# Market Completeness, from Vinh Tu

January 31, 2008 |

"…Left off the balance sheet is the value of the asset that Gary Becker, Nobel Laureate in Economics, calls human capital. Professor Becker says that the skills and experience of our people are worth more than half a million dollars per person. By this calculation, traditional assets comprise less than 25 percent of the national balance sheet, which means that true U.S. assets exceed \$180 trillion…" Mike Milken

I haven't had my morning coffee yet but here's an attempt at arithmetic along Beckerian lines:

A recent FT article put Japanese assets at 75% of its GDP. Pulling a totally random number out of nowhere, if the return on assets is 5%,

GDP = 5%*(total assets)

GDP = 5%*75%*GDP+5%*humancapital

19.25*GDP = humancapital

Looking at World Bank statistics

World GDP 2006 = 48.2 trillion

World financial assets = 170 trillion

Return on assets = 5% (can someone give me a better number?)

Return on financial assets = 8.5 trillion

Return on human capital = 39.7 trillion

Human capital = 794 trillion

population = 6.6 billion

Average human capital per capita (hheh..) = 120303.3

Anyway, very rough calculations with numbers plucked from the ether, but the order of magnitude at least is in line with Prof. Becker.

(Also, I left out something important - GDP is not just a return on capital (even human capital) because human ingenuity produces excess profits and increases the value of the capital. So you'd have to adjust the calculation of human capital to account for growing return. And risk adjustments. Etc. etc.)

Any real macro economists care to point me in the direction of more accuracy?

## Phil McDonnell replies:

Rather than pulling an imaginary growth rate out of our … armpit, perhaps a better approach can be found. GDP is the goods and services produced by a society. However much of that is consumed as well. The number we are really seeking is the net 'profit' figure that can be carried forward into the next year. It is good to remember that any 'profit' carried over must be held in the form of an asset. Thus a reasonable measure of the rate of return would be the net increase in total assets year over year.

## Yishen Kuik counters:

Maybe I'm too classical, but I've always thought that GDP is a flow measure of all the goods and services we produce, of which one portion is consumed to give us present utility and the remaining portion is invested to enhance our ability to increase GDP in the next period.

Presumably all goods have some aspect of both utility and investment ("school is fun and you learn something" or "bridges are beautiful and enable transportation"), but we can think of the investment portion of GDP as flowing into a stock of accumulated capital.

The stock of capital deteriorates over time, so some of that flow is just running to keep still. Part of the stock is human, part of it is physical plant, and part of it is institutional arrangement of society (courts, laws etc). The dollar figure we attach to capital stock is just a very rough attempt at measurement, and doesn't take into account the importance of having the right arrangement of the 3 kinds of capital stock. The right arrangement catalyzes a \$100mm investment to return 15%, while the wrong arrangement will have no such catalyzing effect. That is why \$100mm produces such different results when invested in America versus Africa.

I think it is this accumulated capital stock (human/physical/institutional) which is the right place to discuss big picture returns on investment. Unfortunately much of it is unquantified and unquantifiable.

## Adi Schnytzer brings up the stock market aspect:

Surely the real issue here is that, however, we define GDP, it's notoriously unpredictable? After all, why has the market been shooting up and down so furiously lately? In part it's because every one has been wondering whether or not the US economy is moving into a recession. Well, if we could agree on a way to to measure and predict GDP, we'd have solved that issue for the market pretty quickly, wouldn't we?

## Derek Gard dissents:

This assumes the market moves based on GDP at all.

From 1950 to 1960 GDP went from 1696.765 to 2517.365 (48%) and the DJIA went from 198.89 to 679.06 (241%)

From 1960 to 1970 GDP went from 2517.365 to 3759.997 (49%) and the DJIA went from 679.06 to 809.2 (19%)

From 1970 to 1980 GDP went from 3759.997 to 5221.253 (39%) and the DJIA went from 809.2 to 824.57 (2%)

From 1980 to 1990 GDP went from 5221.253 to 7112.100 (36%) and the DJIA went from 824.57 to 2810.15 (240%)

From 1990 to 2000 GDP went from 7112.100 to 9695.631 (36%) and the DJIA went from 2810.15 to 11357.01 (304%)

GDP during the 60s was higher than the 50s and yet the market barely budged. And GDP during the 60s and 70s surpassed the growth rates of the 80s and 90s, yet what decades saw the greatest gains in stocks? Stock market moves do not correlate well with actual GDP data over decades or even years, let alone the daily thoughts and musings of financial pundits.

To say stocks move on GDP data, or confusion thereof, is not supported by raw data. This is the same logic that says, "Stocks rose on a drop in oil prices" one day and then the very next day says, "Stocks fall despite a decline in oil prices." It is a fallacy promulgated by the same people who earned 3.5% per year in stocks during the 80s and 90s when the market was earning more than triple that.

My argument was not that the market moves in line with GDP, rather that lately the market has been reacting to news suggesting either an imminent recession or not. To measure the relevance of this assertion you need to check whether or not the market falls some months before a recession (thus anticipating it) and not whether over a long period the market tracks GDP.

## Nigel Davies opines:

As a simple chess player I must admit to being confused by the apparent
implication (seen everywhere right now) that positive GDP is good and
negative GDP is bad. In my own admitedly primitive pursuit one rarely
gets the opportunity to play expansive moves on a continuous basis,
there are periods when one must regroup in order to increase the
potential energy of a position.

So if I were an economist I would not be looking for answers in simple
linear relationships. Instead I'd try to study the interplay between
'potential energy' (one might try to define this in many ways, for
example by defining debt in 'real' terms) and GDP. And I'd hypothesise
that one of the most bullish economic times would be during a recession
in which personal debt was being reduced.

## Vinh Tu tries to sum up and conclude:

Whether more GDP is "good" or "bad" is a normative judgment. To an
economist, however, since GDP by definition refers to the production of
"goods", it has to be good. (It is generally assumed that utility is
monotonically increasing with goods.) Whether the increase in goods
produced corresponds to an increase in share prices is an entirely
different matter. A share represents a claim on assets which, in turn,
yield a stream of goods (or money which can be exchanged for goods.)
Whether an increase in GDP is beneficial for share prices has
everything to do with where that increase comes from. An increase in
efficiency, whereby the return on existing assets increases, would
probably increase share prices, all else being equal. On the other
hand, the creation of new capital assets would not increase the value
of pre-existing assets if it resulted in the assets being less
efficient.