Patents Aren’t Signs of Economic Health

The President in the State of the Union speech pridefully observed that America issues more patents than any other country.  So what.  That’s not a sign of economic vitality.  It’s a sign of government giving privileged monopolies to some and allowing them to stop the march of learning, innovation, and research.  Matthew Yglesias understands.  John Bennett at Against Monopoly observes:

Matt Yglesias does a neat skewering of Obama’s State of the Union self-congratulatory allusion to our patents: “No country has more successful companies, or grants more patents to inventors and entrepreneurs.”link hereHe then does a riff on what would have happened if Newton had got a software patent on calculus. He would have sat on the patent “until Leibniz published his superior method and then sued the pants off anyone who tried to take a derivative without coughing up a hefty license fee.”

Yglesias manages to get in other digs over what is currently patentable and the likely lower quality of today’s patents. He concludes by noting patents do not create “property’ but rather are a regulation which creates a monopoly.

Read it.

The same site earlier this week reported how patents are actually slowing and blocking progress in one of the most promising arenas of medical research, stem cell research:

One of the most promising areas for medical research are stem cells, and now that the Obama Administration has lifted many restrictions on their use, you would think this line of research would be booming. Not so according to Medindia which reports that there has been such a rush to patent in this area that research is in fact very difficult now

Romney Doesn’t Know Real History

So Wednesday evening I’m walking on the treadmill at the healthclub.  It’s a mixed experience. I feel better working out but I have to suffer through Fox News on the big TV in front in the treadmills.  So I’m watching the Fox News, and predictably, they’re interviewing Republicans and trying to belittle the President’s State of the Union speech.  Romney, the purported front-runner for the Republican presidential nomination and supposed private business guru is talking.  He’s trying to poo-poo the President’s call for more innovation to help build the economy.  Romney makes the statement (this is close if not exact – it was TV and I was walking) to the effect that “I don’t think the Wright Brothers, or Google , or Thomas Edison needed any government support to produce their inventions”. Romney and the host were mocking the idea that somehow government could help foster innovation in the economy.

Well, let’s see here and check the historical record. Both the Wright Brothers and Edison were protected in their businesses by a government-grant of monopoly in the form of patents.  Edison, in fact, didn’t invent the electric lightbulb first, but he was able with lawyers to overturn the patent for the guy who did and get the patent himself.  The Wright Brothers grew into a large commercial aviation business (along with Douglass and Boeing and the other aircraft companies) due to military investments in World War I.  As for commercial aviation, it grew in the 20th century largely thanks to the technologies developed for Air Force planes.  Huge numbers of commercial airline pilots were actually trained in how to fly by the Air Force at no cost to the airlines. Commercial aviation got a headstart thanks to the U.S. Post Office’s efforts and contracts to launch air mail.  And of course, there wouldn’t be many airports to land at if it weren’t for governments (federal and local) picking up the tab for their construction.  Let’s not forget the FAA and air traffic control.  That’s government too.

Let’s think about Edison and the great electrification of the country.  One light bulb doesn’t create an industry.  However, government contracts and grants of exclusive dealing are necessary to build the early generating stations and the networks of wires that make our electric usage possible.  We might still be waiting for electricity to reach rural areas and the South if it weren’t for the Tennessee Valley Authority, setup in FDR’s New Deal. Hundreds of cities nationwide had to setup thier own utility companies because the profit-seekers wouldn’t do it in the early parts of the 20th century.

Now let’s think of Google, the poster-child new tech mega-corporation born of private venture capital.  Except that with no Internet and no Web, there’s no Google. And where did the Internet come from?  Decades of military, government, and non-profit academic research and investment in designing and building the networks and the technology.

It’s a common pattern. Most of the really dramatic innovations do depend on a critical government role at some point in their development.  Typically the need is either for fundamental research or to subsidize ongoing developmental research.  Private investors simply don’t take those risks.  Even though Samuel Morse proved the telegraph worked in a building, no one would invest in building a telegraph until Congress paid to build a demonstration telegraph line between Washington and Baltimore.  Once government took the risk and proved it, private investors were willing to step up.

Then there’s infrastructure – virtually always the province of government. From the building of the Erie Canal (New York State government) to railroads (government subsidies and land grants) to aviation (see above) to the Internet, it’s government making it possible.  Mr. Romney needs to go back study the real history of the country, not a make-believe history.

GDI vs GDP

One of the most fundamental identities in macro economics is that income = spending.  Since this is a macro-level national income accounting identity, that means two things: First, it must be true after-the-fact as an accounting factoid. In other words, when the BEA adds up the numbers each quarter, the money spent in the economy had to be equal to the income (really sources of funds).  Another way of stating this is that we say the size of the economy is the market value of everything we produced for final use.  There’s two ways we could count this.  We could count how much was spent to buy all of the goods/services we produced – that’s called GDP, gross domestic product. We count GDP by counting what was spent by whom, consumers (C), businesses for investment (I), government (G), and rest-of-world (eXports – iMports).  Hence the equation GDP = C + I + G + (X – M) which I’m forever repeating in class.

But there’s a second way to count how much we produced and that’s to count the money flow through the Resources or Factor markets.  We call this the GDI, or Gross Domestic Income.  It’s what we got paid to produce the GDP. We break-up GDI according to the type of income being paid and to whom. Roughly it’s wages, profits, interest, and taxes.

Like I said, income = spending. So, GDI = GDP. It’s an after-the-fact necessity of the accounting framework by definition.  But it’s also a useful concept for analysis of disequilibrium and dynamics.  After all, think of what happens in the following scenario.  Suppose every month we spend $1000 and we get paid $1000. Income = spending. But suppose some month, income declines unexpectedly to $900. In the month the income declines, we either cut our spending short to adjust to the new lower income, or we borrow (or spend from accumulated financial assets) to make up for the shortfall and adjust our spending the following month.  In this scenario, we can identify that when income from productive sources = spending we have an equilibrium in the economy and no changes are expected.  But if income is less, then we are at a disequilibrium and can expect changes. For the economy as whole then, we have:

C + I + G + X – M = GDP = GDI = Wages + Profits + Interest + Taxes.

So with that in mind, let’s look at what’s been happening.  I turn to Rebecca Wilder at Angry Bear:

There are two measures of income: the spending side (Gross Domestic Product, or GDP) and the income side (Gross Domestic Income, GDI). I’d like to see what GDI is telling us about the Y/Y recovery, since it’s a better predictor of turning points, according to FRB economist Jeremy J. Nalewaik.

The chart illustrates the contribution to Y/Y GDI growth coming from each of the main income components. (Click to enlarge.)The series is deflated using the GDP deflator, since the BEA only releases the nominal numbers. All references to GDP and GDI below refer to the real series.

What conclusions can we draw?  Well it’s largely a confirmation of conclusions about GDP – the “recovery” is unbalanced. It isn’t being shared with 80-90% of the population that works for a living.  Wages are not growing, but corporate profits have recovered in record time near record levels. Productivity has improved but the benefit goes to capital owners, not labor.  A very interesting comment was provided by Mark Sadowski:

We only have five quarters of data for the current recovery. However, how does it compare so far? So far 76.7% of the growth in RGDI has gone to corporate profits. Needless to say this recovery is setting a totally new precedent.

What can we conclude? This seems to be an increasing pattern with recent recoveries. I speculate that much of it has to do with the combination of sticky wages, an increasing degree of labor flexibility and a trend towards lower inflation rates. Such a combination means adverse shocks to AD result in larger increases in unemployment. Recoveries in a low inflation environment are notably slower due to the limitations of conventional monetary stimulus against the zero lower bound. Thus the labor surpluses are increasingly persistent and compensation growth becomes slower and slower in each subsequent recovery.

Is this bad? Only if you work for a living.

Update on the 4th Quarter GDP numbers

Division of labor, specialization, and the Web are beautiful things.  In my earlier post on the 4th quarter 2010 GDP numbers I observed that inventories declined significantly and I wasn’t sure why. Well, James Hamilton at Econbrowser did the heavy lifting of investigation so I don’t have to.  I only have to quote him:

Consumption spending was strong in the fourth quarter, and could have generated essentially all the real GDP growth by itself. Exports added another 1%. Since imports are subtracted from GDP, the fourth-quarter decline in imports would have provided a further 2.4% boost to the reported GDP growth rate. Nonresidential fixed investment contributed 0.4%, almost entirely from equipment and software. And even housing made a slightly positive contribution.
gdp_comps_jan_11.gif
With all these strong positives, how did we end up with only 3.2% growth? The answer is that a huge estimated decline in inventories subtracted back out 3.7%. The extra spending by consumers and firms was much more than we produced domestically, and the difference represents goods sold out of inventory.

But the fact that a huge negative contribution of inventories coincided with a huge positive contribution of imports does not seem to be a coincidence. There’s a clear pattern in the recent data that when one of these makes a positive contribution to GDP growth, the other makes an offsetting negative contribution. Although we often think of inventories as a substitute for production (you could either produce a good or sell it out of inventories), in the current environment inventories seem to act more as a substitute for imports (you could either import the good, or sell it out of inventories). So although inventories shouldn’t be the same drag on GDP in 2011, I expect imports to go back up and exert a drag of their own.

Fox, Hen House, Economic Advisors

President Obama, in his never ending desperate quest to be accepted by Congressional Republicans as being just like them, even if it means abandoning the changes he was elected to lead, has changed his lead economic advisors.  Simon Johnson in the NY Times observes:

President Obama is embarked on a major charm offensive with the business sector, as seen, for example, in the appointments of William M. Daley (formerly of JPMorgan Chase, now White House chief of staff) and Jeffrey R. Immelt (chairman and chief executive of General Electric and now also the president’s top outside economic adviser).

This should not be an uphill struggle – much of the corporate sector, particularly bigger and more global businesses, is doing well in terms of profits and presumably, at the highest levels, compensation. But when exactly will this approach deliver jobs and reduce unemployment? And does it increase risks for the future?

Republican rhetoric over the last two years was relentless in its assertion that the Obama administration was antibusiness. Supposedly, this White House attitude undermined private sector confidence and limited investment.

Simon also points out that corporate profits, and the financial, banking and multi-nationals in particular, have recovered quite nicely from the recession. Indeed, profits for them not only returned to record levels but recovered from the recession in record time. According to the President, our challenge is create jobs. I would certainly have to agree, as I’ve noted here and here. But these appointments don’t appear to help.  These guys have been part of the problem. They’re not part of the solution.  Catherine Rampell of the NY Times agrees:

In the wake of Jeffrey Immelt’s ascent to the chairmanship of President Obama’s jobs council, some commentators have questioned whether the leader of General Electric, a company that has sharply reduced its United States payrolls over the years, is the best person to be orchestrating a jobs revival.

Among executives of multinational companies, Mr. Immelt is hardly alone in having presided over a major reduction in domestic jobs amid a major increase in foreign jobs. Witness the following chart, which shows changes in domestic and foreign employment at American multinational companies from 1998 through 2008 (that is, the decade leading up to the financial crisis):

The chart is taken from testimony by Martin Sullivan, an economist and contributing editor with Tax Analysts, in a discussion of how international tax rules favor foreign, rather than domestic, job creation, especially by United States multinationals.

So the CEO of one of the largest multinationals on the planet is now advising the President on jobs creation.  The same guy who led that company to move thousands of jobs out of the U.S. and create new ones in other countries.But it’s not enough that Immelt’s the wrong guy to ask about how to create jobs.  The President is asking the fox for advise about protecting the hens.

Rampell also points out how one of Immelt’s pet proposal that he’s been pushing for a long time is for a “tax holiday” that allows U.S. based multinationals to repatriate foreign profits to the U.S. without paying tax.  In many cases the “foreign profits” of these multinationals are actually U.S.-earned profits that have been laundered through foreign subsidiaries using a variety of tax dodges and artificial internal transfer prices (see Dutch Sandwich for one example of how Google got it’s U.S. tax rate down to 2.4%).  So at a time when we are supposedly concerned about the deficit, the President is turning to one of the biggest tax dodgers around: GE.

To add further injury, let’s consider the inherent conflicts of interest.  GE, despite it’s recognizable brand name among consumers and it’s heritage as Thomas Edison’s creation, is not a the entreneurial industrial competitor it once was generations ago.  GE doesn’t  really compete in capitalistic free markets for consumers’ attention to make it’s money. GE works the government.  One of GE’s largest subsidiaries is also one of the largest military contractors dependent on the pentagon military budget. Up next is the power generation division is dependent on subsidies for the promotion of clean and renewable energy. Another huge subsidiary is the medical devices  unit which sells primarily to hospitals and doctors who in turn bill Medicare and health insurers – and healthcare spending is driving the fed government spending. The NBC subsidiary depends on the FCC for favorable decisions and protection from competition. And finally, the last major subsidiary is the financial services unit which benefitted from the bank bailouts.  Let’s face it, GE is a giant that depends primarily on the federal government for support. Yet, not only is Immelt, the GE CEO in a position to have the President’s ear on economic and budget issues, he’s doing it without resigning from GE. Can we all say “conflict of interest” folks?

The other appointee, William M. Daley, is resigning (for now) his position as a senior executive with JPMorgan Chase, the monster bank that the Feds bailed out and then they fought financial reform.  Let’s be real. Daley’s job lasts at most 2 years. Then he needs another job. He knows that. He also knows JP Morgan Chase will likely hire him back at a much increased salary – if he gives advice to the President favorable to JP Morgan Chase.

This isn’t representative democracy.  This isn’t even rule by some technocratic advisors.  This is crony capitalism, rule by an oligarchy.

Choice and Welfare

Is Economics (mainstream, neo-classical economics) moral?  Does increasing choices necessarily increase welfare?

Professor Ed Glaeser of Harvard defends his view of the economics profession in the New York Times recently against charges that economists have “no moral compass or core”. He maintains that:

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

He quotes both Adam Smith and John Stuart Mill. Economists on the defensive with the public always like to quote Adam Smith.  I am not so sure Adam would appreciate their summary of his views. But Ed mostly quotes Milton Friedman, including this snippet.

In the last century, Milton Friedman offered “freedom is a rare and delicate flower” and “a society that puts equality — in the sense of equality of outcome — ahead of freedom will end up with neither equality nor freedom.”

I don’t really agree with Glaeser. I believe economics (and economists) has (or should have) a singular moral purpose: to discover how to increase the well-being of people in this world. I happen to think that choice and freedom is an essential element of well-being, but I don’t buy the idea that well-being arises solely from choice. If I am starving, my well-being is better enhanced by access to a single, nourishing adequate meal than if I were to instead only have access to multiple but-all-inadequate alternative meals.

I found this rebuttal of Glaeser’s arguements by Richard Green to be interesting.  I’m not sure he hits the problem head-on, but it’s close.  I also think the comments are fascinating as well and urge readers to them.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can’t help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom’s Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.

Personally I had always thought that increasing choice was desirable only because, and only to the extent that, it was instrumental in achieving higher welfare. Yes, freedom and choice enters into the “utility function” as a good in it’s own right, but so do other goods such as love, health, security, and the ability to produce or grow.  It is not clear to me that choice necessarily trumps these other goods, nor is it clear that these other goods can only be gained from some abstract freedom of choice that Friedman espouses.

No, Sovereign Currency Nations Don’t Go Bankrupt

National debt continue to dominate economic and political talk. This week Moody’s bond rating agency downrated Japan’s national government debt. The Serious People and Talking TV Heads will be full of dire prognostications for Japan. Of course, I don’t see why we should believe Moody’s or S&P anymore after they reassured us for years that sub-prime mortgage-backed securities were AAA rated secure stuff.  It’s clear they live in an alternate reality world. And that’s where the dire prognostications for Japan belong too – in an alternate reality world, not this one.  Krugman in his NYTImes blog reminds us what happened to Japanese interest rates the last time their debt was downrated to only AA, not even AA-:

Amid all the stories about the S&P downgrade of Japan, I’ve seen hardly any mentions of the fact that Japan was downgraded below Botswana in 2002. And here was the effect on the interest rate:

DESCRIPTIONEurostat

Nada. In fact, if you bought JGBs just before the downgrade, you ended up doing very well.

I’m not saying that Japan’s long-run budget situation isn’t troubling. But the rating agencies (a) don’t know anything the rest of us don’t (b) are way too quick to downgrade sovereign debt, especially as compared with their what-me-worry attitude toward private securities (c) have very little actual influence on market.

Japan is an advanced industrial nation with a sovereign fiat currency that borrows in it’s own currency. Much like the U.S., Canada, and Australia. But “Japan has close to 200% debt-to-GDP ratio! ” the debt terrorists scream.  It’s going to collapse and go bankrupt, they say.  The truth is not in this real world.  It’s perfectly supportable. There’s no need to for drastic austerity measures in Japan. Just like there’s no debt problem in the U.S. where the ratio is only around 70-75%.