painful way to end a downturn

Every year of low demand, low output, and high unemployment causes irreversible damage. Slow processes cannot outrun this damage.

Maybe it depends for how the accounting method used treats depreciation?

I wonder if there could be any relationship between slowing depreciation rates and technological advancement. Many Boeings and Airbuses built during the 50s and 60s are still flying around today.

Restoration techniques, new oils/lubricants, technology is making things last longer. (new medical tech= slower human capital depreciation?)

Japan's population growth has been steadily declining since the mid-1970s. As that compounds, the existing stock of capital is too large relative to the number of workers. The MP of K is declining naturally without any need for much new investment.

Tyler, the fundamental problem with your analysis is that you still think of the U.S. economy as a closed economy.

Hope I could use "Time Machine" to go back to the late 1980s and think about Japan and the other Asian high-income economies at that time (Hong Kong, Taiwan, Singapore, Korea, as well as Australia and New Zealand), in particular to understand how the emergence of China (and later India, Vietnam, Indonesia, the Philippines, Thailand, and even Mongolia and East Russia) led to large reallocations of resources in the past 25 years. I'm not aware of any detailed, comparative study of how Japan and each of the other high-income economies adjusted and I'm not familiar with the details of each of these countries (except for Hong Kong). It's my impression, however, that any analysis of the poor performance of the Japanese economy that fails to take into account this adjustment is seriously flawed. From my work in China (and Mongolia), I know that HK, Taiwan and Singapore (and to a lesser extent Australia and Korea) had a much easier access to China than Japan. Although Japan tried hard to access China (but not Mongolia), they failed because of the Japanese atrocities in China during the 1930s. The same would have happened if the Japanese had attempted to enter into Mongolia. Likely some Japanese scholars have studied how much Japan has lost because of not being able to access China.

Once we understand that adjustment in all Asian countries, then we may ask how the rest of the world has been adjusting to the emergence of China and the other countries, as well as to the end of the Soviet Union and the liberalization of East Europe (at least 3 billion people have been integrated into the world economy in the past 25 years). Given what we know about other shocks to the world economy (and to large national economies) that implied significant reallocations of resources, the rise of the emergent economies most likely has been prompted a reduction of domestic investment in physical capital in advanced economies (as well as of a large change in the composition of this investment). How much lower has been depending on domestic policies (often terrible policies) and other factors, but after the financial and fiscal crises of the advanced economies in the past three years we now know that new policies to accelerate the adjustment to the rise of the emergent economies cannot include higher taxes and subsidies. The reason is quite simple --they wouldn't be credible.

So, let me say it again, open your mind to the idea of a U.S. open economy integrated into the world market economy.

E., I agree with you regarding supply shock of persons coming on the market who had been off the market for some time.

I am reminded of a neighborhood we once lived in suburbia. There was this farmland surrounding a lake, and the residents of the community gave all sorts of tax breaks to the farmer back in the 70s so he would not sell the land and create subdivisions, thereby increasing density. The land stayed off the market.

Years later, the kids sell the farmland--this time, the land is at such a high price, it becomes densely populated with condos and highrises, creating far more density than had the property been sold and subdivided in the 70s.

Had China or the USSR been integrated with the world economy back in the 50s, we would probably had a different course of economic development, with those countries having the same industrial infrasture and employment as West. Now, the floodgates are open, and there is a bunch of low hangin fruit in terms of human capital waiting to be sold at very low prices.

1. The boost to aggregate demand has to be based on sustainable increases in real wealth, rather

That, I think, nails it.

Japan definitely had structural problems -- layoffs and writeoffs were still somewhat culturally anathema so a lot of ZMP workers and dead loans were being warehoused. Then they built a lot of Bridges to Nowhere with fiscal stimulus that did not create real wealth. (Note that employing unproductive workers and fiscal stimulus mirrors some prescriptions on AD here.)

The flip side of all this was that their decade of recession wasn't all that painful for the median Japanese worker, but otoh they're still a significantly less productive society than the U.S., which isn't something many would have predicted in the 1980s, and certainly isn't the overall optimal outcome their society as a whole could have achieved. I think those focusing on AD here should take a lesson from the tradeoff there: pain vs. growth.

Preparation for an alien invasion doesn't help for the same reason that WW II didn't raise living standards, even in the U.S. (where there was rationing and half a million deaths) let alone globally. This is where econometrics can mislead us: yes, the numbers start moving in good directions, but what are they measuring? The ultimate purpose of an economy is to produce utility, but if that is shifted from the utulity of food, clothing, etc. to the utility of fighting off aliens/Nazis/Japanese then the overall well-being of those served by the economy will diminish even as the numbers look better.

I think things like war tend to be seductive to those would plan the economy precisely because they bypass the messy business of markets figuring out what people want, replacing them with singular goal for which it's relatively easy to define utility.

"Why has it not worked in Japan?"

In a senese, it worked. See
Row 10 is depreciation of fixed asset, and row 15 is NGDP. You can see the ratio of the former to the latter rose about 5% point from the late 80's to the early 90's(*). If the ratio would have been the same, NGDP would have been smaller by 5%, other things being equal.

(*)The ratio was stable before that. See
(Same format, old base-year data)

Many nations invest great quantities of money into their airports for continuous upgrades and aesthetics since it is the first impression to the tourist. They also spend a lot of money in their touristy areas to keep them clean and push the hooded fellows out of the gentrified capitals and museum/club/restaurant/entertainment districts.

They are following the money (tourism) as opposed to artificially stimulating demand with make-work projects.

The slow rot hypothesis for AD does not realize how Americans (and Japanese) can not only not buy new things, but actively reduce their standard of living. You would think that all our houses, cars, washing machines, computers, etc. would eventually have to be replaced. This is wrong. People double-up on housing, decide to live with one less car instead of buying a new one, etc. In my personal experience, in 2009 my company decided to combine offices after the lay-offs and didn't re-up one of their leases. So if another office building was falling part, that office could move into the office we vacated instead of building a new office building.

So why is an Alien Invasion better than Slow Rot? Because living standards can only be reduced so far in a liquidity trap. When Aliens bomb most of Manhattan, those residents with savings won't go homeless. They'll look to move somewhere empty and when there's no empty spaces left, they'll build new buildings.

So the core issue was, is and will always be increased liquidity preference in a liquidity trap. So many people have plenty of savings and income, but are very reluctant to spend money on anything new or even replace something that went bad. They're also reluctant to invest in anything other than ultra-safe bonds. In such an environment, of course AD falls and instead of going to lower across-the-board wages, the fall in AD has to be made up with less workers.

+1. Liquidity trap denialists are unwilling to confront the failure of monetary policy to dig you out of the hole. Slow rot of fear.

Er, no. Even Krugman didn't argue that an actual alien invasion would be beneficial. His argument was that the threat would create a reason for the gov't to spend lots of money money (the obvious flaw in that reasoning is that alien-defense stuff isn't actually useful so overall living standards would fall; see above).

TallDave: Actual alient invasion v. threat of alient invasion: this is a distinction without a difference: the point was, unless you believe in alien invaders, that even stupid spending was better than none in a liquidity trap. But, we don't have to be stupid: we can find things that we need to spend on. But, you can do your own alien spending.

Do I really have to explain why aliens actually causing huge amounts of damage is different than aliens not causing huge amounts of damage? Yes, it makes a gigantic difference.

Unfortunately, marginal gov't spending is pretty stupid at these levels anyway. It would be different if we were currently spending, say, 15% of GDP, but we're closer to 40%. Japan tried that trick in the 1990s and it didn't work.

Whatever happened to the role of rational expectations?

And; is there not also a continuing historic decline in ROA - Return on Assets?

Summing up several conversations threads above, there certainly should be more attention paid to the depreciation of human capital. That econometricians have difficulty placing a value on human capital makes it that much easier to ignore, but no less important.

A significant amount of the productivity boost often attributed to WWII is due to the buildup in human capital -- with a million or more skilled members of the workforce suddenly not available, lots of people (including lots of women) had to develop some basic workplace skills (showing up on time, following instructions, etc) and others levered into much higher skill positions than they would have had access to without the unfortunate circumstance of the war. Yes, wars destroy a lot of physical capital; but other than the soldiers actually killed (generally a small relative number), the stock of human capital is on net increased.

Tax incentives for investing in human capital are an idea whose time has come. If we can only agree on an accounting standard ...

Problem with Japan: Zombie Banks.

Problem with U.S.: Zombie Banks.

In the US, and in Japan, people are not creating wealth, not investing.

Why not?

Well I am not investing. Why am I not investing? Because of social decay and insecurity of property rights. Because I need a dozen permits, each permit needs a bribehighly paid consultant with the right connections and a revolving door to the bureaucracy, and if the n+1'th permit is unobtainable, the bribes paid for the previous n permits are wasted.

Assets are in the hands of people too big to fail, and too incompetent to succeed. Why are they still in their hands? Because the government keeps them so. When the government intervenes politically to ensure that X cannot fail, the inadvertent effect is that it intervenes politically to ensure that Y cannot succeed.

"The boost to aggregate demand has to be based on sustainable increases in real wealth"

Now that's just crazy talk. Production before consumption? Saving before spending? Next thing you'll be telling me is printing up money and buying government paper with it doesn't add to real wealth.

then the crushed material will be discharged from the lower opening of the crushing room

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