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February 07, 2005

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» POLITICS: The Simpleton from Baseball Crank
The Minute Man continues his dissection of Paul Krugman's broadsides against Social Security reform, and argues that Krugman gets three points wrong in the macroeconomic case against private accounts helping to close the funding gap. As I understand Ma... [Read More]

» The Minuteman Asks: Who Would Like To Bet On Paul Krugman? from Brad DeLong's Website
Tom Maguire asks: JustOneMinute: Who Would Like To Bet On Paul Krugman?: However, my point stands in direct contradiction of a column written by Paul Krugman.... So, my proposition - I will pick out a couple of key phrases that summarize the Krugman ar... [Read More]

Comments

creepy dude

"If a consensus emerges that I am correct, you pay; if, OTOH, I am right, I pay."

Yep. Financial wizard you are. Krugman's toast.

Al

Paging Brad DeLong!

Drew

Well, I understood "Paul Krugman" "wrong" and "social security." Normally, when I see all those together, I can agree with the context of the article, so I'm going to guess that you're probably right.

Any chance of printing something like this in terms that an idiot like me can understand?

George M. Behr

Thought you were trying to get me on a 'sucker' bet:

"If a consensus emerges that I am correct, you pay; if, OTOH, I am right, I pay"

I think you meant "OTOH, I am wrong, I pay".

MattJ

If I were Krugman, I would represent myself as a credible economist, endorse my own opinion, and take all your money.

Or woould that be cheating?

Patrick R. Sullivan

"some credible economists emerge"

Ay, there's the rub.

But, don't accept any bets from Australian economists.

TM

if, OTOH, I am right, I pay"

I think you meant "OTOH, I am wrong, I pay".

Oh, man, someone will pay for that. COPY BOY! GET ME REWRITE!

T J Sawyer

I quit reading Krugman's latest rant when he got to "... 6.5 or 7percent after inflation ... a rate of return that high is mathematically impossible." Seems I had just finished reading the year 2000 book, Valuing Wall Street, in which the authors present Wharton economist Jeremy Siegel's extensive work showing that the average real return (after inflation) has been surprising stable at guess what - 6.75% Is this worth maybe $110 alone?

Geek, Esq.

Can I bet on Krugman being wrong, and Donald Luskin being even worse?

Crank

Looks like Krugman should go brush up on this essay's point about how people who won't use multi-variable equations shouldn't write about economics.

As for me, you lost me at a few points, but I believe I understand the central ideas here. Let's see if I can summarize these points without mischaracterizing them:

#1: Krugman contends that it "is mathematically impossible" to have growth in returns on stocks in the neighborhood of 6.5-7% without very high levels of growth in the economy as a whole, higher than any reasonable current estimate. TM contends that it is possible, and that this can occur if corporations hold down wage growth and thus pass on to investors much or all of the benefits of economic growth. You would think that liberal/Democratic pundits would grasp this zero-sum-game workers vs. capital dynamic as a possibility. As TM has noted before, this scenario becomes more plausible when you consider the possibility of capital invested in low-wage foreign markets.

If TM is right, not only is this a possible outcome, but it is one in which it becomes uniquely desirable for laborers to become capitalists to offset their vulnerability to stagnant wages. Which explains why #3 is wrong too: since private accounts are an investment in the international stock and bond markets while the current pay-as-you-go means (on a macro level) an investment in domestic payrolls, any scenario in which (a) wages don't keep up with profits or (b) jobs go offshore is likely to throw off the 1:1 relationship of returns on capital:payrolls, and thus defeat Krugman's tidy syllogism.

#2, I'm not sure I understood, however. I think Krugman is saying that corporate profits (before, or after payment of interest to bondholders?) determine the return on capital to the corporation's owners. I get that you say this is not necessarily so, but I'm not sure I followed why.

Don Luskin

The answer is so much simpler than this. Krugman is wrong even using his own numbers. As I wrote here -- http://www.nationalreview.com/nrof_luskin/kts200502021117.asp -- his 3% dividend/repurchase yield plus 3.4% GDP growth gets you there no problem. And by the way, I have the history of corporate earnings growth back to 1900, and it very closely tracks GDP growth. My NRO article yielded an response from Dean Baker, the loony leftist economist whom Krugman quoted, and he conceded that I was right, but emphasized that the "real" point was that you can't get there from the low GDP growth figures that the actuaries use. And so now Tom has arisen to show that you can, or at least to argue that. I tend to think that you cannot. For Tom to be right, in other words for the return to capital to be so disproportionate as to close the gap, you would have to experience what Baker and Krugman talk about -- p/e ratios rising to heights that are unprecedented, and staying there. Not to say that it's impossible, but there is surely no reason to expect it; quite the opposite. To see what I mean, you could call the NASDAQ bubble of 1999/2000 a case in which the "return to capital" was "disproportionate" in the way that Tom posits. So it can happen. But it is unlikely to last.

If I were forced to make the case, I would look to non-US sources of earnings. The easiest way for profit growth to exceed GDP growth would be for US-domiciled companies to earn increasing fractions of their profits from non-US sources.

yetanotherjohn

I did a quick google search. Between 1926 and 1999, the return was 11% for the US Stock market average. As another example, 1963 to 1993 was 11.83%.
Now, I don't know what the productivity gains where from 1926 to 1999, but I would be amazed if it was anywhere close to 11%. So I'm not sure how you can link productivity to expected return.

Pat Curley

Luskin had some fund with that same column. He points out that Krugman talks about 3% dividends and 3.4% real growth; by definition that indicates a 6.4% return.

I have also commented that a company's share price can increase faster than its sales if it makes use of long-term fixed rate debt; something that is well-known to commercial real estate investors.

ArminTamzarian

I get 3.9% real growth in the DJIA from the June 1932 low of 42 to the February 2003 low of 7750, using the GDP deflator. Dividend yield over that period isn't below 3%, so there you go, 7% real stock returns. Are there any broader historical indexes anyone's put together?

Coincidentally, real GDP growth from trough to trough, 1933 to 2001, I get as 4.0%. Krugman's numbers are going to be a little off if he's going from 1929 to 2004.

Why is real GDP growth supposed to be so much lower than 3.4% over the next 75 years? Real per capita GDP growth from 1933 to 2001 was 2.9%. Are we expecting less than 0.5% population growth?

TM

Are we expecting less than 0.5% population growth?

IIRC, we are - 0.2% workforce growth springs to mind, although I am hazy as to the relevant time period.

Tim Worstallt

I go with Don Luskin. Global capital markets mean that the link between growth in US profits does not need (in fact won’t) to track growth in the US economy. It should, dependent upon how global those markets really are, track global GDP growth.

ArminTamzarian

"IIRC, we are - 0.2% workforce growth springs to mind, although I am hazy as to the relevant time period."

I checked the Census website: 0.6% growth in the 20-64 group over the next 45 years.

CBKiteflyer

Question: Can somebody explain to me whether the "proof" that Michael Kinsley offers at http://www.latimes.com/proof is related to Krugman's claims?

CBKiteflyer

Question: Can somebody explain to me whether the "proof" that Michael Kinsley offers at http://www.latimes.com/proof is related to Krugman's claims?

Jim Glass

"I have the history of corporate earnings growth back to 1900, and it very closely tracks GDP growth.... If I were forced to make the case, I would look to non-US sources of earnings.

"The easiest way for profit growth to exceed GDP growth would be for US-domiciled companies to earn increasing fractions of their profits from non-US sources. "

~~~~~

The simplest solution is to have world GDP be the relevant GDP.

If world GDP grows at 4% over the next 75 years that's two extra points and there we are -- back to the stock market's 7% return.

(If anyone wonders why this should be the case in the 21st century when it wasn't in the 20th, well, there were little things like Communism and socialism taking most of the world out of the market, a couple of World Wars, capital controls, Smoot-Hawley and its like ... but past record is not a reliable indicator of future performance.)

There has been some suggestion that markets equalize when they come into contact.

If Krugman had consulted with someone who knew something about international economics, instead of Dean Baker, he might have picked up on that idea.

TM

I go with Don Luskin. Global capital markets mean that the link between growth in US profits does not need (in fact won’t) to track growth in the US economy.

Jim Glass made that point right out of the chute, and I got there a day later. Weirdly, I initially dropped it from this post for expository purposes (although it may have reappeared after a subtle revision).

As to the question about Kinsley's proof, I would say he is making a different point, that personal accounts don't change total savings, and so they are a glorious wash.

Randall

What a fool you are. Nice to be at Princeton, and know you are not.

TM

I'm sorry, Randall, was there a specific point with which you care to disagree? They are numbered (1), (2), and (3) for your convenience.

spencer

The intermediate ss case assumes about 4% nominal gdp growth. To get 10% nominal stock returns under that scenario you have to have some combination of the following developments:

1. PE rises to levels suggested by Krugman
2. after tax earnings share of the pie rises from around 6% of gdp to around 35% of gdp
3. firms regularly pay out over 100% of earnings in dividends. This is under a scenario where you return to a pre WW II type market where dividends acount for the bulk of returns.

One of more of these variables has to grow much faster then nominal gdp year after year after year-- you can not get away from that conclusion..

Retief

Back to Algebra you go. There are not two instances of the variable "Workers" in your equation but three. You can't cancel just two of them and have the other one disapear on its own. You noted this one sentence before you tried to do it:

Capital = Workers x (Capital/Worker) or C=W(C/W)

Then you give us your return on Capital

SO: Return on Capital =

[Workers x Productivity x Inc Sh to Cap] / Workers x (Capital/Worker)

or Return on Capital = WPI/(W(C/W))

You have just noted that you denominator simplifies to C, giving you Return on Capital = WPI/C. Which leaves you with no W in the denominator. As any basic Algebra student can tell you, one can cancel the two Ws but that will also leave you with Return on Capital = PI/(C/W). When you multiply by the inverse you get right back to WPI/C. Multiplying C by W/W can have no lasting effect on the W in the numerator.

Maybe we should think twice before daring equations.

Paul G. Brown

Tom-

Over on Brad DeLong's site, you commented:

"All somewhat beside the point - can we find someone to defend Krugman's assertions, please? My money is waiting."

Dude. You just did defend Krugman.

Paul Krugman's first analysis suggests earnings growth at 1.9% and stock dividends and buybacks at 3%. So, we can project real returns to be 4.9%. [Nominal returns of 7.9%].

You said (in same comment thread): "In fact, if "6" is the over/under, I would bet "under" - I picked 5% a few days ago (and now I am stuck with it, I guess...)."

4.9% - PK, 5% - Tom.

Meanwhile, "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".

Well break out the accordian, folks, cos' we're all gonna polka!


dsquared

How do you reinvest dividends in this model? If the amount of capital employed is presumed constant, what are the dividends being invested *in*?

Btw, Retief is dead right above; both arithmetically and economically, adding workers in your model *does* increase the return on capital. If you have a fixed amount of capital and a constant marginal productivity of labour and you add more workers, return on capital increases. It's the same phenomenon as having a fixed number of workers and a constant marginal efficiency of capital; adding more capital increases productivity.

TM

Gents, do not take me to task for my failure to re-state my assumptions for the umpteenth plus one time Here is what I said earlier in the post:

In the high growth scenarios, we need to model levels of investment (replacement plus new investment), a capital/labor ratio (those new workers need capital to be productive), and an income share to capital.

What folks will realize, upon reflection, is that the return on capital will only go up if the relative capital deployed falls, or the income share of capital rises.

Now, *IF* we are assuming a onstant capital/labor ratio (as I said), then d-squared's objection disappears, and Retief's observation that not all of the workers cancel is a part of my point - if the C/W ratio is kept constant, then adding workers to get more growth also requires more capital, and the return on capital does not change.

[Sorry, this was a very late response - I think d-squared and I must have moved on to a follow-up post].

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