LONDON (Reuters Breakingviews) - American companies are looking weak when it comes to technological innovation. When it comes to corporate earnings, however, it’s a whole different story.
The economist Robert Gordon was one of the first to proclaim a slowdown of growth at what he called the “technological frontier”. In 2012, the Northwestern University economist predicted the gains from the computer revolution – the latest frontier – were winding down.
The theory is contentious. But one sign of this technological maturity would be a decrease in the productivity of research spending. Each breakthrough would require more effort than the last. Research by Nicholas Bloom and three co-authors suggest that is what is happening.
The researchers, from Stanford University and MIT, compared U.S. spending on research and development with increases in reported labour productivity. The result is clear – the system needs a lot more fuel to keep improving at the same pace. More precisely, the academics calculated that it would take a doubling of research effort every 13 years just to avoid a productivity slowdown.
That slowdown has not been avoided. A 2017 report from the McKinsey Global Institute points out that average annual U.S. productivity growth was 2.1 percent between 1987 and 2004. In the subsequent decade, the average rate was 1.2 percent, and the trend has been downward.
Of course, some parts of the economy are still leaping ahead. For example, big data is rapidly getting more tractable, and therefore more valuable. But behind such technological frontiers lies an ever-growing mass with slowing progress.
Bloom and his colleagues also looked at a few key industries. Their conclusion about crop yields is typical: “yield growth is relatively stable or even declining, while the effective research that has driven this yield growth has risen tremendously.”
Some, including Gordon, regret the slowing pace of innovation. It makes more sense to recognise how far technology has come. People in developed societies already have enough of it to live long, safe, comfortable and stimulating lives. And even with slower progress from here, there is probably enough forward momentum to address current challenges and find new opportunities.
However, slowing innovation should also change the structure of competitive markets. If the stream of breakthroughs is thinner, fewer companies should be able to enjoy large and durable competitive advantages. On this more level corporate playing field, the industry standard would be slower productivity growth and smaller market share gains. That, economic theory says, should lead to narrowing profit margins.
Two New York University professors suggest that this economic logic has been partly right. A paper by German Gutierrez and Thomas Philippon looked at the largest American companies, both overall and by industry. They found that the trend lines for these “star” firms changed dramatically around the year 2000.
For example, they measured the contribution to annual national productivity growth of the four largest companies by market capitalisation in 62 industries – a group that has included Google owner Alphabet, Facebook, Apple, Amazon and Microsoft. The companies at the top shifted over the years, so the list always included the winners of the period. From 1960 to 2000, the annual average contribution to productivity growth of these 248 companies was 0.72 percentage points. From 2001 to 2016, the average was 0.43.
The pattern is similar for market shares. Domestic sales of the 248 industry leaders accounted for 29 percent of GDP in 1980. That fell to 25 percent in 2016. There are not enough all-conquering star companies to hold off the levelling effect of slowing technological gains.
However, one aspect of corporate performance has not behaved as economic theory says it should. Dwindling competitive advantages have not hurt the bottom line. Indeed, U.S. government statistics show that the ratio of corporate profit to national income has averaged 6.7 percent for the last 10 years, up from a 5 percent average between 1991 and 2000.
Those higher earnings did not fund increased capital spending. On the contrary, private investment declined in the same periods – from 17.6 percent of GDP to 16.2 percent.
It has clearly been much easier for managers to push forward financially than technologically. Or perhaps it has just been more rewarding for them. After all, executive remuneration packages are mostly geared to higher earnings and share prices.
The divergence of trends in technology and profit does not seem fair. In effect, shareholders of American companies are extracting more from businesses that are providing less innovation and making fewer investments.
Of course, bosses are not paid to worry about such matters. The can talk up whatever technical progress they make, without thinking too much about the big picture. And as signed-up members of the cult of shareholder value, the idea that profit can be excessively high is anathema.
Politicians are in a different position. They are supposed to think about justice. They have powerful weapons, including taxes on corporate profit, antitrust regulation and rules on collusion. With these tools, they could probably change the trends in profit and productivity. That would be tough on shareholders, but it might just be good for society.
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