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May 15, 2006
On the market value of economies
Well, I'm back. Where was I? Part of the time I was lurking in the back alleys of Granada and Cordoba in Spain, helping my wife research her new novel (which is set in medieval Spain).
But I also spent some time considering the direction of this blog, and how best to improve it for the future. I have some ideas, but for now I'm back posting.
For this morning, a pointer to my new column, where I calculate that the fundamental market value of the U.S. economy--a concept that I just invented--is between $225 trillion and $255 trillion. That's the net present value of future GDP.
I also calculate that the fundamental market value of the U.S. economy is rising at $4 trillion to $7 trillion per year. That's the annual capital gains--more than enough to pay for all the international borrowing that the U.S. is doing.
More about this later.
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What discount rate do you use? I can see discounting capital income at whatever discount rate the market uses for each particular type of income, but it?? not at all obvious to me how one should discount labor income.
Posted by: knzn at May 15, 2006 10:49 AM
I use a 3% real rate for discounting. That seems like a reasonable number. Moreover, the calculations aren't that sensitive to small changes in the discount rate, since I only have a 20 year time horizon.
Posted by: Mike Mandel at May 15, 2006 11:17 AM
The assumptions may even be modest. Note that economic growth is not merely a linear trendline, but an accelerating one, throughout human history :
The difference may not be that noticeable in just 20 years, but while 3.5% a year appears to be the trendline now, the trendline might be 4% or 4.5% a year by 2025.
Posted by: Kartik at May 15, 2006 01:07 PM
I am always dubious of large numbers. The real question is how these numbers have been changing over time and whether trends have been getting better or worse. A doubling of standards of living in 24 years seems realistic, if modest. (And no, I don't buy that economic growth has been accelerating over time although it would be nice to believe now is different. If anything, it has been remarkably constant.)
Posted by: Lord at May 16, 2006 01:19 PM
Michael, PV/Gov't Spending=100.
Another way of looking at your figure is the US Economy is worth $1,000,000 per person.
It will cost that to incarcerate someone for their lifetime or pay for one's retirement until death.
In 10 years this will be a bargin.
"Be Honest Now."
Posted by: Frank Drake at May 16, 2006 03:45 PM
The concept sounds interesting, but we need more details on the methodology and the theory behind it.
I think it may be related to the ??isk-free rate puzzle.? The puzzle, as I understand it, essentially asks, given that interest rates are low (as they usually are), and given an expectation of growth, and given diminishing marginal utility (which means that future consumption – being higher – will have less marginal utility than current consumption), why do people save rather than borrow? Today, arguably, the puzzle has disappeared for the US, and perhaps we should regard the current situation as the normal one rather than the anomaly. It’s a similar argument that, if people properly value their future expected consumption, they are actually getting richer despite borrowing.
Posted by: knzn at May 16, 2006 05:43 PM
I'm having a hard time with this analysis. "Market value" of the economy means "what someone would pay for it"...and, since it appears that the calculated number includes all wages paid to labor, I don't think anyone would actually pay this amount to buy the US economy unless they could establish universal slavery and keep all those monies for themselves...
Posted by: David Foster at May 17, 2006 12:15 PM
On the other hand, do you really feel living standards have doubled since the early 80s? I don't believe real household incomes have. There certainly have been improvements, telecommunications, medicine, housing, etc., frequently at large cost, although usually not so much in the areas affecting the cost of living, or affecting it neutrally. Other than accumulating more assets over time as anyone working does, I, for one, don't really feel that much better off. Certainly not twice as well off.
Posted by: Lord at May 17, 2006 01:27 PM
GDP is the wrong measure. GDP per capita is much more relevant. Since half the growth has been due to population, the standard of living would double only every 48 years. That we are living twice as well as our parents/grandparents in the late 50s is much more believable, although I wonder if even they would think so.
Posted by: Lord at May 17, 2006 04:09 PM
You make a good point. On the other hand, the same issue arises when we ask who is responsible for the national debt. It has to be paid back in the future..but in principle any individual could welch on their share of the debt by moving to another country.
Same thing here. In principle you don't have to contribute to the future GDP, but in reality you are still likely to be living here.
Posted by: Mike Mandel at May 18, 2006 09:03 AM
In this case GDP is the right measure, I think. Additional population growth generates additional output which could be used to pay for today's debt.
Posted by: Mike Mandel at May 18, 2006 09:04 AM
For those who question our standard of living improvements.
I sold real estate for a while and I can say there is a big difference between a house built in 1955, 1975, and 2005. This is true in a state (Michigan) with early success and later repeated heavy blows from outsourcing and foreign competition. I can only imagine what the differences must be like in places like Arkansas where they had little early success but are booming today. There is something interesting though; a home built in the 1920s is often as nice as the ones built today. Those 20s must have really been roaring.
For those who want to say that our bigger lifestyle is because women went to work. Women have always been at work. The efficiency of that work has improved to such a degree as to cause women seek additional work outside the home. PBS did an interesting show called 1940s house that illustrates this to quite well.
Posted by: Joe at May 22, 2006 12:04 PM