Germán Gutiérrez and Thomas Philippon from NYU Stern published another interesting NBER working paper this week:
The U.S. business sector has under-invested relative to Tobin’s Q since the early 2000’s. We argue that declining competition is partly responsible for this phenomenon. We use a combination of natural experiments and instrumental variables to establish a causal relationship between competition and investment. Within manufacturing, we show that industry leaders invest and innovate more in response to exogenous changes in Chinese competition. Beyond manufacturing we show that excess entry in the late 1990’s, which is orthogonal to demand shocks in the 2000’s, predicts higher industry investment given Q. Finally, we provide some evidence that the increase in concentration can be explained by increasing regulations.
I already saw some very positive reactions on Twitter.
The paper is a 74-pages beast and it took me three days to work through it. At times, it reminded me of a job market in which you try to show your skills as much as possible. Their analysis is definitely very thorough. But frankly, sometimes their point gets lost a bit in all the details. So I’ll try to summarize the main line of argumentation here.
- There is an investment gap in the U.S., i.e., firms invest too little compared to what fundamentals (Tobin’s Q) would predict. This is a problem because, well, have a look at essentially every macroeconomic debate of the last decade (zero lower bound, etc).
- Surprisingly, the investment gap is largest for industry leaders. These firms might be hugely profitable but somehow don’t invest as much of their profits anymore.
- Overall, levels of competition in U.S. industries (not in Europe, interestingly) have decreased. That is to say, a majority of sectors have become more concentrated with fewer active firms. Theoretical models suggest that this could be an explanation for the investment gap.
- Looking at industries that experienced strong import competition from firms in China (which is assumed to be exogenous), Gutiérrez and Philippon find that, as a reaction, firms that were leaders in their industry start investing more. Laggards, by contrast, stop investing and eventually exit the market because they’re not able to withstand the international competition. The net effect of these opposing forces seems to be positive.
- Now comes the twist: the data are consistent with what we currently see happening in the U.S.—just exactly the other way round. While the “China shock” increased competition (mainly in the years after 2000), today competition decreases. Therefore we see the reverse effects: leader invest relatively less, laggards more.
- Conclusion: decreasing competition (according to the authors mainly driven by excessive regulations during the Bush and Obama administration) is one factor to explain the investment gap. Whether it’s also the most important mechanism compared to others remains and open question though.
Personally, I’m mostly interested in one particular type of investment, namely research and development (R&D). Therefore I find it a bit unfortunate that the paper, for the most parts, lumps together physical capital build-up and investment in intangibles, such as intellectual property and R&D.
My own analysis, published on hbr.org, suggests that there is no investment gap for R&D (at least not in aggregate levels). What is true though, is that the distribution of R&D becomes more and more skewed. Rising levels of R&D expenditures are driven by fewer firms than in the past, and predominantly by industry leaders. The inequality between firms increases. What I find is thus more consistent with the “China shock” scenario.
Exciting stuff indeed! Lots of questions still remain. So there is plenty of room for further research on the topic…