Macroeconomic policy and long-run growth

The long-run trend of productivity growth is the sole important determinant of the evolution of living standards. The current recession has seen as large a fall in American consumption per capita as any post-World War II recessions year-over-year decline of about 2.3 percent. Yet the post-1973 productivity slowdown in the United States has been an order of magnitude more significant, reducing current consumption by nearly 30 percent. And the post-1973 productivity slowdown has been more severe outside than inside the United States. While the growth rate of output per worker in the United States slowed by 1.4 percentage points per year comparing the 1950-73 with the 1973-90 period, productivity growth has slowed by 4.5 percentage points per year in Japan, 4.2 percentage points per year in Germany, and by 1.9 percentage points for the Organization for Economic Cooperation and Development (OECD) as a whole. This paper addresses the role of macroeconomic policies in determining long-run rates of productivity growth. We begin by highlighting aspects of the interspatial and intertemporal variation in productivity growth which suggest that much of what is important for raising growth rate lies in the domain of structural policy, since macroeconomic policies are less than dominant in determining rates of productivity growth. We then take up what we regard as the two fundamental macroeconomic decisions any society makes: how aggregate demand (or its near-equivalent nominal income) will be managed, and how total output will be allocated between consumption ad various forms of investment. Our policy conclusions can be stated succinctly: * Much of the variation in productivity growth rates cannot be traced to macroeconomic policies and must be attributed to structural and external factors. It is implausible that the deterioration in productivity performance between the 1970s and 1980s is the result of macroeconomic policies that were inferior in the 1980s. Bad macroeconomic policies can insure dismal performance. But good macroeconomic policies, while necessary, are not sufficient for outstanding productivity performance. * Monetary policy that either encourages high inflation or permits large-scale financial collapse can inflict severe damage on productivity growth. Countries in which workers, investors, and entrepreneurs have confidence in the political independence of an inflation-fighting central bank have attained significantly more price stability. There is some evidence, however, of productivity costs from excessively zealous anti-inflation policies. * Even substantial increases in investments that yield social returns of even 15 percent per year will have only modest effects on observed rates of productivity growth. Only increases in specific investments with very high social returns well in excess of private returns have a prospect of arresting any substantial part of the productivity slowdown. * International comparisons suggest a special role for equipment investment as a trigger of productivity growth. This suggests that neutrality across assets is an inappropriate goal for tax policies, and that equipment investment should receive special incentives. The paper is organized as follows. The first section examines the productivity growth record, focusing on the extent of variations in productivity growth across countries and across decades. The second section considers the role of nominal demand management policy. The third section examines the relationship between rates of investment and rates of return. It highlights the difficulty of raising growth rates by magnitudes comparable to the extent of the productivity slowdown through general increases in investment, and emphasizes the importance of strategic high-return investments. The fourth section highlights the special role of equipment investment in spurring growth. The article concludes by commenting further on the policy implications of our analysis. …