Paul Krugman continues to assault both Social Security reform and his own professional reputation with his Tuesday effort titled "Many Unhappy Returns". Let's excerpt a bit:
Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.
...The Social Security projections that say the trust fund will be exhausted by 2042 assume that economic growth will slow as baby boomers leave the work force. The actuaries predict that economic growth, which averaged 3.4 percent per year over the last 75 years, will average only 1.9 percent over the next 75 years.
In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.
I have just one word for the Earnest Prof - plastics.
Now I have another word - globalization. For a fellow who hopes to win a Nobel Prize for his work in international trade and finance, Prof. Krugman seems to have become horribly absent-minded about his specialty.
Maybe I can help - the opening of global markets and global capital markets was supposed to be bad for the mill worker in Akron, who is now in competition with laborers from Mexico and China, but good for investors in Akron, who can now move their capital from Akron to Mexico or China.
In such a world with capital mobility, the return on capital earned by "US" investors will not be driven exclusively by the growth of the US market. Oh, man, why am I even writing this? Let me give the mike to Barry Bosworth of the Brookings Institute, who also took a stab at this "duh!"-inducing concept:
Alternatively, we could envision the extra saving being invested abroad. In a large global economy with a growing labor force, the decline in the return to capital would be much less...
I think that there is some appeal to a policy that tries to promote the expansion of global capital markets as an offset to population aging in the industrial economies.... The developing world will have a large potential to absorb capital in the future - first because the labor force will continue to grow in these countries, and second, because the capital per worker is still so low compared to the industrial countries. So I think we can see some elements of a bargain between the industrial world and the developing world, that can resolve some of these problems in the future.
...I think that one further analogy that we might consider before we discount the notion of much more integrated global markets is that of in the United States. For a long time the US relied solely on local capital markets, then on regional capital markets; the move to a national capital market has been a relatively recent phenomenon. Interest differentials between California and the East Coast did not decline to zero until somewhere in the 1970s. In prior years, there were large interest rate differentials between various regions of the country. Similarly, we now seem to be observing an integration of European capital markets at a fairly rapid rate. So one might be tempted to simply wait; as the markets to become increasingly sophisticated and able to deal with these problems, we will see an evolution to a more international capital market to absolve some of these problems.
Furthermore, we need not focus on increases in portfolio investment, and similar forms of investment, in these countries. The major mechanism that may be used in the future for channeling funds to emerging markets is direct investment by multi-national corporations. As the labor market continues to slow its rate of expansion in the US, Europe, and Japan, enterprises in these countries are naturally going to turn to the developing world. So if we can tolerate the political consequences of increasing the 'multi-nationalism' of major corporations, (though the recent Seattle incidents demonstrated the strength of domestic opposition to this), that may become the major mechanism by which we try to integrate these markets in the future.
In summary, a global perspective suggests that the problem of population aging is easier to manage than is implied by the common focus on closed economies. Drawing a comparison to the US - for a long time we thought that New England was getting old, and California was young, and then a deal was struck between them: New England invested in California. Why shouldn't we think that the same process would occur globally? As Dr. Holzmann emphasized, there are currently significant barriers to the expansion of a global capital market, and we are still struggling to find the institutional arrangements that will make it possible. But past experience suggests that economic profit tends to overwhelm institutional barriers; and so, I would be optimistic in the long run about the potential for finding solutions to these problems. I think multi-national corporations will prove an important part of the mechanism by which it's done.
No kidding - even though GE and Microsoft are "American" companies, they sell and earn profits abroad. I'm reeling!
Now, a technical question about national income accounts - are profits earned abroad by US companies counted in US GDP? I bet not. But do they increase the value of my shares? I bet they do.
Let's put it another way - Kevin Drum has some good background on the models forecasting lower growth, and the gist is that Output = Available Labor Force x Labor Force Participation Rate x Hours Worked x Productivity. Fine. And since the US labor force will grow more slowly in the future than it has up to to now, the growth in the economy will probably slow (productivity is a swing variable here). Fine again.
But if we take seriously the implicit Krugman argument that equity returns must eventually track growth in the domestic economy, doesn't it follow that equity returns in Germany, Japan and France will be negative over the next fifty years? Is that really Krugman's forecast? Of course it is not - companies "over there" have lots of "foreign" operations [UPDATE: Subsequent research tells me that, although these countries may see labor force shrinkage of less than 1% per year, productivity should grow by enough to assure growth in GDP.]. OK, now tell me why the methodology changes when it is the US on the examining table (Well, yes, we are a lot bigger, but does that invalidate the concept?). While you are at it, tell me what Daimler-Chrysler is (and is it part of the S&P 500?), and tell me why US investors can't buy foreign stocks directly (the Federal Thrift Savings Plan, often touted as the model for the personal accounts option, offers a international index fund).
Maybe the globalization argument about mobile capital realizing leveled returns is all wrong - if the Times had a columnist who was willing to put his economics ahead of his polemics, the rest of us would know.
More: Andrew Samwick is in the mix.