Macro Roundup

the the point you were most interested in, the life of assets having been shorted see top of page 6)"....Whether a gross or net measure is more appropriate depends on the question being asked: the allocation of gross value added between labor and gross capital more directly reflects the structure of production, while the allocation of net value added between labor and net capital reflects the ultimate command over resources that accrues to labor versus capital....For instance, in an industry where most of the output is produced by short-lived software, the gross capital share will be high, evincing the centrality of capital’s direct role in production. At the same time, the net capital share may be low, indicating that the returns from production ultimately go more to software engineers than capitalists—whose return from production is offset by a loss from capital that rapidly becomes obsolete..."Rognlie, Matthew, "Deciphering the fall and rise in the net capital share,"Brookings Panel on Economic Activity, March 2015. Available at:http://www.brookings.edu/about/projects/bpea/papers/2015/land-prices-evolution-capitals-share
"...First, it argues that as a purely descriptive matter,the recent behavior of income shares is widely misunderstood: rather than experiencing a steady rise, the net capital share for large developed economies has followed a U-shaped trajectory in the postwar era, and its long- term expansion originates entirely in the housing sector.Although both gross and net income shares can be meaningful,net concepts are more relevant to the debate on inequality.Second, this paper observes that when net capital income outside the housing sector is disaggregated between the return on fixed assets and a residual share of pure profits, the U-shaped trajectory is driven mainly by the residual—calling the mechanisms in Karabarbounis and Neiman (2014b) and Piketty and Zucman (2014), which rely on changes in the aggregate value of capital, into question. Finally, it describes the theory of factor shares and the role of elasticities of substitution, evaluating various hypotheses by performing counterfactual simulations in a multisector model.....This measurement reveals a striking discrepancy in the long-term behavior of gross and net shares, echoing the claims of Bridgman (2014); and it shows that the net capital share generally fell from the beginning of the sample through the mid-1970s, at which point the trends reversed. In the long run, there is a moderate increase in the aggregate net capital share, but this owes entirely to the housing sector—where, since ownership is less concentrated, the consequences for inequality may be less severe.In the shorter run, there is both the U-shaped pattern in capital income and a strong cyclical element...It starts by disaggregating net capital income in the corporate sector into components that reflect the return on fixed assets—equipment, structures, and land—as well as a residual term reflecting “pure” profits. Although the decomposition between return on assets and this residual can be somewhat ambiguous, both crude and more sophisticated approaches indicate that the residual plays a central role.To some extent, this residual reflects cyclical variation in markups, but its long-term pattern—which parallels the U-shaped pattern in capital income as a whole—may hint at broader changes in market power and the importance of monopoly profits....I note some intriguing shifts in composition: for instance,there has been a long-term shift in net capital income from land in the non-housing sector to land in the housing sector....Motivated by the limitations of a one-sector model, I construct a multisector model that reflects the disaggregation performed in section 3, and use this model (with a tentative calibration of elasticities) to perform counterfactual simulations that study the influence of key forces on the net capital share—including the observed changes in the relative price of various kinds of investment, and also changes in the real interest rate....For instance, in an industry where most of the output is produced by short-lived software, the gross capital share will be high, evincing the centrality of capital’s direct role in production. At the same time, the net capital share may be low, indicating that the returns from production ultimately go more to software engineers than capitalists—whose return from production is offset by a loss from capital that rapidly becomes obsolete.Both measures are important: indeed, a rise in the gross capital share in a particular industry is particularly salient to an employee whose job has been replaced by software, and it may proxy for an underlying shift in distribution within aggregate labor income— for instance, from travel agents to software engineers. The massive reallocation of gross income in manufacturing from labor to capital, documented by Elsby et al. (2013), has certainly come as unwelcome news to manufacturing workers. But when considering the ultimate breakdown of income between labor and capital, particularly in the context of concern about inequality in the aggregate economy, the net measure is likely more relevant. This point is accepted by Piketty (2014), who uses net measures; the general rationale for excluding depreciation is pithily summarized by Baker (2010), who remarks that “you can’t eat depreciation....As we increase capital relative to labor, the net marginal product of capital declines more rapidly than the gross—in short, capital is less substitutable for labor from a net perspective....” Mobile908.303.9747
Office212.404.4646

DeLong, Brad, "DRAFT: Discussion of Matthew Rognlie: “Deciphering the Fall and Rise in the Net Capital Share”"Washington Center for Equitable Growth, March 18, 2015. Available at: http://equitablegrowth.org/2015/03/18/draft-discussion-matthew-rognlie-deciphering-fall-rise-net-capital-share/"....Matt’s focus on the net capital share is surely right.....As Matt stressed, the big news in the post-World War II net capital share is the surge in housing: from 3% to 8% of private domestic value added. How much of this is a real increase in housing intensity? How much reflects congestion driven by exhaustion of the low-hanging superhighways? How much is rent-extraction via NIMBYism? How much trust do we give to these “imputed rent” imputations anyway?There has always been a problem with using our GDP estimates as social accounts. In GDP, we measure each unit’s contribution to production at the final unit’s marginal cost and each unit’s contribution to societal well-being at the final unit’s money-metric marginal utility. In the presence of anything like near-satiation in consumption, or of near-exhaustion in productive capacity, this does not convey a true picture. Hard questions. No very good answers....the secondary big news in his numbers is the pre-1990 fall in the net capital share, a fall driven by a very real rise in depreciation is real. Our capital stock has seen the replacement of long-lasting machines to perform Wellman-Lord desulfurization reactions with video editing machines rapidly obsoleted by Moore’s Law.....But it is puzzling that the pre-1990 fall in the net capital share not matched by a decline in the relative capitalization of the corporate sector. Matt points out a steady rise in capitalization up to the late 1960s, followed in the 1970s by a “negative bubble”-truly absurdly high earnings yields on equities-that lasts well into the 1980s. Then we see a bubbly rise in the relative capitalization of the corporate sector since the start of the 1990s-a rise that persists in spite of sub-par business-cycle performance. Very puzzling....et me end by strongly endorsing what I take to be Matt Rognlie’s bottom line.I take it to be that post-WWII variation in the observed net capital share is not explainable via returns on the underlying assets. Instead, the decomposition in section 3 attributes most of the variation to pure profits, or markups… Accumulation and returns play, outside of housing, a distinctly secondary role, if they play any role at all. But it is equally hard to find any role for the race between education and technology, and there should be if we think the factors of production are labor, education skills, and machines....Likewise, variation in income inequality, is hard to attribute to wealth ownership or to human capital investment or to differential shifts in rewards to factors like raw labor, experience-skills, education-skills, and machines. Matt thus concludes that: "Concern about inequality should be shifted away from the split between capital and labor, and toward other aspects of distribution, such as the within-labor distribution of income."The nly caveat I wish to make is: This is true now. This may not be true in 50 years, if Piketty is right.And Matt’s conclusion is bad news for us economists, for it leaves us in the same position as those trying to explain an earlier large puzzle in the production function, the twentieth-century retardation of the British economy...."

DRAFT: Discussion of Matthew Rognlie: “Deciphering the Fall and Rise in the Net Capital Share” By Brad DeLongPosted on March 18, 2015 at 9:27 am SHAREJ. Bradford DeLong:: U.C. Berkeley and NBER:: delong@econ.berkeley.eduFor BPEA Spring 2015 8:30 AM March 20, 2015

To the extent that land is the driver of shifts in our capital share, this is clear a problem to the extent that it is driven by NIMBYism. But is it a problem otherwise?

And as Matt also stressed, the secondary big news in his numbers is the pre-1990 fall in thenetcapital share, a fall driven by a very real rise in depreciation is real. Our capital stock has seen the replacement of long-lasting machines to perform Wellman-Lord desulfurization reactions with video editing machines rapidly obsoleted by Moore’s Law.

But it is puzzling that the pre-1990 fall in the net capital share not matched by a decline in the relative capitalization of the corporate sector. Matt points out a steady rise in capitalization up to the late 1960s, followed in the 1970s by a “negative bubble”-truly absurdly high earnings yields on equities-that lasts well into the 1980s. Then we see a bubbly rise in the relative capitalization of the corporate sector since the start of the 1990s-a rise that persists in spite of sub-par business-cycle performance. Very puzzling.

Let me end by strongly endorsing what I take to be Matt Rognlie’s bottom line. I take it to be that post-WWII variation in the observed net capital share is not explainable

via returns on the underlying assets. Instead, the decomposition in section 3 attributes most of the variation to pure profits, or markups…

Accumulation and returns play, outside of housing, a distinctly secondary role, if they play any role at all. But it is equally hard to find any role for the race between education and technology, and there should be if we think the factors of production are labor, education skills, and machines.

Likewise, variation in income inequality, is hard to attribute to wealth ownership or to human capital investment or to differential shifts in rewards to factors like raw labor, experience-skills, education-skills, and machines. Matt thus concludes that:

Concern about inequality should be shifted away from the split between capital and labor, and toward other aspects of distribution, such as the within-labor distribution of income.

The nly caveat I wish to make is: This is true now. This may not be true in 50 years, if Piketty is right

And Matt’s conclusion is bad news for us economists, for it leaves us in the same position as those trying to explain an earlier large puzzle in the production function, the twentieth-century retardation of the British economy.

It was Robert Solow who said:

Every discussion among economists of the relatively slow growth of the British economy compared with the Continental economies ends up in a blaze of amateur sociology…

I really would like for us to be able to do better.

Notes:

These big worries are:

Worries about depreciation allowances in these accounts. Mine are perhaps bigger than most.

Worries about how much of the value that comes from installing capital comes from (local) learning about how to handle the technology, and is something that does not depreciate from the point of view of the individual firm. That is not captured.

Worries about, from the societal point of view, how much of the value that comes from installing capital comes from global learning about how to handle the technology.

Perennial worries about what in high-end labor incomes are really incomes earned by raw labor and human capital, and what are rent-extraction and thus sharing in the returns to capital.

In America things are different: the frontier. But in Western Europe one thing going on at the end of theBelle Époqueis the collapse in the value of rents on absentee-owned European farmland.

Downton Abbey-Highclear-was supportable on its entailed rents a generation before World War I. It was not so afterwards. Some of this was taxes. But there was also a steep relative fall in prices of staple foodstuffs. Not just Iowa and Kansas, but Odessa and New Zealand came online.

Western European farmland lost its value as a factor of production at the end of the nineteenth century. To what extent was that it? And to what extent is “it now the rise of housing prices in London, Paris, Rome, Milan, etc.? My teacher the late David Landes, a CUNY graduate, simply bought a Paris apartment as a postdoc post-WWII. Those of our postdocs who could not afford to go to private colleges do not pick up Paris apartments casually in the course of a research trip to take a look at bank records.

The fact that the big news since World War II is a rise in housing as a share of value added raises the question of whether this surge may be in significant part the reversal of story from a century ago-now the rise of valuable urban housing, then the decline of valuable Western European rural farmland.2

Hard questions. No very good answers.

There has always been a problem with using our GDP estimates as social accounts. In GDP, we measure each unit’s contribution to production at the final unit’s marginal cost and each unit’s contribution to societal well-being at the final unit’s money-metric marginal utility. In the presence of anything like near-satiation in consumption, or of near-exhaustion in productive capacity, this does not convey a true picture.

And what hat does this mean, anyway?

How much of this is a real increase in housing intensity? How much reflects congestion driven by exhaustion of the low-hanging superhighways? How much is rent-extraction via NIMBYism? How much trust do we give to these “imputed rent” imputations anyway?

As Matt stressed, the big news in the post-World War II net capital share is the surge in housing: from 3% to 8% of private domestic value added.

I never understood why, in the Solow model, gross savings was supposed to be a function of gross output anyway. There are the big worries over the data.1Let me skip those.

Matt’s focus on the net capital share is surely right.

And this is why it is truly excellent that Matt Rognlie brings well-ordered and insightfully-organized data to these questions.

What about what John Maynard Keynes called the “euthanasia of therentier”? As accumulation proceeds the relative fall in the rate of profit exceeding the relative rise in concentrated wealth? Piketty points to remarkable constancy in the rate of profit at between 4% and 5% per year, but is agnostic as to whether the cause is easy capital-labor substitution, rent-seeking by the rich, or social structure that sets that as the “fair” rate of profit.

He guesses that the real explanation is that 1914-1980 is the anomaly. Without great political disturbances, wealth accumulates, concentrates, and dominates.

Thomas Piketty has a guess.

It is simply not possible to see such an extreme concentration of benefits as in any way a return to a factor of production obtained as the product of “hours spent studying” times “brainpower”.

Relative to 1968 you need 3.5 times the wealth now in the U.S. and 8 times the wealth worldwide. That is an income and wealth an order of magnitude higher than my grandfather ever did.

One of his other grandsons, my first cousin Phil Lord, mighthave a chance of making it into the same financial range-if he can make the transition from co-director to “producer” and “created by” credits-but if he does he will still be breathing much less rarified relative air.

A little family history: My Grandfather Bill was in not just the 1% or the 0.1% but the 0.01% back in the days before the rise in inequality. He sold his chemical construction company to the IMF conglomerate and retired back in 1968.

To get large swings in the income distribution out of small changes in the relative supply of educated workers seems to require less substitutability between formal college and other factors of production then seemed reasonable. Higher experience-skill premiums and sharply higher education-skill premiums, yes. But the action seems to be far, far out in the upper tail.

But, recently, reality does not seem to agree.

I was weaned on the explanation of recent trends in US inequality set out by the very sharp Claudia Goldin, Larry Katz, and company. It was skilled-biased technical change, coupled with the end of the era that had begun in 1636 of making increasing educational levels a priority. That combination greatly raised the return to education-based skills. That was the principal driver of rising income inequality.

Thus I am in an excellent position to, if not add intellectual value, share lavishly in intellectual rents.

Let me thank Matt for doing some very serious and thoughtful digging. The upshot is that I am in an ideal position for a discussant: There are very interesting and important numbers that have not been put together before, and there is an author who is wise enough not to believe he has with the numbers mean nailed.

Sandbu, Martin, "Free Lunch: Piketty meets his match"Financial Times, March 20, 2015. Available at:http://www.ft.com/cms/s/0/bbf09ba8-cd51-11e4-9144-00144feab7de.html"...Rognlie does two things. In terms of theory, he notes a difference between the concept of substitutability used by Piketty and that commonly measured, depending on whether you measure capital (and output) before or after adjusting for depreciation (the investment needed just to offset the wear of machinery over time). Properly measured, he shows, the empirical evidence overwhelmingly shows that capital cannot substitute for labour to anywhere near the degree needed to fulfil Piketty's prophecies. Empirically, Rognlie looks more closely at capital's share of income, and finds that with the exception of one sector, net shares have remained largely constant aside from short-term fluctuations. (They fell slightly until the 1990s and have caught up since. Gross shares have increased more steadily, but that's because of greater use of capital that depreciates faster - software, for example.) The exception is housing, which accounts for a big part of capital accumulation and for all of the long-term rise in the capital income share. Something has clearly been going on in the housing sector - but as Rognlie points out, since the housing ownership is much more evenly spread than productive capital, it may be less worrying for inequality....."
Free Lunch: Piketty meets his match

Martin Sandbu

How could economists not fawn over Matthew Rognlie? A 26-year-old graduate student has delivered a technical critique of Thomas Piketty's theory of capital-driven inequality that is gaining status as the most devastating yet put forward. What started with a comment on the Marginal Revolution blog has grown into a paper that Rognlie is presenting at the Brookings Panel on Economic Activity today - the prime US conference on applied policy economics.

Recall that Piketty, in addition to adding significantly to our empirical knowledge about how incomes and wealth are distributed, theorises that capital accumulation plays a big role in exacerbating inequality and will continue to do so in the future. The idea is that the return on capital will remain sizeable while GDP growth slows (the famous r > g). This means the stock of capital will grow bigger relative to national income and so the share of capital returns in total income will grow at the expense of labour income.

The objection has always been that as capital accumulates, the return on it will fall. Piketty has shown that the rate of return has been remarkably stable historically, and theorised that it can remain so. Technically, how fast returns to capital fall depends on the "elasticity of substitution", ie the ease with which capital and labour can be substituted for one another in the production process. The more easily workers can be replaced by machines, the more capital the economy can absorb without reducing the reward paid to capital owners. If substitutability is moderate, the incremental capital becomes harder to employ productively, and returns fall.

Rognlie does two things. In terms of theory, he notes a difference between the concept of substitutability used by Piketty and that commonly measured, depending on whether you measure capital (and output) before or after adjusting for depreciation (the investment needed just to offset the wear of machinery over time). Properly measured, he shows, the empirical evidence overwhelmingly shows that capital cannot substitute for labour to anywhere near the degree needed to fulfil Piketty's prophecies.

Empirically, Rognlie looks more closely at capital's share of income, and finds that with the exception of one sector, net shares have remained largely constant aside from short-term fluctuations. (They fell slightly until the 1990s and have caught up since. Gross shares have increased more steadily, but that's because of greater use of capital that depreciates faster - software, for example.) The exception is housing, which accounts for a big part of capital accumulation and for all of the long-term rise in the capital income share. Something has clearly been going on in the housing sector - but as Rognlie points out, since the housing ownership is much more evenly spread than productive capital, it may be less worrying for inequality.

Rognlie's work is impressive, and he is receiving well-deserved star treatment today. His discussants are Robert Solow - the nonagenarian Nobel-winning economist known for his theory of economic growth - and Bradford DeLong. DeLong has posted his comments on Rognlie on his blog; they are entertaining and illuminating, though more for raising questions than giving answers.

The upshot is not that inequality doesn't matter. It is that it's hard to explain rising inequality in terms of capital accumulation. Instead, Rognlie concludes, we should focus on changing (and increasingly unequal) distribution within labour income.

Murray is always a joy to read
"...Now let’s look at the income effect in the PIAT when the mother’s IQ is statistically held constant at the national average of 100. Going to a $200,000 family income from a $1,000 family income raises the score only to the 76th percentile from the 50th—an increase of 26 percentiles. More important, almost all of the effect occurs for people making less than $125,000. Going to $200,000 from $125,000 moves the PIAT score only to the 76th percentile from the 73rd—a trivial change. Beyond $200,000, PIAT scores go down as income increases...people refuse to confront it because it exposes an unwelcome reality...more strictly that elite colleges admit students purely on the basis of academic accomplishment, the more their student bodies will be populated with the offspring of the upper-middle class and wealthy—not because their parents are rich, but because they are smart. No improvement in the SAT can do away with this underlying reality.I haven’t used the word “meritocracy” to describe this because it doesn’t apply. Merit has nothing to do with possessing a high IQ.It is pure luck. And that leads to my reason for writing this. As long as we insist on blaming inequality of academic outcomes on economic inequality, we will pursue policies that end up punishing children whose strengths do not lie in academics. We will continue to tell them that they will be second-class citizens if they don’t get a college degree; to encourage them to accumulate student debt only to drop out or obtain a worthless degree. Worse, we will prevent them from capitalizing on their other gifts of character, grit and the many skills that the SAT doesn’t test. What we need is an educational system that brings children with all combinations of assets and deficits to adulthood having identified things they enjoy doing and having learned how to do them well. What we need is a society that has valued places for people with all combinations of assets and deficits. Both goals call for completely different agendas than the ones that dominate today’s rhetoric about educational and economic inequality."Murray, Charles, "Why the SAT Isn’t a ‘Student Affluence Test’,"The Wall Street Journal, March 24, 2015. Available at:http://www.wsj.com/articles/charles-murray-why-the-sat-isnt-a-student-affluence-test-1427238664Why the SAT Isn’t a ‘Student Affluence Test’ A lot of the apparent income effect on standardized tests is owed to parental IQ—a fact that needs addressing. By Charles Murray March 24, 2015 7:11 p.m. ET Spring is here, which means it’s time for elite colleges to send out acceptance letters. Some will go to athletes, the children of influential alumni and those who round out the school’s diversity profile. But most will go to the offspring of the upper middle class. We all know why, right? Affluent parents get their kids into the best colleges by sending them to private schools or spending lots of money on test preparation courses. Either way, it perpetuates privilege from generation to generation. The College Board provides ammunition for this accusation every year when it shows average SAT scores by family income. The results are always the same: The richer the parents, the higher the children’s SAT scores. This has led some to view the SAT as merely another weapon in the inequality wars, and to suggest that SAT should actually stand for “Student Affluence Test.” It’s a bum rap. All high-quality academic tests look as if they’re affluence tests. It’s inevitable. Parental IQ is correlated with children’s IQ everywhere. In all advanced societies, income is correlated with IQ. Scores on academic achievement tests are always correlated with the test-takers’ IQ. Those three correlations guarantee that every standardized academic-achievement test shows higher average test scores as parental income increases. But those correlations also mean that a lot of the apparent income effect is actually owed to parental IQ. The SAT doesn’t have IQ information on the parents. But the widely used National Longitudinal Survey of Youth contains thousands of cases with data on family income, the mother’s IQ, and her children’s performance on the math and reading tests of the Peabody Individual Achievement Test battery, which test the same skills as the math and reading tests of the SAT. For the SAT, shifting to more than $200,000 of family income from less than $20,000 moved the average score on the combined math and reading tests to the 74th percentile from the 31st—a jump of 43 percentiles. The same income shift moved the average PIAT score to the 82nd percentile from the 30th—a jump of 52 percentiles. Now let’s look at the income effect in the PIAT when the mother’s IQ is statistically held constant at the national average of 100. Going to a $200,000 family income from a $1,000 family income raises the score only to the 76th percentile from the 50th—an increase of 26 percentiles. More important, almost all of the effect occurs for people making less than $125,000. Going to $200,000 from $125,000 moves the PIAT score only to the 76th percentile from the 73rd—a trivial change. Beyond $200,000, PIAT scores go down as income increases. In assessing the meaning of this, it is important to be realistic about the financial position of families making $125,000 who are also raising children. They were in the top quartile of income distribution in 2013, but they probably live in an unremarkable home in a middle-class neighborhood and send their children to public schools. And yet, given mothers with equal IQs, the child whose parents make $125,000 has only a trivial disadvantage, if any, when competing with children from families who are far more wealthy. Why should almost all of the income effect be concentrated in the first hundred thousand dollars or so? The money itself may help, but another plausible explanation is that the parents making, say, $60,000 are likely to be regularly employed, with all the things that regular employment says about a family. The parents are likely to be conveying advantages other than IQ such as self-discipline, determination and resilience—“grit,” as this cluster of hard-to-measure qualities is starting to be called in the technical literature. Families with an income of, say, $15,000 are much more likely to be irregularly employed or subsisting on welfare, with negative implications for that same bundle of attributes. Somewhere near $100,000 the marginal increments in grit associated with greater income taper off, and further increases in income make little difference. Let’s throw parental education into the analysis so that we can examine the classic indictment of the SAT: the advantage a child of a well-educated and wealthy family (Sebastian, I will call him) has over the child of a modestly educated working-class family (Jane). Sebastian’s parents are part of the fabled 1%, with $400,000 in income, and his mother has a college degree. But her IQ is only average. Jane’s family has an income of just $40,000 and mom has only a high-school diploma. But mom’s IQ is 135, putting her in the top 1% of the IQ distribution. Which child is likely to test higher? Sebastian is predicted to be at the 68th percentile on the PIAT. Jane is predicted to be at the 78th percentile. If you want high test scores, “choose” a smart but poor mother over a rich but dumb one—or over a rich and merely ungifted one. There is nothing new in this analysis. The relationship between IQ and income was first documented decades ago. But people refuse to confront it because it exposes an unwelcome reality: The Sebastians of contemporary America usually have smart parents as well as affluent, well-educated ones. The more strictly that elite colleges admit students purely on the basis of academic accomplishment, the more their student bodies will be populated with the offspring of the upper-middle class and wealthy—not because their parents are rich, but because they are smart. No improvement in the SAT can do away with this underlying reality. I haven’t used the word “meritocracy” to describe this because it doesn’t apply. Merit has nothing to do with possessing a high IQ. It is pure luck. And that leads to my reason for writing this. As long as we insist on blaming inequality of academic outcomes on economic inequality, we will pursue policies that end up punishing children whose strengths do not lie in academics. We will continue to tell them that they will be second-class citizens if they don’t get a college degree; to encourage them to accumulate student debt only to drop out or obtain a worthless degree. Worse, we will prevent them from capitalizing on their other gifts of character, grit and the many skills that the SAT doesn’t test. What we need is an educational system that brings children with all combinations of assets and deficits to adulthood having identified things they enjoy doing and having learned how to do them well. What we need is a society that has valued places for people with all combinations of assets and deficits. Both goals call for completely different agendas than the ones that dominate today’s rhetoric about educational and economic inequality. Mr. Murray is the W.H. Brady Scholar at the American Enterprise Institute.