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(2) 20.2 hours per week.
(3) 15.9 hours per week.
(4) 9.6 hours per week.

Pick an answer for each of the two productivity scenarios”high
growth and lower growth. If the world turns out as in (2), your grand-
children will be roughly twice as rich as you for each hour that they work.
That means twice as many cars, TVs, fridges, and vacations per hour of
effort.
Before we get to the correct answers, let™s take a step back and under-
stand that even a productivity growth rate of 1% is remarkable and rare.
What is the productivity growth rate for our closest living ancestor, the
chimpanzee? This may seem like a strange question, but the answer is
easy to calculate. Take a modern-day chimpanzee, and calculate the num-
ber of hours of work to obtain a fixed amount of food.
82 The Old Art of Macroeconomics



To calculate change in productivity, compare the modern chimpanzee™s
workload with the comparable figure for a chimpanzee from a thousand
or a million years ago. Of course, we do not have any historical data on
chimpanzees, but the answer is clear. The productivity growth rate for
chimpanzees (and all other animals) is zero. Animals, even those with
culture, show no progress across generations.
The economic opportunities of the grandchildren of modern chim-
panzees will be no higher than today™s chimpanzees (and probably far
worse because of environmental destruction). Perhaps it is obvious that
animals have zero productivity growth. Less obvious is the fact that the
human rate of productivity growth throughout much of history has also
been almost exactly zero! Through most eras, humans have done no bet-
ter than chimpanzees or even bacteria for that matter. Keynes makes this
point in his grandchildren essay noting, “the absence of modern techni-
cal inventions between the prehistoric age and comparatively modern
times is truly remarkable.”
The archeological record reveals that Keynes™s observation applies to
most periods. For most of human existence, the rate of technological
change was essentially zero. Our modern ability to create more material
goods per unit of effort is nothing short of amazing.
Let™s return to our grandchildren. The answers are 20.2 hours per
week for the lower-growth case and just 9.6 hours per week for the high-
growth case. If the next 40 years look like the period 1970 to 1999, our
grandchildren will have to work half as hard as we for the same material
outcome. Alternatively, if productivity grows at the rate of the last few
years, our grandchildren will only have to work one-quarter as hard as we
do. If the high productivity path happens, our grandchildren could work
Keynes™s 15 hour weeks and be considerably richer than we. Note that
productivity growth doesn™t just mean more TVs, it also allows for better
medical care and education.
In terms of economic wealth, small improvements in productivity
translate into big improvements to our lives and those of our children and
U.S. Economic Snapshot 83



grandchildren. When it comes to economic wealth, productivity is the
only thing. Thus, our economic wealth depends almost entirely on the
rate of productivity growth.
There are, of course, a number of important caveats to this productiv-
ity argument that go beyond the scope of this book. First, average eco-
nomic wealth may mean very little if it comes in a world that is
environmentally damaged. Second, the distribution of wealth may be
more important than its total. Third, and most fundamentally, there is
scant evidence that increases in wealth make people any happier. In fact,
studies from around the world suggest that while most of us believe
money will make us happier, wealth does not cause happiness.10 All of
these are important topics, but not for this book, which is dedicated to the
mission of helping investors make money.

Conclusion: If the last few years of extremely high productivity are a
sign of good times to come, we will be much richer, and our large debts
will not be a problem.



America: The Talented Beggar

We started this chapter by asking what path the United States will take.
Will it be Keynes™s vision of examined leisure created by information
technology, or will we stumble down a painful path similar to that taken
by post-bubble Japan?
Those who believe that these are the worst of times are right to recog-
nize the U.S. financial hangover from the bubble years. The aftereffects
of the 1990s are clearly visible in shaky consumer finances, idle facto-
ries, and large government deficits. However, those who believe these are
the best of times are right to recognize the central importance of
extremely high productivity growth.
Thus, productivity is the key. If there is to be a happy financial ending
84 The Old Art of Macroeconomics



for the United States, it must come through information technology and
productivity growth. For investors, this converts to simple advice. Watch
the productivity figures. If productivity can stay above 3% for the com-
ing years, then like my talented running teammate, the United States
should be able to work through its hangover. If productivity drops sub-
stantially, however, the pain of recovering from the excesses of the 1990s
will be much greater.
chapter five


INFLATION
Rising Prices and Shrinking Dollars



Return of the Inflationary Monster?

During the German hyperinflation of the early 1920s, banknotes had so
little value that people had to carry money around in giant sacks. So
worthless had the money become that one man who left a wheelbarrow
full of money unattended for a moment returned to find that thieves had
left his money but had stolen his wheelbarrow. While this story is funny,
the hyperinflation itself was not; it wiped out the lifetime savings of mil-
lions of families.
My first experiences as an investor came in the inflationary 1970s. In
those days, inflation was a mysterious monster ravaging the U.S. and
global economies. When I was in college in the 1970s, my friends and I
used to retire to the student lounge after dinner each night to watch Mel
Brooks™ classic comedy show, Get Smart. Because the lounge had just
one shared TV, a form of adolescent democracy selected the channel.
Other students who wanted to learn and not laugh sometimes outvoted




85
86 The Old Art of Macroeconomics



my friends and me, and on some evenings we were forced to watch the
nightly news.
When it came to inflation in the 1970s, the TV news was bleak. Every
month the government would announce the growing rate of inflation. We
sat and feared that we would not have enough money to enjoy life. Even
presidents seemed impotent to defeat the inflationary monster. In 1974,
President Gerald Ford manufactured millions of “WIN” buttons to exhort
the American public to “Whip Inflation Now” (although he never told us
quite how we were supposed to accomplish this task). In sour economic
times, President Ford lost to Jimmy Carter in the 1976 election. President
Carter in turn lost his 1980 election to Ronald Reagan”a casualty, some
say, in the Federal Reserve™s campaign to defeat inflation.
As shown in Figure 5.1, the 1970s™ U.S. inflationary monster was
tamed, and for the last two decades, the United States has enjoyed a low
inflation rate. Stories of inflationary problems might therefore seem to
apply only to those living in Latin American countries or those with a
long memory. Recently, however, gold prices have risen dramatically,



14%
U.S. Consumer Price Inflation




12%

10%

8%

6%

4%

2%

0%
04*
2002
2000
1952
1954
1956
1958
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998




- 2%
* part of year


FIGURE 5.1 The United States Has Enjoyed Low Inflation for Many Years
Source: Bureau of Labor Statistics
Inflation 87



and the value of the U.S. dollar has declined substantially. These are clas-
sic signs that inflation might be building. What are the prospects for
inflation, and what sorts of financial investments are likely to prosper?
As in most areas to do with money, the best insights on inflation come
from Professor Milton Friedman. Winner of the 1976 Nobel Prize in Eco-
nomics, Professor Friedman is the leader of the monetarist school that
seeks to understand the financial world through the creation and removal
of money from the economy.
The seminal work, A Monetary History of the United States, 1867“
1960, written by Professors Friedman and Anna Schwarz, states, “Money
is a fascinating subject of study because it is so full of mystery and para-
dox. The piece of green paper with printing on it is little different, as
paper, from a piece of the same size torn from a newspaper or magazine,
yet the one will enable its bearer to command some measure of food,
drink, clothing, and the remaining goods of life: The other is fit only to
light the fire. Whence the difference?”1
As Professor Friedman suggests, to understand inflation we must
remove some of the monetary mystery. Accordingly, our investigation
into inflation starts with an analysis of the reason we use money in its
current form. In this journey, we begin by examining a modern market
that does not use money at all.



The Creation of Money: This Kidney
Is Not for Sale!

Kidney transplantation is a potentially life-saving surgery that transfers a
kidney from one person to another. Sometimes the kidney comes from a
donor who has recently died, while many others come from living
donors. Most people are born with two kidneys but can live quite well
with just one.
My Harvard Business School colleague, Professor Al Roth, has
become involved in improving the kidney transplantation system. At first
88 The Old Art of Macroeconomics



glance, the situation seems quite simple and not applicable to the tools of
economics. People in need seek a relative or friend willing to donate a
kidney. Those needy patients who do not find a willing donor wait in line
for kidneys from cadavers. Why is Professor Roth, an economist,
involved in a medical process?
There are special circumstances that make the kidney market particu-
larly problematic and appeal to an economist™s special skills. Kidney
donors and recipients need to match on a number of physiological mea-
sures. So while a needy patient might find a willing donor in, for exam-
ple, his or her spouse, tissue incompatibility may preclude a transplant.
In these cases, a willing donor cannot help his or her loved one because
of biological mismatch.
A potential solution for couples suffering from this mismatch is to find
a complementary couple in a similar situation. In the simplest case, two
such couples might find that they can swap organs. So, for example, Mrs.
Smith wants to donate a kidney to Mr. Smith, but they are biologically
incompatible. Similarly, Mr. Jones wants to donate a kidney to Mrs.
Jones, but cannot. If, by chance, they are mutually compatible, the solu-
tion is to have Mrs. Smith donate to Mrs. Jones, and Mr. Jones to Mr.
Smith. Thus, both patients get the kidneys they need.

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