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America’s spending on physical capital, including buildings and machinery, is declining as a percentage of its total production. Economists have offered a number of explanations for this trend. For example, one might expect this to happen as the technology and service sectors get larger relative to other, more physical-capital-intensive sectors such as manufacturing. In addition, firms are devoting an increasing fraction of their investment to “intangible capital” such as research and development, intellectual property, branding, and organization. And whatever the mix of causes ultimately turns out to be, it might have important implications for economic policy.
Thus, I was interested in reading a recent report from Senator Marco Rubio entitled “American Investment in the 21st Century.” Unfortunately, the report is both poorly reasoned and filled with left-wing talking points.
While the report cites some of the relevant economic literature on the declining share of physical-capital investment, it does so only to establish the empirical trend — not to explore the trend’s causes. Instead, the report tries to explain the trend in investment by appealing to a balance-sheet approach of the economy: a comparison of the financial liabilities and financial assets of particular types of firms.
When the value of a firm’s financial assets exceeds the value of its financial liabilities, the firm is a net lender; if the opposite is the case, the firm is a net borrower. Prior to the 21st century, non-financial firms were net borrowers, while households and financial firms were net lenders. However, in recent years, non-financial firms have become net lenders as well. The report refers to this as the “financialization” of the economy and argues that it is a problem. Why? For one thing, firms used to use their net-borrowing position to invest in physical capital, which they can no longer do as net lenders. For another, in the economy as a whole, total financial liabilities must equal total financial assets — meaning that if financial firms, non-financial firms, and households are all net lenders, there must be some borrower.
This analysis is nonsense. It amounts to reasoning from an accounting identity. It is not the sort of thing that one would find in mainstream economic textbooks, for good reason.
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