Publication: Investor's Notebook
NOBEL LAUREATE EDWARD C. PRESCOTT SEES POSITIVE FUTURE | |
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Investor's Insight - Wednesday, March 1, 2006
"A Digest of Investment Opinion From the
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NOBEL LAUREATE EDWARD C. PRESCOTT SEES POSITIVE FUTURE
by Scott Burns
TEMPE, Ariz. -- Edward C. Prescott stands quickly, walks
to his blackboard and writes an equation for growth. The
last item in the equation is "plus residual." He underlines
it with his chalk.
The word "residual" is to economists as dark matter is to
astrophysicists -- it's something that's there but difficult
to see. Maybe it is impossible to see.
But without it, equations don't explain results -- what we
observe.
Prescott, who won a Nobel Prize for economics in 2004 and
teaches here at Arizona State University, has spent most
of his career thinking about economic growth, what supp-
orts it and what hinders it.
A poster in his office intimates a basic life stance:
Loyalty to petrified opinion never yet broke a chain or
freed a human soul. -- Mark Twain
Unfortunately, I am having some trouble keeping up. It is
one thing to read his papers. Then, I can move my lips at
leisure. Here, listening, I get a visceral understanding
of the phrase "drink from a fire hose."
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But one thing is certain: Residuals are important.
One of those important residuals, explored in a series of
papers with Minneapolis Federal Reserve economist Ellen R.
McGrattan, is the intangible stuff not measured by con-
ventional accountings -- investments that are treated as
expenses, and what most people call "sweat equity."
He describes the '90s -- all the start-ups, the dot-coms,
the rush into a 24/7 world of long workdays, the MBAs who
turned down $100,000 jobs to work 80-hour weeks for
$2,000 a month -- THAT, he says, is sweat equity.
More important, it doesn't appear in any official statis-
tics because, well, how could it?
So while the hours of work were going up and there app-
eared to be little to show for it in national output,
something was really happening. We just didn't have the
measuring tools.
Finally, all that work -- all that unmeasured investment
-- showed up. Where? In IPOs, big capital gains and rich
public stock prices, as all that sweat equity found a
way to be monetized. Skeptics should consider that Yahoo,
a product of the Internet boom, was worth $55.5 billion
at the end of 2005, while Rupert Murdoch's NewsCorp,
which has been around for decades, was worth somewhat
less, $53.9 billion.
And that's not even considering Google, which, at its re-
cently reduced $369 a share and $109 billion market cap-
italization, is still valued at more than eight times
General Motors and nearly twice as much as the entire
newspaper industry.
So expensed investment and sweat equity are real, not
hype. And they explain some of the mysteries of the '90s.
I asked Prescott if he thought the United States could,
and should, privatize Social Security.
"I'm pushing hard for more savings; otherwise, we'll have
generational warfare," he answered. "And, by the way, it
(more private saving) would knock the hell out of poverty,
raise the median wage, and we would have much higher
consumption."
Can we afford the debt? I asked, referring to the unfunded
liabilities of Social Security.
"If we had more explicit debt out there, it would be man-
ageable. We can honor the promises, and we should. On the
other hand, Europe shouldn't. I see the U.S. as just re-
forming its retirement system with cash plans. Add problems
at the Pension Benefit Guaranty Corp., and the system will
move toward mandatory savings.
"I think ownership is important. In Mexico they're develop-
ing a mortgage market. It's making big changes as people
see things differently."
I asked what he thought about our tax system.
"It's a bad system. If you increase tax rates, you won't
get much more revenue. We're pretty close to the top of
the Laffer Curve. Today, what we need is some time consist-
ency with the tax code."
Do you think the Fair Tax proposal (for a national sales
tax) would work to stabilize taxes?
"What scares me is that tax rates would just pop right up.
They can't keep their fingers out of the jar," he said,
referring to our legislators. "In fact, our income
tax is really a consumption tax, because we can put aside
money to consume later (in qualified accounts)."
I asked what he saw as major dangers to the future.
"One would be the anti-globalization nuts. The people
protesting may screw up a good thing. If countries become
islands to themselves, we'll have another depression.
"Will it happen? I don't think so," he said.
What about the price of oil? I asked.
"I don't think the high price of oil is anything. We've
let the market adjust before."
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Is our current account deficit a major concern?
"The question is how can you spend more than you earn year
after year and not be overwhelmed. I've been digging into
these numbers and find these measures don't reflect true
asset values. We see the earnings of the foreign subsid-
iaries and believe they indicate the value of the subsid-
iaries is greatly understated."
Again, the key is "residuals" -- the expense investment
that never shows up in conventional accounting.
"Huge investments have to be made to establish a distrib-
ution network like Wal-Mart," he says, pointing to the
knowledge that is embedded in organizations that never
shows up on a corporate balance sheet but does show up in
corporate profitability.
I leave his office as the sun is setting, heartened. If
one of the best economic minds on the planet believes
individual initiatives and creativity will power a posi-
tive future, maybe those of us in the whining trades
should lighten up.
(Questions about personal finance and investments may be
sent to Scott Burns, The Dallas Morning News, P.O. Box
655237, Dallas, TX 75265; or by fax: (214) 977-8776; or
by e-mail: scott@scottburns.com
Check the Web site: www.scottburns.com
Questions of general interest will be answered in future
columns.)
(Investor's Insight reflects the opinions of experts. It does
not recommend any specific investments, and no endorsement is
implied or should be inferred. For more information, contact
the individual firms cited).
COPYRIGHT 2006 UNIVERSAL PRESS SYNDICATE
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