Thursday, March 31, 2011

Investment and Unemployment: A Reply

  • Paul Krugman wrote a post yesterday afternoon and another one last evening on a January 14 post of mine. In the Janaury post I pointed out the strong correlation between total fixed investment as a share of GDP and the unemployment rate during the past two decades; total fixed investment equals business fixed investment plus residential investment. In his afternoon post, he argued that it’s misleading to look at total fixed investment because most of the recent swing has been in residential investment. “It’s mostly the housing bust!” he argued, continuing that “The rest”—the business fixed investment part—“is just politically motivated mythology.”

  • But the correlation I pointed out is not just due to housing. There is a close relationship during the past two decades between business fixed investment and unemployment. In fact it’s closer than for residential investment and unemployment. Here are the time series charts for business fixed investment and residential investment. You can see the ups and downs in business fixed investment as a share of GDP and the corresponding downs and ups in the unemployment rate, which result in the negative correlation; there is one big swing in housing. If you want to compare correlation coefficients, for business fixed investment the correlation is -.84 and for housing it is -.68. These are facts, not mythology, or whatever other name you want to use.

  • Curiously, in his post of last evening, Krugman includes a scatter diagram between business fixed investment and unemployment, in which he admits to a strong correlation after all. He then brings attention to six points on the lower right of the diagram (he reverses the axes from the diagram I first used), identifies them with the Obama Administration, and notes that they are off an apparent pattern: unemployment is even higher than the high level that would be expected from the low level of business fixed investment. But housing is now omitted from the argument. Remember the “housing bust!” from the afternoon post? Clearly the housing bust has added to the unemployment rate. It is business fixed investment plus residential investment, as I originally argued.

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