Comment on Lance Taylor’s “’Savings Glut’ Fables and International Trade Theory: An Autopsy”

Financial commentator Andrew Smithers responds to Lance Taylor’s INET working paper. You may also read Taylor’s response to Smithers’s comment here.

Lance Taylor’s “Savings Glut” Fables and International Trade Theory: An Autopsy argues correctly that it is misleading to call the net private sector savings surplus shown in the developed world, a savings glut. In view of the decline in tangible business investment it is more reasonable to term it investment dearth.

Professor Taylor’s subsequent analysis is, however, based on a misunderstanding of the data on the profit and labour shares of corporate output. In defense of Professor Taylor it should be noted that this misunderstanding is as common as the one he correctly attacks.

Professor Taylor writes that “The structure of the US economy began to shift markedly 40 or 50 years ago. The profit share of income grew across business cycles at 0.4% per year, or by more than 20% (that is, by eight percentage points) over five decades.” In fact the US profit share is stationary and was in 2019, before the pandemic, slightly below its mean reverting average for US non-financial corporate business and slightly above if financial business is included.

The common misunderstanding appears to arise from the inclusion of capital consumption in the profit share. When the division of income between the labour and capital shares of output are being considered it is vital to use a sensible definition of income and that proposed by Sir John Hicks eighty years ago has, to put it midly, stood the test of time. Hicks defined income as “The maximum a man can spend and still be as well off at the end of the week as at the beginning.”[1] While this leaves the definition of “well off” open to debate, it is clear that spending all profits before depreciation will leave the owner of capital worse off.[2]

In The Debate over the Depreciation of Intangible Capital World Economics Vol. 21 No. 1, I explained that claims to the contrary by several economists were based on this misconception about the profit share.[3] The mean reversion of the profit share and its recent fall also makes it improbable that monopoly power has increased in the US.

In my view the net savings surplus of the private sector in the UK and the US is due to low tangible investment by non-financial companies due to the perverse incentives of modern management remuneration, as I set out in Productivity and the Bonus Culture Oxford University Press 2019.

[1] Value and Capital: An Enquiry into Some Fundamental Principles of Economic Theory by J.R. Hicks Oxford University Press (1939).

[2] Sir John Hicks also remarked that many people found it difficult to distinguish between capital and income, to which Sir Dennis Robertson replied that the jails were full of those who failed to do so.

[3] Intangible Capital and the Investment-q Relation by Ryan H. Peters & Lucian A. Taylor Journal of Financial Economics 123 (2017) 251-272. Investment-less Growth: An Empirical Investigation by Germán Gutiérrez & Thomas Philippon NBER Working Paper 22897, The Great Reversal: How America gave up on free markets by Thomas Philippon Harvard University Press (2019) and Intangible Capital and Economic Growth op. cit.

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