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Who's Really Investing More?


Economic Trends

WHO'S REALLY INVESTING MORE?

America's poor record is a myth

A curious inconsistency has long puzzled U.S. economic observers: On the one hand, published international data have indicated that America's capital investment as a share of gross domestic product has persistently lagged that of other industrial nations in recent decades. The average investment ratio in Canada, Japan, and European countries in the early 1970s, for example, was about 33% higher than in the U.S., and by the early 1990s, it was still 20% greater.

Meanwhile, U.S. real income per capita has grown as fast as in other developed nations since the early 1980s. And average incomes have remained more than 33% higher in America than in its developed peers.

How has the U.S. managed to stay so far ahead of the pack in income terms while plowing so much less output into investment? In a study published by the Federal Reserve Bank of St. Louis, economists Milka S. Kirova of Washington University of St. Louis and Robert E. Lipsey of the City University of New York argue that capital investment in the U.S. has been far higher than conventional measures indicate.

For one thing, measuring investment by looking at nominal outlays as a percent of GDP overlooks the fact that capital-goods prices are appreciably higher in some countries than in others and exhibit different inflationary trends. As it happens, U.S. capital-goods prices are not only lower than in other nations, the authors note, but have also been declining far more rapidly relative to overall inflation. Thus, they find that real investment as a share of GDP in the U.S. has actually been rising since the early 1980s.

On the other hand, similar price adjustments reveal that the average real capital-formation ratio of other developed nations has been slipping for most of the 1970-94 period. As a result, Kirova and Lipsey find that the gap between U.S. and foreign investment ratios, measured in real terms, had almost disappeared by the early 1990s.

That's not all. Economists have long argued that the concept of investment should be widened to include such items as spending on education, R&D, and consumer durables on the grounds that they enhance growth or remain useful for extended periods. Thus, the authors added such outlays to their calculations of capital-formation ratios.

The results cast light on why America's lead in living standards has stayed so large. Counting outlays on education, R&D, consumer durables, and military capital goods as investment, and adjusting for the inflation and price differences noted above, Kirova and Lipsey estimate that U.S. real capital formation as a share of GDP was only slightly lower than the average of other developed countries in the 1970s and has since surpassed it--by about 7% in the early 1990s.

"Real investment per worker, broadly defined, has recently been running about 35% higher in the U.S. than in other industrial nations," says Lipsey. "As long as these trends continue, it's difficult to see how the gap in income levels can be closed."BY GENE KORETZReturn to top

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HOW THE TITANIC HIT WALL STREET

Stocks in the wake of the disaster

The conventional view is that the stock market was far less efficient in the early part of the 20th century than in the post-World War II period. That is, not only was information less accessible, but investors were less sophisticated and far slower in evaluating and acting on new data.

If the market's reaction to the sinking of the Titanic in 1912 is any guide, however, investors were pretty sharp even in that pre-"efficient market theory" era. An article in the Financial Analysts Journal by Arun Khanna, a doctoral student at Purdue University's Krannert Graduate School of Management, tells the story.

As Khanna notes, the Titanic was owned by the White Star Line, which was a subsidiary of International Mercantile Marine (IMM), a company traded on the New York Stock Exchange. The ship cost $7.5 million to build and was insured by Lloyd's for $5 million, so the net loss to IMM was about $2.5 million.

Before the disaster struck, IMM's common and preferred stock were worth about $15.6 million. To estimate the impact of the Titanic's sinking on the shares, Khanna looked at their price movements relative to the Dow Jones industrial average on Apr. 15 and 16, 1912, the day the news of the tragedy first broke and the day after.

Khanna calculates that the market-adjusted returns on IMM's common and preferred stock over the two-day period were equivalent to a decline of $2.6 million in the value of IMM--uncannily close to the $2.5 million actual net loss suffered by the company. "As far as the Titanic was concerned," he says, "the market's reaction was surprisingly efficient."BY GENE KORETZReturn to top


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