In my article arguing that electricity from solar PV (and wind) could soon be too cheap to meter, I didn’t mention transmission networks. That was for space reasons.
The case for public investment is actually stronger for transmission than for generation. Electricity transmission lines have the same cost structure as renewables (low operational cost and long lives), if anything more so, meaning that the cost of transmission depends primarily on the need to secure a return to the capital invested.
More than this, the electricity grid as a whole is a complex network in which valuing the services of any individual component is just about impossible. That in turn means that relying on markets to make optimal investment decisions is untenable.
That’s the headline for my latest piece in Inside Story, looking at the implications of zero interest rates for renewable energy sources like solar and wind. Key para
Once a solar module has been installed, a zero rate of interest means that the electricity it generates is virtually free. Spread over the lifetime of the module, the cost is around 2c/kWh (assuming $1/watt cost, 2000 operating hours per year and a twenty-five-year lifetime). That cost would be indexed to the rate of inflation, but would probably never exceed 3c/kWh.
The prospect of electricity this cheap might seem counterintuitive to anyone whose model of investment analysis is based on concepts like “present value” and payback periods. But in the world of zero real interest rates that now appears to be upon us, such concepts are no longer relevant. Governments can, and should, invest in projects whenever the total benefits exceed the costs, regardless of how those benefits are spread over time.
In the process of working on my book-in-progress, The Economic Consequences of the Pandemic, I’ve been trying to integrate a number of facts about the economy of which I’ve been more or less aware for a while, along with claims I want to make, and put them together into a coherent account of the economic system prevailing (in advanced/developed economies( in the 21st century and how it differs from the industrial goods economy of the 20th century.
As a step towards this, I’ve put together a list of factual claims which I think can be established reasonably firmly, along with claims I want to make that will be more contentious. My plan is to put this together into a coherent analysis, including supporting evidence. So, I’m keen to get good supporting links for any of these points (I have quite a bit, but more would be helfpul). I also want to be sure I’m not missing contrary evidence, and to adjust the claims if necessary, so please point this out also.
Facts (I think)
Most economic activity in the 20th century, including services such as wholesale and retail trade, was fairly directly related to the production and distribution of goods
This is no longer true: most economic activity is now related to human services, information services and finance, and these are at most indirectly related to goods production
Real interest rates for government debt and high-grade corporate debt have been below zero since the GFC and seem likely to remain there permanently under current conditions
Massive issues of government debt during the pandemic crisis haven’t changed this
Net private business investment (non-residential) has been declining relative to GDP/national income since at least 2000
Service industries less capital intensive than goods industries
Information economy firms (Facebook, Google etc) invest very little even counting R&R
Government investment in traditional infrastructure has been falling since 1970s, at most partially offset by private infrastructure
Corporate profits high, mostly derived either from financial sector or from “intangible” assets in IT.
Finance sector profits even higher if payments to managerial level in finance sector are treated as part of profit
Intangibles = monopoly
Revenue and profits in finance and Internet do not arise from sales to final consumers, and bear no obvious relationship to consumer welfare
Implies similar regarding wages for market work
Incentives don’t work in in this kind of economy (if they ever did)
Unmet needs for public investment in human services: health, education, aged care, early childhood, social work
Capacity to meet these through short term increase in public debt, long term increase in taxation
Here’s an extract from my contingent* book-in-progress, Economic Consequences of the Pandemic commissioned by Yale University Press. Comments and compliments appreciated, as always.
The Covid-19 pandemic has taught us several things about inequality, or rather, it has dramatically reinforced lessons we, as a society, have failed to learn. The first is the importance of luck in determining unequal outcomes.
Some of us will get Covid-19 and die or suffer lifelong health consequences. Others will lose their jobs and businesses. Many, however, will be unaffected or will even find themselves better off. Some of these differences may be traced to individual choices that are sensible or otherwise, such as deciding whether to wear a mask in public places. But mostly they are a matter of being in the wrong (or right) place at the wrong (or right time).
Moreover, this isn’t specific to the pandemic. From the moment we are born, luck plays a critical role in our life chances. Our families may or may not be in a position to help us succeed, and may or may not hold together through our childhood. Moreover, this isn’t specific to the pandemic. From the moment we are born, luck plays a critical role in our life chances. Our families may or may not be in a position to help us succeed, and may or may not hold together through our childhood. A child born into the bottom 20 per cent of the US income distribution has only a 4 per cent chance of ending up in the top 20 per cent. The opposite is true at the other end of the distribution with the striking exception of Black children, especially boys.
These facts have been known to social scientists for decades. Yet until recently, in the face of glaringly unequal outcomes, most Americans comforted themselves with the idea that the United States was a land of opportunity where everyone who worked hard had a fair chance of doing well. This was true a century ago, but now there is more mobility between economic classes in European countries than in the US.
That’s not to say everything in Europe is rosy. Piketty examined the UK and France as well as the US and found growing inequality in all three. It seems likely that other European countare are on the path towards what Piketty calls a patrimonial society, where inherited wealth is the most important determinant of success.
Luck doesn’t end with the lottery of family background. Young people who enter the labour force during a recession will experience permanently reduced life chances compared to those who enter during a boom. And at an individual level, lucky or unlucky breaks of various kinds are much more important than many of us like to believe. Robert Frank provides detailed evidence in Success and Luck: Good Fortune and the Myth of Meritocracy.
The pandemic has reinforced this lesson in the most brutal way possible. As is usual, the poorest members of society have been most exposed both to the risk of death and disease and to economic hardship. But everyone is vulnerable, and it is a matter of chance whether any of us gets infected, and whether the consequences are harmless, severe or fatal. Similarly, exposure to economic damage is largely random, depending on the way in which the pandemic affects different industries and regions.
The randomness of economic success implies that concerns about the incentive effects of high taxes on those at the top of the income distribution are misplaced. If the lucky winners in the economic lottery are discouraged from working (something unlikely to happen on a significant scale until marginal tax rates exceed 70 per cent), there are plenty of unlucky runners-up who can replace them.
Contingent because I’m writing on the assumption that Biden wins the US election, and takes office. While a Trump win would be an object lesson in the importance of luck, it would render any commentary on responses to the pandemic pointless as far as the US is concerned and would have drastic consequences for the rest of the world for which I have no analysis to offer at the moment
One of the big questions about the shift to working remotely has been “what about new staff?”. To spell this out, the idea is that, while experienced workers can do everything they need to online, new employees will need personal contact to pick up tacit knowledge and firm culture. It’s inherent in the argument that these terms are difficult to define with any precision – if not, they could be formalised and taught.
This is part of a debate that’s been going on for a couple of centuries, between proposals for formal education in work-related skills and learning on the job, sometimes through apprenticeships and sometimes through “sitting next to Nelly”, that is, picking up the relevant skills by working with people who have already acquired them.
Before 1800, and with the partial exception of ministers of religion, on the job training was the only kind on offer. Since then, starting with lawyers and doctors, formal education has steadily expanded at the expense of on the job training, across a wide range of occupations and in many different countries with radically different labor markets. That includes some economies and industries where lifetime employment by a single firm has been the norm and others where work is largely done on a contract or ‘gig’ basis.
This process has always been contentious. Terms like “credentialism”, “overqualification” and “academic” (used pejoratively) have set the tone of much of the discussion. Nevertheless, there has been little evidence that the trend has been or will be reversed, and no one has managed to find, and sustain, a successful altern ative.
The work of hiring, ‘onboarding’, promoting and firing employees has not been exempt from the process. “Human resource management” emerged as a distinct profession in the second half of the 20th century, taking over much of this work from individual managers. HR departments have in turn begun to outsource some of these tasks to specialised firms such as headhunters and ‘separation management advisers’, though onboarding still appears to be done in-house for the most part.
The shift to remote working will provide another test of this process, at least when firms start hiring new staff on a large scale. Some of the concerns expressed about lack of in-person contact will probably prove to be well-founded (though not insuperable). Others, I think, will not. After a few in-person (and ideally one-to-one or small group) meetings to be introduced to new colleagues, most new hires will be able to learn the ropes through email and Zoom.
One of the central features of the debate about working from home is that it leads to the loss of random, but productive, encounters with colleagues. I’ve responded with the observation that some of my best research ideas have come from largely unplanned encounters on the Internet.
It’s just struck me that there is a conflict here between the interests of workers and those of firms and managers.
A lot of universities (or, more precisely university managers), think of themselves as developing and promoting a corporate brand. In this context, research collaboration within the university (particularly if it is trans-disciplinary) is viewed very positively, while collaboration with other universities is less well-regarded. But for individual academics, the big rewards come from high-profile work within tightly defined fields, which implies a desire for collaboration with other people in the same field who will, in general, be located elsewhere. While intra-university collaboration may be rewarded in internal promotion decisions, the outside opportunities are greatest for people with external collaborators. Those outside options are routinely used as a bargaining chip in negotiations over salary.
This issue isn’t specific to universities. Labor market theory distinguishes between firm-specific skills and general skills (which are of value to any employer). Back in 1964, Gary Becker made the argument that firms would be willing to pay the cost of firm-specific training for their workers, but not for general training which increases their outside opportunities. (This seems entirely convincing to me, although the empirical evidence I found on a quick search is both limited and inconclusive).
What applies to training also applies to serendipitous encounters. Collaboration with co-workers can enhance productivity within the firm, but doesn’t do much for your market value outside. Conversely, if workers enhance their productivity at home by making more use of industry discussion groups, Skype chats with people in other firms who are addressing similar problems, and so on, that enhances their bargaining power relative to their employers.
In this context, it’s striking that the hardest push for a return to the office is coming from the finance sector, led by JP Morgan. Even though textbook finance is all about hard numbers on earnings, risk and so on, the industry actually operates largely on personal contacts, networks and exchanges of favours, particularly information. That’s why it’s concentrated in a handful of global cities, and why so much attention is paid to issues like “poaching” of staff, no-compete clauses and the like. It’s obviously in the interests of employers to build up internal networks and control external interactions.
As with all these issues, my ideas here are provisional and almost certainly wrong in some respects. So, feel free to correct me.
That’s the title of the book I’m working on for Yale University Press, and also the theme of two articles I published yesterday.
One, in The Conversation, looked at the potential benefits of remote work and the likely struggle over who will get those benefits. Key paras
For the most part, disputes over sharing the benefits of remote office work will be hashed out between employers, workers and unions, in the ordinary workings of the labour market.
But what about the other half of the workforce, who don’t have the option of working from home? In particular, what about the mostly low-paid service workers who depend on people coming into offices?
If the productivity gains made possible through remote work are to be shared by the entire community, substantial government action will be needed to make sure it happens.
The other article, in Inside Story, looks at the end of the goods economy and its replacement by an information and services economy, a transformation that’s been highlighted by the pandemic. An important implication is that investment demand by private firms is likely to stay low, even as greater public investment is desperately needed.
Tech firms like Microsoft, which now determine stock market values, don’t need much capital. The book value of Microsoft’s capital stock is less then 10 per cent of its market value. The rest is made up of intangibles, a polite word for monopoly-power network effects, intellectual property, and good old-fashioned predatory conduct.
Without any need for private sector investment, interest rates will remain low unless public investment picks up the slack. With the physical goods economy fading into the past, though, we don’t need more of the transport infrastructure projects governments automatically turn to at times like these. Rather, we need to invest in human services like health (mental and physical), education and childcare, and in information platforms that break the monopoly power of the tech giants.
These are the investments that will allow Australia to flourish in an economy dominated by information and services rather than industrial production.
A few thoughts on the fact that r < 0, where r is the real rate of interest on long-term (< 30 years) debt for developed country governments
Situation predates pandemic and has happened despite central bank attempts to resist it, such as abandoned attempt by Fed to raise funds rate in 2019. Extends to corporate bonds as well. Lowest investment grade BBB currently offering 2.38 which implies expected real return (net of inflation and expected loss from default) also below zero. Was 5-6 per cent before GFC
Implies r < g (nominal growth rate), contra Picketty. But corporate profits are high and (ultra) rich are getting (ultra) richer. Presumably profits are being creamed off as rents in some way. Brett Christopher’s forthcoming Rentier Capitalism is highly relevant
If r < 0, any public investment that generates sufficient income to cover costs improves public finances. If we take r as social discount rate, scope for socially beneficial increased public investment is vast. Implied policy: nationalise sources of rent: IP, monopoly platforms, financial sector etc
In a recent post, I pointed out that long-term (30 year) real interest rates on safe (AAA) bonds had fallen to zero, and suggested that this meant the end of capitalism, at least in the sense that the term was understood in classical economics. On the other hand, stock markets have been doing very well. So what is going on? This is a complicated story and I’m still working it out, An important starting point is the fact that the most profitable companies, particularly tech companies, don’t have all that much in the way of capital assets compared to their market value. What they have is monopoly power, which has been increasing steadily over time. That benefits those who already own and control these firms, but it does not provide new investment opportunities.
I’ll start by looking at price-to-book ratios. Alphabet, which owns Google has a market value five times the book value of its assets https://www.macrotrends.net/stocks/charts/GOOG/alphabet/price-book The ratio is 15 for Microsoft and 21 for Apple. By contrast, for General Motors, the classic 20th century corporation, it’s just under 1.
For the corporate sector as a whole, the comparable measure is Tobin’s q ratio, which has been trending upwards since the late 1970s and is now near the all-time high reached during the dotcom bubble.
The value of companies like Apple, Google and Microsoft is made up primarily of “intangibles”. That term can cover all sorts of things, and is often taken to refer to some special aspect of the firm in question, such as accumulated R&D, tacit knowledge or ‘goodwill’ associated with brands. R&D is at most a small part of the story. The leading tech companies spend $10 – 20 billion a year each on R&D https://spendmenot.com/top-rd-spenders/, a tiny fraction of market valuations of $1 trillion or more. And feelings towards most of these companies are the opposite of goodwill – more like resentful dependence in most cases.
A simpler explanation is that the main intangible asset held by these companies is monopoly power, arising from network effects, intellectual property, control over natural resources and good old-fashioned predatory conduct.
In this context, the crucial point about intangibles isn’t that they aren’t physical, it’s that they can’t be reproduced by anyone else. No one can sell a Windows or Apple operating system, even if they were willing to invest the effort required to reverse-engineer it. While there are competitors for the Google’s search engine (I recommend DuckDuckGo), there are huge barriers to entry, notably including the fact that the product is ‘free’ or rather supported by advertising for which all consumers pay whether they use Google or not.
There’s a complicated relationship here between the rise of monopoly and the development of the information economy in which the top tech firms operate. Information is the ultimate ‘non-rival’ good. Once generated by one person it can be shared with anyone else without diminishing in value. As the cost of communication has fallen, it’s become possible for everyone in the world to gain access to new information at essentially zero cost. What this means is that there is very little relationship between the value of information and the ability of corporations to capture value from it. The protocols and languages that make the Internet possible are a public good, created by collaborative effort and made freely available. The information on the Internet is generated by households, business and governments using these protocols. Without these public goods, Google would be worthless. But because advertising can be attached to search results, ownership of a search engine is immensely profitable.
In turn, this means that traditional ideas about capital and investment are largely irrelevant in the information economy. More on this soon, I hope.