Timothy Taylor points to an IMF report, which says,
The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump
I have an argument that this represents crowding out, caused by increased government deficits. However, this is not textbook crowding out, in which the government increases the demand for savings, raising interest rates and reducing investments.
Instead, it is crowding out of financial intermediation. Recall that my view of financial intermediation is that the public wants to issue risky, long-term liabilities and hold safe, short-term assets. Financial intermediaries accommodate this by doing the opposite.
When the government incurs large deficits, it issues safe, short-term liabilities. This crowds out private financial intermediation, because much of the demand for safe, short-term liabilities is satisfied by government debt. Think of the public holding a $100 balance sheet. Without government deficits, financial intermediaries might hold $100 in risky, long-term investments and issue $100 in safe, short-term securities. Instead, with $100 in government bonds issued to financed deficits, the public’s demand for safe, short-term securities can be satisfied with zero investment. Financial intermediation goes away altogether, or just consists of intermediaries who issue safe securities backed by government bonds.
Wonder whether your post connects these dots:
Timothy Taylor’s (which you linked),
and Tyler’s http://marginalrevolution.com/marginalrevolution/2015/04/is-ge-getting-out-of-commercial-credit-a-sign-of-triumph-for-dodd-frank.html
(Curiously, Tyler links to Timothy’s in his preceeding post, but does not connect them.)
I’ve heard some anecdotal accounts from several small businessmen, not in traditional ‘start up’ or ‘venture’ industries either. Basically, they are decreasingly getting their funds from banks as middle-men between depositors and entrepreneurs, and instead interacting with other sources of capital, usually some kind of funds that represent less risk-averse, more consciously self-aware ‘investors’.
They use banks for mortgages on their real property, and for ordinary transaction accounts and small lines of credit. But when it comes to major investments, they are going to other institutions, or even to family, individuals, or small groups of individual investors.
There seems to be a growing wall of separation between ordinary deposits and entrepreneurial investments not heavily secured by rock-solid collateral, like real estate.
This is very interesting. Could you, please, elaborate what you mean by “some kind of funds that represent less risk-averse, more consciously self-aware ‘investors’” and “small groups of individual investors.” Does it mean ad hoc groups? If not banks, how can we call them? Can you name a group or a individual investor which is part of this trend?
I don’t know (and I’m skeptical that anyone else knows) what level of investment and economic growth the right public policy would bring.
I am especially skeptical of the idea that the rate of growth during a stock market bubble and a real estate bubble represent the correct baseline for an aging population. The higher our standard of living gets, the more I would be inclined to expect it to be difficult to maintain previous rates of growth in investment.
Today our most innovative and successful corporations are lenders, not borrowers. Maybe the changing relationship between the number of lenders and credit worthy borrowers has more to do with demographics and technology than government policy.
I’m pretty skeptical, Arnold. Sure, people want to hold low risk assets, but they also want yield, and government bonds don’t give you that.
Dean Baker concludes private non-residential investment is back to what it was as a portion of gdp, excluding non-residential structures. Commercial real estate follows residential.
There is probably something to this, but the crowding out of financial intermediation may have had some help from the regulatory environment.
(To what extent is the justification of the post-2008 regulatory regime as aimed at limiting financial system risk just rationalization? Could economic theorizing that takes stated policy goals at face value miss the main point?)
Carmen Reinhart has had some things to say about the relationship between public debt and financial repression. That point of view may be complimentary to your crowding out argument.
I’ve often made the joke that economists should have signs made up that say “we see no evidence of crowding out today” like the bars that have the “free beer tomorrow signs.” I have never seen an economist not say that. But if they don’t believe in the signs of crowding out, how could they even look for them? So, I am delighted Arnold is shedding light on the topic.
Banks diversify their loan portfolio so that many loans don’t go bad at once. They also hope that all depositors don’t redeem at once.
The government has similar mechanisms that rely on scale, diversification, and laws of large numbers.
What if there is a period of allowed or forced credit spread compression? But what if the government gives a head-fake that, for example, bank pooling of risk may not be backed up by government as much as we thought? Banks are more on their own than we thought. Even the FDIC is questioned. What happens? Credit spreads. Default risk reemerges. The government won’t default (even if it should). When your chief concern becomes return of capital, are you going to invest in the bailer or the bailees?
So, here I think is the question: why wouldn’t this theory even out? Here is y proposal. During the credit spread compression phase, the bad actors get lumped in with the good ones. During the credit rest reading phase, the good actors get lumped in with the bad ones.