Distinguished Lecture on Economics in

Government: Lessons from Past

Productivity Booms

Roger W. Ferguson Jr. and William L. Wascher

The U.S. economy has been enjoying substantially faster productivity

growth for the past eight years than it did over the preceding two decades.

From 1995 to 2003, labor productivity rose at an average annual rate of

about 3 percent, up from an average annual rate of around 1.5 percent between

1973 and 1995. In both 2002 and 2003, output per hour increased more than

4 percent. The significance of the improvement since 1995 can hardly be overstated, even after one takes into account the possibility that the increases of the past

two years in part reflect cyclical influences and thus overstate the underlying trend.

If productivity were to continue to rise at an average annual rate of 3 percent, the

standard of living in the United States would double roughly every 24 years. If, on

the other hand, productivity growth were to revert to an average annual pace of

1.5 percent, a doubling in the standard of living would occur every 47 years.

A number of observers argue that the present era of robust trend productivity

growth will soon come to an end. Others contend that the potential gains to

productivity from the technological advances associated with the computer revolution are far from complete.1 In assessing the likelihood of these alternative outcomes, one should recognize that periods of strong trend productivity growth,

although perhaps novel to many of us, are not new to the U.S. economy. In

particular, three earlier periods of strong trend productivity growth stand out from

1 For pessimistic views, see Baker (2002) and Madrick (2002). For more optimistic views, see Jorgenson,

Ho, and Stiroh (2002) and Oliner and Sichel (2002). For a recent assessment of the new economy in this

journal, see Baily’s Distinguished Lecture on Economics in Government (Baily, 2002).

y Roger W. Ferguson Jr. is Vice Chairman and William L. Wascher is an Assistant Director

in the Division of Research and Statistics, Board of Governors of the Federal Reserve System,

Washington, D.C.

Journal of Economic Perspectives—Volume 18, Number 2—Spring 2004—Pages 3–28
the historical record as especially worthy of further scrutiny for the lessons they may

offer regarding the current episode: the late 1800s from roughly the end of the

Civil War to around 1890; the decade or so between the end of World War I and the

onset of the Great Depression; and the period from about 1950 to the early 1970s.2

We will start by setting out some facts about these three previous periods of

strong productivity growth in the United States. Each period can be associated with

particular advances in technology, a connection implying that technological

progress is a necessary component of trend productivity growth. But significant

technological advances were also evident in periods when productivity growth was

less robust. Thus, a natural question to ask is whether complementary factors—

including aspects of the labor market, of the business environment or of government policies like those related to education—combine to render technological

change especially potent or help to foster the transmission of technological change

into real gains in the efficiency of the production process.

After touching briefly on possible reasons for the end of productivity booms,

we will then turn to some of the lessons that can be learned from what, in many

ways, are striking similarities across the three previous episodes and the current

one. Those lessons suggest that government policies have only a limited role in

these periods of elevated productivity growth. The larger share of the credit goes to

the private sector, as private agents are generally responsible for creating and

exploiting the technologies that drove these previous productivity booms. Nonetheless, governments can play an important subordinate role by supporting basic

research and by fostering an economic environment that is conducive to private

sector initiative.

Previous Productivity Booms by the Numbers

Basic facts about economic growth, not to mention the interpretation of those

facts, are sometimes subject to considerable debate. Some of these disagreements

result from the lack of consistent information on U.S. productivity before data from

the Bureau of Labor Statistics (BLS) became available in 1948.3 For this earlier

period, we use data developed by John Kendrick (1961), who constructed estimates

2 Others will undoubtedly disagree with this taxonomy. Gordon (2000a), for example, argues that the

historical record of productivity growth in the United States is best seen as one big “wave” that begins

its rise in the late 1800s and tapers off in the late 1960s and early 1970s. From a standpoint of

technological advance, that characterization may be appropriate. But for assessing the diffusion of

technology and the forces that contributed to the speed of the diffusion, a focus on narrower periods

of labor productivity booms is arguably more relevant.

3 Some analysts have also questioned whether the more recent estimates are overstating productivity

gains, suggesting that these estimates do not accurately capture increases in hours worked away from the

office made possible by the new information technologies. See, for example, Roach (2003). Freeman

(2002) mentions this possibility, as well, but he and Gordon (2000b) also note that the availability of the

Internet in the workplace may reduce productive work time in the office. To our knowledge, there are

no statistical studies that net out these opposing effects.

4 Journal of Economic Perspectives
of GDP going back to the 1870s that were consistent with the prevailing definitions

in the National Income and Product Accounts and were, in turn, based on estimates made by Simon Kuznets (1946). These estimates are often cited as the best

available measure of U.S. output and productivity growth for that period. Although

subsequent researchers—notably Balke and Gordon (1989) and Romer (1989)—

have refined these estimates, the additional refinements focus primarily on the

cyclical properties of output. A number of economic historians have also estimated

U.S. GDP for the period before the Civil War (Gallman, 1966; Rhode, 2002).

However, given that these estimates are based on less reliable information than

those for the later, more industrialized period, we have elected to focus primarily

on the period after 1870.

Table 1 presents average growth rates of productivity over various periods from

1873–2003. The data for labor productivity—defined as output per hour worked in

the nonfarm business sector—appear in the first column. The two remaining

columns show a breakdown of labor productivity growth into the portion attributable to multifactor productivity (output per unit of labor and capital inputs) and

the portion attributable both to capital deepening (capital services per hour

multiplied by capital’s share of current dollar costs) and the quality (education and

work experience) of the workforce. As noted above, we focus mostly on the growth

of labor productivity because of its relevance for improvements in the nation’s

average standard of living. However, the decomposition of labor productivity

growth into its major components is also of interest because it provides information

on the relative importance of technological progress and efficiency gains (which

are included in multifactor productivity growth) versus the diffusion of technological change through investments in fixed and human capital.

For the total period from 1873 to 2003, labor productivity rose at an average

rate of 2.2 percent per year, with both multifactor productivity and capital deepening contributing importantly to overall productivity growth. However, the increases in output per hour did not proceed in a steady fashion. Instead, periods of

robust growth were interspersed with periods of more modest productivity gains.

Recognizing that the choice of periods is subjective, we take as the first episode of

strong productivity growth the period from 1873 to 1890. During this period, labor

productivity rose 2.6 percent per year, a rate thought to be considerably higher

than the average growth experienced over the first 100 years of the United States.

Kendrick’s (1961) decomposition suggests that labor productivity growth in the late

1800s was fueled in part by capital investment—as indicated by the 1.1 percent

annual rate of increase in the last column of the table.4 From 1890 to 1917, the

growth rate of labor productivity slowed to an average pace of only 1.5 percent per

4 This estimate of productivity growth is the change from Kendrick’s estimate of the average level of

productivity in the 1870s to the level of productivity in 1890. Decompositions of productivity growth

before 1948 are the subject of some debate, and thus estimates of multifactor productivity for these

earlier periods should probably be viewed as less reliable than are the estimates of labor productivity.

Roger W. Ferguson Jr. and William L. Wascher 5
year. The U.S. economy then enjoyed a relatively brief spurt in labor productivity

until about 1927, with labor productivity rising 3.8 percent per year and multifactor

productivity up 2.8 percent per year. This productivity boom was led by the

expansion of the automobile industry and robust productivity gains in manufacturing more generally. Productivity growth was markedly slower during the period

that included the Great Depression and World War II (from 1927 to 1948), largely

because of a lack of capital deepening. Multifactor productivity rose at a relatively

solid pace—albeit not as fast as earlier in the century—despite the weak economy

during much of that period.

From 1948 to 1973, a period sometimes referred to as the golden age of

productivity growth, labor productivity rose at an annual rate of close to 3 percent.

During this period, productivity accelerated across a broad range of industries, and

both capital deepening and gains in multifactor productivity contributed to the

strong pace of growth. During the productivity slowdown of the 1970s and 1980s,

labor productivity growth slowed to an average pace of 1.4 percent per year, while

Table 1

U.S. Productivity Growth, 1873–2003

(average annual percent change, nonfarm business sector)

Period

Labor

productivity

Multifactor

productivity

Contribution of capital deepening

and labor composition

1873–2003 2.2 1.3 .9

Episode I

1873–1890 2.6 1.5 1.1

1890–1917 1.5 .8 .7

Episode II

1917–1927 3.8 2.8 1.0

1927–1948 1.8 1.7 .1

Episode III

1948–1973 2.9 1.9 1.0

1973–1995 1.4 .4 1.0

Episode IV

1995–2003 3.0 1.0 1.6

Notes: Labor productivity is measured as output per hour worked in the nonfarm business sector.

Multifactor productivity is defined as output per unit of combined labor and capital inputs. The

contribution of capital deepening to labor productivity growth is the change in capital services per hour

weighted by capital’s share of nominal output, and the contribution from labor composition is the

change in the average quality of the work force (by education and experience); separate estimates for

capital deepening and labor composition are available only beginning in 1948. Data from 1873 to 1948

are taken from Kendrick (1961). For the periods after 1948, we use data from the U.S. Bureau of Labor

Statistics. Labor productivity data from the BLS are available through 2003, whereas data on multifactor

productivity, capital services and labor composition are published only through 2001.

6 Journal of Economic Perspectives
multifactor productivity growth fell to a pace of 0.4 percent, the slowest pace of any

of the periods shown in the table. Finally, labor productivity growth averaged

3.0 percent at an annual rate from 1995 to 2003, with higher rates of both capital

deepening and multifactor productivity growth contributing to the pickup.

Sources of Past Productivity Booms: Technological Change

Although the productivity booms of the past century and a quarter obviously

differed in many respects, each episode can readily be associated with the introduction of one or more prominent new technologies.

The productivity boom after the Civil War, for instance, appears to have had its

genesis in a set of technological improvements that increased the flexibility of

production and reduced transportation costs, which allowed firms to take advantage of economies of scale in production and distribution. The widespread introduction of steam engines and machinery powered by coal enabled firms to move

away from sources of water power and closer to areas where inputs of labor and raw

materials were more readily available. The Midwest—where water power was less

abundant but coal was more abundant—benefited greatly from this development

and, indeed, within a few decades became known as the “industrial heartland” of

the United States. As a result of this regional shift in economic activity, the share of

personal income generated in the Midwest rose from 20 percent in 1840 to

35 percent in 1880, whereas the share of income generated in the Northeast

declined from 43 percent to 31 percent over that period (Easterlin, 1961).

The expansion of railroad transportation also helped raise productivity growth

in the second half of the nineteenth century. Improved methods of steel

production—notably, the Bessemer process and, later, Siemens’s open hearth

method—enabled railroads to lay longer-lasting steel track rather than iron track.

The growth of telegraphy enabled railroad companies to coordinate the movement

of trains over a wider area. As a result, railroads expanded their geographic

coverage significantly after the Civil War. From 1860 to 1890, the number of main

track miles operated by railroad companies more than quintupled, from

31,000 miles to 167,000 miles, while the number of freight cars in operation

jumped from 185,000 to more than 1 million (U.S. Census Bureau, 1997, Series

Q321; Fishlow, 1966).

Although the magnitude of the railroad’s contribution to productivity growth

during this period is the subject of considerable debate (David, 1969; Fishlow, 2000;

Fogel, 1979), the expansion of the railroads clearly drove transportation costs

sharply lower and resulted in significant increases in the geographic size of product

markets. In 1830, the transportation of goods from New York to Chicago occurred

mainly by canal and required three weeks even during the warmer months of the

year; moreover, canals often did not operate in the winter. In contrast, by 1870 the

same goods could be transported between these two cities in three days by railroad

Lessons from Past Productivity Booms 7
any time of the year (Paullin, 1932). In addition, the construction of new rail lines

in western states opened those markets to a wide range of east coast and midwestern

manufacturers. Subsequently, freight rates fell from 21

4 cents per ton-mile in 1860

to less than 1 cent per ton-mile by 1890. As a result, the quantity of goods

transported by rail increased sharply, from about 12 billion ton-miles in 1870 to

80 billion ton-miles in 1890.5

The advances in transportation were complemented by improved communications, largely as a result of the expansion of the telegraph. As noted above, the

telegraph aided the expansion of railroads by improving the coordination of rail

traffic. But the ability to send messages rapidly over long distances also proved

valuable in many other industries. Initially, sending a telegram was relatively

expensive, with rates between New York and San Francisco averaging $7.45 for ten

words or less in the late 1860s. By the late 1880s, rates for the same message had

fallen to as little as $1.00. As a result, the number of telegraph messages handled by

Western Union rose from less than 6 million in 1867 to nearly 56 million in 1890

(U.S. Census Bureau, 1997, Series R48 and R74). The better information flows that

accompanied the wider use of telegraphy contributed to better decision making

and higher productivity throughout the economy.

Agriculture also was increasingly mechanized in the decades immediately after

the Civil War, though the change in agriculture was not as impressive as in the

industrial sector. The abundance of land in western states limited the interest

among farmers in raising land productivity. However, labor services were often

difficult to obtain, so farmers were quite willing to invest in labor-saving machinery.

As a result, the better plows, seed drills, reapers and threshers developed by

manufacturers were in high demand by farmers, and the amount of labor required

to farm an acre of land fell sharply for many crops (Atack, Bateman and Parker,

2000).

In the second productivity boom in the years after World War I, the chief

technological innovation was most likely the spread of electrification to the factory

floor. The use of electric motors in the production process increased substantially

in the first quarter of the century (David, 1990; Mowery and Rosenberg, 2000). For

example, the amount of mechanical energy derived from electric motors rose from

475,000 horsepower in 1899 to nearly 34 million horsepower in 1929, and the

fraction of overall factory horsepower produced with electricity rose from less than

5 percent to more than 80 percent over that period (U.S. Census Bureau, 1997,

Series P70). With electric motors, each machine in a factory could be driven by its

own power source. As a result, manufacturing plants could be organized in a way

that maximized the efficient movement of materials, rather than the efficient

transmission of power. In this regard, electric motors facilitated the spread of

5 Estimates of track construction, freight rates and ton-miles transported are taken from Fishlow (1966,

2000).

8 Journal of Economic Perspectives
continuous processing techniques and assembly lines. As firms moved to reorganize

their production processes to take advantage of the increases in efficiency afforded

by electric power, factory productivity rose significantly. By one estimate, productivity growth in the manufacturing sector as a whole increased about 51

2 percent per

year between 1919 and 1929 (Kendrick, 1961, p. 152).

Of course, other technological innovations also contributed to productivity

growth during this period. Notable among them were the telephone, which by the

1920s had largely replaced the telegraph; the internal combustion engine, which

led to motorized vehicles that brought sizable productivity gains in the transportation and agriculture sectors; and a variety of technological advances in machine

tools. In addition, the early 1900s were characterized by the first wave of office

automation equipment, including the portable typewriter and adding and duplicating machines. These machines improved the efficiency of a wide range of

management and accounting tasks. In real terms, business investment in office

equipment increased from about $50 million (in 1929 dollars) in 1899 to nearly

$500 million in 1929, with a particularly large jump evident in the 1920s (Cortada,

1993, Figure 3.1).

The productivity gains of the 1950s and 1960s had their roots in a wide range

of technological innovations made during the 1930s as well as in research sponsored by the military during World War II. Field (2003), in particular, emphasizes

the importance of technological change in the 1930s and points to the array of

process and product innovations compiled by Kleinknecht (1987), Schmookler

(1966) and Mensch (1979) as evidence.6 Examples of important innovations during

this decade include research advances in polymer chemistry that led to the invention of Plexiglas, Teflon and Nylon; significant advances in civil engineering; and

the introduction of the DC-3 aircraft in 1936.

Research aimed at enhancing U.S. military capabilities during World War II

also led to new technologies that had important spillovers to commercial applications after the war (Mowery and Rosenberg, 2000). For example, although the

major research advances in synthetic polymerization chemistry (most notably, the

introduction of catalytic cracking in the processing of crude oil) were made in the

1920s and 1930s, the synthetic rubber program launched during the war resulted

in techniques that led to the mass production of the first synthetic polymer from

petroleum-based feedstocks. Similarly, production of polyethylene, a petrochemicalbased plastic discovered in the 1930s, jumped in the 1940s because of its widespread use in military equipment. The military’s need for large stocks of penicillin

led to a production process for it that turned out to have applicability to a wide

6 Field also points to the sizable increase in multifactor productivity between 1929 and 1941 as evidence

of the extent of technological progress during the 1930s. As he notes, however, Goldin (2000) and

Bernanke and Parkinson (1991) offer alternative explanations for the rise in productivity over that

decade.

Roger W. Ferguson Jr. and William L. Wascher 9
range of pharmaceuticals, while wartime advances in microelectronics subsequently

contributed significantly to the development of new commercial electronic

products.

The commercialization of these earlier innovations sharply increased the

number of products made wholly or partly from newly developed plastic polymers

and other synthetic materials. The use of polyethylene, for example, spread quickly

after the war, and additional technological advances isolated new forms of synthetics and further reduced production costs for chemicals and pharmaceuticals.

Overall, between 1947 and 1970, production in the rubber and plastic products

industry rose nearly 7 percent per year, and the output of the chemical products

industry rose more than 8 percent per year (Board of Governors of the Federal

Reserve System, Indexes of Industrial Production). In comparison, over the same

period, production in the manufacturing sector as a whole rose about 41

2 percent

per year.

Other notable contributors to productivity growth during this period include

the invention of the transistor in 1947 and the diffusion of earlier technological

advances into the transportation sector. Commercial applications of the transistor,

initially in solid state consumer electronic products, were stimulated by improvements in the fabrication process (in 1954) and by the introduction of the integrated

circuit (in 1958). With the rise in demand, semiconductor production jumped

markedly, rising nearly 20 percent per year during the 1960s (Board of Governors

of the Federal Reserve System, Indexes of Industrial Production).

In transportation, the 1950s and 1960s saw major productivity improvements in

all three major segments: air, rail and trucking. Gordon (1992) estimates that labor

productivity in the railroad industry rose at an average annual rate of around

41

2 percent between 1948 and 1969; contributing importantly to those productivity

gains were the replacement of steam locomotives with diesel locomotives and

innovations that increased the capacity of the rolling stock (Mansfield, 1965). The

use of the jet engine in commercial aircraft—most notably, the introduction of the

Boeing 707 in 1958—sharply reduced the time and cost of transporting passengers

and freight, and Gordon’s estimates place the growth of productivity in the commercial airline industry at more than 7 percent per year during the 1960s, well

above the rate of labor productivity growth for the economy as a whole.7 Finally,

while technological improvements in internal combustion engines also found their

way into medium and heavy trucks during this period, productivity gains in

trucking—estimated by Gordon at about 31

2 percent per year in the 1950s and

1960s—were fueled importantly by substantial investment in road improvements,

7 Of course, the invention and commercial use of the airplane was a technological innovation that

predated the jet engine, and air travel in the late 1920s represented a substantial improvement over

other forms of passenger transportation. The estimates of Gordon (1992) show that productivity in

airline transportation rose about 7 percent per year between 1935 and 1959, as well.

10 Journal of Economic Perspectives
most notably the federally funded expansion of the U.S. highway system (Keeler

and Ying, 1988).

For purposes of comparison, the technological origins of the more recent

productivity boom also bear a brief mention. Obviously, the invention of the

transistor and the development of the mainframe computer were precursors of the

technological advances that contributed to the current productivity boom. However, the real drivers of the productivity gains in the 1990s were the related

high-tech innovations of the 1970s and 1980s, including the personal computer,

fiber optics, wireless communications and the Internet. Many of the recent technological innovations have significantly altered the ways in which firms interact with

their customers and have raised the productivity of the economy as a result

(Brynjolfsson and Hitt, 2000). Nearly all large retail chains have followed the lead

of Amazon.com and established an on-line presence; customers now routinely pay

bills online; and computerized reservations and e-tickets have become the norm in

the travel industry. Moreover, from manufacturing to retailing, innovations in

supply-chain management practices made possible by new technologies have substantially reduced inventory-related costs.

Sources of Past Productivity Booms: Organizational Change

In most cases, the principal technologies that stimulated past productivity

booms were invented well before the productivity gains were realized. For example,

the steam engine was invented in the 1700s, well before it had any measurable

effect on the production process in the United States. Similarly, railroads were

being built in the 1840s, and the first electric power plant was built in 1882.

Computers were introduced in 1945, and the absence of a measurable contribution

to productivity was a puzzle to many economists as late as the mid-1990s (Oliner

and Sichel, 1994). What delayed the translation of these innovations into gains in

productivity? In part, the lags reflected the challenges of developing commercial

applications for the new technologies; for example, complementary innovations

were frequently required to enable new inventions to be put to practical use. In

addition, replacing older machines with equipment that embodied the new technologies was often not immediately profitable, and thus, firms frequently took some

time before making the capital investments required to take full advantage of

technological progress.

However, substantial changes in business practices and in the organization of

firms often were also needed to enable businesses to achieve the potential productivity gains associated with new technologies. In many cases, these organizational

changes went hand in hand with the technological advances—the changes both

being made possible by the new technologies and being necessary to achieve the

additional productivity associated with the use of these technologies. Chandler

Lessons from Past Productivity Booms 11
(1977), in particular, documents the evolution of the modern business enterprise,

pointing out both how new technologies influenced the optimal hierarchical

structure of the firm and how the resulting changes in business organization

increased productivity.

In the productivity boom of the late nineteenth century, the major organizational changes involved firms growing in size to take advantage of the economies of

scale made possible by the new technologies. Before the Civil War, most businesses

were either sole proprietorships or partnerships serving local markets, and they

consisted of small shops that employed skilled workers involved in each aspect of

the production process. As the spread of railroads lowered transportation costs and

increased the size and number of potential markets, the greater availability of steam

power enabled manufacturers to set up factories to take advantage of economies of

scale in production. As a result, the size of firms rose substantially in many

industries. In the cotton industry, for example, the median firm size (measured as

the annual value of gross production in 1860 dollars) rose from $31,000 in 1850 to

nearly $100,000 in 1870; similarly, in the iron industry, the median firm size rose

from $24,000 in 1850 to more than $200,000 in 1870 (Atack, 1986). Outside

manufacturing, the emergence of large wholesalers (and, later, retailers) to take

advantage of increased distributional efficiencies reduced the costs of moving

commodities and manufactured goods from the farm or factory to retailers’ shelves.

These larger enterprises had to confront communications challenges in both

production and distribution. With the telegraph making rapid communication over

great distances more feasible, firms were able to monitor activities from a central

administrative office. However, processing the increased flow of information required changes in the organizational structure of the firm. In particular, to make

effective use of the opportunities presented by better communications, firms often

set up hierarchical management systems to control the production process and to

coordinate the flow of goods across the distribution system. The more informed

decision making associated with this administrative structure enabled firms to

match production to orders, shorten delivery times and reduce inventory holdings.

The second major productivity boom, in the years after World War I, required

changes in business organization that permitted firms to take advantage of advances in production processes in the early 1900s. These changes involved both the

economies of scale associated with the increasingly complex production techniques

in the manufacture of goods and also large organizations embracing economies of

scope. The diffusion of the electric motor throughout the factory floor increased

the use of continuous-process methods and the assembly line and, thus, accelerated

the trend toward mass production. In addition, as early as the 1880s, manufacturers

had begun to integrate forward into distribution; one noteworthy example was the

meatpacking industry, in which firms purchased refrigerated rail cars that allowed

the shipment of beef from centralized slaughterhouses to branch houses that

served local markets. The advances in mass production techniques and the increasing complexity of many manufactured products led firms in other industries to

12 Journal of Economic Perspectives
integrate forward not only into distribution but also into retailing; this vertical

integration reduced transactions costs even more and further increased the optimal

size of firms. Many of the large corporations that arose at this time—Ford, General

Motors and General Electric, for example—are still with us today.

The vertical integration of these large corporations, in turn, led to a greater

emphasis on retail, accounting, advertising and other activities not directly related

to production (Galambos, 2000). To compete in retail markets, firms needed to

understand the latest consumer trends and to encourage consumers to associate

specific products with a particular firm; in addition, firms needed to establish

accounting systems to keep track of a wider range of activities. As a result, marketing, advertising and accounting departments increased in size and importance

within the typical corporation. Also, with their executives now more sensitive to

market share and their cost advantage over their competitors, large corporations

began to develop applied research departments aimed at providing the firm with a

technological edge.

During the third productivity boom, following World War II, firms responded

to the myriad of new products made possible by the technological advances of the

1930s and 1940s by making new changes in their organizational structure. In

particular, corporate managers increasingly split their firm’s activities into separate

divisions, each with its own manufacturing and marketing departments. For domestic production, this multidivisional approach was well-suited to the manufacturing of diverse product lines by a single company; DuPont and Monsanto are

good examples of this approach (Baskin and Miranti, 1997). This structure also

turned out to be an effective method of handling corporate operations in different

geographic areas, as seen by the rise of multinational corporations during this

period. After World War II, new trade agreements and efforts to revitalize Europe

and Japan allowed American firms to make significant inroads into foreign markets.

To handle these long-distance operations more easily, corporations often set up

foreign subsidiaries that could adapt quickly to changing circumstances in the host

country’s marketplace. The economic importance of these multinational corporations rose steadily, so that by 1966, the total assets of U.S. multinational firms

accounted for nearly 35 percent of U.S. corporate assets (U.S. Bureau of Economic

Analysis, 1966).

Organizational structure during the productivity boom of the late 1990s has, in

some respects, shifted away from the large corporations that dominated the U.S.

economy during much of the twentieth century. To be sure, the marketplace in

many industries is still characterized by large, well-established firms. In some

industries—the financial services sector comes to mind—recent technological innovations have, if anything, increased the scale of business. But in other industries,

intense global competition has motivated many corporations to narrow their focus

to core production-related activities and to outsource other functions. Increasingly,

these supporting firms are providing their services from overseas, taking advantage

both of lower labor costs there and of the revolution in communications. The

Roger W. Ferguson Jr. and William L. Wascher 13
impact of this outsourcing is already evident in the business community, with some

computer-related support for U.S. providers located in India, architectural drawings rendered in the Philippines and some legal functions provided from nations

in the Caribbean.

In addition, much of the rapid technological innovation since 1995 or so has

occurred outside the large corporate sector, and the success of that innovation has

boosted the pace at which new ventures are being created. For example, more than

700,000 new businesses were incorporated each year, on average, in the 1990s,

about double the pace of the 1970s (U.S. Census Bureau, 2001). Of course, many

of these firms failed. However, many others either grew or were bought by larger

firms better able to market and distribute the most promising innovations.

Sources of Past Productivity Booms: Financial Market Change

A third major ingredient in promoting the productivity gains associated with

technological innovation has been a complementary set of innovations in the

financial sector that have changed the financial landscape in ways that were

especially appropriate to the predominant form of business organization in each

period.8

Before the Civil War, most nonfinancial business investment was financed

internally with retained earnings, with capital provided by family or friends or

through partnerships formed with other proprietors. The chief exceptions were the

canals and railroads, which were issuing stocks and bonds in the 1850s (Chandler,

1977). With the sharp increases in the scale of operations of many firms after the

Civil War, however, businesses in other industries perceived a need for greater

capital investments and began to look more toward external sources of financing.

The main sources of funding in the decades after the Civil War were debt and

preferred stock—that is, stock that promised a certain dividend but had no voting

rights. (Railroad companies were an exception to this pattern—they sold sizable

amounts of common stock to investors seeking large capital gains after the completion of new construction projects (Fishlow, 2000).) Debt often took the form of

secured loans, in large part because investors were concerned about the informational asymmetries they faced in evaluating the bankruptcy risk of particular firms.

In addition, the owners of many firms preferred financing with debt rather than

common stock because they did not want to see their equity diluted or their control

of the enterprise diminished. Similarly, preferred stock, which reduced bankruptcy

risk but did not dilute the owners’ equity in the firm because it offered no voting

rights, was often used when assets were insufficient to secure the loan. Thus, despite

the prevalence of information problems, financial intermediaries were able to

8 This section draws from Baskin and Miranti (1997) and White (2000).

14 Journal of Economic Perspectives
provide firms with external sources of funds, making possible the rapid buildup in

the capital stock that took place in the late 1800s. Indeed, the total value of bank

loans rose from less than $1 billion in 1870 to more than $4 billion in the early

1890s, a notable increase in nominal value during a period when the aggregate

price level was falling (U.S. Census Bureau, 1997, Series X581).

Corporate finance in the years after World War I was characterized by an

increase in the importance of equity markets. At the New York Stock Exchange

alone, the volume of stock sales rose from 186 million shares in 1917 to more than

1 billion shares in 1929 (U.S. Census Bureau, 1997, Series X531), the value of

preferred and common stock issuance increased from $455 million to $6.8 billion

over the same period (U.S. Census Bureau, 1997, Series X514-515), and the

number of individuals holding stock jumped from 500,000 in 1900 to 10 million by

1930 (Hawkins, 1963).

The public’s interest in common stock increased for several reasons. First, and

probably most important, the profitability of large corporations during the early

1900s was accompanied by expanding middle and upper classes that wanted to take

part in the economic gains associated with the introduction of new technologies

such as the internal combustion engine and the electric motor. The main way to

share in these capital gains was to purchase some ownership in those corporations.

About the same time, the informational problems that had constrained interest in

common stock through the early 1900s were declining. Rising demand from

investors in the late 1800s for information about railroad companies had led to the

proliferation of newsletters that reported on developments in that industry, and

similar publications soon sprang up to provide information on other traded securities. These newsletters evolved into ratings agencies covering a wide range of

individual corporations, with Moody’s issuing the first bond ratings in 1909. Although these agencies’ ratings focused on corporate bond issues, many also provided economic forecasting services and more detailed information about the

relative risk of specific companies. As a result, more public companies recognized

a need to address investors’ concerns about risk and began to issue regular audited

financial statements (Miranti, 2001). Interest in common stock was also fueled by

the tendency to imbue them with characteristics similar to those associated with

debt, with which investors were more familiar. For example, businesses frequently

attempted to establish steady dividend streams in order to boost investors’ confidence about the future profitability of the firm and to encourage them to hold their

securities (Baskin and Miranti, 1997). Finally, the marketing of securities to the

household sector became more aggressive in the 1920s, led by investment trusts—

which offered investors a means of diversifying individual portfolios—and retail

brokerage firms.

The third productivity boom, in the years after World War II, was accompanied

by another rapid increase in bond and equity issuance. Despite significant increases

in internal funds, the growth of investment spending over this period outpaced the

rise in retained earnings, and the ratio of external financing to overall capital

Lessons from Past Productivity Booms 15
spending rose from an average of around 30 percent in the late 1940s to more than

40 percent in the early 1970s (Board of Governors of the Federal Reserve System,

Flow of Funds Accounts).

Two specific developments in financial markets during this period bear mentioning. First, the late 1950s and 1960s saw the rise of the Eurodollar market—a

market for U.S. dollar deposits and loans outside the United States and, at least

initially, in Europe. Although the origin and early development of the Eurodollar

market is attributed, in part, to a desire by holders of dollars to avoid U.S.

regulations, including the Regulation Q interest rate ceilings, that market subsequently became a useful source of short-term financing—complementary to the

commercial paper market—for large corporations seeking alternatives to more

costly domestic commercial bank loans (Johnston, 1982; Kindleberger, 1993).

Although no direct data on the size of the Eurodollar market are available, Baskin

and Miranti (1997) estimate that this market increased from about $9 billion in

1964 to $247 billion by 1976. Second, the 1950s and 1960s were characterized by a

sharp rise in the importance of large institutional investors—especially pension

funds—in the stock and bond markets. This rise, coupled with the growth of mutual

funds and brokerage houses, enabled smaller investors (either explicitly or implicitly) to invest more easily in stocks and bonds and to diversify their portfolios.

In the most recent productivity boom, financial intermediaries have expanded

the range of financing alternatives available to businesses in response to the

proliferation of start-up businesses and what is, for many firms, a riskier business

environment. For larger lower-rated corporations that have significant default risk,

the so-called junk bond market has offered the capability to raise funds even when

other sources of financing are less available. Such firms’ use of this market has

increased markedly: Junk bond issuance rose from about $11 billion in 1984 to

more than $100 billion in 2001, and the par value of outstanding junk-rated debt

has increased from less than $100 billion in the mid-1980s to nearly $700 billion

today. For smaller and yet-riskier firms, venture capital and initial public offerings

have been important sources of financing. Venture capital investments, which were

negligible in the early 1980s, rose to more than $100 billion in 2000, although they

have since dropped back. Similarly, initial public offerings for nonfinancial companies (excluding spinoffs and leveraged buyouts) exploded from less than

$5 billion per year in the late 1980s to roughly $30 billion in 2000.9

In addition, the financial industry has made significant advances in quantifying

and managing risk. Many large financial institutions have, over the past decade,

increasingly adopted internal credit-risk models to improve their ability to assess

the riskiness of their portfolios. Moreover, financial market innovations, including

9 Data on junk bonds in this paragraph are from Thompson Financial Securities Data Corporation and

Moody’s Investors Service. Data on venture capital investments are from PricewaterhouseCoopers/

Thomson Venture Economics/National Venture Capital Association, MoneyTree Survey. Data on initial

public offerings are from Thompson Financial Securities Data Corporation.

16 Journal of Economic Perspectives
securitizations, credit derivatives and an improved secondary loan market, have

allowed these institutions to manage their exposure to such risks better. These

improvements in risk management may help to explain why financial institutions

weathered the 2001 economic downturn so well relative to their difficulties in

previous recessions.

Sources of Past Productivity Booms: Human Capital Accumulation

A fourth ingredient contributing to the productivity booms of the past has

been the availability of a workforce capable of bringing to fruition the possibilities

opened up by the technological innovations. In the 1800s, the new manufacturing

technologies tended to be complementary with unskilled labor, whereas those

associated with the distribution of goods tended to require more-skilled workers. In

contrast, in the 1900s, technological change tended to increase the demand for

skilled workers in both sectors. These shifts in labor demand typically were manifest

in changing wage premiums for skilled labor, and workers responded to the

incentives in ways that generally provided employers with a mix of workers able to

harness the productivity improvements associated with the new technologies.

During the productivity boom in the late nineteenth century, technological

change had two disparate effects on the demand for labor. First, the shift in

manufacturing production from artisanal shops in the mid-1800s to factories after

the Civil War and the subsequent rapid growth in the capital stock led to a

substantial increase in the demand for unskilled labor (Engerman and Sokoloff,

2000). The new capital equipment embodying the technological advances of that

period, coupled with the use of unskilled labor and the abundance of raw materials,

often proved to be an effective substitute for skilled artisans (James and Skinner,

1985), and so firms increasingly looked to hire workers without any specific

expertise to operate the new machines. Although such workers—who were often

women, children and immigrants—likely reduced the average skill level of the

manufacturing workforce, the availability of a large pool of unskilled labor enabled

firms to take advantage of the potential organizational efficiencies and economies

of scale associated with the new technologies, thus raising productivity for the

economy as a whole.

Second, increases in firm size and the growth of businesses in the distribution

sector increased the demand for workers who could perform clerical and managerial tasks. For example, the share of employed men who worked in white-collar

occupations rose from less than 5 percent in 1850 to nearly 18 percent by 1900

(Margo, 2000). As these jobs typically involved some basic knowledge of reading

and mathematics, such workers tended to have more formal education than the

average individual. However, the level of competency needed for these jobs generally consisted of bookkeeping and secretarial skills that required, at most, a high

school education (Chandler, 1977).

Roger W. Ferguson Jr. and William L. Wascher 17
On net, these influences seems to have led to only a slight increase in the wage

premium for skilled labor during the 1870 to 1890 period (Margo, 2000), and as a

result, there was little impetus for widespread increases in educational attainment

among the U.S. population. School enrollment rates among children held steady at

about 50 percent over that period, and high-school graduation rates remained

below 5 percent (U.S. Census Bureau, 1997, Series H433, H599).

The productivity boom of the early twentieth century was accompanied by a

significant rise in the demand for higher-skilled labor. The need for white-collar

workers continued to increase with the further growth in corporate size and the

new focus on activities not directly related to the manufacture of goods. Moreover,

these additional activities required better-educated managers to control and coordinate the diverse functions of the corporation and more-skilled clerical workers to

process the increased flow of information associated with vertical integration. The

acquisition of these additional skills took place in different ways. Chandler (1977)

emphasizes, for example, the inception of the modern business school during this

period, with classes on commerce, accounting, marketing, law and finance. Cortada

(1993) notes also that vendors of new office machinery often educated clerical

workers about the uses and operation of the new equipment.

In contrast to the late 1800s, the use of more-advanced technologies in the

manufacturing sector also led to a relative shift in labor demand toward more

capable and highly educated blue-collar workers. In particular, the increasing

use of continuous processing production techniques made possible by the

electrification of factories reduced the demand for unskilled manual workers,

while the greater complexity of the newly installed capital equipment increased

the demand for workers who could read manuals and blueprints, perform

mathematical calculations requiring knowledge of algebra and geometry and

had some basic knowledge of science (Goldin and Katz, 1998). In response,

enrollment rates in secondary schools increased sharply, and the high school

graduation rate rose to more than 25 percent by the late 1920s (U.S. Census

Bureau, 1997, Series H599).

The productivity boom of the 1950s and 1960s showed a similar pattern. The

new technologies and skilled labor again were complements in production, so that

the availability of skilled labor in this episode helped to maintain the returns to

technological innovation. As in the early 1900s, the greater cognitive skills possessed by more-educated workers were especially effective in implementing the new

technologies (Nelson, Peck and Kalachek, 1967), and in this instance, the demand

for workers in professional and technical occupations increased sharply, with

especially rapid growth for engineers and technicians (U.S. Census Bureau, 1997,

Series D233-D682). With the occupations in highest demand now requiring a

college education, the percentage of 18- to 24-year-olds enrolled in college rose

18 Journal of Economic Perspectives
from about 14 percent in 1950 to roughly 32 percent in 1970 (U.S. Census Bureau,

1997, Series H701).10

The current productivity boom has also been characterized by skill-biased

technological change, with the advances in the high-tech sector associated with a

sharp increase in the demand for workers with computer-related skills and a further

widening in the skill premium for workers with a college degree. As a result, college

enrollment rates, which stagnated during the productivity slowdown in the 1970s

and 1980s, began to rise again in the 1990s. In addition, the demand for lowerskilled workers has been damped in recent years by the longer-term downtrend in

large segments of the manufacturing sector and competitive pressures more generally (Paul and Siegel, 2001). In response, many lesser-skilled adults have moved

to retool their skills by returning to school (Kane and Rouse, 1999). Most notably,

enrollments at community colleges increased about 30 percent between 1985 and

2000, and the percentage of adults attending an education program rose from

33 percent in 1991 to 45 percent in 1999, with a particularly large increase evident

for the unemployed.11

Why Do Productivity Booms End?

It is informative not only to identify the sources of past productivity booms, but

perhaps also to ask why periods of strong trend productivity growth end. Three

possibly overlapping hypotheses have been put forth. First, successful new technologies may eventually lead to financial imbalances and overinvestment associated

with excessive optimism. Second, periods of strong productivity growth may eventually run out of steam as the productivity-increasing opportunities associated with

new technologies are exhausted. Third, exogenous shocks may bring an end to

boom periods. Although elements of these three hypotheses can be seen in the past

episodes of productivity booms, no clear pattern emerges.12

Some support for the hypothesis that financial imbalances may end productivity booms can be seen in Figure 1. Each of the episodes discussed in this paper

10 The increase in college enrollments during this period was likely also boosted by the use of college

deferments during the Vietnam War and by the G.I. bill.

11 U.S. Department of Education, Digest of Education Statistics. Owing to data limitations, this measure

includes adults enrolled in personal development programs. In 1999, for which more detailed information is available, roughly one-third of adults were participating in postsecondary education or

career-related courses.

12 We also note that each of the productivity booms we have discussed ended with a severe recession.

However, this fact is a feature more of the way we identified the episodes of rapid productivity growth

than of the episodes. In particular, we chose to measure our productivity booms between years in which

cyclical conditions were roughly comparable precisely because we wanted to avoid contaminating our

estimates of longer-run productivity growth with the sharp cyclical decline in productivity that typically

accompanies a recession.

Lessons from Past Productivity Booms 19
included a period of soaring stock prices: in the late 1870s, the 1920s, the 1960s and

the late 1990s. In the late 1920s, the end of the run-up in equity prices was followed

by a stock market crash; in the other three cases, after the run-up, stock prices fell

substantially, but these declines could perhaps be considered “corrections” rather

than “crashes.” Did these stock market booms and falls reflect an overbuilding of

investment capacity? By the end of the 1920s, certain industries—most notably

automobiles and electric utilities—arguably had experienced a significant overbuilding of capacity. Similarly, in the late 1990s, there does appear to have been an

overinvestment in high-tech and telecommunications equipment. But evidence of

overinvestment is much harder to find in the late 1800s and in the 1960s. Indeed,

one can even argue that the decline in stock prices in the mid-1970s was due largely

to the beginning of a recession and the failure of economic policy to control

inflation rather than to excessive optimism. Moreover, although the stock market

declines of the 1880s and 1920s were both followed by extended economic depressions, modern economic analysis stresses that serious monetary policy mistakes

were necessary for these depressions to occur (Rockoff, 2000; Bernanke, 1995).

Also, although there likely was overinvestment in the high-tech sector in the late

1990s, the recent productivity data do not suggest that the current productivity

boom has ended.

The second hypothesis—that productivity booms end when innovation and

technical change levels off—surfaced to explain the productivity slowdown of the

1970s, with proponents pointing to a deceleration in the growth of research and

development spending in the late 1960s as evidence of a decline in innovation.

Figure 1

S&P Stock Price Index

187518801885189018951900190519101915192019251930193519401945

19501955196019651970

19751980

198519901995

2000

20

260

500

740

980 1220 1460 1700 2000

Index, 1941–43  10

20 Journal of Economic Perspectives
Griliches (1988) has argued convincingly that this shortfall in R&D spending was

not of sufficient magnitude to contribute much to that productivity slowdown, and

the absence of data on R&D spending in earlier periods makes this hypothesis

difficult to evaluate more generally. However, even if technological advances are

eventually exhausted, we have no evidence that this possibility is as yet a significant

risk to the current productivity boom. Both industrial R&D and patent applications

have risen rapidly in recent years, suggesting that innovation—and the potential

productivity gains associated with technological progress—will likely remain an

important source of economic growth in the United States in coming years.

The third hypothesis—that exogenous shocks may contribute to the end of

productivity booms—is also evident in some, but not all, past productivity booms.

The 1973 oil shock is perhaps the most convincing example of an adverse shock

that came at the end of a productivity boom, although the question of whether the

“golden era” of productivity growth had actually ended a few years earlier is still the

subject of much discussion. In addition, the severe bank panic of 1893 is viewed by

some as an important contributor to the depression of the 1890s; however, whether

this event was an exogenous shock or an indication of earlier economic excess (as

in 1929) is debatable. Of course, the U.S. economy has also experienced significant

exogenous shocks in recent years: for example, the terrorist attacks of September

11, 2001, the Iraq conflict and a variety of corporate scandals. It is encouraging that

the economy seems to have successfully weathered these shocks with no significant

harm to productivity growth.

With so few episodes to examine, we cannot definitively identify the reasons

that productivity booms come to an end, as no clear pattern emerges among the

four productivity booms discussed in this paper. Of course, we have no reason to

expect that all productivity booms should end because of the same circumstances.

Thus, our sense is that focusing on the conditions that are most conducive to

fostering extended periods of strong productivity growth will be a more fruitful line

of research.

Lessons from Past Productivity Booms

Productivity booms seem to involve four key ingredients: technological innovation; the willingness and ability of owners and corporate managers to reengineer

the internal organization of their firms to take maximum advantage of those

innovations; financial sector innovations tailored to the forms of business organization predominating at the time; and a skilled and flexible workforce. We undoubtedly can learn many valuable lessons from these similarities, but we will touch

on a few that seem particularly important.

First, many of the technological innovations associated with past productivity

booms were “general purpose technologies” with widespread applicability. Such

technologies often operate through various channels—through improvements in

Roger W. Ferguson Jr. and William L. Wascher 21
energy, transportation or communications, for example—raising productivity not

only in production but also in distribution and business practices. In many cases—

railroads and computers being notable examples—the productivity improvements

were initially most pronounced in the production of the capital equipment embodying the new technologies. Fishlow (1966) estimates that multifactor productivity in the railroad industry rose nearly 4 percent per year, on average, between

1840 and 1900, compared with increases of around 1 percent per year for the

economy as a whole. Similarly, Oliner and Sichel (2002) estimate that, since 1990,

efficiency gains in the production of high-tech equipment have accounted for

about half of overall multifactor productivity growth in the nonfarm business

sector.

In addition, general purpose technologies tend to attract substantial new

investment capital. Fishlow (2000) points out that in the 1870s, investment in

transportation facilities (mainly railroads) amounted to more than 15 percent of

capital formation. Similarly, in 2003, investment in high-tech equipment as a share

of overall business fixed investment stood at 34 percent, up from 13 percent in

1980. Moreover, the development of these new technologies often had important

intersectoral linkages to other industries (Fishlow, 2000; Mowery and Rosenberg,

2000). In the nineteenth century, for example, the construction of railroads had

backward linkages to the coal, iron and steel, and machinery industries and forward

linkages to the distribution sector. Likewise, in the twentieth century, the innovations in electricity, chemistry and the development of the internal combustion

engine led both to widespread productivity improvements in mature industries

(like steel and railroads) and the creation of new industries (like plastics and

commercial air transportation).

The importance of general purpose technologies raises the question of

whether governments should attempt to stimulate the development of these technologies. To be sure, government intervention has, at times, made valuable contributions to technological progress. At a general level, state and federal governments have been an important source of funding for basic research, often in

research universities or federal laboratories. In addition, the legal system provides

incentives for innovation through the protection of intellectual property rights; in

this regard, patent laws in the United States have attempted to strike a balance—

allowing the inventors of new technologies to reap the benefits of their innovations,

while encouraging the timely diffusion of new technologies and limiting the

damage from monopoly power (Engerman and Sokoloff, 2000).13 In some cases,

government has supported certain new technologies more directly. In the 1850s

13 For a discussion of patent policy tradeoffs in this journal, see Gallini (2002). For a discussion of patent

policy in the context of financial market innovations, see Ferguson (2003). Some observers have also

emphasized that technological diffusion can be effectively achieved through the sharing of information

or collective invention. See Meyer (2003), who points to the technological improvements in steel

production in the 1800s and in personal computers in the 1970s as examples of such networking gains.

22 Journal of Economic Perspectives
and after the Civil War, for example, federal land grants and state and local aid

were a source of financing for railway construction. Military support for chemical

research that focused on developing new materials during World War II contributed to subsequent productivity gains in the private sector. The federal government

funded the building of the interstate highway system during the 1950s and 1960s,

while the Department of Defense supported the development in the 1960s of the

ARPANET, the precursor of the Internet.14

Without downplaying the role of government in encouraging invention, however, the private sector seems better equipped to identify the most promising

technologies and to work out the most effective way to use these new technologies.

Indeed, general purpose technologies such as the steam engine, the electric motor

and the computer were developed and diffused through the economy primarily

because of the profit opportunities they afforded the private sector. And even for

the nineteenth-century railroads, external financing came mainly from private

domestic or foreign sources; the proportion of government-funded investment by

railroad companies was less than 10 percent after the Civil War (Fishlow, 2000).

In this regard, the government can arguably contribute most effectively to

technological change by promoting an economic, financial and legal environment

that is conducive to innovation and to the diffusion of new technologies—and then

allowing businesses the flexibility to reorganize their operations in ways that permit

them to take maximum advantage of new technologies. Of course, some government regulation of business and labor markets is essential for consumer and worker

protection. But in retrospect, the deregulation in the 1970s and 1980s of pricing in

a number of industries, such as airlines, trucking, financial services and natural gas,

seems to have boosted productivity growth by allowing businesses in those industries to operate with fewer constraints and more flexibility.15 For example, Winston

(1998) cites evidence that unit operating costs have fallen 25 percent in the airline

14 Also, each of the historical productivity booms followed the end of a major war. This sequence raises

the question of whether these postwar booms reflected either a combination of new technologies and

pent-up demand developed during the war or a war-related breakdown of factors previously restraining

long-run growth (for example, the special interest groups emphasized by Olson, 1982). We have already

noted the importance of war-related technological advances in the post–World War II productivity

boom. However, it is more difficult to see such factors playing an important role in the booms that

followed the Civil War and World War I. Moreover, other major wars were not followed by productivity

booms, nor did the post-1995 productivity boom follow the end of a war.

15 There has been an ongoing debate about whether protectionist measures—such as tariffs and

quotas—might also be helpful in raising long-run productivity growth by encouraging the diffusion of

new technologies into the domestic capital stock. Lipsey (2000) summarizes the debate for the nineteenth century, reviewing the argument that tariffs, which protected domestic markets from foreign

competition, provided U.S. manufacturers the opportunity to expand more rapidly. However, even if

one can build a case for targeted protectionism of “infant industries” in low-income countries, the

experience of the United States in the twentieth century suggests that protectionist measures are not an

effective means of promoting the diffusion of technology in an industrialized economy. Indeed, the

United States has, over time, consistently and successfully responded to competitive pressures from

abroad, often through technological innovations that create new markets and opportunities.

Lessons from Past Productivity Booms 23
industry since deregulation, between 35 percent and 75 percent in trucking and

roughly 35 percent in the natural gas industry.

Another lesson from past productivity booms is that investors must be willing

to hold securities if firms are to raise the working capital they need to take

advantage of the productivity potential of new technologies. As noted above, the

information problems of the late 1800s and early 1900s constrained interest in

common stock, and this reluctance by investors to hold equity presumably raised

the overall cost of capital until methods of reducing these information problems

were in place. Similarly, unless the corporate governance issues of the past few years

are aggressively addressed, the damage to the financial intermediation process will

undoubtedly result in a higher cost of capital. In this regard, prudent regulation of

financial markets is particularly important, starting with the requirement that firms

provide financial information that is extensive, accurate and interpretable in a

straightforward manner.

Efforts by policymakers to provide broad access to education has also helped

to stimulate economic growth by improving the ability of the workforce to adapt to

technological change. In the past, a basic facility in reading, mathematics and

science has been essential to workers in a wide range of occupational settings; in the

future, the educational requirements of the population will likely be even greater.

As a result, continued public recognition of the value of education as well as

ongoing efforts to ensure widespread access to effective schooling at all levels will

be indispensable.

Finally, sound macroeconomic policies have also been essential in promoting

long-run economic growth. Although identifying a strong causal relationship between a healthy economy and productivity growth is difficult, several empirical

observations suggest such a link. First, some evidence points to a correlation

between low inflation and strong productivity growth (Fischer, 1993; Rudebusch

and Wilcox, 1994).16 Second, the number of patent applications tends to be higher

in good economic times than during recessions.17 If patenting is a valid measure of

technological change, such a correlation suggests that innovation is stimulated by

healthy economic conditions. Third, business fixed investment—and thus the

diffusion of new technologies through renewal of the capital stock—is likely to be

better maintained in an economic environment characterized by sustainable economic growth and low inflation.

16 However, the direction of causation associated with this correlation is difficult to assess. For example,

in the United States, it is sometimes argued that strong productivity growth reduced inflation in the late

1990s (Ball and Mankiw, 2002). In addition, Bruno and Easterly (1998), in a cross-country study, find

evidence only of a correlation between inflation and productivity growth at high rates of inflation. 17 Engerman and Sokoloff (2000) point out that the growth in patenting was especially high in the 1850s

and 1880s, both periods of rapid economic growth. Similarly, Griliches (1990) finds a positive coefficient

on real GDP growth in a regression relating the growth in patent applications to changes in real GDP

and gross private domestic investment for the period 1880 to 1987. Geroski and Walters (1995) find a

similar result for the United Kingdom.

24 Journal of Economic Perspectives
Conclusion

Productivity improvements are the building blocks for increases in the standard of living. The experience in the United States suggests that extended periods

of strong productivity growth are characterized by innovations in technology that

are accompanied by changes in organizational structure and in business financing

arrangements and by investments in human capital. Underlying these determinants

of productivity growth, however, is a more fundamental factor: the willingness of

society to transform itself dramatically, with the confidence that technological

progress and the economic opportunities attending that progress will enable

people to improve their lives. In such a society, economic growth is best fostered in

an environment of economic and personal freedom and government policies that

are focused on erecting sound and stable macroeconomic conditions most conducive to private-sector initiative.

y This paper is an edited version of a lecture delivered by Roger W. Ferguson Jr. to a joint

session of the Society of Government Economists and the American Economic Association at the

meetings of the Allied Social Science Associations in San Diego, California, on January 4,

2004. We are grateful to William English, Paul Harrison, Daniel Sichel and David Wilcox

for their valuable insights on many of the historical examples discussed in the paper; to James

Hines, Michael Palumbo, Lawrence Slifman, Charles Struckmeyer, Timothy Taylor, Mike

Waldman and Joyce Zickler for helpful comments on earlier drafts; and to Jennifer Gregory for

excellent research assistance. The views expressed are those of the authors and do not

necessarily represent the views of other members of the Board of Governors or staff of the Federal

Reserve System.

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