Monday, August 7, 2017

Explanation versus evidence

The reddit title caught my eye: Intangible capital making output gap & Phillips curve irrelevant? There is a good opening:

Here’s my thesis upfront: The growing dematerialization of capital accumulation has material consequences for financial markets and for the conduct of monetary policy: It helps to explain why there is a corporate savings glut that contributes to ultra-low interest rates, and why time-honored concepts used by generations of economists such as the output gap and the Phillips curve are becoming increasingly, well, immaterial.

Next, they explain what they mean by "immaterial":

Our economy is becoming ever more intangible. A rising share of our consumption is services rather than tangible goods. And to produce these services and goods, firms nowadays typically invest more in intangible capital than in physical capital. New ideas generated by smart people, patents, copyrights, brand, software and cloud space matter more than bricks and mortar, machines and inventories. In short, production processes are dematerializing – more sales are generated with less physical capital.

This caught my interest. Not because it's right, particularly -- it's way too soon to make a judgement call like that -- but because I never heard the story before. New ideas are rare and precious, even when they might be wrong.

It caught my interest. So I kept reading:

A growing body of research suggests that the progress of intangible capital has been the most important fundamental driver of the secular uptrend in corporate cash holdings over the past few decades...

Sentences like that unfailingly fool me into thinking I'm seeing evidence. However, such sentences are only stories about evidence; the conclusions they reinforce remain unsupported.

The paragraph continues:

The reason is that, unlike physical capital, intangible capital cannot easily be pledged as collateral for loans.

This sentence does not present any of the evidence we've just been told about. Rather, it plunges deeper into the story, giving us a "reason" for "the progress of intangible capital". Please note: I'm not saying it's all bullshit. I like the story, despite myself. It's just that, on second read, I'm seeing a story supported by explanation rather than evidence. So far, it remains only a story.

The rest of the paragraph builds on the unsubstantiated analysis:

Therefore, to maintain the financial flexibility to invest in intangible capital – spending more on R&D, buying start-up companies with smart people and products, acquiring or developing brands and patents, investing in artificial intelligence etc.—firms optimally hold larger cash balances. Of course, other factors, such as a U.S. tax system that only taxes corporate profits generated abroad once they are repatriated, also contributes to swelling (foreign) cash holdings. However, the dematerialization of capital investment seems to be the single biggest factors explaining the corporate savings glut.

As I say, it's a good story. And here's how the next paragraph starts:

This corporate savings glut, along with a higher desire by private households to save more in the face of rising longevity and with strong demand for safe assets from emerging economies, is the main reason why the natural or equilibrium rate of interest is very low.

Wow, see? It even explains why the natural rate of interest is so low. (Told ya it was a good story!)

But, well, the corporate savings glut, I've heard of that. And the strong demand for safe assets. And of course the low natural rate of interest. I am not yet sure how these factors fit my own economic theory, but at least I've heard of them.

But I never heard of the "higher desire by private households to save more in the face of rising longevity". Never saw a story about a connection between longevity and savings. It seems to make sense, yes, but it's just a story. One small piece of a larger story. But this storybook connection is something I can actually look at: Is it true that increasing longevity has brought a rise in the personal saving rate?

FRED says No:

Graph #1: Life Expectancy and Personal Saving
Life Expectancy and Personal Saving run in opposite directions. When life expectancy was low, the saving rate was high and rising. As life expectancy went up, the saving rate turned and went down. And now life expectancy is high and the saving rate is low, try as it might to increase.

So I don't see "a higher desire by private households to save more in the face of rising longevity". I can easily believe there is a higher desire to save, a desire that is never actualized. But if it doesn't show up in the numbers, it's only a story.

By putting longevity and saving together in a single thought, they gave me a relation to look at. So I looked. And, hey, I looked at only the one graph. But it's not there. The relation is not there.

I tried to participate. I went looking for evidence. I tried to confirm one little thing they told me. The FRED graph contradicts the story. So I lost interest in the story they tell, because it's only a story.

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