The effect of lower capital costs tends to be stronger for decisions to replace long-lived assets that have not yet reached their physical life limits. Examples include a middle-aged blast furnace or a programmable machine tool. There is very little solid evidence, however, to tell us exactly how much productivity might rise in response to a policy-induced reduction in capital costs. Its volume depends in part upon the cost of investable funds, which can be influenced by government policies. Taxing capital gains at a preferential rate, or reducing the inflation tax on capital gains through indexation, would also encourage investment in high-technology startup companies, which are responsible for a disproportionate share of technological innovations in U.S. industry.
Technological advances are without doubt the most important contributor to economic growth today.
But while the possibilities for raising productivity growth rates through such policies are clear conceptually, their effects are very hard to predict quantitatively. Technical progress and productivity growth are far more difficult to accelerate than a car or space vehicle. While speeding the output of important innovations is critically important to our economic prospects, actually doing so poses difficult challenges. F.M. Scherer is Larsen professor of public policy and management at Harvard University.