Consider also the history of corporate leverage. Equities are riskier because bond interest is paid first. If equities grew faster, however, leverage would constantly
decline. That is not what we see.
This inferred concentration of risk premium in cash flow rate is convenient for testing. Growth and return are two of the most closely followed variables in economics. We have no direct measure of the pure consumption rate, or cash flow rate at the collective scale. Nor have we any direct measure of growth and return to total capital at any scale. But we have a good idea of average return and growth and cash flow to securities and business assets. By the maximand rule, return to human capital should be the same but for differences in risk. | model human capital as somewhat riskier, for reasons just given, and human capital is the larger factor. Then if I am right in placing the risk premium within the cash flow component of return, and in estimating average-risk cash flow rate at 3.5%, cash-flow rate to the
business sector as a whole should be somewhat less.
Next generation theory predicts at the collective scale. Collective return is implicitly average return, and that means average-risk return. My reading of history, which
rules out progressive growth of higher-risk assets at the expense of lower-risk ones, simplifies that to average-risk cash flow plus whatever collective or average growth
happens to be at the moment.
Don’t Grandparents Invest?
Next generation theory assumes that each generation invests all its capital of both factors in the next within the generation length. We expect it to do the same in turn. We care about grandoffspring too, but serve them best by trusting and enabling
their parents only.
A first reaction is that this denies the obvious. Humans today, in advanced countries, normally live to nearly three times the generation length. (3 x 28.5 = 85.5). Even
retirement at age 65 comes eight years after twice that length. And job number one
Chapter 7 Petty’s Idea 2/3/16 23
HOUSE_OVERSIGHT_011082