Sunday, March 22, 2009


Last week my blog post was entitled “In the Land of Re.” Dr. Philip Neches, my distinguished scientific adviser and student of history who sits with me as a trustee of the California Institute of Technology, emailed me the thoughtful response below.

I expect Phil to play a role on a new hedge fund I will manage.


Interesting blog post! I see an echo of our conversation on Friday in the part about looking behind the increase in reported lending.

I also note that, at least on the surface, the US savings rate has increased in the last few months. Economists note that while this builds the kind of investment capacity you discuss at the end of your blog post, money just saved does not have an immediate stimulative effect.

Standard accounting does not make a good distinction between spending and investing. Some spending is purely consumed in a way that does not expand economic capacity. Examples include military supplies and spa treatments: once used, they never get back into the economy. On the other hand, spending on things like product development and public infrastructure create things that directly or indirectly produce new economic value for months or years to come. In this sense, such spending is investment.

Conversely, if increased savings result in increases of debt or equity -- which must be done to generate the return -- the savings are spent, either as investments or as consumption. It just means that someone other than the saver does the spending.

My point is that investment can be enabled by saving or by spending. To better measure the long-term prospects for the economy, we should be measuring and trying to increase the investment rate, not the savings rate or spending rate. If the economic crisis gets people to shift their spending and savings to do less consumption and more investing, we will be better off in the long run, and perhaps even in the short run.

Finally, I think that the automation and mechanization of labor is still accelerating, not decelerating. The percentage of the work force involved in agriculture is still declining, as it has been since the early 1800s. The percentage of the work force involved in manufacturing is still declining, as it has been since the 1950s.

I think we have seen the peak in percentage of the work force employed in information technology. I have been writing for several years now that IT as a percent of the work force will decline. I mean this world wide: outsourcing just moves the jobs and temporarily makes it possible for workers who are less productive to be competitive due to currency and standard-of-living arbitrage.

As the arbitrage declines, those workers are even more vulnerable to technological obsolescence than their US-based counterparts. Call center workers can be replaced by voice response systems. Low level application programmers can be replaced by new software development tools.

Agriculture, manufacturing, and now IT are characterized by continuing technology innovation that increases productivity: more output from fewer hours of labor. For the first 50 years of the IT industry, demand increase so much faster than productivity that employment increased. Demand is still increasing, but at a slower rate as the industry finally has enough capacity to meet the demand and is no longer growing into unfulfilled demand. Productivity growth remains high, and the balance is now such that the need for workers is growing slower than the population, or the economy as a whole.

As costs and living standards increase in other countries, off-shoring will make less sense. In manufacturing, as people count in the real costs of transportation, a lot of off shore manufacturing now looks less advantageous. While a lot of manufacturing can "come home," I do not foresee manufacturing employment ever returning to the levels of prior decades.

So the result is that the workers who a decade ago were in great demand and short supply now find their circumstances radically altered. Ex-investment bankers and ex-programmers are driving taxis and limos while they figure out what's next.


Philip Neches received his BS, MS and PhD from CalTech

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