Paul Krugman says that recent technical change has been capital-biased. That robot story sounds plausible to me too. But if so, why are real interest rates so low? (Yes I know there's a global recession on, but real interest rates were falling even before the recession). Maybe we are forgetting a third factor, land, and land rents are rising?
Suppose there were a new technology that caused both wages and interest rates to fall. Why wouldn't capitalists and workers say "Stuff that, let's go back to the old technology!"? Any individual firm, or group of firms, that went back to the old technology, while borrowing at the new low interest rates and paying the new low wages, would make super-normal profits. And all the other firms would eventually choose to, or have to, follow it back.
Unless there were a third factor, and the new technology paid higher rents to that third factor.
We used to think that that third factor was skilled labour, that knew how to work with the new "skill-biased" technology, was very productive at the margin, and so earned high rents. But if, as Paul says, the college premium has stopped rising, and so that third factor is not skilled labour, what is it?
Much longer ago, in the days of Malthus and Ricardo, we used to think that that third factor was land. Maybe it is again. Maybe some of those increasing "profits" are really increasing resource rents?
(I have found good data showing strongly rising rents on agricultural land in the UK, but I can't find a Canadian or US equivalent, only anecdotal evidence of rising rents. And there are more natural resources than agricultural land, of course. Rising land prices are consistent with my story, but don't really support it, because if real interest rates fall land prices will rise even if rents stay the same.)
Or maybe, if not land, it's some other fourth factor that is earning higher rents?
[PS. Historians of thought may recognise some very old questions here. Like how could Marx get both increasing immiserisation of the proletariat and a falling rate of profit? Unless land rents were rising, like In Ricardo. I can't remember if they ever solved that one.]
Worthwhile Canadian Initiative 
The explanation could also fall outside the realm of monetarism: rates could be low artificially, due to high unemployment.
And if unemployment is low not due to not enough money (explained by monetarism), but due to technology globally replacing hundreds of millions of workers permanently (which falls outside monetarism), then the Fed’s lowering of rates due to unemployment addresses the wrong problem: no amount of money will make those workers useful again, in a capitalist, free market economy.
“Freedom” includes the right to marginalise, abuse and ultimately abandon other people.
I’m not confident I understand your thinking, but i don’t see how thismnew tech can cause return to labor and returns to captial to fall whilst still being something that somebody would wish to adopt, unless you suppose a third input like land, and it is, directly or indirectly, the landowners who are driving adoption of this tech. And presumably this tech is being adopted because it out competes its rivals, so captial owners can’t revert to the old tech because they’d be unable to compete with the new tech implementers.
Are real interest rates, by which I presume you mean something like Fed or bank savings account rates minus inflation, a good indicator of the rations being enjoyed by owners of physical and intangible captial?
I’ve often puzzled about this. Could we be in a situation where returns to installed captial are high and may have even been increasing as wages fall, yet the returns to new investment are low?
Returns, not rations
What about the return on Graduate level studies? How has that fared? A Ph.D. is the new B.S. Seems to me people with an MBA from a prestigious university are doing quite well these days…
Luis Enrique: “I’m not confident I understand your thinking, but i don’t see how this new tech can cause return to labor and returns to captial to fall whilst still being something that somebody would wish to adopt,..”
I don’t see it either. I think they wouldn’t adopt it. My argument is that if they did adopt it (for some unknown reason) they would soon unadopt it.
What is the mechanism that is supposed to tie real interest rates in financial markets to returns in the real economy? I presume the basic idea is that if real returns are high, then demand for loans to invest in real projects would be high, driving up interest rates whilst the investment thus funded drives down available returns in the real economy, eventually equating financial real rates with real real rates.
But what if high return investment projects are somehow rationed (intentional spelling this time) and financial rates are set by policy makers? Then the mechanism is bust. Some lucky duckies have access to investment projects involving robots, their cost of capital is low, and they make out like bandits. But there is no boom in demand for loans to move the financial markets.
I expect somebody to blow a hole in this idea.
Hunter: good point. It might be just a signalling war, where as more people invest in a BA the signal isn’t worth as much, so you now need to signal your abilities with an MA or PhD. And nothing to do with any bias in technical change.
Luis Enrique: That idea can make sense too. Top managers grabbing control and skimming off the rents for themselves. But I think there would need to be some sort of barriers to entry. Or top managers might be the fourth factor, with technology being biased towards their skills.
Nick,
This is right (and krugman is right). Asymptotically, when robots do all the work including the development and manufacturing of robots, all rents will flow to the owners of land just like a few hundred years ago. At that point the prescriptions of Henry George will be self evidently true. Until then a great deal of rents will flow to the owners of non-land capital. Watch for ever broadening, ever lengthening IP protections, and continuing income polarization.
Nick: US corporate board membership is a pretty closed club with high barriers of entry.
The rents are high, so there are little incentives to change.
That’s 1 trillion dollars per year of corporate profits looted – a 6% rate.
I think one thing you’re missing is the international savings glut, which predates the recession. To put it in economistic terms, there seems to have been an exogenous decrease in the subjective rate of time preference somewhere around the turn of the millenium. (Or one could say that the Chinese government just decided to dump a boatload of capital on the world in the decade-plus following the Asian financial crisis.) This would explain both why interest rates are low and why businesses are substituting capital for labor. It’s noteworthy that, at least in Asia, the savings glut seems to have reversed (although now we have a different savings glut in Europe and North America, reflected in the zero interest rate bound rather than in high observed savings rates, but presumably that will change as balance sheets get repaired and as confidence improves). So maybe the labor-to-capital substitution is not a trend that is going to continue.
K, Anon, Andy: three good comments. I have nothing to add.
I would suggest the third factor is “brands” . Brands are of course supported by additional intellectual property such as patents and copyrights in addition to trademarks. The high rents go to brands owners that can charge a premium price even in markets that are essentially competitive.
Vlad: not a bad idea. But brands can be seen as capital. If you invest, you create a brand that makes your goods more desirable in the eyes of consumers.
But here’s a slightly different interpretation: brands may make markets less competitive, in the sense of reducing elasticity of demand for a firm’s product. Which means firms will be operating on the downward-sloping part of their ATC curves, and do not fully exploit economies of scale. (It’s hard for me to explain that clearly without diagrams.)
Nick:
To make the hypothesis even more pessimistic, maybe it’s not just land rent of agriculture and resource extraction, but also the rent of habitable land near the centers of economic activity — which is rising because economic activity is increasingly concentrated.
We do seem to be going towards a world where there just isn’t much to do outside of a few large metropolitan areas and resource extraction centers. What can you do in a small town these days? Some agriculture, some government work, and some services that emerge around these, but that’s pretty much it. So masses of people flock to the big cities where there’s a lot of productive activity and hence jobs, which pushes the land rent in these areas through the roof.
This of course leads to the question why the capital doesn’t move out to low-rent, low-wage places. This is indeed happening with the mechanical capital for the physical assembly of stuff. However, if the physical assembly is becoming less important relative to the organizational capital that’s necessary to run the rest of the business, and where you must have a concentration of people who are able to meet face to face, there’s no way to escape the land rent of big population centers.
Vladimir: very good point. I wonder how big that implied land rent is, and where it shows up in the national income accounts? I ought to know the answer to that question. It’s maybe different for owner-occupied vs rental housing. And different again if a business rents or owns the land.
Let me ballpark it. Suppose we spend 20% of our income on housing rents, or implied rents. And that a quarter to half of that is land rent (the value of the lot is that fraction of the total value of the house). We’re at 5% to 10% of GDP.
I’m with vlad. Some people thing marketing adds consumer value. Seems to me that competing to wear the coolest shoes is a zero sum game. The monopoly rents enabled by competition for social rank make it negative sum, a totally inefficient equilibrium. Brands are yet another form of IP not deserving of government protection. Why do we subsidize increasing returns to scale? If we need to protect producers from deceptively inferior knockoffs we could issue all producers an exclusive producer number that nobody else can use. But protecting the Rolex logo – what a waste.
Vladimir, Nick,
Good points.
“there’s no way to escape the land rent of big population centers.”
No, but you can tax them at 100% without loss of output. That’s 5-10% of GDP we can use to cut bad taxes like sales or income. How awesome is that???
Don’t know – space is still available in urban areas, if really needed: vertically. High rise buildings are one of the greatest inventions of humanity, ever.
If land rent was our big story, wouldn’t we see something dramatic in California’s vacancy rates, and in other fast growing population centers?
Yet we don’t.
Anon,
What is the postulated relationship between land rents and vacancy rates?
K: assuming a functioning market, wouldn’t we see historically low vacancy rates in fast-growing urban areas, driving up rents/rates?
Yet the vacancy rate follows (and in the latest recession, leads) the business cycle, well within historic ranges.
If the story of a long term land squeeze in these areas was true then I’d expect something unprecedented: the vacancy rates ignoring the business cycle or at least going outside the usual range.
Land rents in urban (New York, London) and playground (Aspen, Davos, Gstaad)for the über-class and limited membership in said class ( part of it going to tuition fees at Harvard. Their income is deducted from corporate profits and thus lower return on K while we ascribe their income to their MBA and so manufacture a non-existent return to education myth.
Vacancy rates in überland are essentially zero and we do manufacture more in the form of skyscrapers. Not fast enough to lower the rent and anyway, as they extract more and more, they have the income to push back.
I think one thing you’re missing is the international savings glut, which predates the recession. To put it in economistic terms, there seems to have been an exogenous decrease in the subjective rate of time preference somewhere around the turn of the millenium. (Or one could say that the Chinese government just decided to dump a boatload of capital on the world in the decade-plus following the Asian financial crisis.) This would explain both why interest rates are low and why businesses are substituting capital for labor. It’s noteworthy that, at least in Asia, the savings glut seems to have reversed (although now we have a different savings glut in Europe and North America, reflected in the zero interest rate bound rather than in high observed savings rates, but presumably that will change as balance sheets get repaired and as confidence improves). So maybe the labor-to-capital substitution is not a trend that is going to continue.
To follow on from this, firms have engaged in labour arbitrage for the last 25 years, substituting cheaper Asian labour for expensive North American labour as a strategy to boost profits. It impacted the bargaining power of a great swath of North American labour. But the consumption market for that substitution labour, that is where that labour’s goods were going was still North America.
Now that trends seems to be ending. Asian labour wants higher wages and North American consumers are tapped out and restraining their spending. So the trend is being attacked from both ends. Asia, particularly China seems to be approaching the 1890’s – 1920’s era in North America where labour began to flex its muscle and demand higher wages and improved conditions.
Thus the last available market for labour arbitrage is Africa, but Africa still has government barriers (lack of stable governments) and it is smaller if you try to arbitrage labour in Asia, Europe and North America so it will have less of an effect.
But the rate of profit isn’t falling Nick. Corp profits are at an all time high.
And risky real rates are not low.
The theory of interest rates without risk or uncertainty is so incomplete that it is completely misleading.
Anon,
I don’t think so. I would guess that vacancy is almost entirely driven by the business cycle rather than the equilibrium level of rents. At equilibrium I don’t see why vacancy would be lower in a small town than in a mega city. Vacancy and rents can be high in big cities during a temporary downturn and housing can be very difficult to find in a booming rural region. So long as a booming city is growing at a predictable rate I would expect supply to keep up with demand and vacancy to remain stable.
“I have found good data showing strongly rising rents on agricultural land in the UK,”
I would be very careful of interpreting that particular set of numbers.
Farm support (through the EU) changed from per capita (ie, crops produced, cattle kept etc) to simple ownership of the right to farm a piece of land. Not to the land owner, but to the tenant (or the landowner if no tenant). Quite substantial sums, £100 an acre pa or more seems to stick in the mind.
As Ricardo would immediately have pointed out this is going to feed through into the capital/rental value of the land soon enough.
Whether that’s the whole story is another matter: but it’s certainly part of it.
Tim: good point. The CAP will mess with UK data. I really need Canadian or US data, but all I can find is things like newspaper reports that say “Yes, land rents have been going up a lot around here recently” (I’m not very good at finding things on the web.)
Ritwik: The level of corporate “profits” isn’t the same as the rate of return on investment. Interest rates, stock dividend yields, earnings/price ratios, would give a better measure.
Anon: if there were a sudden increase in demand to rent land, we might see vacancy rates fall in the short run, because rents are sticky. But I’m talking about a longer run trend of growing demand, so we would expect to see rising rents and vacancy rates staying roughly constant.
Strategic savings in emerging countries and changes in demography based savings could overcompensate the increasing demand for capital and thus explain increasing capital and and real interest rates. With the share of middle-aged saving people increasing and the dissaving rentier class still relatively small, demography is pointing to high savings more than ever. Does that make any sense to you?
Makro: that makes sense, but I don’t think it’s right. If there are only 2 factors, how can increased savings make both wages and interest rates fall?
Corp profits as % of GDP are on a secular rise. Investment as a % of GDP is on a secular decline. I wasn’t talking about the level of corporate profits.
Of course, the expected rate of return on fresh investment is low, which is why we’re in a recession. There’s a dynamic argument to be made here where current high profit rates maybe in response to an expected decline. But there’s no escaping the fact that in recessions past, including the GD, corp profits took a hit, even as % of GDP. That’s no longer the case now.
There are ways for local areas to adapt as returns of scale will sometimes reverse in production, such as with 3D printing which has wide applications. Because of this growing technological trend, by no means should such manufacture have to be “bad” in terms of capital structure or potential land use, because a wide variety of local 3D and related manufacture can become part of community inclusive production choices. What that means in practical terms is that people can invest in such equipment not so much for profit (“external” economic activity on the part of what they invest in) as the knowing that they can benefit as a consumer over time in what the machines are capable of producing locally, and any extra product that other communities want from this largesse is like a dividend. Such production would be beneficial in that it could also focus on local resource options along with recyclables. Plus, the knowledge required for such production could become a part of local education.
Suppose there were a new technology that caused both wages and interest rates to fall. Why wouldn’t capitalists and workers say “Stuff that, let’s go back to the old technology!”? Any individual firm, or group of firms, that went back to the old technology, while borrowing at the new low interest rates and paying the new low wages, would make super-normal profits. And all the other firms would eventually choose to, or have to, follow it back.
Nick, if you have time, could you explain the reasoning here a little more? Once the investments have been made to replace the old technology with the new technology, then I assume going back to the old technology is a further cost. So even if the return to capital had been higher under the old technology, the cost of going back to it might exceed the gains to be made by going back to it. I’m assuming that the daily investment of capital can be divided up into something like these three time periods:
1. Daily capital investment – old technological regime
2. Daily transitional period capital investment
3. Daily capital investment – new technological regime
If the capitalists undertake the expensive period 2 investment because they anticipate that the rate of return during period 3 will be higher than during period 1, but they turn out to be wrong, it could be that the cost of re-installing the old technology is higher than the accumulated expected incremental daily return from going back to the old regime.
But also, couldn’t it be that the higher return under the old technology was only possible when all of the competitors in the industry were using that old technology, and can’t be recovered by going back to it? I’m thinking for example of a shift from a technology that permitted to 10-day order turnaround to one that permits a 3-day turnaround. If in a given industry all of the firms mutually anticipate that their competitors will all shift to a new technology, and that the shift is going to reduce prices of the industry’s product, make the production of the product more efficient in terms of both labor and capital, and result in a lower return to each, might they not still conclude that they have to make the shift anyway because their only choices are between a small reduction in the ROI and a massive reduction in the ROI.
Maybe this is the similar to K’s point?
Finally, what if the shift to the new technology is accompanied by an increase in the number of capitalists, so that you end up with more capitalists, each making a smaller return on investment, but the total return to capital is much higher than before, and also the share of returns going to capital v. labor is higher as well.
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international savings glut, which predates the recession. To put it in economistic terms, there seems to have been an exogenous decrease
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~~Andy Harless~
Believe it! We are overcapitalized in this country with an excess of savings but with increasing level of unused capacity. Why no opportunities for proper investment? Because our rulers have taxed out of business most of the small business start-ups. As a favour to lobbyist representing the excessively large dinosaur companies Congressional Critters have taxed small business straight into bankruptcy court.
And we vote for those gals/guys
?
“Makro: that makes sense, but I don’t think it’s right. If there are only 2 factors, how can increased savings make both wages and interest rates fall?”
I feel this does not have to be a contradiction. While the interest rate is falling, interest income can still stay high when high net investment compensates.
I think the question in your op is misleading: “Suppose there were a new technology that caused both wages and interest rates to fall. Why wouldn’t capitalists and workers say “Stuff that, let’s go back to the old technology!”?”
I think it is not a new technology they can choose from that makes the difference. it is competition due to high supply of savings which capitalists would have to control to be able to keep the status quo. The new technology might even lead into the direction of higher interest rates but can be overcompensated.
I think the data in Krugman’s post are just wrong.
Cleveland Fed Gomme and Rupert
St Louis Fed Pakko
Both dispel the kind of data Prof K uses. Its a non- issue.
per Dan Kervick’s last paragraph: greater dispersal of capital among economic actors also allows for the potential of greater knowledge use dispersal among economic actors creating overall gain…compromise, anyone?
I do think you’re being overly restrictive in demanding that the technological change lowered real interest rates. I think you’d do well to allow for multiple factors.
Freer trade increased wage competition to U.S. domestic workers and enabled increased productivity of developing economies which may have resulted in greater global savings (and so lowered real interest rates). Technological change may be especially evident in the declining relative price of investment goods (e.g. robots building robots) while not so evident in time-evolving cost of capital (i.e. risk-adjusted real interest rate).
Nick, K:
So if (business) housing supply keeps up with demand, how can prices be so high as to amount to a rent?
There’s no natural monopoly here: the third dimension has space up to a mile and more. Let’s assume a functional market, I.e. no collusion between sellers and no monopolization of supply. (This, except in a handful of critical areas like housing close to stock exchange computers, is largely the case.)
So why shouldn’t prices approximate the cost of building (and thus be one-off, not a perpetual rent), why should they amount to a rent?
Agricultral land data by state and land type for the United States can be found here:
http://quickstats.nass.usda.gov/
Survey>economics>expenses>rent>cash expense for crop or pastureland in $/acre>
Not sure if this says anything about the conjecture, but the labour share in Canada – which profits from resource scarcity – doesn’t seem to have the same downward trend you see in the US:
Labour’s share of income: why are trends in the U.S. and Canada so different?
Anon: “a mile or more”?! .No. Tecnologically yes but above 70 stories, no rent is worth construction costs and what you need in extra servitude space ( water conduits and elevators) takes back on the lower levels what you gain on the upper floors. You can try double-deck elevators and sky lobbies but building above 70 is today as it was for the Empire State Building and the belfries of medieval cathedrals: signs of youthfulboasting. Let’s not go into trivial Freudism but sometimes a tower is not just a tower…
judabomber: Good find! thanks.
So, US land rents were rising slowly, roughly in line with inflation, until 2007, at $77.5 per acre. Then they increased more quickly, to 2012, at $125 per acre.
That is some sort of confirmation of my hypothesis/guess.
Stephen: good point. Not sure if that confirms or disconfirms, what should be a global hypothesis. Maybe it’s because Canadian labour is used more in the resource sector?? Ours being a more resource-intensive economy?
Jacques:
Let’s assume an even more conservative limit: 50 stories max, with current technology.
We are nowhere near that limit in most of the fast growing economic centers, except a few square miles of the hottest business centers and special geographic/political regions like Hong Kong.
And the vacancy rates I cited appear to support that view: there’s still healthy supply & demand forces at work, with only the occasional scarcity.
(You can also check rental/office space spending of some of the largest U.S. corporations in their SEC filings – it’s not a significant sum in terms of GDP impact: less than 1% GDP I’d estimate.)
Dan: “Nick, if you have time, could you explain the reasoning here a little more? Once the investments have been made to replace the old technology with the new technology, then I assume going back to the old technology is a further cost.”
If the new technology meant lower wages and lower rates of return (interest) why would they switch to it in the first place? Even more so if there are adjustment costs of changing technologies.
Ritwik: “Corp profits as % of GDP are on a secular rise. Investment as a % of GDP is on a secular decline. I wasn’t talking about the level of corporate profits.”
Corporate profits are not the same as total returns to capital. They include land, if the corporation owns land. They exclude the returns to those who hold corporate bonds. They exclude non-incorporated capitalists.
Capital =/= corporations.
And, I’m not talking about profits as a % of GDP. I’m talking about the % per year rate of return on investment.
One argument I haven’t seen mentioned is somewhat of a taboo in economist circles: the long term effects of systematic union busting in the U.S.
Unions, in the abstract, increase negotiation strength – pricing – on labor supply side. Their counterparts on the business side are business associations and business lobbying groups.
Union membership is at historic lows in the U.S. and the business lobby is at a historic high.
Is it really a surprise that disorganized workers are getting a worse deal than decades ago and that most of the profit remains with business owners?
Robert: good point.
Paper by Paul Gomme and Peter Rupert here (pdf)
But I can’t find which Pakko paper you are referring to on this list.
Anon: Ricardo pretty well closed the book on this topic some 200 years ago. Wiki Law of Rent: “the rent of a land site is equal to the economic advantage obtained by using the site in its most productive use, relative to the advantage obtained by using marginal (i.e., the best rent-free) land for the same purpose, given the same inputs of labor and capital”
Vacant land in a big city has enormous value, the PV of all future rents. The owner never did a thing to create that value; it’s entirely a windfall positive externality produced by other peoples economic activity (which is why it should be taxed at 100%).
“Suppose there were a new technology that caused both wages and interest rates to fall.”
How does this work?
I’m particularly interested in the logic of choice which says new technology lowers the rate,of interest.
Greg: short answer; it doesn’t work (assuming no third factor). My argument was a form of RAA. Suppose it did work. Then they would reject it, and go back to the old technology. Therefore it wouldn’t work (unless they made a mistake in choosing it originally).
Old technology: 1 unit of labour produces 1 unit of output 1 year later.
“New” technology: 1 unit of labour produces 0.5 units of output 1 year later.
Paul Krugman has a new post, responding to this one (saying I might be right, but not sure if the land effect is big enough, more research needed — fair enough), and saying it could instead be an increase in monopoly power, similar to Vlad’s/my argument in comments above.
Hmmm. A big chunk of the variation in the cost of owning or renting land is property taxes, so I plotted property tax collections as a share of GDP: http://research.stlouisfed.org/fred2/graph/?g=dEx There doesn’t seem to be much of a correlation.