Mark Thoma Misses the Point

Hairshirts versus growth proponents--the real story
Michael Mandel

Mark Thoma attacks Chris Farrell's BusinessWeek Online column. Thoma mocks Farrell for creating "some new (and confusing) schools of economic thought - the hairshirts and the Growth proponents."

Actually, it's Thoma who completely misses the point. 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.

Physical capital is the accumulation of new buildings, machinery, and equipment. Wal-Mart is planning to open up to 365 new stores in the U.S. this year. Each of them--the building, the info tech equipment needed to run the store, the extra trucks needed to do deliveries--represents an addition to the country's physical capital.

Human capital comes from the improvement of the education and experience of the workforce. The college-educatedness of the Americans have been rising (In 1998-1999, the University of Oregon conferred (a wonderful word) 2998 bachelor's degrees, compared to 3465 baccalaureates in 2003-2004)

Intellectual capital is all the ways that we work smarter--new technologies, better ways of organizing work, improvements in the financial and legal system. For example, I consider venture capital to be one of the great financial innovations of the 20th century, and a key reason why U.S. economic performance has surpassed that of Europe.

Based on the latest report from the Bureau of Labor Statistics, here is a table showing the relative importance of the three forces:

Annual productivity growth (1948-2002) 2.3
contribution of capital investment 0.9
contribution of labor composition 0.2
contribution of multifactor productivity 1.2

Multifactor productivity represents the broad influence of intellectual capital, including technological change. (Go here for a story that I did earlier this year on multifactor productivity).

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. They worry about the profligate U.S. economy, and about how much debt we are leaving our children. The hairshirts talk a lot about "tightening our belt" and the need to increase savings.

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 (real nondefense R&D spending only rose by 1.9% during Clinton's first term in office, when he was busy cutting the budget deficit).

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). The assumption is that the positive long-term effects of a boom will outweigh the negative effects of the bust.

Hairshirts can be either Democratic or Republican--so can growth proponents. Paul Krugman is a hairshirt, though he might deny it. Alan Greenspan is a growth proponent, though he might deny it as well.

Hairshirts are basically pessimists, who believe that getting more growth is like wringing water from a damp towel--we have to squeeze out every last drip until our hands hurt. Growth proponents are basically optimists, who believe that it's ultimately more fruitful to spend our time looking for a new stream.

I'm an optimist.

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