Dean Baker, J. Bradford DeLong, and Paul Krugman (2005), "Asset Returns and Economic Growth"

Dean Baker, J. Bradford DeLong, and Paul Krugman (2005), "Asset Returns and Economic Growth," Brookings Papers on Economic Activity 2005:1.

Abstract:

We in America are probably facing a demographic transition—a slowdown in the rate of natural population increase—and possibly facing a slowdown in productivity growth as well. If these two factors do in fact push down the rate of economic growth in the future, is it still prudent to assume that the past performance of assets is an indication of future results? We argue “no.” Simple standard closed-economy growth models predict that growth slowdowns are likely to lower the marginal product of capital, and thus the long-run rate of return. Moreover, if you assume that current asset valuations represent rational expectations, simple arithmetic tells us that it is next to impossible for past rates of return to continue through a forthcoming growth slowdown. Only a large shift in the distribution of income toward capital or current account surpluses larger than those of nineteenth century Britain sustained for generations give promise for reconciling a slowdown in future economic growth with a continuation of historical asset returns.

Comments

[pgl]

Straight to the top of my read pile. Thanks for the advanced copy!

[bncthor]

I also look forward to reading your paper. It is very timely. And, I realize it is in draft form and will be edited before being published. To that end, I call your attention to the paragraph below the Abstract. I think you wanted it to read...we would like to thank the National Science Foundation, rather than "think that..." Your efforts and contributions to a better understanding of the economic issues facing our country are much appreciated.

[anne]

What an excellent analysis. Well done; and now to think more on the consequences of the analysis and especially productivity growth projections.

[johnchx]

Thanks for this! After convincing myself of two completely opposite conclusions on this topic (chronicled in my comments elsewhere) I realized that I couldn't get to the bottom of this without doing a full-blown model. And behold...you've done three! You've saved me a whole passel of work! Thanks again!

[Robert Waldmann]

Page 2 2nd to last line "immigration will play as large a role in America's future *than* it has in the past" should be "immigration will play as large a role in America's future as it has in the past"

Also immigration makes it a lot easier to justify positive lambda. People may be perfectly altruistic towards their grandchildren but current American residents are hardly altruistic at all towards those 2042 US residents who will immigrate between now and then (or their children). This does not fit a Ramsey representative agent model, but it is important.

[tante aime]

Intelligent Artifice and Global Scarcity

If you read the commentators, and Jim Sinclair is particularly focused on this, then you know Fed's Bernanke is flooding the world with US$ paper at the same time as Fed's Greenspan is bumping up the interest rates the US taxpayer is paying to foreign Federal debt holders. Every day, 11AM, $2B Fed's are being pumped into the US markets to stem the red ink. Every day, another 1/10th mil share of the US estate slips away.

The world is awash in US$ liquidity, so much so that the old standard P/E of 11 has floated past 28. In the span of just four years of raging Bushcoholic mania, the US$ of ours has sunk in value by a full 50%. With nowhere else to go, capital is pouring into real estate, bumping housing to a level, even with creative "pay only a minimum fee on a zero down loan" financing, that is unreachable. A true Argentinian meltdown, and people are finally starting to recognize those parallels.

That huge slug of overliquidity float by the Fed will take years, maybe a decade or more, to work through the system. We are truly foundering, all of us below decks. But there's more to it. Every day you hear the siren song of scarcity. It's a fraud. Every gas station pushing it's prices to $2.29 is doing so in the face
of a recent Fed audit that shows gasoline reserves are 175% of last year's against flat US demand! It's not scarcity, it's not the high price of crude, transport or refining, it's monopoly price gouging. Pure and simple. Monopolism at its finest.

GM and Ford are MSRPing vehicles for twice what they sold for ten years ago. Fancy, faux chrome cars but low MPG, and some for half the cost of what you used to buy a house for. Their discounts are huge too. I heard one ad for $10,000 off! GM is technically bankrupt, their stock at near junk levels as GE Capital cancels their lines of credit. Ford isn't far behind. Every vacant parking lot of every town is packed with used cars.
Every vacant super-center losing out to WalMart sells used cars.

Ask your local jobber, hey, what's the price of steel today, Jim? He'll groan and say his suppliers have just raised the price again. But if you get the world steel price off Meps, it's not a whole lot higher than last year, and a lot lower than in past. What goes for so much a pound on the world market is selling in the US for twice. Artificial scarcity towards price inflation,
the world market analysis is steel prices are declining, as a whole spate of major smelting projects kick off in ASEAN, and as the auto makers cut back their sheet metal contracts.

So which is it? This drastic deflation, or a spiraling inflation?

Gold, silver, oh, buy, buy, buy, the pundits cry! "The market is being manipulated, contracts are barely being met, and at any moment gold will soar to $1000 and silver to $50!" Ain't gonna happen. The Russian's are flooding the boards, if you read the metal industry news instead of the market spam. Mining is going at a frenetic pace, pumping out more of everything
than last year, against a barely rising global demand.

Your choice is eat, or buy gold. You can't eat gold.
It's not global scarcity, it's temporary supply dislocations.

Everything is topsy turvy. Gross overliquidity is chasing any investment opportunity in any country with resources and a large cheap labor market. "Pricing", as such, is absolutely undefineable at this point, at the retail level. Everything has become relative to everything else. Pricing floats to the point where it reaches saturation sensitivity. Gas, food, housing,
utilities are soaring. Gew-gaws, toys, tools, cars are crashing.

Capital is chasing profit and the search for profit is driving pricing and outsourcing, all helped along by monopolism, hailed by the twisted sisters of corporatism and bureaucracy and their running dog media whores.

A monsoon of monopolism.

Americans pay twice as much for pharmaceuticals as other
countries. Americans pay twice as much for food as other
countries. Americans pay twice as much for gasoline as in developing countries. Americans pay twice as much for most commodities too, pick anything you want, as other countries. American cars have some of the highest prices and worst fuel efficiency (their real hidden cost) as any other country's. Driving your fancy new car 100,000 miles costs you $20,000.

Airplanes will start falling from the sky in sheer disrepair. Oil refineries will start exploding suddenly at mid-morning. Pension funds bankrupcies will soon overwhelm the Fed. We are doubly screwed, going and coming, now and the future. All because of Fed's Bernanke and Greenspan's easy money, and that Goofy White Boy fundamentalist in the White House.

Great Depression was a panic, and US got out of it by
limiting margin investing, by going off the gold standard onto fiat money, by making loans to a nation of farmers to capitalize new development, and finally, by all-out world war mobilizing labor and capital.

This time, we got nothing to fall back on. There is no more labor growth. Farmers are less than 5% of the
population. Everything is leveraged, everything is worthless. You can't write a fiat check on fiat money, only float the sixth refi of the fifth refi of the fourth refi until someone torches your property.
Then you deficit your grandkids to fight for your insurance against their lawyers.

Knowing that, knowing that US$'s are becoming worthless,
and with them capital investments, and budget and trade and entitlements shortfalls will inevitably bring a socialist taxation, what's the point in hanging back? Buy, buy, buy? It's every man and woman for themselves against the state and the public? Buy anything at any price that looks like a momentum play? Leverage up the ass in derivatives and margin plays, you can always pay it back in worthless future dollars if they call?
Your 401(k) is worthless at a future 65% tax bracket?

That's the formula for an Argentinian meltdown. We are trapped by the inexorably laws of loose monetary supply and free trade and deliberately bad financial advice. Bank profits are soaring! It will take an infinity of years, or a cusping reversal, to unwind this conundrum, if we ever do, assuming we pull up and don't go Soviet on the world economy. If that happens, who knows?

"Would you like cabbage soup with your boiled turnips, comrade? There will always be a future for rickshaw drivers and pleasure girls in the New World Order."

Now go outside and enjoy the springtime while you can. Spring comes every year, and has forever, and doesn't cost a penny. You can't buy Spring for all the cash in Bernanke's print factory. Turn off the TV and ignore the Internet. Big Brother hates that.

[ChasHeath]

Page 5 - "form 2015 on" should be "from".

Page 6 - "thus, we here, past asset" -> "we hear"

Page 30 - sentence fragment "Equity market and other". Maybe this is intended. But. At the end of 30 pages, in a concluding section, perhaps best to lead with something more coherent. Or perhaps, my brain is fried, and I owe y'all an apology in the morning. Also review the "not ... not" in the following sentence. I'm much better at math than english, so take these suggestions with a grain of salt.

[anne]

Productivity, there is the critical projection, but advance in productivity always is the base of our long term well being. I am hopeful.

[lise]

Low interest rates tell us there is no reason to fault the Federal Reserve for excess liquidity formation.

[Bruce Webb]

Unanticipated benefit of the blogosphere: dozens of volunteer copy editors, typos may be a thing of the past.

But from the draft it seems you may be jousting with a counterfactual windmill. It is certainly true that the Trustees' Reports rely on a slowdown in population and a slowdown in productivity but it is far from clear that we should be taking them seriously. It seems to me that the "no economist left behind" challenge got turned on its head. From following Dean over the years I gathered that his fundamental challenge was to the productivity assumptions and not necessarily to models that purport to show historical returns on equities even given those pessimistic assumptions. I'll know more after reading the paper, but personally I have no argument with those that believe stocks will return 6.5%. I just don't believe they can in any economic reality that still supports "crisis".

Not that engaging and defeating privatizers on their own ground isn't important and valuable, but from my point of view simply asserting that the economy will continue to grow at or above the 2.2% rate needed to beat Low Cost is a lot easier argument. Who exactly is arguing that point?

[knut wicksell]

Will read immediately. I recall Warren Buffett saying pretty much the same thing in the Fall of 2000.

[David]

yet, Bruce Webb, the very technology (considered broadly) that makes a plethora of eager on line copy editors available is what makes the types of spelling errors that the volunteers find more prevalent (homophones and misspellings of words that are themselves words). dialectics, or what?

[RonK, Seattle]

And in conclusion: "Equity market and other asset returns determined by the overall cost of capital in the global economy and by the return investors require to bear the risk that comes with equity ownership."

This sentence a verb missing? Many other similar in ways different.

But I assume this is a discussion draft, and final will receive a ruthless line-editing from soemone skilled in the art. (Deeper thoughts, if any, on further reading and reflection.)

[anne]

Growth of 2.2% is entirely reasonable, but stock market returns of 6.5% will be tricky. There is no reason to believe we are anywhere near exhausting productivity gains from development and application of information technology tools. Productivity applications in health care are wonderfully promising, and we will not soon experience a slowing of growth in demand for health care services. Growth-wise, I am optimistic. Looking to our economic structure, I worry.

[Harold McClure]

Interesting paper but it may be missing one element. Marginal Revolution suggested your approach did not incorporate Andrew Samwick's endogenous payout ratio suggestion. Yes, the paper does address this issue in a way, but it's not entirely clear or convincing. There may be a simple way to do so and still be consistent with the BDK conclusions.

[spencer]

One issue that was not discussed in the paper and I worry about is the change in the life of capital.
This paper probably is not the place to raise the issue,
but it is something to think about.

With the massive increase in high tech's share of
capital spending some big changes are occurring that
we may need to start thinking about. With most traditional capital the life span of much of the capital structure is typically measured in decades.
However, the life span of most information processing equipment and software is usually only a few years.
Info processing equipment now accounts for about 6%
of real GDP out of the under 12% of gdp in real private nonresidential equipment and essentially accounts for
all the growth in business fixed investment over the last quarter century.

The question I have is if about half of capital spending is on equipment that has a much shorter life span does it mean we have to run faster just to stay even since a greater portion of each years new spending is just to replace old equipment that is depreciating faster.

But this issue does raise some very difficult questions about retruns on capital and the ammount of capital per worker. This is probably too complex an issue to incorporate into this paper, but it is something I have not seen the economics profession address. But if we are discussing long range growth I believe it should be brought into the discussion.

[anne]

Spencer

The issue has come up before, and it really is time to consider this fully. If Moore's law prevails in information technology advance, so does it prevail in cost to obtain the advance. Please extend these thoughts.

[spencer]

anne-- I'm not sure what would be the next step.

One would be to look at net investment rather
then gross investment.

Reason I brought it up in this contex of long run growth to start a discussion.

[anne]

'Now! Now!' cried the Queen. 'Faster! Faster!' And they went so fast that at last they seemed to skim through the air, hardly touching the ground with their feet, till suddenly, just as Alice was getting quite exhausted, they stopped, and she found herself sitting on the ground, breathless and giddy.

The Queen propped her up against a tree, and said kindly, 'You may rest a little now.'

Alice looked round her in great surprise. 'Why, I do believe we've been under this tree the whole time! Everything's just as it was!'

'Of course it is,' said the Queen, 'what would you have it?'

'Well, in OUR country,' said Alice, still panting a little, 'you'd generally get to somewhere else--if you ran very fast for a long time, as we've been doing.'

'A slow sort of country!' said the Queen. 'Now, HERE, you see, it takes all the running YOU can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!'

'I'd rather not try, please!' said Alice. 'I'm quite content to stay here--only I AM so hot and thirsty!'

[anne]

Well, I am thinking as well :)

[anne]

Thank you Spencer :)

[Matt]

I'm looking forward to seeing you discuss this paper on Thursday, especially considering the other discussants that will be present ... hehe