Editor’s Note: This item is cross-posted from Innovation and Growth. 

Bill Gross of Pimco has just written a piece where he argues that the real return on stocks in the future will be much lower than the long-term historical average of 6.6%:

Yet the 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes – a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?

He then goes on to argue that:

The Siegel constant of 6.6% real appreciation, therefore, is an historical freak, a mutation likely never to be seen again as far as we mortals are concerned.

In a world of slow innovation, Gross is likely to be correct.  The economy grows slowly, and it becomes difficult to justify compensating risk capital if risks are not paying off.

The calculation changes, however, if we have big disruptive innovations. Big disruptive innovations offer risk on both the upside and the downside. On the upside, disruptive innovations create a wave of high-growth companies that drive the stock market higher. On the downside, disruptive innovations offer the distinct possibility of driving existing companies out of business, once again accentuating risk. Continue reading “Why Bill Gross is Wrong: Innovation and Long-term Returns on Equity” →

I found myself reacting to the Libor scandal more strongly than a lot of the earlier revelations of financial institutions misdeeds. First, the banks were just blatant out-and-out lying about a simple number.

Second, their lying led to a distortion of a crucial piece of publicly available data–the Libor rate. In a market economy, intentional misrepresentation of a market price is not a victimless crime –in fact, the victims are everyone who relied on that price to make decisions.  That includes regulators who presumably watched Libor as one of their guides to the amount of stress in the global banking system. Here’s a chart of Libor across the key period (downloaded fromhttps://www.fedprimerate.com ).

Would Libor have shown more signs of stress sooner if it wasn’t being manipulated in 2007 and 2008? And would banks, regulators, and investors reacted sooner? We’ll never know.

But this confirms what I’ve written in the past–the financial crisis was in part a data crisis, where all sorts of numbers were sending misleading signals. In particular, the strength of the financial position of the banks was overstated.

The question is whether the Libor scandal is a vestige of the past, or a sign of future troubles to come. My sense is that we’ll see a lot more opportunities for manipulation of private data to send misleading public signals. Forget about financial markets for the moment. I’m thinking now about the way that websites continually try to game Google’s search algorithms in order to get a higher ranking. Hotels and restaurants have a big incentive to try and manipulate their reviews on consumer sites such as Yelp. App developers have an incentive to game their reviews on the Apple and Google app stores.

Will the bad information drive out the good? Or can we build information aggregation mechanisms that are more difficult to manipulate?

This item is cross-posted from Michael Mandel’s blog, Mandel On Innovation and Growth.

Whether U.S. Presidents succeed or fail often depends on a big factor beyond their control: the timing of the business cycle. Lucky Presidents – Ronald Reagan, George W. Bush – experienced downturns early in their first term, leaving plenty of time for an economic rebound to lift them to reelection.

Barack Obama, who took office months after the Great Recession started, must be cursing his luck. Just at the point when investment and jobs normally would be coming back, the U.S. economy has taken a sickening swoon.

Last month’s feeble job numbers – just 54,000 jobs created, far short of the 300,000 or more needed each month to return unemployment to pre-crisis levels – reinforced the public’s growing economic gloom. They also suggested that the administration has erred in viewing the economy’s problems as cyclical.

If that were true, the White House strategy of waiting for the economy to heal itself might make sense. But if America faces structural impediments to growth, we can’t just wait for the economy to revert to normal.

Since the Great Recession officially ended in the fall of 2009, the economy has grown just 2.8 percent per year, well below the average 4.6 percent growth that follows typical recessions, economist Lawrence Lindsey said. And instead of declining steadily, unemployment is rising again.

From GOP presidential aspirant Jon Huntsman to liberal columnist Paul Krugman, commentators across the spectrum are rightly talking about a “lost decade” of economic growth. According to the Wall Street Journal’s Gerald Seib, America has endured 11 straight years of lackluster growth since 2000, the last year in which economic growth exceeded four percent.

The job picture is even worse. As this useful chart shows, the U.S. economy created 23 million jobs on Clinton’s watch and 16 million on Reagan’s. Bush’s job-creation record is a paltry 3 million. And we can’t just blame the Great Recession. Even before it hit in December 2007, the rate of job growth lagged well behind the record of the previous decades.

No doubt about it: the aughts under Bush were a lost economic decade. While no president can be blamed for cyclical downturns, it is fair to say that Bush’s economic policies did little to address the structural roots of slower economic and job growth. On the contrary, his purblind economic policy mix – coupling a spending binge with deep tax cuts – helped dig America into a deep fiscal hole.

Nonetheless, the lingering economic malaise has cast a shadow over Obama’s reelection prospects and boosted Mitt Romney’s political stock – the two are now running neck-in-neck in the polls. The 2012 election will largely be a contest over which party has the most credible plan for reviving U.S. economic dynamism.

The Republicans have a simple fiscal theory that leads to an equally simple solution. They see the size and cost of government as the chief obstacle to growth. Cut public spending, and the economy will sit up on its haunches again and roar.

Many liberals, including Krugman, seem stuck in the Keynesian paradigm, arguing that the problem is inadequate demand, which means government needs to spend more until the economy recovers its “animal spirits.”

Obama is smart enough to reject a witless choice between less or more government. He has, however, yet to develop a plausible plan for restructuring the U.S. economy to unleash economic innovation, capture its benefits in good jobs that stay in America, and boost our ability to win in world markets.

Above all, Obama needs to spell out big, concrete initiatives that can inspire public confidence that his administration has properly diagnosed the economy’s structural ills and prescribed realistic remedies.

PPI has developed bold proposals that meet this standard: An independent National Infrastructure Bank, to unlock hundreds of billions of private investment in state-of-the-art transport, energy and water systems; pro-growth tax reform that closes inefficient tax expenditures and reduces the corporate tax rate; and a base-closing style commission charged with periodically pruning regulations that impede economic innovation and business start-ups, the engine of most new American job creation.

America can’t afford another lost economic decade – and neither can progressives. This is an FDR moment for Obama – a time for “bold, persistent experimentation” to get America’s economy moving again.

Photo credit: S. Hernandez