David R. Henderson  

Scary Data on Private Investment

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Although the financial-market panic that had flared up in late September 2008 began to subside early in 2009, net private investment continued to fall, becoming negative (-$53 billion, annual rate) in the first quarter of 2009 and even more negative in the second quarter (-$119 billion). Although some improvement began in the third quarter of 2009, net private investment remained negative during the third and fourth quarters. For the entire year 2009, the amount of net private investment amounted to a large negative amount (-$69 billion). So, in other words, the value of the private business capital stock fell by that amount. Hardly by coincidence, real GDP also fell substantially in 2009, by 2.6 percent.

In 2010, net private investment increased smartly for three quarters, reaching an annual rate of $270 billion in the third quarter, then contracted sharply - by almost 47 percent - to $144 billion in the fourth quarter. For the entire year, the amount of private net investment was $177 billion. Whether the collapse in the final quarter of 2010 will turn out to have been a fluke or the beginning of a longer-term decline, we shall have to wait to see.

This is from Robert Higgs, "Private Investment Remains in a Deep Ditch," February 20.

The whole thing (it's not long) is worth reading. I don't totally buy Higgs' idea, stated in the article, that unemployment can't fall without a big increase in investment because unemployment can be low with any level of investment if wages are flexible enough. Wages are more flexible in the long run than in the short run and would be more flexible than they are if not for the long-term European-style unemployment benefits that Bush Jr. and Obama saddled us with.

In any case, these numbers are scary, with or without wage flexibility. Regime uncertainty, anyone?

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CATEGORIES: Macroeconomics

COMMENTS (6 to date)

Not to invade Daniel Kuehn's territory, but he recently pointed out some research to me that suggests that while wages might be flexible in the "aggregate" sense (total aggregate demand for labor might fall), it doesn't mean that wages fall proportionally to the degree that everyone can find employment. I guess research shows that employers are likely to fire lower wage workers and keep higher wage workers, maintaining that wage disequilibrium.

I don't know how universal this evidence is. Where I work, higher wage workers were fired and lower wage workers were kept. But, I guess it really depends on the firm.

Nevertheless, it goes to show that the relationship between wage/aggregate nominal demand for labor is really not as clear cut as we'd like to believe it is.

David R. Henderson writes:

@Jonathan M.F. Catalan,
I'm not making a point about aggregate demand: I'm making a point about the law of demand.

I'm not catching your drift. I'm making a point about the law of demand as well. Let's say that a firm has a total amount of money going towards employment, and we'll call this aggregate nominal demand for labor. However, the wages at which they pay existing workers is higher than the market clearing wage for that firm/industry. We see an excess of labor, and a shortage of employment in that firm. The firm, however, may not need to decrease wages, because the level of productivity garnered at the existing employment level + wage level (let's say that 9 workers paid at $20 an hour are more productive than 6 workers paid $10 an hour [I'm just throwing random numbers out there]) ... or, the management may not be aware that productivity would clearly rise if they lowered wages/fired high wage workers. The relationship is still the same.

So, if this true for a major portion of the market, it's conceivable to see relatively high unemployment, because wages aren't falling despite a drop in aggregate nominal demand.

I.e. purposeful wage inflexibility that seemingly benefits those employed and the employer, but not those that are unemployed.

Then, the solution to employing the unemployed is creating more jobs, which depends entirely on increasing productivity.

Chris Koresko writes:

For the entire year 2009, the amount of net private investment amounted to a large negative amount (-$69 billion). So, in other words, the value of the private business capital stock fell by that amount. Hardly by coincidence, real GDP also fell substantially in 2009, by 2.6 percent.

Having some contextual information would make these figures more meaningful. I wonder how this $69 billion compares to the total value of the capital stock. In other words, what is the percentage change this represents? Also, how does this change compare with historical values -- is this typical for a recession, comparable to normal fluctuations in periods of growth, or a once-in-a-century event?

blink writes:

The simplest explanation would be to say that private investment is negatively correlated with government spending due to (partial) crowding out. This also fits the timeline rather well.

Daniel Kuehn writes:

To clarify what Jonathan was saying - I was asking him to take a look at a short note I had written that included a discussion of the literature on real wage cyclicality - that aggregate wage data appears to be counter-cyclical (indicating some sort of sticky wage/artificially high wage argument), but disaggregated wage data is mildly pro-cyclical.

The reason for this is a composition bias in aggregated data - higher productivity workers are maintained during a downturn, driving up the aggregate average wage. Wages are clearly going to be more rigid in the short run relative to the long-run, but they're going to appear more rigid when aggregated than they actually are. I'm not sure that changes the story you're telling - but that's what Jon was refering to.

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