Tag: externalities matter

Short Term vs Long Term

Friday’s post contained this line:

“But that simply behooves us to accept the economic principle that Time Matters. Take the long term view, not the short term one!”

Here’s Stephen J. Terry, via Tyler Cowen, over at MR:

R&D investment reduces current profits, so short-term pressure to hit profit targets may distort R&D. In the data, firms just meeting Wall Street forecasts have lower R&D growth and subsequent innovation, while managers just missing receive lower pay. But short-termist distortions might not quantitatively matter if aggregation or equilibrium dampen their impact. So I build and estimate a quantitative endogenous growth model in which short-termism arises naturally as discipline on conflicted managers and boosts firm value by about 1%. But short-termism reduces R&D, and the social return to R&D is higher than the private return due to standard channels including knowledge spillovers and imperfect competition. So at the macro level, short-termist distortions slow growth by 5 basis points yearly and lower social welfare by about 1%.

https://marginalrevolution.com/marginalrevolution/2023/10/the-costs-of-short-termism.html

Here’s a simple (perhaps too simple) way to understand this point:

  1. Imagine you’re 18 years old. What is the best thing you can do to raise your income today? Drop out of college and start working, of course.
  2. What is the best thing you can do to raise your income over the course of your entire lifetime? Do not drop out of college and start working, of course.
  3. Investing in education today maximizes your chances of earning a higher amount of money over the course of your life. Or so the theory goes today, at any rate. That’s a bit like investing in R&D today.
  4. But the reason I added the caveat “perhaps too simple” because I acquiring an education today benefits me, not others (although there might be some spillovers, sure). But R&D today may not benefit only my firm, it might benefit other firms more. Ask ChatGPT to explain this sentence – “the social return to R&D is higher than the private return due to standard channels including knowledge spillovers and imperfect competition”. Which is why this analogy isn’t perfect.
  5. But even so, the point is (or should be) well taken. Think long term! (I struggle with this myself, by the way, but I console myself by saying almost all of us do).