Krugman's long term forecast for stocks

I'll have lots more in response to Paul Krugman's New York Times column today, in which is asserts that stock market returns cannot possibly be anywhere near as high in the future as they have been in the past (and thus, he argues, stocks must inevitably disappoint investors who hold them in Social Security personal accounts).

Krugman's argument is technical, and it will get a technical response. But first, let me point out that, on the face of it, there is very little reason why anyone should listen to Paul Krugman's forecasts about the future. He himself admitted to Tim Russert on CNBC that "Compare me … compare me, uh, with anyone else, and I think you’ll see that my forecasting record is not great." He's right to have been so modest. When he was an economist with the White House Council of Economic Advisors, he warned in 1982 of an "inflation time-bomb" -- just when inflation was about to fall to near zero over the next twenty years. In today's column he speaks of the prices of "technology stocks at the height of the Internet bubble" -- yet at that very height, in February 2000, he wrote "I'm not sure that the current value of the Nasdaq is justified, but I'm not sure that it isn't." And his books in the early 1990s contained forecasts -- then still quite fashionable among liberal economists -- of how America was certain to continue to lose ground to the economic juggernaut of Japan.

And in the column today, Krugman betrays a fundamental misunderstanding of the economics of Social Security itself. He write, "we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come." Krugman has forgotten -- or chosen to ignore -- that under current law Social Security benefits are indexed to wage growth. If the economy grows like Krugman is talking about, yes, payroll tax revenues will grow too -- but so will benefits, nearly perfectly proportionately. The sensitivity tables given by the Trustees of the Social Security Trust Funds don't show this -- because they arbitrarily cut off the calculation after 75 years. But the reality is that the early benefits of increased tax revenues are eventually offset by the higher cost of benefits. Gee -- think how good Krugman could make that look if he reduced the window of analysis to just 10 years.