Larry Summers and Ben Bernanke have been debating this. Both agree that it’s because of an excess of savings over capital spending, but whereas Summers emphasises the lack of investment, Bernanke stresses the importance of the global savings glut. This, he says, is due largely to government policies: he cites Asian governments’ desire to raise savings and FX reserves since the crisis of 1998, but he might add the lack of welfare states in many countries and fiscal retrenchment and the failure to adequately recapitalize banks in the euro area.
This difference matters for policy. If Summers is right, the answer is for governments to invest - to do what the private sector isn’t doing. Bernanke, however, believes the need is for policies to reduce savings in Asia.
I’m inclined to side with Summers. The question here is: why haven’t negative interest rates boosted capital spending by more? Bernanke says: “If the real interest rate were expected to be negative indefinitely, almost any investment is profitable. For example, at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades.”
Pay whom? It would take a private investor decades to recoup his money from toll fees. He would only invest if he could be sure that his property would be secure for decades. But of course, he cannot have such assurance.
This same problem applies even more forcefully to Bernanke’s other argument against stagnation - that if there are good investments outside the US, capital should flow from the US to those countries, thus weakening the dollar and improving investment opportunities in the US. This too ignores the fact that property rights are not secure in many countries, so investors can’t be assured of a return. For years, money has flowed from poorer countries into the US (this is the basis of the “Bretton Woods II” system described by Michael Dooley) and into London property. This has happened because of insecurity in many developing nations.
The point broadens. William Nordhaus has famously shown that the profits from innovation have always been low because innovators cannot appropriate all the benefits for themselves. Instead, new ideas are emulated and this competes away profits: Steve Jobs' genius at Apple consisted not so much in innovation but in designing products so desirable that they could fight off competition. Most other innovators have not been able to do this.
US Federal Reserve figures show that profit rates are lower now than in the 60s and 70s. This suggests that the forces of creative destruction have become stronger. Granted, average profit rates are well above interest rates. But firms don’t invest in an average project. They invest in particular projects, the return on which is uncertain. And with average profitability low, the chances of a negative return are higher.
There’s another obstacle to investing, pointed out by the Bank of England’s Gregory Thwaites. Capital, he says, is not always easily substitutable for labour - or at least not yet. This, he says, means that lower capital goods prices don’t lead to a proportionately higher volume of investment. The upshot is that nominal capital spending has fallen as a share of GDP, which has bid down interest rates.
These problems of uncertainty, lack of appropriability, creative destruction and inelasticity of substitution are, I suspect, ineliminable features of a market economy - though they might be especially bad right now. Hence the failure of investment to respond to low rates.
But does this debate matter? As Tony Yates points out, Summers and Bernanke’s explanations agree upon one thing – that there are fundamental forces behind negative real rates, and these won’t disappear soon. For investors, therefore, the problem of negative returns on safe assets will stay with us, perhaps for many years.
