Warren Buffett's 2% Growth Fallacy------Future Prosperity Is An Illusion

Warren Buffett, in his latest annual letter to shareholders, took aim at the idea that 2% real economic growth wasn’t sufficient to create economic prosperity for future generations was wrong.

Via Myles Udland from Business Insider:

“Some commentators bemoan our current 2% per year growth in real GDP – and, yes, we would all like to see a higher rate. But let’s do some simple math using the much-lamented 2% figure. That rate, we will see, delivers astounding gains.

Here is the math Buffett uses to reach his conclusion:

“America’s population is growing about .8% per year (.5% from births minus deaths and .3% from net migration). Thus 2% of overall growth produces about 1.2% of per capita growth. That may not sound impressive. But in a single generation of, say, 25 years, that rate of growth leads to a gain of 34.4% in real GDP per capita. (Compounding’s effects produce the excess over the percentage that would result by simply multiplying 25 x 1.2%.) In turn, that 34.4% gain will produce a staggering $19,000 increase in real GDP per capita for the next generation. Were that to be distributed equally, the gain would be $76,000 annually for a family of four. Today’s politicians need not shed tears for tomorrow’s children.”

On the surface, such a bit of “back of the napkin” calculation would seem completely logical. Unfortunately, it hasn’t actually worked that way.

The first chart below shows the annual growth rates of both total U.S. population, including armed services personnel overseas, and real, inflation-adjusted, growth of GDP.

GDP-PerCapita-Population-GrowthRates-022916

First, with population growth at its lowest levels since 1900, currently at .77% annually, this single factor alone will continue to weigh on future economic growth.

As I have discussed repeatedly in the past, the current rate of employment growth has been less than the rate of population growth since the end of the financial crisis. As the population increases, the incremental demand in consumption leads to demand for employment increases. Unfortunately, companies have hired only enough to keep pace with current demand which is why the labor force participation remains an issue as the excess growth in the population remains unemployed.

Employment-vs-Population-Growth-022916

Secondly, if I project out 2% real economic growth and .77% population growth, the resultant prosperity increase is only marginal at best. (This also assumes NO RECESSION over the next decade which would drastically lower this forecast.)

GDP-Real-Growth-Pop-PerCapita-022916

If we look back throughout that the entire history of the economy, we find that Buffett’s outlook is even a bit more depressing as the rate of current and projected economic growth/capita is only slightly above that of the 1900’s and far below that seen even during the “Great Depression.” 

GDP-PerCapita-By-Cycle-022916

If Buffett’s math was correct, growth rates of organic economic prosperity should have soared during the 80’s and 90’s. But, as discussed in detail previously, the only thing that “boomed” during that period was debt as the gap between wage growth and the standard of living needed to be filled.

Debt-PCE-Wages-022916

With consumer’s having reached the limits of leverage, it is of little wonder why recent survey’s continue to show a large majority of American’s living paycheck-to-paycheck.

Furthermore, productivity increases due to advances in technology, communications, and outsourcing will continue to weigh on wage growth in the future.

It is also worth noting there is a massive difference between economic growth per capita and an individual’s actual living standards. Real GDP per capita does not directly translate to increases in personal wealth. If it did, economic prosperity would have lifted the entirety of America to a higher living standard over the last several years rather than creating a massive surge in wealth inequality. 

While the young people today certainly enjoy a higher level “stuff” than their parents, such does not lead to the one important aspect that Warren Buffett overlooked, the fulfillment of the “American Dream.”

The foundation of the “American Dream” is NOT acquiring a home, buying a load of useless crap we don’t really need using debt, or investing in the stock market. The “American Dream” is the ability to start with nothing and build a business which creates future prosperity which leads, eventually, to the ownership of property. The very bedrock of this nation is the story of people like Thomas Edison, Henry Ford and many others who started with nothing and built an empire through entrepreneurship.

Unfortunately, entrepreneurship in America has been sharply on the decline in recent years. Increases in regulation, slow economic growth and increased costs of employment, healthcare and benefits have made starting a business much less accessible in recent years as shown by a recent Federal Reserve study.

Fed-Survey-2013-BusinessEquityOwnership-091014

Today’s politicians do need to “shed tears for tomorrow’s children.” The accumulation of debt will continue to weigh on both future economic growth and personal prosperity until that trend is reversed.

While it may be a mistake to “bet against America,” and I am certainly not suggesting you should, the “golden goose” that laid the egg allowing Warren Buffett to build his empire was served for dinner beginning in the early 80’s.

America’s social security promises will be honored, but not without a negative impact to future generations. Our kids today may have access to more technology, better healthcare, and the greatest access to information ever in history, but if they do not have the ability to utilize that information, or manifest those benefits into entrepreneurship, the end result will be disappointing.

While I certainly appreciate Warren’s optimistic view of the future, ignoring the facts will only delay the inevitable need for reforms needed to allow future generations to become “the next great generation.”  

Lance Roberts

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Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, and Linked-In

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