I thought about this for another minute, and realized one thing that hadn’t been salient to me previously. (Though quite possibly it was clear to you, as the point is extremely basic. - It also doesn’t directly answer the question about whether we should expect stock returns to exceed GDP growth indefinitely.)
When thinking about whether X can earn returns that exceed economic growth, a key question is what share of those returns is reinvested into X. For example, suppose I now buy stocks that have fantastic returns, but I spend all those returns to buy chocolate. Then those stocks won’t make up an increasing share of my wealth. This would only happen if I used the returns to buy more stocks, and they kept earning higher returns than other stuff I own.
In particular, the simple argument that returns can’t exceed GDP growth forever only follows if returns are reinvested and ‘producing’ more of X doesn’t have too steeply diminishing returns.
For example, two basic ‘accounting identities’ from macroeconomics are:
β=sg
α=rβ
Here, s is the savings rate (i.e. fraction of total income that is saved, which in equilibrium equals investments into capital), g is the rate of economic growth, and r is the rate of return on capital. These equations are essentially definitions, but it’s easy to see that (in a simple macroeconomic model with one final good, two factors of production, etc.) β can be viewed as the capital-to-income ratio and α as capital’s share of income.
Note that from equations 1 and 2 it follows that rg=αs. Thus we see that r exceeds g in equilibrium/‘forever’ if and only if α>s - in other words, if and only if (on average across the whole economy) not all of the returns from capital are re-invested into capital.
(Why would that ever happen? Because individual actors maximize their own welfare, not aggregate growth. So e.g. they might prefer to spend some share of capital returns on consumption.)
Analog remarks apply to other situations where a basic model of this type is applicable.
I thought about this for another minute, and realized one thing that hadn’t been salient to me previously. (Though quite possibly it was clear to you, as the point is extremely basic. - It also doesn’t directly answer the question about whether we should expect stock returns to exceed GDP growth indefinitely.)
When thinking about whether X can earn returns that exceed economic growth, a key question is what share of those returns is reinvested into X. For example, suppose I now buy stocks that have fantastic returns, but I spend all those returns to buy chocolate. Then those stocks won’t make up an increasing share of my wealth. This would only happen if I used the returns to buy more stocks, and they kept earning higher returns than other stuff I own.
In particular, the simple argument that returns can’t exceed GDP growth forever only follows if returns are reinvested and ‘producing’ more of X doesn’t have too steeply diminishing returns.
For example, two basic ‘accounting identities’ from macroeconomics are:
β=sg
α=rβ
Here, s is the savings rate (i.e. fraction of total income that is saved, which in equilibrium equals investments into capital), g is the rate of economic growth, and r is the rate of return on capital. These equations are essentially definitions, but it’s easy to see that (in a simple macroeconomic model with one final good, two factors of production, etc.) β can be viewed as the capital-to-income ratio and α as capital’s share of income.
Note that from equations 1 and 2 it follows that rg=αs. Thus we see that r exceeds g in equilibrium/‘forever’ if and only if α>s - in other words, if and only if (on average across the whole economy) not all of the returns from capital are re-invested into capital.
(Why would that ever happen? Because individual actors maximize their own welfare, not aggregate growth. So e.g. they might prefer to spend some share of capital returns on consumption.)
Analog remarks apply to other situations where a basic model of this type is applicable.
Ah, good point! This was not already clear to me. (Though I do remember thinking about these things a bit back when Piketty’s book came out.)