All Terrain Thinking

A Compendium of things I think are Important

Economics: It's not just whats' in your wallet

Economic Growth: Where and Why?

We have now seen some alternative means to getting more - territorial expansion, productivity growth, and trade. We have also seen that even small differentials in growth rates can have dramatic effects on the levels of economic activity in the 'long-run.'  It is now time to turn our attention to three questions that we have glossed over - which countries are growing, how do we explain economic growth and will it bring about convergence or divergence, and how do we achieve / promote economic growth? 

At the outset of the discussion, however, it is important to recognize that not everyone has boarded the economic growth bandwagon.  The anti-growth movement has been around for many years and in recent years it has been associated with the environmentalist movement.  It is not hard to see why.   What will happen to the levels of pollution if China ever does succeed in achieving a level of development experienced in the US, if the Chinese turn in their bicycles for cars and if they want TVs, refrigerators, air conditioners and the array of other appliances that require electricity?  If we look at the data on electric energy production we can get a sense of the magnitude of the problem.  In 1990 per capita energy consumed in the US was 10,798 kilograms while in China it was 811. If China were to achieve the same level of energy consumption as the US, total world energy consumption would need to DOUBLE - and that was only China.  It is hard to think of achieving this level of energy consumption without serious environmental degradation.

Patterns of Income and Growth

Why then is growth so important?  One of the reasons is the extent of the inequality that exists and the belief that that this inequality will create pressure by the 'have nots' to reduce the differential - to get their share.   There are two possibilities for redistribution - taking from the rich and giving to the poor or growing and giving the poor a larger share of the growth.  In both cases there will be convergence, but the 'politics' of the two choices will be quite different as the first is likely to be more forcefully resisted.  We see a similar situation when we look at the distinction between real vs. nominal wages.  Although a 2 percent decline in wages in a zero inflation environment is the same as a 2 percent wage increase in a 4 percent inflation environment, the former is likely to be resisted more forcefully than the latter. 

How big is the differential?  BIG. According to the World Bank, in 1997 GNP per capita in the wealthiest countries was 74 times larger than in the poorest countries - a differential that shrinks to 16 times when purchasing power parity measures of GDP are used.

Diagram 1

What does this mean in terms of total world output?  In 1997, the 16 percent of the world's people who lived in the wealthiest countries earned 84 percent of the world's income, while the 55 percent of the population living in the poorest countries earned 4 percent of the world's income.  

Diagram 2

Are the differences in income declining?  Will there be a convergence in incomes?  One way to answer that question is to look at the historical experience of the US.  By the mid 19th century, improvements in transportation and communications technology were increasing the interaction between the high income and low income regions in the US which brought about a pronounced convergence in regional per capita incomes.  Incomes in the Northeast (NE) that were approximately 50 percent above the national average at the outbreak of the Civil War, and in the Southeast (SE) where income had fallen to 50 percent of the national average after the War, began to converge by the late 19th century.  This convergence was so complete that by the late 20th century the differentials had all but disappeared.

Diagram 3

Among the world's high-income industrialized nations, there is also a pattern of convergence.  According to data reported by Maddison, between the years 1870 and 1960 nations with high initial levels of income (Australia) grew more slowly than nations with low initial income levels (Japan).

Diagram 4

The same cannot be said, however, when we move beyond the industrialized nations.  Prichett (1997) has concluded, based on his estimates of per capita incomes since 1870, that there has been a substantial divergence between the incomes of wealthiest and poorest nations.  According to his calculations, the ratio of per capita income in the US to that in the poorest country has risen five-fold between 1870 and 1990 - from nine to forty-five.  Taking a somewhat shorter perspective and using the World Bank's data, we find that some countries have managed to escape the poverty trap, but others appear to have been unable to escape.  In the 1980s the dominant trend was divergence with income per capita growing in the high income countries at a rate of 3.2 percent, higher than the growth rate of the middle and low income nations in all regions except Asia.  The situation changed in the first half of the 1990s with growth slowing to 2 percent in the high income nations so that only sub-Saharan Africa, where income was growing at the same rate, and Central Europe and Asia (Transitional countries of former Soviet Union), where output was actually falling, failed to outgrow the high income nations.

Diagram 5

In addition to the inequity, there has also been a slowdown in economic growth that has affected all of the industrialized countries.  The GDP growth rates in the table below clearly show a slowdown across all of the countries after 1973, a slight rebound in the late 1980s, and a slowdown in the recession of the early 90s.  This slowdown has been the focus of considerable research which we will discuss in the next section as we look at the determinants of growth and try to explain the differentials.  

Economic Growth
(GDP annual rates of change)

	US	Japan	Germany	France	UK
1960-1973	4	9.6	4.4	5.7	3.1
1973-1986	2.4	3.7	1.8	2.3	1.4
1986-1990	2.6	5.1	3.4	3.3	3.1
1990-1992	0.8	3.2	2.2	1.7	-0.9

 

Models of Economic Growth

It should now be quite clear that enormous differences exist in the levels and growth of income and that divergence is an all too common feature of the growth process.  What we now want to turn our attention to is the secrets of growth.  Are there any factors which we can identify that explain the differences - any policies that might be adopted to speed up the process of growth?  This is certainly what Kennedy was looking for in 1960 when he set about the task of getting "the country moving again." It was also Ronald Reagan's goal in 1980 and Bill Clinton's goal in 1992. 

As a first step toward understanding the process of economic growth, let's look at a very simple example where we have Chris, a fisher who spends all day fishing by hand and catches one fish a day - barely enough on which to survive. All of Chris' efforts would be used to meet basic survival needs and as a result Chris' situation would likely be the same in five years as it is today.  Chris lived 'hand-to-mouth' and there was nothing likely to change this since each day was devoted completely to producing enough to survive. 

Output could increase, however, if Chris were able to invest in some capital  - a fishing rod that would allow the catch to rise to five fish per day.  This would be possible if Chris could save some time to devote to creating the fishing rod.  With the investment in this capital, output could increase five-fold.  Chris would use some time fishing and some time building the fishing rods and thus output would be increased - we would have seen economic growth.

The story is not over yet since the higher level of output by Chris would mean that enough food was being caught to feed more than just Chris. One possibility would be the higher level of income allowed Chris the opportunity to have a larger family and that the increase in the number of mouths to feed meant that the larger family was still at a subsistence level.  There may be growth, but there is no progress or increase in the standard of living. 

Fortunately, there is another possibility.  What if Chris used the fishing rod for only one-fifth of the day and caught the one fish needed to survive.  With the time saved by the new fishing rod Chris did some research and came up with a new approach to fishing.  Chris discovered a boat which permitted Chris to fish offshore where there were more fish.  Now the output of fish could be expanded twenty-fold if Chris could use some of the freed up time and produce a boat.  In this situation we are experiencing economic growth and an increase in the standard of living.  If we followed on with the 'logic' we would find that the key to the economic growth was productivity growth.  Furthermore, economic growth had been associated with the creation of an entire new industry, boat building, and you could easily see where this could lead.  There would be a factory that was built to construct the boats, a logging industry to harvest the lumber, a machine-tool industry to make the tools to build the boat.

The first of these possible scenarios is generally consistent with Thomas Malthus' Classical Model of economic growth.  According to Malthus, economic growth could temporarily move a nation above the subsistence level but this produced a population boom and eventually the additional mouths which needed to be fed returned the nation to a subsistence level.   This rather dismal view that economic growth would never allow society to escape subsistence levels, is what got economics dubbed "the dismal science." 

The second scenario is generally consistent with the views on economic growth expressed by Adam Smith.  Smith identified specialization and the division of labor as the keys to economic growth.  If a nation's resources could be employed where they were most productive, then we would get more from these resources. 

The difference between the two views can be demonstrated  with a simple equation - an identity where income per capita [income (Y) divided by population (P)] is defined as the product of two terms. The first of these terms Y/L is labor productivity - how much output (Y) is produced by workers in the labor force (L). The second term is the percentage of the population in the labor force.

(1) Y/P = (Y/L)(L/P)

Using equation (1), with a little more algebra, we can generate an equation (2) for the growth rate (percentage change) in income per capita (y/p). The growth rate in income per capita, a standard definition of standard of living, is the sum of the growth rate in labor productivity (y/l) and the growth rate in the labor force / population ratio (l/p).

(2) (y/p) = (y/l) +(l/p)

Income per capita growth occurs if there is an increase in the percentage of the population in the labor force or an increase in the rate of labor productivity growth.   While these are both sources of growth, there is a significant difference between the two. 

Extensive growth, growth attributed to growth in the participation of the population in the labor force has an upper bound so it cannot be viewed as a permanent source of economic growth.  You can think of this as growth attributed to working harder.  Intensive growth, meanwhile, is attributed to growth in productivity and is sustainable indefinitely and for this reason it has been the focus of considerable research directed at uncovering the 'secrets' of increased productivity.  Where Malthus saw only limited possibilities for intensive growth,  Smith saw enormous potential for this type of growth.

For the possibilities envisioned by Smith to materialize, there needs to be a well developed system of exchange so that you can use your energies to do what you do best and then exchange some of what you produce for other items which you need / want.  Such a system would include markets where goods, services, and resources are exchanged; a medium of exchange to facilitate the transactions; incentives for individuals to engage in economic activity and not simply 'hang out' on the beach. 

If you specialized in what you did, but there was no money and you needed to use barter to find someone interested in a trade, then a considerable amount of time and energy that could have been used to produce something would be wasted in the transactions.  This is why money was invented and why we will examine in some detail the monetary system - who prints it and distributes it.  As for the incentives, property rights which allow people to keep the income from selling or renting the assets that they own - one of which would be their own labor.  Climate also would matter - if you lived on a Caribbean beach where food and water were plentiful there would most likely be less incentive to 'work' than there would be if you lived in New England where you needed to get through the cold winters.  You would also be likely to have less incentive to work if there was no well defined legal system - a problem in Russia as it attempts to make the conversion to a market system. 

The impact of these factors can be seen in some research on economic growth.  The research of Hall and Jones (1997) supports their hypothesis that "an important part of the explanation [of income differentials] lies in the economic environment in which individuals produce, transact, invent, and accumulate skills.   The infrastructure of an economy is the collection of laws, institutions, and government policies that make up the economic environment.  A successful infrastructure encourages production.  A perverse infrastructure discourages production..."   They conclude that infrastructure, as measured by indexes of variables such as the extent of a people's fluency in an international language, scope of private ownership of the means of production, and openness to trade are important, but "distance from the equator is the single strongest predictor of long-term economic success..."  Sala-I-Martin's (1997) study of economic growth identified regional influences (distance from the equator), political factors (rule of law, political rights, and civil liberties stimulating growth and number of military coups and wars retarding growth).  Location also shows up in the Sachs & Warner (1997) study of growth where they find that a nation's location in the tropics or its landlocked status reduce the rate of long-term growth.  Sachs and Warner also include as an explanatory variable  Institutional quality index that is comprised of measures of bureaucratic quality, rule of law, and corruption.  Easton and Walker (1997) have found that there is a relationship between "economic growth and the ownership and market-pricing variables" - economic growth tends to be higher in those countries where governments interfere less with the market mechanism and where economic freedom is higher. 

In fact the analysis of the success / lack of success of the transition of the Eastern European and former republics of the Soviet Union looks very much like the more traditional analysis or economic growth.   Selowsky and Martin (1996) find that the success at restoring growth was related to "progress in liberalization."   Both economic growth and foreign direct investment was higher in those nations that move toward liberalization and privatization.  In an effort to explain the differential response of Poland and Russia to liberalization policies, Frye and Scleifer (1996) conducted a survey of retailers in Warsaw and Moscow and found that the institutional setting was significantly different in the two cities.  In Moscow the government had a more hands on approach at the same time that 'private security' extorted higher payments from Moscow shopkeepers.  Rather than being the helping hand, government was the grabbing hand.

This infrastructure can be considered to be the preconditions to economic growth, but for long-term sustained growth there are additional requirements.  There is a need to do more than simply get bigger, there is a need to get 'different' and move beyond extensive growth to intensive growth.  If a society is to experience long-term sustained growth, then it would be necessary to see continual increases in labor productivity. 

But where do these increases in productivity come from?  The growth in productivity comes from four sources: structural change in the economy, savings and investment, increased quality of labor, and research and development. 

Structural Change

One of the features of economic growth is the structural change that takes place during the growth process.  Agriculture is the dominant industry in the early stage of development, but eventually resources are moved to the industrial sector.  In the US between 1900 and 1940, the share of employment in agriculture declined in the US from approximately 40 percent to 20 percent while the share in manufacturing rose from 22 to 27 percent.  Because productivity levels are higher in the industrial sector, the reallocation of resources from agriculture to industry raises overall productivity levels.  Economic growth would thus have been fostered by the process of industrialization and urbanization - the movement of resources of the farms into the cities and factories. 

Krugman (1994) raised many eyebrows when he reported that the Asian miracles could be attributed primarily to extensive growth - the growth in inputs associated with a structural change as workers left the fields and moved to the cities to work in factories.  At a time when the conventional wisdom was that we were well on our way to the Asian 21st century, Krugman was raising doubts about the ability of Asia to sustain its growth.  Weitzman (1996) examined the situation in the Soviet Union and concluded that the demise of the Soviet Union was attributable to inadequate growth.  According to Weitzman, the early Soviet rulers were able to produce economic growth by the 'forced' build-up of capital and the movement of labor into the factories, but they were unable to get more from their resources and it was this inability to make the transition from extensive to intensive growth that resulted in the slowdown in growth and the uncompetitiveness of the Soviet system. 

This transformation is certainly what we saw in England in the mid 19th century and in the US somewhat later in the century. In fact New England provides one with a wonderful opportunity to see first-hand the changes that accompanied the industrial revolution.   A good place to start would be Plimouth Plantation which provides a view of life in the early seventeenth century.  From there you can move to Mystic, CT or Sturbridge, MA to get a feel for life a century later.  Then it is on to Pawtucket, RI to see the first factory in the US - Slater mill.  Here you can see the first attempt to formalize the production process in what we would call a very small factory.  It is then time to move on to Fall River where you can see the massive structures that housed the textile operations that made Fall River one of the world's leading textile centers in the late 19th century. 

As we move forward into the post WW II era, however, the structural changes may have worked to lower productivity growth.  Since 1940, the share of employment in manufacturing fell from 27 to 15 percent while the share in services rose from 13 to 32 percent.  This move to a post-industrial economy would thus tend to lower productivity growth rates since productivity gains tend to be lower in the service sector than the manufacturing sector.  This is one of the factors that makes it to most lists of factors responsible for the slowdown in productivity in the US in the post 1973 period.

Investment and Saving

Workers efficiency will be increased by the use of physical capital - machines.   If an economy is to grow then then it must be able to produce more than is needed simply for subsistence and then use some of its 'extra' resources to build factories and buy machinery. Intensive growth, therefore, will be related to the extent of the investment a society makes in its future and this in turn depends on the level of savings.   This was a point made by Robert Solow in the 1950s as he developed the outlines of the Neoclassical Model of economic growth.  If savings are high, then the pool of funds available to firms making the investment will be large which will drive down the price of those funds.  As we saw earlier, a decrease in the cost of capital will increase the level of investment spending and thus increase the capital base - a process called capital deepening. 

The growth in productivity that comes from capital accumulation is, however, limited due to diminishing marginal product of capital.  The relationship between output and the capital - labor ratio is described in the diagram below. As the size of the capital base grows (move from K1 to K2), output will increase (X1 to X2), but it will increase at a decreasing rate.   Furthermore, if one also assumes that capital is mobile and technology is universally accessible, then we should expect to see a convergence in national incomes as the result of the process and spread of economic growth. 

Diagram 6

The result of this approach has been the identification of saving as an important determinant of growth.  This has certainly been the that the high savings rate in Japan source of growth.  This was generally accepted without question until the Asian crises of 1997-98 focused attention on Japan.  What emerged was a picture of a nation with too much capital and a system poorly designed to move the capital to support the best ideas.  You also see this in the research of Sala-I-Martin (1997) who finds equipment investment and non equipment investments as significant sources of economic growth. 

Quality of the Labor Force

The level of labor productivity can also increase if there is an increase in the quality of labor.  The investments made in this area would increase human capital.   We have already mentioned some of these investments - language and writing and mathematics.  The ability to keep written records is necessary for the specialization and division of labor that provide the basis for intensive growth.  Imagine keeping even the simple records that are associated with your college bills if there were no accounts, invoices, and agreements. 

It is also true that the increasingly sophisticated scientific analysis requires mathematical sophistication which is at the center of the research into the physical, chemical, and biological processes that were the foundation of the industrial revolution. This is cited as one of the factors responsible for the Asian growth miracles of the last few decades of the 20th century.  In international comparisons of college age students command of science and mathematics, the Asian countries are near the top of the list. 

Technological  Change and Research and Development

The final source of growth is technological change - the discovery of new products and methods of production.  The impact of technological change on output is demonstrated in the diagram below.  Technological change increases the output that is available from any resources which is reflected in the upward shift in the output curve.   With a capital-output ratio of K1, it is now possible to produce X3 units of output.

Diagram 7

Technological change has long been recognized as an important source of economic growth, at least since the pioneering work of Solow and Kuznets.  Solow in 1956 set out the growth accounting framework that divided growth into that component that could be explained by the growth in inputs (capital and labor) and that component that was unexplainable - the residual which was productivity growth.  Of the two sources, it was the residual that was by far the most important determinant of economic growth.   And at least in the simplest versions of Solow's model, productivity growth was exogenous and beyond the control of policy makers or the explanation of theorists - what was called "a measure of our ignorance" by Abramovitz (Dougherty and Jorgenson (1996))

In the 1990s there was a considerable amount of effort exerted to reduce the level of our ignorance of the process of productivity growth.  In the New Growth Theory research, technological change is viewed as an endogenous factor and the innovation process, is affected by the nation's structure and policies.  A nation will grow faster, will have faster rates of technological change, if there are incentives to innovate and this focuses attention on those factors that induce innovation. 

According to Romer (1996), new growth theory is based on a new division of the world's inputs.

"New growth theorists now start by dividing the world into two fundamentally different types of productive inputs that can be called "ideas" and "things."  Ideas are nonrival goods that can be stored in a big string.  Things are rival goods with mass (or energy).  With ideas and things, one can explain how economic growth works. Nonrival ideas can be used to rearrange things, for example, when one follows a recipe and transforms noxious olives into tasty and healthful olive oil.  Economic growth arises from the discovery of new recipes and the transformation of things from low to high value configurations. . . .

It emphasizes that ideas are goods that are produced and distributed just as other goods are.  It removes the dead end in neoclassical theory and links microeconomic observations on routines, machine designs, and the like with macroeconomic discussions of technology."

Where then does one look for the sources of comparative advantage in the production of ideas?  Crafts (1996) and Romer (1996) find that this perspective sheds considerable light on the growth in the US that eventually eclipsed growth in England.   The key difference, and one beyond the control of any policy official, was the scope of the American market.  The larger size, greater homogeneity, and better transpiration system of the US market meant that the returns to the ideas would be larger there. 

And there are other factors that contribute to differences in the production of ideas.  Romer identifies institutions like the United States Geological Survey, the private university, the large multidivisional firm, and the specialized research laboratory" as also being important.  Crafts (1998) suggests that productivity growth depends on technological progress, which in turn results from the profit-motivated allocation of resources to the search for innovations.  This requires that innovators can appropriate returns from their successful searches, which implies that innovation is taking place in an imperfectly competitive environment.  The incentives to innovate in such models are typically increased by larger markets, by improved supplies of human capital, by greater productivity of labor in research, and by reduced fears that rewards will be expropriated by other agents or by government." 

Why did growth slow and how do we promote faster economic growth?

We have now identified a set of four factors that are associated with economic growth and it should come as no surprise that this is where we begin the search for explanations for the slowdown in growth after 1973 and policies to stimulate growth.   First, however, let's look at the track record to see what has happened to growth in the US since 1973.  In the table below we see that the slowdown was not peculiar to the US with growth rates in the 1973-86 period less than half the rate in the 196073 period. 

Annual Growth Rates

	US	Japan	Germany	France	UK
1960-1973	4	9.6	4.4	5.7	3.1
1973-1986	2.4	3.7	1.8	2.3	1.4
1986-1990	2.6	5.1	3.4	3.3	3.1
1990-1992	0.8	3.2	2.2	1.7	-0.9

What is not evident in the slowdown was a changing composition of growth.   In equation 2 the decomposition of growth into its extensive and intensive components was specified and the data for the US appears in the table below. In the earlier period, output per worker accounted for nearly 60 percent of economic growth, more than twice its share in the latter period. Working in the opposite direction was the growth in the labor supply. This accounted for 33 percent of growth in the latter period, but only 2 percent in the earlier period. Not only did we see growth slow, but we saw a shift to extensive growth.  Output growth was sustained by increases in the employment / population ratio that were the result of increases in the labor force participation of women, specifically married women, and the movement of the baby boomers into the labor force.  While these developments may have softened the decline in growth, they are not sustainable.

The US Track Record

	y	l/p	y/l	p
48-73	3.92	0.08	2.32	1.48
73-94	2.54	0.84	0.69	0.99
48-94	3.29	0.43	1.57	1.26

So how do we explain the slowdown?  Three factors have been identified as contributing to the slowdown.

• composition of output
• energy shocks
• regulation of industry

We have already mentioned the first of these.  In the 1950s and 1960s resources in the US economy were being shifted from agriculture into industry which put upward pressure on productivity growth rates, but by 1970 the situation had changed.  The 1970-1990 was a period where the economy experienced a movement from the high productivity growth manufacturing sector to the low productivity growth service sector which could be expected to lower overall growth rates.   The relationship between the service sector, productivity growth, and inflation is a key to understanding a feature of the modern industrialized nations - the cost disease of the service sector.

In the energy crises of the 1970s the industrialized nations experienced dramatic increases in the cost of energy.  Almost overnight many factories and a good deal of the transportation capital (autos and planes) became obsolete.  The cost of running an old, energy intensive factory simply made no sense in a high energy cost world and the factories were taken off-line.  The same could be said of gas guzzling autos and planes and as a result there was a reduction of the capital base which would lower the productivity of labor.  In the output diagrams, this would cause a shift to the left in the capital/output ratio which would lower total output and thus reduce any measure of labor productivity.

The third factor was the growth in regulation - most notably environmental regulation. In the 1970s US industry was 'forced' to invest in technology to clean up the production process.  While this may have reduced the amount of environmental degradation that accompanied the production of the nation's goods and services it lowered labor productivity growth.  Funds that historically would have gone into increasing labor productivity went into environmental productivity.

How should the government get involved in speeding up growth?

To answer this we can look at each of the four contributors to growth. 

Subsidize research and development:  The modern growth theory points out the public good nature of technological change and the benefits shared by all of these improvements.  It is not a surprise then that there have been a movement to expand government support of research and development spending.  

Improve quality of labor: In those tests of scientific and mathematical ability that the Asian students did so well in, the US ended up at the bottom of the list which has raised concerns about the ability to sustain the technological leadership if it falls behind in investment in human capital.  This identification of labor quality as an important source of economic growth combined with the poor international performance has centered attention on reform in the formal education system in the US.

Structural change:  In the growth process there will be industries in decline and growing industries and growth will be higher if you have more winners.  This has led to government policies to 'pick winners' by directing funding into those industries.  This process of targeting industries, known as industrial policy, has been hotly debated in the US.  Many supporters of the idea pointed to Japan success with MITI as an example of the success of this type of government involvement, while others wonder why government bureaucrats will have any better luck picking winners than the private sector.  In Rhode Island in the early 1980s a proposal that included a state funding of start-up money known as The Greenhouse Compact was put before the people and soundly defeated.

Stimulate savings and investment:  A key ingredient in the process of growth is the level of investment spending, but the level of spending is dependent upon the pool of available savings.  The Asian miracle economics were often cited as the models for this and this led to policies designed to increase savings.  As we will see later, Ronald Reagan used the expansion of the pool of savings as one of the elements in his supply-side economics platform. 

You could also attack the problem of investment spending directly.  You could reduce the cost of investment indirectly through tax cuts targeted at investment spending.  This is precisely what Kennedy proposed, and got, in 1962.  The theoretical basis for fine-tuning the economy and speeding up the growth process with an investment tax credit can be demonstrated with the AS - AD diagram. The shift in the AS curve from AS to AS' can be thought of as a shift in potential output which is the result of some combination of increases in inputs and productivity. Where the economy actually ends up depends upon the shift in aggregate demand. In the example below, the shift in AD matches the shift in AS - the result being that output expands with no upward pressure on the price level. If the demand curve shifts out further than shown, the result will be a higher level of output and a higher price level.

Diagram 8
Economic Growth

It wasn't until after the Summer of 1961, however, that the policies derived from the theoretical discussions of growth began to take shape. By then the tax cutters had gained the upper hand in the debates over the proper course for government policy and by the Fall of 1962 the first piece of the tax cut plan was in place. In September and October new depreciation schedules were adopted and the Investment Tax credit bill was passed, initial steps toward faster growth.

If there was to be a second step, it would have to be after a significant national debate that in many respects resembles the one that would take place in twenty years. The budget balancers had assembled some powerful spokespeople including President Eisenhower who spoke in favor of not only a balanced budget, but elimination of national debt. President Kennedy, sounding very much like Keynes thirty years earlier, indicated that our choice "is not between deficit and surplus but between two kinds of deficits: between deficits born of waste and weakness and deficits incurred as we build our future strength." The secret was the multiplier, "the $8-9 billion added directly to the flow of consumer income would call forth a flow of at least $16 billion in added consumer goods and services." Finally, three months after President Kennedy's assassination, the second step was taken with passage of the Revenue Act of 1964 - a combination of tax reform and tax reduction. Individual income taxes were cut and the progressivity of the tax schedule was reduced, while corporate taxes were cut and the investment tax credits of 1962 broadened. We had now seen the adaptation of the Keynesian anti depression model to deal with recessions.

Ronald Reagan would follow suit two decades later with passage of tax reform package in 1981.  By lowering the cost of investment with accelerated depreciation and an investment tax credit, Reagan hoped to stimulate investment spending that would get the economy growing again.

The death of the business cycle and the promise of unbroken economic growth proved to be a bit premature.  after a rebound from a brief slowdown in 1970, the US economy fell into the abyss of high inflation and low unemployment in 1973 that ushered in a decade of stagflation.  By the end of the decade, there was a need to rethink economic policy and the theories upon which it was based.  In our discussion of the 1970s we will examine the dramatic changes in monetary policy that closed out the 1970s and then we will look at the fiscal policies of Ronald Reagan in the early 1980s.

 

 

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