Month: December 2017

Second, that there is some pure “profit,” some pure “rent,” some “unreproducible input” (i.e. something that did not come from a past unmeasured investment), something like the classic “unimproved land” that can be taxed, without distorting any decision. It goes hand in hand with the complaints of greater monopoly.

But I find it hard to find and name a concrete source of profits that, once named, does not distort the decision to undertake some useful activity to make those profits. Starting, organizing, and improving a business, figuring out the intangible organizational capital that makes it a successful competitor, creating a product and a brand name, are all crucial activities for which no investment tax credit will successfully offset a large profits tax. “Intangible capital” is about all most companies have these days.

That is John Cochrane replying to Stephen Williamson, there is much more at the link.  I would add also that Williamson’s model seems to take “r” as constant.

Germán Gutiérrez and Thomas Philippon have a new paper on this topic:

We analyze private fixed investment in the U.S. over the past 30 years. We show that investment is weak relative to measures of profitability and valuation — particularly Tobin’s Q, and that this weakness starts in the early 2000’s. There are two broad categories of explanations: theories that predict low investment along with low Q, and theories that predict low investment despite high Q. We argue that the data does not support the first category, and we focus on the second one. We use industry-level and firm-level data to test whether under-investment relative to Q is driven by (i) financial frictions, (ii) changes in the nature and/or localization of investment (due to the rise of intangibles, globalization, etc), (iii) decreased competition (due to technology, regulation or common ownership), or (iv) tightened governance and/or increased short-termism. We do not find support for theories based on risk premia, financial constraints, safe asset scarcity, or regulation. We find some support for globalization; and strong support for the intangibles, competition and short-termism/governance hypotheses. We estimate that the rise of intangibles explains 25-35% of the drop in investment; while Concentration and Governance explain the rest. Industries with more concentration and more common ownership invest less, even after controlling for current market conditions and intangibles. Within each industryyear, the investment gap is driven by firms owned by quasi-indexers and located in industries with more concentration and more common ownership. These firms return a disproportionate amount of free cash flows to shareholders. Lastly, we show that standard growth-accounting decompositions may not be able to identify the rise in markups.

On the road I have yet to read it, but it looks like one of the most important papers of the year.

In standard macroeconomic models, GDP is GDP and an industry is important only to the extent that it produces GDP. In other words, there are big industries and small industries but there are no special industries. The standard view implies that the structure of production can be ignored. It doesn’t matter, for example, whether an industry sells to final consumers or to other businesses. It doesn’t matter whether an industry sells an easy-to-substitute product or a hard-to-substitute product. And it doesn’t matter whether an industry is a weak-tie link or a strong-tie link. Thus, in the standard view, the oil industry is no more important for understanding economic fluctuations than say the retail sales industry, since they are about the same size.

The standard view isn’t arbitrary, Hulten proved that it was true under certain assumptions. Hulten’s theorem appeared to offer a very useful simplification and so it diverted the attention of economists away from trying to model the structure of production.

But I’ve always been skeptical. One reason is that rapid increases in the price of oil have preceded almost all U.S. recessions (see Hamilton’s papers) and such increases appear to be much more important than the size of the oil sector would allow. More generally, although the canonical real business cycle model emphasizes aggregate technology shocks, I’ve always looked favorably on variations with sectoral shocks–this is one reason why Modern Principles is one of the few principles of economics textbooks to devote significant attention to real shocks, including oil shocks, and the mechanisms that can transmit and amplify these shocks from one sector to the wider economy.

The sectoral approach gets new support in a recent paper, The Macroeconomic Impact of Microeconomic Shocks: Beyond Hulten’s Theorem (non-gated) by Baqaee and Farhi. The authors show that Hulten’s theorem offers a true simplification only under very restrictive conditions. Relax those conditions and what seem like second-order mechanisms can have first-order effects. The structure of production–how industries are linked to one another, elasticities of substitution, reallocation speeds and so forth–matters in theory.

In a calibration Baqaee and Farhi consider “the response of GDP to shocks to specific industries” and:

…It turns out that for a large negative shock, the “oil and gas” industry produces the largest negative response in GDP – this despite the fact that the oil and gas industry is not the largest industry in the economy.