Mark Mandel weighs in on a Mark Thoma critique of a column written by Chris Farrell – but seems to have missed the point of the Farrell-Thoma debate. Farrell and Thoma were discussing the role of monetary policy and the business cycle. As Mandel accuses Thoma of missing the point, he changes the discussion to one of long-term growth theory:
Let me explain the difference between the hairshirts and the growth proponents. Remember that long-term productivity growth–which is our ultimate goal–is driven by three forces: Physical capital, human capital, and intellectual capital … What’s interesting is that capital investment only accounts for about 40% of long-term productivity growth, while multifactor productivity accounts for a bit more than half. Now, here’s where the hairshirts and the growth proponents come in. The hairshirts, explicitly or implicitly, focus on the capital investment component of growth. They talk about the need to cut personal consumption and the budget deficit in order to free up more money for business investment … The growth proponents give equal weight to both technology and investment. They argue that it’s more important in the long run to focus on funding research and development spending, encouraging start-ups and venture capital, appropriately regulating (and sometimes encouraging) new technologies, and getting the right intellectual property policies. In practice, hairshirts and growth proponents advocate very different short-run policies. The hairshirts want to cut the budget deficit, even if that means stinting on R&D spending … The growth proponents are willing to let the economy run ‘hot’, arguing that a boom encourages risk-taking and corporate spending on both R&D and capital equipment (companies tend to set R&D budgets as a percent of sales, so industry R&D spending rises during boom times).
If Mandel has not heard of the Denison residual in growth accounting, he might perhaps read Solow’s 1987 lecture describing the history of economic growth theory. Solow notes the importance of savings and investment – Mandel’s hairshirts. I had told Mark Thoma that I’m not a monetary hairshirt economist in the Farrell sense – and I don’t think Solow was either. But most students of growth theory realize the importance of capital investment. Solow also notes the Keynesian insight that prolonged recession tend to be associated with weak investment demand. Also note the following from Dr. Solow:
The formal model omitted one mechanism whose absence would clearly bias the predictions against investment. That is what I called “embodiment”, the fact that much technological progress, maybe most of it, could find its way into actual production only with the use of new and different capital equipment. Therefore the effectiveness of innovation in increasing output would be paced by the rate of gross investment. A policy to increase investment would thus lead not only to higher capital intensity, which might not matter much, but also to a faster transfer of new technology into actual production, which would. Steady-state growth would not be affected, but intermediate-run transitions would, and those should be observable.
Simply put – embodiment implies that the diffusion of new technology is faster if investment is higher so these two factors complement each other.
Finally, I suspect Mandel believed the shouting from Bill O’Reilly about R&D during the 1980’s v. the 1990’s in that debate with Paul Krugman, but it seems the facts did not support O’Reilly’s shouting.
Mark Thoma asks what contribution was made by Mandel’s column. I don’t see any. But Mr. Mandel might consult a good growth theory textbook.