Dark Matter

Posted by: Michael Mandel on December 28

Anybody who wants to understand today’s global economy needs to read this paper: “U.S. And Global Imbalances:Can Dark Matter Prevent A Big Bang?” by Ricardo Hausmann and Federico Sturzenegger of Harvard.

To me, this paper hits the nail on the head. Let me summarize it.

*The international trade statistics are great at tracking flows of goods, and okay at tracking flows of services

*The trade statistics are terrible at tracking cross-border flows of intellectual property. For example, when Intel sets up a chip fabrication plant in Ireland, that country reaps the benefit of Intel’s designs, and all of Intel’s accumulated wisdom about how to run a fab successfully. In effect, a massive amount of intellectual property has been exported to Ireland, without showing up in the trade statistics at all.

*These massive and unobserved exports of intellectual property—“dark matter”—imply that the U.S. is actually running a much smaller current account deficit than the official data shows.

*In addition, U.S. assets abroad are really worth a lot more than we thought, because the official calculation doesn’t include the value of the intellectual property. That explains why it appears that U.S. investments abroad appear to earn a much higher rate of return than foreign investments in the U.S.

Hausmann and Sturzenegger write:

In a nut shell our story is very simple. The income generated by a country’s financial position is a good measure of the true value of its assets. Once assets are valued accordingly, the US appears to be a net creditor, not a net debtor and its net foreign asset position appears to have been fairly stable over the last 20 years. The bulk of the difference with the official story comes from the unaccounted export of knowhow carried out by US corporations through their investments abroad, explaining why the US appears to be a consistently smarter investor, making more money on its assets than it pays on its liabilities and why the rest of the world cannot wise up. In addition, the value of this dark matter seems to be rather stable, indicating that they are likely to continue to compensate for the measured trade deficit.

Globalization has made the flows of dark matter a very significant part of the story and the traditional measures of current account balances paint a very distorted picture of reality. In particular, it points towards imbalances that are not really there, making analysts predict crises that, for good reason, remain elusive.


In addition, they write:

Dark matter also sheds a different light on the often discussed savings puzzle. According to the official statistics, the US appears as a profligate consumer with dismal savings. However, these numbers understate the US savings rate by the amount of dark matter it exports and overstates the savings of the rest of the world by the amount of dark matter it imports.
I will write more about this paper. But for now, it makes a lot of sense.

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Reader Comments

zac

December 28, 2005 11:03 AM

Andy Kessler was the first to really highlight this issue in his book Running Money...

http://www.andykessler.com/andy_kessler/2004/11/reviews_of_runn.html

Chris

December 28, 2005 11:13 AM

Here's the Link:
http://www.cid.harvard.edu/cidpublications/darkmatter_051130.pdf

Mike Mandel

December 28, 2005 11:18 AM

Thanks for reminding me about the link..I meant to put it in and just forgot.

jon watson

December 28, 2005 03:22 PM

Shouldn't 'dark matter' be refered to as 'bright matter'?? hahhaha. get it!?

Mike Mandel

December 28, 2005 03:27 PM

Note to self: Hire this guy watson.

Great idea...

Kartik

December 28, 2005 05:34 PM

Brilliant! I knew something good would come of getting hundreds of millions of people in Asia to watch Baywatch, Friends, and MTV..

I have always had a disagreement with those who insist America's dominance is waning, just because we might be becoming a slightly smaller share of world GDP. This is because whenever you go to India, Taiwan, China, etc., you see hundreds of American brands plastered all over the place, on billboards, buses, T-shirts, etc. None of this was visible 20 years ago.

It appeared that America's dominance was *increasing* by this measure.

touche

December 28, 2005 10:47 PM

“when Intel sets up a chip fabrication plant in Ireland, that country reaps the benefit of Intel's designs, and all of Intel's accumulated wisdom about how to run a fab successfully”

Under these circumstances, Intel still owns the profits produced by the plant and the profits are credited to the current account of the foreigners who own the stock.

Mike Mandel

December 29, 2005 07:12 AM

Yes, the profits are credited to Intel..but the production is credited to Ireland. Moreover, the uncounted value of the export of intellectual property will generally dwarf the profits.

Let's do a little calculation. The book value of Intel's plant and equipment is 39 billion (16 billion net of depreciation). The market cap of Intel is $156 billion. Annual profit is about $20 billion.

That is, annual profit is of the same order as the physical capital base. But Intel's intangible assets--the knowledge and the ability of how to run a global chip business--are an order of magnitude larger.

Claus Vistesen

December 29, 2005 01:05 PM

An excellent post (reseach paper) which presents a refreshingly new perspective other than the traditional "saving glut" argument. It definitely deserves mention.

Leo Chan

January 3, 2006 04:30 PM

There is a counter argument on the dark matter written by John Quiggin at http://crookedtimber.org/2005/12/19/dark-matter-and-phlogiston/

His argument is that that there is another explanation for the strength of US income inbalance -- low interest rate. So if interest rate goes up, then the US income inbalance will fall.

Mike Mandel

January 4, 2006 04:51 PM

Leo

I've heard others say the same thing. It's a little bit circular, since part of the reason why rates are low is that people are willing to invest in the U.S., despite the big trade deficits.

Don Nichols

January 5, 2006 10:12 AM

Thinking About Dark Matter

Ricardo Hausmann and Federico Sturtzenegg use the “dark matter” metaphor to support their claim that the high profits earned on U.S. investments abroad are due to its investments in intellectual property and that the existence of those profits suggests that there must have been a past export of that property. Such exports, it is claimed, are huge, and explain a large part of the U.S. current account deficit.

An example in the discussion is that of Intel, whose profits in Ireland are high relative to Intel’s physical investment in plant in Ireland. These profits, it is argued are a return on an unmeasured investment of intellectual property in Ireland.

The Hole in the Dark Matter Argument

Intel’s profit abroad should be thought of as a royalty on Intel’s past intellectual investment in the U.S., not as profit on an unmeasured intellectual investment in Ireland.

The payment should be thought of as akin to a purchased service, not as a return on an unmeasured investment.

Thinking about purchased services

If Ireland purchases electricity from a generation facility in Belfast, UK, it is not true that part of the power plant must have been snuck into Ireland when the data collectors were not looking. Services can be purchased from abroad.

If Intel U.S. licenses its patents to a non-Intel Irish manufacturing company, it is not true that the royalty payments collected by Intel represent a return on an unmeasured capital investment in Ireland. Services can be purchased from abroad.

And if Intel’s internal transfer pricing policy required its own Irish plant to remit to its U.S. parent a fair market royalty on each manufactured chip, the consequences of the international accounts would be the same as if this royalty were being charged to a competitor. Services can be purchased from abroad.

But Intel, to the chagrin of the IRS, chooses not to pay itself a royalty, but to book its profits in Ireland. This choice of accounting practice does not signify that a real, though unmeasured investment must have been made by Intel in Ireland. It signifies that a royalty on intellectual property has been defined as a profit for internal accounting reasons. The profit continues to represent the purchase of a service from abroad.

In Econ 101 terms, if marginal cost equals zero, an additional sale does not require additional investment. Hence additional production from Intel’s Irish plant does not require additional investment in Ireland of intellectual capital.

Blastdoor

January 21, 2006 09:50 PM

That article strikes me as an attempt at alchemy. I think that it is Don Nichols who has "nailed it."

Hin Chung

April 28, 2006 11:06 PM

The authors never discussed the fact that even though US companies invests abroad, particularly in China, and sets up subsidiaries there. And assume these subsidiaries are profitable, all of these profits are accounted in Chinese Yuan. Certainly, the profits are reflected in the parents consolidated financial statements, and translated into US Dollar, only in accounting conversion and not an actual conversion. The fact of the matter remains until these subsidiaries are sold out and the proceeds are remitted back to the US and converted into US Dollar. Most of these investments profits are still contained within China and accounted in Chinese Yuan. Annual repartriation of actual dividend payment account a very small percentage of the total profits and investment return of the subsidiaries. And for most foreign companies operated in China, they will have to wait a long time probably more than 10 years before they even see a 1cent of dividend payment back to the parents. Therefore there is an inherent downward pressure on the value of the US Dollar, due to the containtment of profits of American companies abroad in foreign currencies and an upward pressure on the value of foreign currencies against the US Dollar.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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