Bears bash Bush – over the events of 2080

You

wanna look stupid, forecast the

stock market. You wanna look really stupid, forecast the stock market over the next 75 years. Actually, maybe the 75- year forecast is safer — how many people will be around to remember what a dope you were three- quarters of a century earlier?

Anyway, some of America’s best- known economists recently went on record with their calls for 21st-century puts. Why would they risk it? That’s easy: It was a chance to Bush-bash. Whether you think the president’s plan to let people divert part of their Social Security tax to a private investment account is a good idea depends in part on whether you think there will be good private investments around. The average real return on U.S. equities over the last 75 years was 6.5%. If the next 75 years won’t be as good, then by tempting people to go private maybe Mr. Bush is being a moron again.

And he is, say Paul Krugman of Princeton and The New York Times, Brad De Long of the University of California at Berkeley and Dean Baker, a Washington economist. In a new paper for the Brookings Institution, they reason the U. S. economy will grow more slowly than it has in recent decades. If it does, profits will fall and stock returns suffer.

Why will the economy slow? One big reason is that the feminist revolution has already happened. Just about all women who want to work do work. There aren’t any more to come pouring into the labour market and ramp up output, the way they did in the 1950s, 1960s and 1970s. It’s strange to think stocks did well in the last few decades because women decided to take up paid work, but then lots in economics is strange.

Same story for immigration. Krugman, De Long and Baker think the years of big immigration to the United States are over. They could be wrong, of course. One of their critics argues that if immigration rates drift up to 0.5% of the population from 0.4%, then 75 years from now U.S. population will be 610 million, not 425 million. But if not, slower population growth will also cool the economy.

Why does slower labour force growth hit profits? With lots of workers around, capital is relatively scarce, and thus useful, sought- after and valuable. With not so many workers around, each has access to lots of capital, which therefore isn’t so valuable at the margin. In competitive markets ,people, goods and inputs are paid what they’re worth at the margin, so with capital un-scarce, it won’t earn as much.

But that’s only if people keep saving, say the critics, so the stock of capital keeps growing. If instead they cut back on saving — and “ American savings” is a bit of an oxymoron these days — capital stays scarce and valuable and equity returns high.

OK, say Krugman, De Long and Baker, but what about the equity premium? Real returns on U.S. bonds averaged 3% over the last 75 years. With equities paying 6.5%, that means the equity premium, which compensates for stocks’ greater risk, was 3.5%. But equity markets are a lot deeper, safer and more efficient now than in the 1930s and 1940s. Is it rational for people still to be so shy of stock? (Arguing with lefties who believe in the rationality of capital markets isn’t so easy!) Suppose the equity premium falls to 2.5%. All else equal, that gives a real return for the rest of this century of 5.5%, not 6.5%. And Bush is looking bad again.

But hold on, says Greg Mankiw, just- retired head of Mr. Bush’s Council of Economic Advisers. Even if your growth forecast is right, U.S. corporate profits don’t just depend on events in the U.S. economy. If American firms invest in other countries, they can enjoy the high returns produced by rapid growth elsewhere. Future American retirees can get a piece of this action by investing their Social Security savings with U.S. firms that invest abroad.

In fact, a couple of other economists add, Asian governments are piling up so much U.S. government debt precisely to encourage such investment. They argue that foreign investors are comforted by such large reserves of U.S. treasuries: If China, say, nationalizes U.S. multinationals, the U.S. can default on China’s reserves. It’s a form of economic Mutual Assured Destruction.

In the end, the largest dollop of sanity comes from William Nordhaus of Yale. He estimates likely future stock returns of almost 7%, compared to 4.4% for Krugman, De Long and Baker. Over 75 years, that’s an enormous difference. “ It may be possible to reduce this factor- of- two uncertainty,” he writes, “ but I doubt it.”

So the president’s plan may work out OK. Or it may not. What we should be debating, says Nordhaus, is what happens if lots of people invest in the private option and don’t do well. In the end, do we bail them out?

Apologies to anyone who was looking for a straight recommendation on equities. You didn’t actually expect that from economists, did you?