Saturday, April 3, 2010

Why Did Investment Fall During the Recession?

My view is that investment fell largely because labor fell (and labor and capital are complements). For example, if fewer people are to be working, it's time to slow down the building of new office buildings and factories in which they would work.

An alternative view is that businesses were actually hungry for loans to finance new investment, but that banks were in such a chaos that loans were not available. So workers who would have worked with the new capital are out of a job.

Under that alternative view, the unemployment rate for CAPITAL should be low (and its marginal product should be high -- more on that later), because businesses would work their existing capital harder as an imperfect substitute for having the new capital that they really desire. But the chart below shows that the opposite was true -- capital was under utilized during the recession.



My view explains why the unemployment rates of labor and capital BOTH increased for two straight years: fewer workers means a lower marginal product of capital (and a higher marginal product of labor) and thereby less capital utilization.

There may be yet another theory explaining some of these facts, but I am not aware of an explanation for all four:

  • low labor usage
  • low capital usage
  • low marginal product of capital
  • high marginal product of labor

7 comments:

Don said...

"My view is that investment fell largely because labor fell (and labor and capital are complements). For example, if fewer people are to be working, it's time to slow down the building of new office buildings and factories in which they would work."

This seems right. I'm just wondering how it's going to be construed.

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