America - an economy you can bank on

It turns out that John McCain, who was widely mocked for saying that "the fundamentals of our economy are strong," was actually right. We're in a financial crisis, not an economic crisis. We're not entering a second Great Depression, says Casey B. Mulligan, a professor of economics at the University of Chicago.

How do we know? Well, the economy outside the financial sector is healthier than it seems.

One important indicator is the profitability of non-financial capital, what economists call the marginal product of capital:

It's a measure of how much profit that each dollar of capital invested in the economy is producing during, say, a year.

Some investments earn more than others, of course, but the marginal product of capital is a composite of all of them – a macroeconomic version of the price-to-earnings ratio followed in the financial markets.

When the profit per dollar of capital invested in the economy is higher than average, future rates of economic growth also tend to be above average.

The same cannot be said about rates of return on the S.& P. 500, or any another measurement that commands attention on Wall Street.

Since World War II:

The marginal product of capital, after taxes, has averaged 7 percent to 8 percent per year (in other words, each dollar of capital invested in the economy earns, on average, 7 cents to 8 cents annually).

During 2007 and the first half of 2008, when the financial markets were already spooked by oil price spikes and housing price crashes, the marginal product was more than 10 percent per year, far above the historical average.

The third-quarter earnings reports from some companies already suggest that America's non-financial companies are still making plenty of money.

Source: Casey B. Mulligan, An Economy You Can Bank On, New York Times, Oct. 10, 2008.

For text: http://www.ncpa.org/sub/dpd/index.php?Article_Category=27

For more on Economic Issues: http://www.nytimes.com/2008/10/10/opinion/10mulligan.html


FMF Policy Bulletins / 21 October 2009