Faster growth: who gains?

Here's an antidote to Bryan Appleyard's pessimism - Arnold Kling considers the possibility that economic growth is accelerating; Robin Hanson's view (pdf) is especially interesting.
There's one point, though, I want to quibble with. Arnold says:

Investors...consistently under-estimate the long-term growth rate of the economy and of the stock market. That might explain some of the persistent equity premium. If investors were to apply a more accurate nonlinear forecasting model, stock prices would jump to a higher level, beyond which the excess returns from holding shares would be minimal. Instead, using linear thinking, investors are continually surprised.

I'm not sure about this, because faster economic growth needn't imply faster dividend growth, expecially for existing companies. In this old paper (pdf), Brad DeLong and Richard Grossman calculate that the real dividends of the UK stocks that existed in 1870 did not grow at all between 1870 and 1990.  120 years of economic growth benefited new companies, not incumbents.
There's a simple reason for this. Technical progress - the key to growth - destroys firms as well as creates them. There's been fantastic technical changes in communications and photography in recent years. And look what this did to Xerox and Polaroid. Remember Schumpeter's creative destruction?
What's more, the profits to innovative activity are tiny. William Nordhaus  says:

Only a miniscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.

Look at the UK market in the last 20 years. Sectors where there's been good innovation - media, software, telecoms - have under-performed the index. The three best performing sectors (according to Datastream) have been tobacco, banking and mining - industries that haven't innovated much at all.
Technical change, then, doesn't translate easily into stock market growth - a lesson, surely, investors should have learnt in 2000.
Stocks rise not because investors are surprised by economic growth, but because investors are surprised by the extent to which firms can capture this growth in the form of profits.
However, their ability to do this could decline if technical progress accelerates.  First, such progress could mean more quoted firms go the way of Xerox or Polaroid. If the offsetting growth comes from firms yet to be listed on the stock market, the net impact could be bad for shares.
Also, imagine that we'd had years of faster growth, and we were all five times richer than we are now. Would you then bother to work?
In recent years, this problem has been solved because people's wants - and new products - have risen as incomes have risen. But why should this continue?
It's quite possible, therefore, that economic growth would strengthen workers' bargaining power so much that profits were badly squeezed.
Maybe, then, faster growth is a threat to the stock market, not a hope for it.      

Comments

[Rob Read]

Just a thought.

The three best performing sectors are the most regulated companies.

As regulation tends to prevent innovation, this is another clue to the accuracy of your observation.