ISS REPORT: Don’t be afraid of the big bad economy, urges Nobel Laureate Prescott

by Bob Haavind, Editorial Director

Caution, even fear, is the feeling of many executives as they plan for a slowdown in 2007. The global economy is of major concern because it’s tracked much more closely now by the semiconductor industry, due to consumerization.

Are we heading into a recession with the US dollar slumping and the stock market plunging? No way, suggested Nobel economist Edward Prescott of Arizona State U., in his opening talk at the recent Industry Strategy Symposium (ISS) in Half Moon Bay, CA. He projects that growth in living standards will slow to 3% in the US and 2% in Western Europe in a soft-landing scenario.

Prescott explained that some of the worst fears about the future of the US economy are really myths. One of the biggest myths, he said, is that US government debt is way too big. If only interest-bearing federal government debt held by foreigners and foreign central banks is considered, this was only about 40% of US gross national income in 2003, well below the near 100% level of the mid-1940’s (see chart above). The rest of the debt is owed to Americans or the government. As a result, he thinks the US dollar is just as likely to appreciate as go down further in the coming year. He also believes that the stock market is just as likely to go up as to decline.

The common belief that Americans don’t save is yet another myth, Prescott claimed. Savings should include real estate, and both tangible and intangible assets of US businesses and the government. An adjustment must be made, he believes, in balancing US-owned foreign assets against foreign ownership of US assets. The government statistics suggest that the US asset position vs. the rest of the world has declined more than 20% since 1984, but they also show US income from foreign assets steadily matching foreign income from US assets over that period (see chart below). That doesn’t make sense. The problem arises, according to an analysis by McGratten and Prescott (Dec. 2006), because the value of US foreign subsidiaries is much greater than the statistics indicate. The reason, Prescott said, is that many of these investments are immediately expensed rather than depreciated over time.

The conclusion is that US wealth relative to income has actually been rising slightly over the past decade, and that savings are adequate to finance needed investments.

Rapidly rising US productivity, driven, he believes, by information technology advances in almost every economic sector, should ensure steadily rising living standards well into the future.

Prescott’s conclusion is that the Chicken Littles of economic forecasting are wrong. He also thinks that widespread access to information by the public will force better, more responsive government in the future. — B.H.

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