The interesting conclusion from this analysis is to try to imagine what an economy where profits are equal to a third to a half, or more of GDP would look like.

I could ask a million questions. But the first that pops into my head is what kind of a reinvestment rate would be required to sustain this economy?

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Btw, all four things can happen in combination, and probably will.

[A stock market crash? A huge trade surplus--larger in proportion to the economy than Britain's before WWI--for generations to come? Sudden massive undercounting of true earnings on a scale never before seen? And a huge further shift in income away labor and toward capital?

Don't be silly.]

Brad:

OT - but on the front business page of the SF Chronicle is a picture of Barbara Boxer slamming the Bush Administration on SS reform. Of note is that she appears to be holding a printout from Brad DeLong's Web Site. I hope she skips the comments.

Nice and tight and useful analysis. The conclusion is if the Social Security actuaries are right in assuming a 1.9% long term economic growth trend, then private accounts will return much less than a projected 6.5% a year. If growth were to be faster than 1.9%, than Social Security will be fine as is as far as we can project.

There is no reason to reduce Social Security benefits, nor is there reason to massively add to debt to form private accounts.

Patrick R. Sullivan, your comment is about as intelligent as would be calling the Athenians' Syracusan expedition a roaring success. By the way, speaking of the Syracusan expedition...

You use the identity
(Earnings Growth) = (Economic Growth)
and a variation of this later on in the write-up.

Is this identity true empirically? It seems unlikely. Public companies make up only a portion of the economy. Furthermore, you would expect public companies to be run better than private. Thus, you'd expected their earnings growth to be greater than private companies.

The degree to which economic growth is related to public company earnings growth is only the degree to which these companies make up the economy.

If Bush thinks that public companies are more profitable than private, than it seems logical to bet you can make a higher return by investing in that sector of the economy.

[But then public companies would grow as a share of the economy... and they haven't been]

Accounting earnings are now massively understated.

Please stop. I am trying to hold in my head the picture of a thousand CEO's talking to a thousand CFO's, saying, "Jeebus, you gotta hide more of these earnings. You're making me look too good, and you're pushing my incentive compensation through the roof! Cut it out!"

Yes, I am sure that is what's happening.

Ok, your 0.9% buy back is just another form of
dividend. So you have a dividend of 1.7%% plus
0.9%, or 2.6% while earnings are growing at 1.9%.

If you start out with a 50% dividend payout ratio
after about 30 years dividends would have to be greater then earnings every year.

Will Ambrosini wrote, "Is this identity true empirically? It seems unlikely."

Here are a couple articles that show the historical relation between corporate profits and GDP. Unfortunately, the author doesn't say whether he meant profits of *public* corporations, but nonetheless the articles are informative.

http://www.efficientfrontier.com/ef/702/2percent.htm
http://www.efficientfrontier.com/ef/102/pie.htm

"The conclusions? That you can reconcile current 1.7% dividend yields..."

Why in the world would anyone assume 1.7% dividend yields? For 75 years???

[Put it this way: current dividend yields are telling us that either (a) capital gains are going to be bigger than historical averages (which means growth is going to be a *lot* bigger than 1.9%) or (b) that the equity premium has fallen significantly or (c) that stock returns are going to be really lousy over the next decade or so as price-dividend ratios fall--or all three. If (a), the SSA needs to rethink its growth assumptions. If (b), the SSA needs to rethink its equity premium return assumptions. If (c), now is *really* not the time to start investing Social Security taxes in equities...]

[troll]

Let me see if I can catch up to you guys:

The easiest way for the stock market to rise at its historical rate is to do what it's done up until now - ride the wave of the growing economy.

Tom MacGuire says another way is for profits to become a larger proportion of the economy.

That can be done by ending all unions, (inviting just enough workers to keep price pressure on wages, but not enough for the economy to grow,) ending taxes on corporations and increasing the tax burden on wages.

Now that we have an idea of how it supposedly can happen, what is the proportion of profit to GDP in the most business-friendly economies in the world? Singapore & similar places?

If the US aimed for and became Singapore by 2050, what would the stock market look like between now and then?

How much does the proportion of capital to gdp have to rise to give the same stock returns we have now but without today's economic growth?

In other words, Tom MacGuire is taking choice 2. The shift towards capital.

How much would income have to shift towards capital per year to maintain the historical stock payouts without the historical growth?

[Raise the corporate profit share of GDP by three-tenths--reduce the labor share by less than one-fourtieth. It *could* happen. Give us tight monetary policy and slow employment growth for a decade.]

Spencer

Thank you for all the fine analysis. your article will be happily read.

To Patrick Sullivan: *Anything* can be made to seem possible if you build enough windfalls into your assumptions! The future *is* open, which to me means that first of all one might doubt the 1.9% limit on long term U.S. growth -- it's only by being a domestic growth-pessimist that you make the case for the social security reform in the first place. The Bush administration case, then, is built on a weird combination of deliberate pessimism in some areas and wild optimism in others.

Second, while it sounds superficially reasonable to say that the 4 things could share the burden, you *must* think about what each thing *means*. As has been entertainingly pointed out (3) is improbable on its face, while (2) (and I do think the wage share can be considered a politically-manipulable variable) would just take away with one hand what it gave with the other -- workers get lower real wages and then get some of their loss back later. So you're left with (1) and (4). It's not clear that (1) is even compatible with (4): are we now, simultaneously, on the verge of a long-term export boom and a stock market crash?

One also needs to think through, rigorously, the very large BoP and income adjustments that the long-term-export-boom scenario would imply. Who abroad is going to buy more of which U.S. exports? And/or *how* much are imports from abroad going to be compressed? What will be the impact on foreigners of that? And so on.

Similar questions about selective pessimism and BoP-shift implications could be asked of the Jim Glass scenario.

Hmm. While US corportations and investors in general might indeed make very good returns on their capital by investing it abroad there is a pretty major problem in assuming that this will in any way benefit any social security accounts. Namely; those accounts will, at the very least, have their general investment strategy set by congress and does *anyone* think that they are going to advocate parking a few trillion overseas?

Yhea, right.

Wouldn't Option Two, the Bush-in-heaven scenario where the whole thing is sorted by a redistribution from labour to capital, tend to be self-cancelling?

As Social Security is funded by a payroll tax, wouldn't slashing payrolls (or at least the growth in them) reduce the payroll tax revenues by exactly the same proportion? And - obviously - the cash available to invest in the private account, as that' s a percentage of your payroll tax! So, you get higher dividends, but on fewer shares.

I will grant that choice (4) has quite a different feel from the others, but, following Patrick, why could we not have (a) a weak stock market; (b) corporations responding to competitive pressures by holding back wahe increases; and (c) increased dividends/buybacks, as firms effectively "disinvest" (actually, reinvest more slowly) in response to a more slowly growing economy.

A good starting point for a serious discussion would be to ask whether the Social Security trustee's forecast actually embed any kind of a return on capital at all; if they do not, perhaps they could (a) explain why they said they did, in a recent press release, and (b) revise them so that they *do* embed a target return on capital.

Which would give us all a chance to admire their methodology, and wonder whether the profit, wage, and tax shares of the new forecast were realistic/desirable.

Well.

As a bonus, increasing the profit share at the expense of wages will hasten the date of financial distress for Soc Sec, for the reasons noted above by Alex.

And FWIW, I am firmly on both sides of this issue - I think a good case can be made that the future risk premium *ought* to be lower; however, I am deeply skeptical of "proofs" that it "must* be.

I agree that when gdp growth is only 1.9% that you should be happy with a 4.5% return.
But I see some more possibilities for a higher return:

[But to keep these running for 75 years or more? That's the real question...]

1. profit growth could be higher than gdp growth when the leverage increases further. That is rational when the bond yields are lower than the gdp growth as is now the case.
2. The Bush administration thinks it will depress government spending. Because of government taking less of gdp there is more room for profit growth (and wage growth) in the coming c.10 to 15 years (a longer period seems to me impossible).
3. Because of mergers and acquisitions the shareholders receive some extra capital growth.
4. profit growth could be higher than gdp growth when multifactor productivity is very high, like it was in the previous years. That also tends to go together with lower real bond yields. An optimistic assumption is that this situation could last c.10 to 15 years.

Hasn't Brad said repeatedly over the last couple years that #2 IS happening, but that it can't possibly continue? I mean, according to Brad's prior posts, we're already years past the point at which a normal recovery would have led to wage growth, but we're not seeing any. Someone above referred to this as the "Bush in Heaven" scenario.

I guess it's unrealistic to think that the gov't could really create policy to manipulate the economy into a decades-long shift in capital-labor balance, but stranger things have happened....

Maguire seems to be pushing for option #2: the stagnant wage scenario. As I pointed out on Drum's site, there is a little problem with this, something called "reality."

After all, the only reason there is a Social Security "problem" is that we face a shortage of labor.

And basic economics (the only type I know) tells us what happens when you push down the supply curve.
A shortage of workers will result in higher wages.

So scenario #2 is not just unlikely, it is improbable.

Are you assuming the SSA's growth projection of 1.9% is correct? Growth has averaged something closer to 3.4%, so why use the SSA's number?

Bill: The point is that the privatizers assume that the SSA's numbers are correct in order to claim that SS has a problem -- then turn around and use stock growth numbers which are INCOMPATIBLE with the groweth numbers, to push private accounts.

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