“High-Return Investments”

I’m still perserverating on Joseph Stiglitz’s remarks about “high-return investments”. Does anyone really oppose making high-return investments? I would assume that businesses don’t need other incentives to jump all over them. The investments that require government intervention are those with low returns, very long payoff times, or too speculative.

Even saying that we need to put stimulus spending into high-return investments assumes that we are, effectively, leaving money on the table. Is that really the case? Quite to the contrary I think that problem is more that we have already picked the low-hanging fruit, there are no easy, short-term high-quality investments to be made, and what we are left with have returns that are too low for the bucks we’d invest, take an unacceptably long time to materialize, or are just too oblique.

Furthermore, I’m not convinced that going after such projects would resolve the near term problems we face. Let me give some examples.

Outer space exploration can almost unquestionably yield a high return on investment. Not only is there a lot of knowledge to be gained but there’s a lot of stuff out there. Stuff we want. Room to put stuff we don’t want, well out of the way where it’s not in anybody’s backyard.

Closer to home putting a little more investment into the education and care of a kid who without it would be a lifelong ward of the state sounds like a pretty high-return investment to me. I’m not talking here about average kids who just aren’t interested but about kids with special needs who with the right care and education can be self-sufficient or nearly so. Another example: pre-natal nutrition and care. Incentives for mothers to stay off drugs and alcohol. That kind of stuff can pay off for sixty or seventy years worth of enhanced productive activity. It won’t put a lot of unemployed people to work, though.

I’m beginning to wonder about Nobel Prize winners. And Finanical Times op-ed writers. These observations are almost too vapid for words.

17 comments… add one
  • I think Stiglitz would reply that the high return investments are the type where the social payoff is high, but the ability of a business to capture some or all of that payoff is low–i.e. public goods and investments with significant positive externalities.

    Of course, you observation is correct about what we really want is to invest in things with a high social rate of return and will also help with the employment/unemployment situation. That is even a smaller subset of the available programs/areas to spend government dollars. While your examples are good and noble and possibly worth doing….we can’t afford to do them now because we spent so much money already and as you note wont likely help the employment situation.

    I’m beginning to wonder about Nobel Prize winners. And Finanical Times op-ed writers. These observations are almost too vapid for words.

    It would indeed help to have a couple of examples one can whip out in those instances. Of course it isn’t just Nobel winners. Over at OTB in a conversation with Hey Norm (who I don’t think has won a Nobel) he makes it sound like there is some magic to do list for economic growth. He argued if he were president he’d get growth to Clinton levels. How? Beats the f*ck out of me, but apparently he thinks if he just does whatever magic Clinton did he’ll get it. What that magic is I don’t know.

    I think this is emblematic of a larger problem. People think that government can solve these problems easily.

    Do:

    1. X
    2. Y
    3. Z
    4. ???
    5. Low unemployment!

    Most people are underwear gnomes in this country, about 90-95% of them. They really think the above list exists. Of course, it makes one wonder…why didn’t George H. W. Bush use the list when he was President, get unemployment down and beat Clinton? We are a bit more than 1 year out from the next Presidential election, why hasn’t Obama used the list? Why didn’t Carter? The facts don’t match the myth.

    And Presidents exploit and perpetuate the myth. How elections where each candidate has come up with a plan to reduce unemployment or get the economy going again? The plans are all variations on the one I’ve posted above, but they fill in the X, Y and Z with actual policies that may or may not do what they are hoping to accomplish and they delete step 4.

    The reality is there is no sure fire way to solve these problems. Hell, my guess is most of the time they solve themselves and if anything government gets in the way more often than not. Rogoff and Reinhart have noted that as public debt rises about the 90% threshold after a financial crisis growth takes a one percentage point hit. At the same time we know that the Republican forced debt ceiling crisis solution* will likely end up repeating 1937. I’d argue that this time we could very well see the same outcome, another recession. If Rogoff and Reinhart are right we need to deal with the debt, but not in a way that will make the economy even worse.

    *Note, I’ve been on record favoring a balanced approach with some spending cuts and tax increases, preferable in future years with some sort of commitment mechanism.

  • While your examples are good and noble and possibly worth doing….we can’t afford to do them now because we spent so much money already and as you note wont likely help the employment situation.

    Pretty much my point.

  • He argued if he were president he’d get growth to Clinton levels. How? Beats the f*ck out of me, but apparently he thinks if he just does whatever magic Clinton did he’ll get it.

    I tbink I can answer that. It appears to be an article of faith with a substantial group of people, even people who should know better (like Paul Krugman), that the tax increases during the Clinton Administration were the cause of the boom of the Clinton second term.

    I think that’s arrant nonsense. My explanation for it is the enormous level of capital investment in technology that had gone on for the previous decade or so without much in the way of payoffs.

    So I presume that his solution is repealing the “Bush tax cuts”. Yes, it’s an underpants gnome solution. Or, in an even closer analogy, it’s a cargo cult solution.

  • Dave,

    I don’t know if I should be happy or afraid we are agreeing. We usually aren’t that far off, but sometimes I like it that you offer a different perspective, but this time…okay I guess I’m afraid.

    sigh

    Michael! Michael, where is the scotch man. It isn’t even 9:30 am yet, and I feel I need a drink.

  • PD Shaw

    As I indicated in the previous post, I support high-return investments — I just believe the evidence for thim is thin. My criticism was centered on this post that Dave had linked to for another reason:

    “The beauty of construction spending is that you wind up with things — roads, bridges, tunnels, rails, schools, sewage treatment plants, power plants, airports, dams — that last for decades and get passed from one generation to the next.”

    http://www.ritholtz.com/blog/2011/08/not-too-stimulative/

    The linked data complains about the state of existing bridges and roads; it doesn’t purport to seek to build new things. It’s really proposing an increase in the gas tax for maintenance repairs. And I agree with Dave’s comment, some of these “things” in less than good shape are in remote unpopulated areas. I looked at the Illinois list of defective bridges a few years ago, and I’d say a good number of those bridges need to be destroyed (at the risk of angering the local legislator).

    Where would we find potential HRIs? Where federalism has spread the butter too thin, leaving infrastructure improvements of national consequence sacrificed to make sure every Congressional district gets a piece. In places like railway/railyard improvement where railroad monopolies and government impotence create inefficiencies. Maybe in new techonologies and materials? I’m willing to be convinced.

  • Drew

    From my perspective, high return investments abound. Of course, I come from a different perspective.

    We don’t do “outer space.” We don’t do venture (Facebook etc). However, we do do late stage companies who need to get to the next level. So we provide capital, mgmt expertise, marketing sense, sourcing expertise, organizational development, optimizing the manufacturing footprint, add-ons etc etc.

    A typical investment doubles its operating profit during our ownership. Sometimes its 2-3x. And folks, these are plain Jane widget companies. Plastic bottles, electrical components – as Reynolds derisively commented awhile back: washing machine and transmission parts companies. And so forth. The companies reside in Michigan, Ohio, Florida, Texas, Massachusetts, California, Arkansas etc. Everyman stuff.

    Its all out there and available. Bigger companies, more profitable companies, more employment and – oh yeah – more taxes. But the idiot govt and liberal types have their gunsites set on us. Dodd-Frank. Attacks on the tax treatment and so on. How does this make sense? Instead they want to stifle people like us, while embarking on the Chevy Dolt, er, Volt or ethanol subsidies, solar panels or the United Auto Workers…….

    Its just crazy. Any wonder I don’t have any spot in my heart for Obama? There are plenty of things to invest in – including energy by the way – but this crew is just plain out to lunch with their ideology. Confused and moronic.

  • Instead they want to stifle people like us, while embarking on the Chevy Dolt, er, Volt or ethanol subsidies, solar panels or the United Auto Workers…….

    Hmmm, here is a question….

    It is often bandied about that things like promoting electric vehicles will provide x thousands of jobs and be “good for America”. How? How can something that needs a subsidy to survive provide a net positive benefit?

    Serious question, anyone care to take a shot at providing an answer?

  • PD Shaw

    Steve, I believe the argument is that these new technologies need a subsidy to get to the point of profitability. Or alternatively, a subsidy is needed to even the playing field against subsidized competitors. Or its an indirect subsidy that isn’t even obvious to most people so isn’t counted on the ledger.

    Not making these specific arguments myself necessarily, just that is the nature of the argument I believe.

    I want to know how we can improve on analyzing what might be a good infrastructure investments like the California High Speed Rail, that quickly moves into cost overruns that might double or triple the project’s cost?

  • In addition to what PD said, there’s also the sense that, “if you build it, they will come.” I think that’s true for some things, not true for others.

  • steve

    “that the tax increases during the Clinton Administration were the cause of the boom of the Clinton second term. ”

    I dont really remember seeing that anywhere, but maybe it is because I dont believe it. What I think I see people write, is that the increases did not destroy the economy as was predicted.

    “Dodd-Frank”

    How does Dodd-Frank affect VC guys?

    Steve

  • sam

    “How can something that needs a subsidy to survive provide a net positive benefit?”

    You might ask Alexander Hamilton that question.

  • sam

    BTW, weren’t the first transcontinental railroads underwritten, in a sense, by a subsidy?

  • PD Shaw

    sam, I believe the transcontinental railroad financial subsidies were repaid with interest. Doesn’t mean they weren’t subsidies, its just that it’s probably an example of a high-return investment.

  • sam

    That’s what I was getting at, PD.

  • Drew

    ” “Dodd-Frank” How does Dodd-Frank affect VC guys?”

    This is the laugher query in the thread, and shows why I get so hyperbolic.

    Dodd – Frank is an absolute dagger in the heart of VC’s. Ill conceived legislation intended to be punitive to hedge funds and to wash the blood from Barney and Chris’s hands, its so ill conceived that the SEC is regularly pushing back its implementation deadlines because they know they’ve made a monstrosity of law that will kill private equity. Current pushback: March 2012. And publicly they would never, ever admit that, but they know its true.

    steve – it puts impossible costs on venture capital. Impossible. The SEC knows it. Barney, when not on his knees, knows it. So they are delaying implementation.

    What is disappointing to me is that you, an obviously smart guy, is suckered into this. You’ve posted previously on the greatness of Dodd Frank, counter to my position. The fact of the matter is that you have no clue what you are talking about, the SEC now recognizes this is completely unworkable, it is delaying implementation until it can get its act together, and I suspect it will ultimately gut certain provisions. If not, firms like mine will fold tent. The regulatory costs are just too great.

    Stick to medicine. You are a bad businessman.

  • Drew

    “It is often bandied about that things like promoting electric vehicles will provide x thousands of jobs and be “good for America”. ” etc

    As, I guess, the resident private equity guy, I would never, ever invest in a business reliant on govt subsidy. Know why? On Thursday morning you could wake up and read in the NY Times why your business has been rendered worthless by Harry Reid, Barack Obama, or whomever. Wake TFU.

    Anyone in ethanol? Solar panels? Wind mills? Good luck. Musical chairs is your game……..

    In the past three years our firm has seen at least 20 dead solar deals looking for recovery capital. Not a chance. No chance. NOT ECONOMICAL. RELIANT ON SUBSIDY.

  • Steve, I believe the argument is that these new technologies need a subsidy to get to the point of profitability. Or alternatively, a subsidy is needed to even the playing field against subsidized competitors. Or its an indirect subsidy that isn’t even obvious to most people so isn’t counted on the ledger.

    None of these are “good for America” IMO in that they all result in net social losses.

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