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.
Professor 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 supports 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."
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 conventional 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 work days, 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 statistics because, well, how could it?
So while the hours of work were going up and there appeared 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 recently reduced $344 a share and $101 billion market capitalization, is still valued at 8 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 90's.
I asked Professor 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 manageable… We can honor the promises and we should. On the other hand, Europe shouldn't. I see the U.S. as just reforming its retirement system with cash plans. Add problems at the PBGC and the system will move toward mandatory savings…
"I think ownership is important. In Mexico they're developing 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 consistency 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 consumer 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."
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."
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 subsidiaries and believe they indicate the value of the subsidiaries 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 distribution 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 positive future, maybe those of us in the whining trades should lighten up.
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