What explains sluggish business investments?

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.

  1. 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).
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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…

Networking For Innovation

Olav Sorenson from Yale published a new NBER working paper called “Innovation Policy in a Networked World”. The essay is quite interesting because it reviews insights we got from social network theory (no, not Facebook, although you could analyze Facebook with the same tools) and puts them into context for designing effective policy measures to stimulate innovation. Continue reading Networking For Innovation

Innovation on (government) demand?

Next week we will organize the 7th ZEW/MaCCI Conference on the Economics of Innovation and Patenting in Mannheim and the program will be great. We will have Bronwyn Hall from Berkeley and Pierre Azoulay from MIT as keynote speakers. I’m definitely looking forward to hear them speak.

Myself, I will present a new project on the relationship between public procurement and innovation. In brief the research question is the following. Continue reading Innovation on (government) demand?

Cardwell’s Law

While reading Joel Mokyr’s newest book I came across an older paper of him, which I found very interesting. It is about what Mokyr calls Cardwell’s law*— the empirical regularity that “most societies that have been technologically creative have been so for relatively short periods”. Throughout economic history successful countries in terms of innovation and economic growth have usually lost their competitive edge pretty soon again and were overtaken by others. Continue reading Cardwell’s Law

Innovation,unemployment and subjective well-being

These days, everybody is talking about the losers of globalization and how they made Trump and Brexit happen. People in industrialized countries lose their jobs due to offshoring and international competition, which leads them to vote for right-wing populists, so the common narrative goes. That might not be the full story though. Continue reading Innovation,unemployment and subjective well-being

Why is Apple sitting on a pile of cash?

Recently I stumbled over this picture on the internet. I have not checked the numbers, but everybody knows that Apple is sitting on a huge pile of cash (the same goes for Microsoft, by the way). Of course, this number makes a good conspiracy theory about what might really be going on in Cupertino. Is Apple the last fire-drake of California jealously hoarding a pile of gold in his lair? I would like to object. There are actually good economic reasons for Apple to have large cash holdings. Continue reading Why is Apple sitting on a pile of cash?