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Going Long

Rational Exuberance

There is absolutely no reason to be pessimistic about either the U.S. or the world economy.

Increasingly we are told that our economy is facing a “new normal.” This appellation, bestowed by Bill Gross and Mohamed El-Erian, co-chief investment officers at Pimco, holds that the economy is going through an extended period of slow growth caused by households unwinding the large debts they incurred during the past boom. That means not only slower growth but also lower returns for stock-market investors.

Although advocates of the new normal might think they represent a new reality in economic thinking, they are in fact spouting an ultra-Keynesian theory that economists long ago discarded. Keynes believed that the level of economic activity was determined solely by aggregate demand, or how much economic agents -- namely U.S. consumers, businesses, foreigners and the government -- want to buy. It was a theory born of the Great Depression, also an era when slow-growth theories proliferated.

Although Keynesian economics has proved to be a useful way of looking at what determines the level of gross domestic product in the short run, it has been a disaster in predicting long-term economic growth. Its first mistake came right after World War II, just as Keynesian thought began to dominate economics.

At the time, most economists were forecasting a return to depression as government spending on manpower and war materiel fell sharply. Furthermore, our economy was saddled with government debt that was about twice as high relative to gross domestic product as it is today. But instead of stagnation, demand exploded as returning veterans took jobs that were being created to produce consumer goods for a postwar America.


Technology’s impact. Economists had to come up with another theory to explain long-term growth. Robert Solow, the Nobel Prize-winning economist from the Massachusetts Institute of Technology (and a Keynesian), developed a model in which long-run output is determined by the quality and quantity of land, labor and capital that go into the productive process. He showed that technological growth generates the demand that pushes our economy forward and stimulates a rise in standard of living.

Today the outlook for technological growth is brighter than ever. For the first time in history, thousands of scientists and researchers from China, India and other emerging markets are working together toward scientific breakthroughs. Progress depends on access to information, and the Internet has made information more accessible than ever.

Advances in medicine, alternative energy, conservation and control of the environment will require huge expenditures, but will reap equally large benefits. In the future, the rate of technological growth will actually increase, not decrease.

Another important factor pessimists ignore is that stock-market returns depend not on growth in the U.S. alone but on growth throughout the world. Almost half of the revenues and profits of the companies in Standard & Poor’s 500-stock index come from overseas, and that fraction is destined to increase. I see no reason why investors cannot continue to earn their historical stock-market return of 6% to 7% a year after inflation.


Advocates of the new normal cite the large U.S. indebtedness as one of the factors behind slow future growth. However, there’s a vast cache of unused purchasing power in the rapidly growing middle classes in emerging economies, especially India and China. These rising middle classes represent the largest untapped markets the world has ever known and will drive demand in the next decade. And they want quality goods and brand names that are produced by firms based in the U.S.

As we emerge from the financial crisis, there is absolutely no reason to be pessimistic about either the U.S. or the world economy.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania’s Wharton School and the author of Stocks for the Long Run and The Future for Investors.