The Entrepeneurship Deficit

I want to back up Matt Yglesias’s response to Chris Edwards’s post at the Cato blog provocatively called “The Death of Private Investment”. In the original post Chris points to alarming statistics from the Bureau of Economic Analysis. He declaims:

Business investment continues to be in a deep recession. Companies are simply not building factories or buying new machines and equipment.

Why not? I suspect that many firms are scared to death of higher taxes, inflation, health care mandates, increased labor regulation, and other profit-killers coming down the road from Washington. That is speculation, but I haven’t heard a better explanation of the death of private investment in America.

to which Matt responds:

Note that though the steepest cliff-diving happened in 2008 Q4 and 2009 Q1, the decline actually began way back in 2006, so it’s hard to say how fear of Barack Obama could have caused it. As for a better explanation, how about the problems in the financial system that were accumulating during this period and then reached a true crisis point in the fall of 2008? Surely we haven’t forgotten about that already, have we? And since the collapse, we’ve been facing a problem of low aggregate demand and deflationary expectations, both of which discourage investment, combined with massive overcapacity in real estate.

I’m forced to point out that the steps that the Obama Administration has taken over the last ten months to bolster the economy have, unfortunately, served to incentivize additional capacity in areas in which we already have “massive overcapacity”. Cash for Clunkers hasn’t just enabled auto companies to work off inventories. It’s caused them to re-open production lines and boost production.

However, Matt is right. I’m no graph-drawer so you’ll need to forgive the clumsiness of the next two charts, both taken from the BEA’s numbers linked above. Here’s the gross private domestic investment in real 2005 dollars from 1946 to date:

As you can see it’s been showing robust growth for more than 50 years. There was a sharp dip during the recession in the first part of this century and another dip now. But if you look more closely at the data there’s more cause for concern. The following chart illustrates real gross private domestic investment less residential investment 1995, the first year for which data is available, to date:

To my eye this chart illustrates domestic investment that has been pretty flat for more than a decade. I wish I had the ability to segregate investment in the medical sector from the rest of the data. Because of the heavy government subsidies in the sector, investment in the medical sector, particularly things like palatial offices for doctors and Taj Mahal hospitals, are attracting a considerable amount of private investment. They are seen as having reduced risk.

I think what we’ve seen over the last decade is a genuine deficit in entrepeneurship, i.e. risk-taking. Consequently, I believe that while Matt is correct in observing that the lack of investment didn’t start with Obama, Chris is right in that it’s a genuine problem.

I can offer all sorts of explanations for the decline. The large proportion of foreign capital (sometimes referred to as the “global savings glut”) is risk averse. So are big companies. So are the wealthy. Big companies and wealthy individuals tend to go to substantial lengths to avoid or mitigate risks rather than embracing them.

However, I honestly don’t see how the economy can recover, particularly how it can create new jobs, by returning to the status quo ante. We should not go back to the over-leveraged past. We should allow resources to flow to the industries of the future rather than propping up the industries of the past. That’s the direction that policy in any administration should be taking.

Unfortunately, existing industries and established institutions have political influence and are willing to exert it to support its position while the industries of the future have none.