Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Friday, November 11, 2011

Keystone Kops and Deficient Demand

Don't worry Sir...we'll find a way to stop those Canadians!
Domestic capital spending has been very slow to recover in the U.S. following the official end of the previous recession. Why is this the case?

Deficient demand, that's why. People are pessimistic. Their pessimism leads them to cut back on spending. And because everyone cuts back on spending, there is little incentive to hire new workers or start new capital projects. This means lower incomes for workers, which leads them to cut back even more on spending. Fear has become a self-fulfilling prophecy.

That's right -- all you people in the private sector out there -- you're a bunch of scaredy cats. That's why the government needs to take your money and spend it for you. You'll be the richer for it.

The problem with this "scardey cat" hypothesis is that there seems to be plenty of evidence suggesting that the private sector would love to start spending, if only the government would let it.

James Hamilton lists a few examples here highlighting some of the impediments to capital spending in the U.S. energy sector: Making Jobs Priority One.

Here is Hamilton describing the Keystone Gulf Coast Expansion Project in greater detail. He summarizes nicely here (in Shovel Ready):
And TransCanada wants to spend $7 billion of its own currency (no federal dollars asked for at all) to build exactly what we need in the form of the Keystone Gulf Coast Expansion Project. The pipeline would add capacity to transport another 500,000 barrels each day from Canada, North Dakota, and other regions in the U.S. to refiners on the Gulf Coast. At a price differential of more than $20/barrel, that wold generate over ten million dollars in new wealth every day. Beneficiaries of that wealth creation include the estimated 20,000 Americans who would work on construction of the pipeline and the $5 billion in estimated new property tax revenue for state and local government over the pipeline's lifetime.
Evidently, this project has been "shovel ready" for at least three years now. The project is being held up because of environmental concerns; see here and here (although, see Mark Perry). In fact, just yesterday, the Obama administration once again postponed the critical permitting decision until 2013; see here. Among other things, the following is highlighted:
The delay pushes a decision on the contentious proposal well beyond the 2012 presidential election in November, allowing President Obama to avoid a politically fractious determination in the midst of his reelection bid.
The political calculus is obvious here. And sadly, it's probably a good political calculation. But I do not wish to criticize the politics behind this (and several other related) decision(s). Not here, at least.

What I should instead like to stress is this: Whatever the merits of the cases made against these large private capital expenditure plans, their effect is to depress private domestic capital spending. This depressive is not some psychologically induced "animal spirit" that so many commentators and policymakers appear fond of ascribing to private sector behavior. It constitutes a real "tax" on private economic activity. And while it may be hard to quantify precisely how much this "regulatory tax" is holding back the recovery in domestic capital spending, the evidence from the Keystone project alone suggests that it is not insignificant. 


  1. This story is a great example as to why many people (like Pete Boettke, Jerry O'Driscoll, Bob Higgs and others) want modern macro to include public choice factors.

    Not being a macro person I don't know how easy that would be to include but it seems like a promising research direction.

  2. What exactly do they mean by "public choice factors?" Does this mean modeling the political economy explicitly? (There is a literature that does this.)

    In any case, the main point of this post is that people should think twice before attributing "deficient demand" to psychological factors. There are real barriers to investment out there.

  3. David,

    What I mean is modeling the government's own incentives when deploying money. For example, the stimulus spending (extra G) was disbursed according to political incentives, rather than economic need.

    I get your main point - and fully agree. I'm pretty sure I've been saying it for a couple years now.

    Can you suggest a couple of papers that you're thinking about when you say they model the political economy explicitly? It might be exactly what I'm talking about.

  4. Prof J, I was thinking about the work of Alberto Alesina. When I searched, I came across this book:

    I've used the following text in a development class I once taught:

  5. Thanks for the recommendations. Dr. Doom, huh? I'll look into that one.

    I like Shleifer and Vishny. Two of the most important researchers in finance today. I never read the Grabbing Hand, but it's on my list now.

  6. David,
    I agree with some of your views, but it seems that your claim that there are "plenty" investment opportunities is somewhat bold a claim. What is your evidence other than some anecdotal ones one could probably counter by anecdotal evidence of deficient demand whatever that means. Moreover I always thought that if you give up rational expectations and people would believe out of a sunspot that the future is sad, one could generate a sad future. Now of course we dont like this explanation because we can generate whatever we want, but the pure fact that it is scientifically not appealing does not make the possibility wrong. Are you aware of some formal testing or on an identification scheme that actually sorts out how believes are currently formed? If not your arguments only make a simple assertation, nicer put and better than Krugmans demand demand garbage but still not really convincing.

  7. Anonymous, thanks for the comment.

    When I look around me, I see a lot of opportunity. When I drive in the early morning traffic, I see people striving to exploit opportunities. When I see jurisdictions that free up zoning and/or tax laws, I see investment flowing. Yes, I see plenty opportunities (I see plenty impediments too). The Keystone project alone is estimated to employ 20,000 workers. That's *one* project! Isn't that plenty enough?

    The multiple equilibrium interpretation is grounded in solid theory. However, this is not the theory that Krugman and other "Keynesians" typically espouse (they prefer to rely on sticky nominal prices, with Keynes never did).

    Finally, note that I have never asserted this theory is right and that theory is wrong. The primary purpose of this post, along with most of my posts, is to make people think twice about why they cling strongly to their pet hypotheses.

  8. David, fair enough. I still think though that the project is not sufficient evidence whatsoever that regulations hold back the recovery. a.) the investment channel might be less important according to chari, kehoe, mcgretten than other channels, though arguably these people have a funny way of thinking about labor, but b.) more importantly i have trouble understanding your argument: even if i grant you the importance of regulator taxes, for affects on the cycle what matters would be the change in this tax not the level. i guess i could find a similar project of size 2004 that was delayed no? To make the argument i would have thought you need a countercyclical increase, that makes this recovery different from others. is that what you argue?

  9. Anonymous:

    You do not think that prohibiting investment from going ahead inhibits the growth of investment spending. Alright.

    I don't know the Kehoe et. al. argument. Note that I like to interpret investment broadly to include recruiting intensity (investment in employment, a la search models).

    Yes, you could probably find a similar project that was delayed in 2004. You could probably also find firms back then complaining that they did not have enough demand for their product.

    I'm not sure what you are asking in your last sentence. I'm just trying to suggest that there appears to be significant barriers to investment put in place by the current administration. And while it may not be able to account for all or even most of the recover in investment, I do not see any evidence suggesting that it is not significant.

  10. David, is your argument that it is prospective regulation rather than existing regulation that is the problem, or both?

  11. Anonymous,

    Let me try again. A lot of people claim that investment is being held back because of psychology. I am suggesting that there appear to many real impediments out there right now. The prospect of future regulatory taxes is a separate argument, but is also something that may be influencing investment demand. Finally, I am not suggesting that this is "the" problem. It may not even be a problem; maybe it is the price that needs to be paid for a cleaner environment.

  12. Perhaps my language was imprecise, as I was not trying to put words in your mouth by suggesting you see regulation as "the" problem.

    I agree with your "suggestion" that "there appear to many real impediments out there right now". I am just curious as to whether you think the impediments are existing regulations or potential regulations. Why? Because if you think the issue is existing regulation, then perhaps we could expect to see some correspondence (on a cross-country basis) between the OECD's PMR measure and investment growth. Future regulation is harder to deal with. There is the NFIB survey, but that's the only attempt I know of to quantify expectations about future regulation.

  13. Anonymous,

    Surprise changes in existing legislation may signal something about future legislation, so it's difficult to disentangle.

    But maybe we're all just "over-thinking" things here. Let's open our eyes: there are corporations out there (like TransCanada) that want to spend billions on capital investment in the USA. This is a FACT. The administration is not permitting the spending to go forward (for 3 years now and counting). There are many other examples in the US energy sector. What are you trying to argue here? That these things don't matter? That they are not holding back investment? I don't understand what you are trying to persuade me of.

  14. David, there are different anonymous (11:33 one thats me), causing the confusion; I thought we were discussing the question:
    "Domestic capital spending has been very slow to recover in the U.S. following the official end of the previous recession. Why is this the case?"

    your argument is that there are regulation taxes. Relieve them and the economy will move to a higher steady state with investment growth along the way. thats agreed, is straightforward and holds for any inefficiency tax and obvious. what was not agreed is, that this statements answers the question, namely why recovery is slow. If regulatory taxes have been in place before and after the crises, the steady state might be disturbed, but has zero effect on the speed of recovery, on the crises, on your discussion about deficient demand which is related to a business cycle shock argument or the question you start your blog with, unless you claim, that this tax is increasing in this recession relative to before, so the current government did something new, and bad, relative to the pre-crises government; you clarified this arguing that this government in your view increased the tax burden, I think. It remains to show how quantitative important this "change" is, because that is what matters.

  15. "Surprise changes in existing legislation may signal something about future legislation, so it's difficult to disentangle."

    Good point, and not one I had considered.

    "What are you trying to argue here? ... I don't understand what you are trying to persuade me of."

    I'm not trying to argue a position and I'm not trying to persuade you of anything. I am interested in whether there is an empirical relationship between uncertainty and investment, that's all. I appreciate you taking the time to respond to my comments.

    Re: Keystone XL - bad for the US, perhaps, but not so bad for Canada, as it seems the oil will now go to BC and then on to Asia.

  16. Anonymous @ 11:00AM,

    It remains to show how quantitative important this "change" is, because that is what matters.

    Agreed. Now, if only the same hurdle were to be placed before those who assert "deficient" demand.

  17. david
    beating a dead man (scientifically) like deficient demand seems not to be the point and politically that is up to you to think whether your blog has an impact. but coming up with a positive assessment what causes the slow recovery and making a positive proposal is the challenge. i think that your regulation tax is so far away from anything at the root and therefore at the solution that i made the above comments. are regulation taxes and the example really the best we (i include myself as most economists) to currently come up with? sounds more like
    a bancrupt declaration given some other ideas your have i think you could do much better but i fully agree it is clearly better than deficient demand

  18. Anonymous (it is really getting hard to keep track of all you anonymous types!):

    First, I do not believe that the deficient demand hypothesis is a dead scientific horse. I take the possibility of multiple equilibria seriously.

    Second, I am free to choose what the point of my blog posts are (and you are free to ignore the point, of course). My point was to highlight real impediments to domestic capital spending. If these impediments were removed, capital spending would increase. I doubt that you would disagree, but somehow it seems you want to.

    Third, I concluded with the statement:
    And while it may be hard to quantify precisely how much this "regulatory tax" is holding back the recovery in domestic capital spending, the evidence from the Keystone project alone suggests that it is not insignificant.

    Which is to say, I don't know how much of a role this "tax" is playing today, but you tell me why you think it is insignificant given the evidence I pointed to.

    Finally, you say that you think the "regulation tax" idea is so far away from the root of the problem. That may very well be the case. Or maybe it isn't. How do you know? Have you had experience in managing a business or coordinating a large capital project? Judging by the business leaders I speak to, I think that us academics do not fully appreciate just how difficult it is to get a capital project under way. The hurdles they face are sometimes mind-boggling to me. Maybe it's always been that way. But in any case, if you have some better idea, please do let me know!

  19. Krugman's latest post, citing research by Sufi and Mian claims that the unemployment data is consistent with an aggregate demand deficiency.
    Although I am unable to see personally why it is not also consistent with a Long and Plosser model. But thats just me.


  20. Krugman has one world view, based on his experience with a local babysitting cooperative. Nothing will ever change his view.

    For a more direct critique of the post you cite, please see Scott Sumner:

  21. On the one hand, contemplate all the hyper-vigilant hysterical measures implemented to combat 'terrorism' following Sept. 11. The economic costs were and still are enormous.

    On the other hand, contemplate how Canadian oil piped overland to the USA solves the US oil security issue. Moreover, pipelines are models of safety compared to US highways.

    Sad to say, it appears to be easier for the US to invade and occupy a foreign country. It appears less controversial to kill large numbers of civilians than build a simple pipeline. Different values I guess. Must be that "White Man's Burden" thing at work.

  22. westslope: "The economic costs were and still are enormous."

    What's "enormous?" I figure that the US might have spent about 1.5% of GDP a year for 10 years or so on extra security and the wars in Iraq and Afghanistan. In terms of relative GDP, that is about what the US spent on WWII over the first 4 months of 1944.

    westslope: "On the other hand, contemplate how Canadian oil piped overland to the USA solves the US oil security issue."

    I am all for using Canadian oil but I don't see how it solves any US oil security issue. The US already buys most of its imported oil from the Western Hemisphere.

    If oil supplies in other parts of the world are disrupted, the US is still screwed through trade and financial links and the fact that oil prices will still soar.

    westslope: "Sad to say, it appears to be easier for the US to invade and occupy a foreign country. It appears less controversial to kill large numbers of civilians than build a simple pipeline. Different values I guess."

    What are you talking about? I assume that you think that the wars in Iraq or Afghanistan had something to do with oil? Why? What is the connection?

    westslope: "Must be that "White Man's Burden" thing at work."

    Congratulaions! You get leftie bonus points for working racism into your argument without explaining what you mean, much less presenting evidence. Well done.

    Unfortunately, you failed to mention George Bush, global warming or sexism in your rant so you do not advance to the next round. We do have some lovely parting gifts though.