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Macroeconomics' Technology' and
Economic Growth: An hn~oduction
to Some Importar~t Issues
MICHAEL J. BOSKIN
It is incumbent on all of us to attempt to understand the relationship
of macroeconomic policy, technical change, and economic growth
much better than we do today and to make sure that this information,
as it is generated, is used in the evaluation of economic policy.
This chapter provides an introduction to some important issues in the
interrelationships among macroeconomics, technology, and economic growth.
Too often, technology is taken for granted and assumed to be exogenous in
the analysis of economists. Similarly, those concerned with technology com-
plain about the macroeconomic environment and macroeconomic policy, but
have neither the time nor the resources to analyze how the macroeconomy
affects technological advances and subsequent economic growth. And among
economists? there is substantial division of labor; macroeconomists have little
interaction with those economists generally working on issues of technology,
and neither of these groups has much interaction with growth economists.
My purpose in this chapter is to provide a heuristic, and impressionistic,
introduction to various issues and events common to macroeconomics, tech-
nology, and economic grown. The next section presents a taxonomy of the
major economic issues in macroeconomics: fluctuations in output, employ-
ment, and price levels; long-run trends in real economic grown; and issues
in the composition of output. It suggests that while economic fluctuations
may at times be induced by technological occurrences, and certainly the
overall relative stability of the macroeconomy may influence investment in
new technology and its dissemination, the major issues in economic fluc-
33
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34
MICHAEL J. BOSKIN
tuations are probably less important for understanding the relationship be-
tween technology and economic growth than is an understanding of the details
of the underlying long-run growth potential of the economy. It also argues
that the relationship of technology and economic growth may be substantially
affected by what might be called "second-tier macroeconomic policy": the
composition of government spending among R&D and investment, on the
one hand, and consumption and transfer payments, on the other; the structure
of the tax system used to raise given levels of revenue; and the influence of
monetary and fiscal policies on the private economy's decision making.
The discussion then turns to venous debates in macroeconomics concerning
the structure of the economy and the efficacy of economic policy. It introduces
some important but subtle issues to the concemed noneconomist. Included
are brief discussions of the economic history of the 1970s; current debates
among Keynesians, monetarists, "new classical" macroeconomists, and
supply-side economists; and my own tentative conclusions concerning some
basic issues of macroeconomic policy.
The final section returns to the discussion of issues relating to technology
and long-run economic growth and provides a partial research agenda on the
subject of the macroeconomics of technology and economic growth, given
the discussion in the preceding sections. It also points out that the micro-
economics of technology and economic growth are likely to be at least as
important as the macroeconomics thereof.
ISSUES IN MACROECONOMICS RELATED TO TECHNOLOGY
Macroeconomics- a study of the overall economy as opposed to that of
a particular firm, market, or industry primarily deals win three interrelated
issues. First, macroeconomics is concerned with fluctuations in the overall
economy, Ocularly fluctuations in output, employment, and the price
level. Thus, it is concerned win the causes and consequences of inflation
and recession. Analyses of this first issue invariably focus on policies to
dampen the amplitude or decrease the frequency of such fluctuations. The
primary policies on which such analyses focus are monetary policies (which
affect the supply of money and credit to the economy) and fiscal policies
(changes in Me rate of government spending on goods and services or in
Aces and debt). The primary controversies in macroeconomics concern He
potential efficacy of monetary and fiscal policies (or a host of over policies)
in controlling economic fluctuations. Based on alternative conceptual models,
different evaluations of empirical (primarily econometric) analyses, and the
study of historical experience, various schools of thought have developed
concerning both He efficacy and the propriety of active use of monetary or
fiscal policy in attempting to control economic fluctuations. Some of these
different opinions are described below.
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MACROECONOMICS, TECHNOLOGY, AND ECONOMIC GROWTH
35
Second, macroeconomics is concerned with the long-run growth of He
economy's potential and actual output. Just as bouts of inflation and persistent
unemployment have motivated much of the study of economic fluctuations,
so differentials in the growth of various measures of the standard of living
motivate much of the analytic and empirical interest ~ economic growth.
Across time in any county and across countries over any span of time,
differences in growth rates, as in inflation and unemployment rates, can be
substantial. This naturally spurs He scientific curiosity of growth economists.
What factors are associated with differences in growth rates in the short or
long run? And, as usual, not far behind the "positive" economist seeking
to explain the observed economic phenomenon comes (often in the same
person) the normative economist: How can we increase He growth rate?
What is the optimal rate of economic growth? In my opinion, the study of
economic growth is as important, if somewhat less suited to the short-run
political time horizon, as Hat of economic fluctuations. Modest variations
in growth rates compounded over, say, a generation or two, can drastically
alter the nature of an economy and a society. One need only look at the
performance of the United Kingdom relative to that of the United States,
Germany, and France to realize how easy it is for a society to transform
itself from the wealthiest on earn to a relatively poor member of the advanced
economies.
The studies of economic growth usually attempt to decompose the rate of
grown of real GNP—or some related measure into He contributions of
venous factors thought to explain it. These include such factors as increased
labor input, increased capital per worker, improved resource allocation, and
a general category labeled "technical change." If we are examining the
ability of the economy to improve standards of living per capita, for example,
then He growth of real GNP per worker will depend heavily on the capital-
labor ratio, the rate of technical change, the rate of improvement in the
quality of the labor force, and other factors.
The phrase "economic growth" is often misused in political and media
discussions. Often, these discussions are concerned with growth over a few
quarters, perhaps from the trough of a recession. An economist focusing on
the long-te~ growth rate has a much longer time horizon and attempts to
"net out" cyclical fluctuations. For example, it turns out that increases in
real per capita income over the last century in He best-performing advanced
economies have averaged a little less than 2 percent per year. While this
number is substantially larger in less-developed counties during periods of
rapid growth, let us take something like 1.5 to 2 percent as a range of
reasonable long-run growth performance. Now, compound real per capita
income over two generations in two hypothetical, initially identical economies
at 1.5 percent and at 2 percent, respectively. The more rapidly crowing
economy becomes one-third again as wealthy as the less rapidly growing
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36
MICHAEL J. BOSKIN
economy. Thus, we are evaluating differences of fractions of a percentage
point in the long-term growth rate in attempting to assess our growth per-
formance. Increasing He growth rate (at minimal opportunity costs) per-
manently by a few tenths of a percentage point may not sound very exciting ,,
but it is an enormous economic and social achievement.
Policies designed to alter the rate of economic growth directly tend to
focus on enhancing technological advances, the quality of the labor force,
and the level or rate of growth of capital per worker. It is important to note
that the only way to raise the long-n~n growth rate permanently is to increase
the rate of technical change or to increase the rate at which the quality of
the labor force is improved. Loosely, the rate of technical change is affected
by R&D expenditures, and the rate of improvement of the quality of the
labor force is affected by investment in human capital, such as education
and training. A policy that can lead to higher levels of income and a tem-
porarily higher growth rate is one that increases the capital-labor ratio (for
example, by increasing the rate of investment and net capital formation).
But such a policy will lead only temporarily to a higher growth rate, although
it will lead permanently to a higher level of income. This is not just semantics.
The situation is described in Figure 1, in which we see the economy's original
growth path (labeled D, given its presumed (for the moment exogenous)
constant rate of technical change. Real per capita income grows at the rate
of technical change and labor-quality improvement, given the capital-labor
ratio. Now along, comes a policy, perhaps tax policy, that increases the desired
capital stock of firms (or perhaps more accurately, the desired wealth of the
population, relative to levels of income). This leads to an investment boom
for a span of years, which will cause a spurt in the short-run growth rate
along the dotted path in Figure 1 until we get to the new long-mn growth
path (labeled 21. Note that the level of per capita income is permanently
higher along (2) than on growth path (1), but that once the transition to the
new growth path is complete, the rate of economic growth (given by the
slope of the output curve) returns to the original rate given by the underlying
factors of the rate of technical change and improvement in labor-force quality.
Anticipating somewhat the discussion below, one is immediately struck
by the issue of what caused this rate of technical change. Clearly, it has not
been constant; this is just a convenient abstraction. But is it really exogenous?
Are there economic policies that can permanently affect it? Are those policies
worth the cost of enacting them (for example, foregoing some current con-
sumption in order to finance R&O expenditures)? ~ shall return to this issue
below. But it is already clear that technology lies at the heart of the second
great issue In macroeconomics.
Another concern involves the relationship of these two issues of macro-
economics. Is it the case that, in an economy subject to wider swings, to
booms and busts, Can occur in a more stable economy, the rate of technical
change is likely to be systematically different and that, therefore, controlling,
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MACROECONOMICS, TECHNOLOGY, AIRED ECONOMIC GROWTH
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FIGURE 1 Alternative growth paths: technical change and capital fonnation.
37
economic fluctuations, if it is possible, might increase or decrease the long-
nan underlying rate of growth? And is it possible that in an economy with
an environment which promotes long-te~m growth and rapid technological
advance, more severe economic fluctuations are more likely? Or less likely?
Does the promotion of technological change imply greater flexibility in adapt-
ing our institutions to technical change? Or, does it imply greater short-tenn
disruption in the economy?
Finally, a host of policies designed to protect jobs or the capital in particular
industries (e.g., tariffs, government loans, and other subsidies) may impede
the adoption of new technology in favor of the short-term goal of mitigating
the economic distress caused by economic fluctuations or industry- or region-
. ~ . . .
specific torelgn competition.
While economic growth is good for the population as a whole, its benefits
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38
MICHAEL J. BOSKIN
accrue unevenly. Much of our economic policy is designed to promote equity
or spread the cost of economic disruption more evenly. Sometimes, unfor-
tunately, these noble goals result in policies that impede growth.
The third major issue in macroeconomics closely related to the two
above—concerns the composition of the various components of aggregate
output, such as consumption, investment, government expenditures, and net
exports. Factors primarily affecting (in the first round) any of these major
components of GNP obviously also potentially affect He level of aggregate
demand and, therefore, the fluctuations in output, employment, and the price
level. It is likely that the policies that most directly affect the generation of
new technology, and therefore lon:,-term growth, occur here, one layer down
from aggregate GNP, at the level of the components of spending in the
economy. For example, while some people still focus on the level of real
government spending in the control of economic fluctuations, the composition
of that spending among research and development expenditures and physical
and human investment, versus payments to individuals for income support,
net interest, and purchases on noninvestment types of goods and services,
obviously can affect the rate of technical change. Probably the most important
of these is direct government support of research and development. Table 1
presents data on recent trends in federal ~,ovemment expenditures on R&D,
physical investment, and other categories of government spending. As can
be seen from the table, current real government spending on R&D and real
government physical investment are both substantially lower as a percentage
of GNP than in Me 1960s, although defense investment and defense R&D
have made something of a comeback in the last few years.
Tax policies make up a second set of policies that, by affecting the way
in which the private sector utilizes its resources, can affect the generation
of new technology. Again, the first major issue, economic fluctuations, tends
to focus on the aggregate level of taxes and changes in total tax receipts.
But the structure of the tax system can affect substantially He rate of in-
vestment in the economy and the rate of R&D spending by changing the
costs of such spending relative to other activities a firm might use to produce
its current or prospective new product, and the methods by which it does
so. Recent examples include a series of changes in depreciation schedules
beginning in 1954, the investment tax credit introduced in 1962, the various
swings in the differential treatment of long-term capital gains, and the R&D
tax credit, to name but a few.
Monetary policy also can affect the composition of output, as well as the
level of aggregate demand in the economy. Monetary policy potentially
affects the before-tax cost of capital, interest rates and their tea structure,
and ~us, the real cost of embarking on R&D or investment projects.
Finally, it is important to note some potential interactions among major
categories of spending and the rate of technical change. Either of two
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40
MICHAEL J. BOSKIN
appealing but difficult-to-document conjectures would imply that a society
with a high investment rate would not only have a temporarily high growth
rate in its transition to a higher growth paw (as in Figure 1) but actually
could increase the long-run rate of growth. These are the so-called learning-
by-doing and embodiment hypotheses. The former reflects the anecdotal
notion that in the process of investment we learn new ways of doing things,
such as new production processes, and new potential products become known.
Thus, the rate of investment affects He rate of technical change in a positive
manner. This process is displayed by growth path number (3) in Figure 1.
At the microeconomic level, consider the options opening up in the course
of a major project, e.g., of] exploration in the frozen tundra or the ocean
depths. Just as new technologies arise sometimes to meet such chal-
ienges, He rate of technical advance may depend on He level of investment.
The embodiment hypothesis entails the notion that it is much too expensive
to embody new technology in old capital by converting it and, therefore,
that the rate at which new technology really does augment the productivity
of labor and machinery will depend on the rate at which new capital is
generated, i.e., our investment rate. ~ shall return to these issues below.
Thus, three very important issues in macroeconomics, which concern the
short- and long-run standard of living of our citizens, drive much of our
economic policy. They are concerned with economic fluctuations, long-run
grown, and a detailed examination of the composition of output. The three
issues are interrelated in many ways, only some of which have been hinted
at in this discussion. Underlying each issue is He current state of technology
and the rate at which new technology enables us to produce more goods and
services with the same labor input. Before turning to a more detailed dis-
cussion of some of these grown issues and a partial research agenda, I want
to develop a framework for analyzing, or at least a perspective on, some of
the different schools of thought in macroeconomics Hat get so much press
attention.
CHANGING VIEWS ON A CHANGING ECONOMY:
ALLEGED CRISIS IN ECONOMICS
Macroeconomic analysis underwent significant changes in He 1970s as
He prevailing Keynesian theories were found wanting in accounting for
emerging economic events. Keypesian economics placed great fain in the
government's ability to "fine-tune" He economy Trough aggregate demand
management—which means constant adjustments in He level of taxes, gov-
ernment spending, and He money supply. Keynesian analysis stressed He
importance of the multiplier effect and the short-run ~ade-off between in-
flaiion and unemployment, popularly known as the Phillips Curve. In He
Keynesian perspective, policymakers could simply direct policy to achieve
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MACROECONOMICS, TECHNOLOGY, AIRED ECONOMIC GROWTH
41
the most desired combination of unemployment and inflation rates, e.g., they
could maintain low unemployment by accepting some fixed, stable level of
inflation. Unfortunately, events both worldwide and in the United States in
the past 15 years have demonstrated the naivete of these Keynesian models
and policy prescriptions.
While there is no single model of the economy around which consensus
can be reached, substantial strides have been made in improving our under-
st;anding of the operation of the economy, which Is much more complex and
subtle than had been presumed in earlier models. Since the economic events
of the 1970s were so important to the decline in the acceptance of earlier
models, there follows a whirlwind tour of the economic history of the 1970s.
Economic Events of the 1970s
The most important economic event from the late 1960s to the early part
of this decade was the tremendous slowdown in economic growth. In the
decade from 1973 to 1983, the standard of living for most working, taxpaying
Americans improved hardly at all. This contrasts with the roughly 2 percent
per year growth in real per capita income discussed above and the 2.5 percent
per year growth in the period 1948 to 1973 in the United States. While the
cause of the slowdown is disputed, its consequences are not: it was without
a doubt, for example, a major cause of the tax revolt. Among explanations
advanced for the slowdown are reduced sector-specific rates of technical
change, a slowing rate of increase in the capital-labor ratio, energy price
increases, changes in the legal environment, shifts in the economy toward
services, and changes in the age and sex composition of the labor force. One
major school of thought, to which I subscnbe, is that a major culprit in the
slowdown was the decline in the incentives to produce income and wealth.
Reasons for these declining incentives include rising marginal tax rates,
especially on the return on saving and investment; high and rising inflation,
which greatly increased uncertainty about the returns on investment and
saving; and the growth of government regulation. Undoubtedly, many other
causes of the slowdown in growth and, by implication, potential remedies
to restore our long-term growth can be found and defended; an exact allocation
of the slowdown by cause is still a subject of some dispute, and additional
research on the subject continues to be a high pnonty.
To place some of these issues in perspective, recall that the 1950s through
mid-1960s were years of relatively low inflation, about 2 percent per year,
on average. Substantial inflation occurred in the United States primarily with
the removal of price controls at the end of wars. We have not experienced
anything like the hyperinflation that ravaged Central Europe in the 1920s or
the substantial inflation recently experienced in Latin America and Israel.
Indeed, by intonational and historical standards, our inflation was quite
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42
MICHAEL J. BOSKIN
modest. But recall that our current 4 percent inflation is down from double-
digit rates in 1979-1980. To place this in perspective, President Nixon
imposed wage and price controls when inflation was no higher than current
levels.
Certainly the energy price shocks in the 1970s caused a substantial dis-
ruption in our economy- most importantly, a transfer of wealth from Amer-
ican consumers of energy to producers outside the United States. Although
these price shocks and our reaction to them probably contributed to the
inflation, increases in energy prices caused no more than 3 percentage points
of the double-digit inflation rate in 1979-1980. It was only a few years ago
that both economists and politicians understated the cost of high and fluc-
tuating inflation and oversold its benefits in permanently reducing unem-
ployment. It was common to argue that we could learn to live with double-
digit inflation merely by indexing venous features of our contracts, tax
system, and the like. Numerous studies, however, such as those by Martin
Feldstein, Stanley Fischer, and Franco Modigliani, illustrated how inflation
distorts incentives and increases uncertainty about future returns.
The 1970s destroyed the notion of a stable Phillips Curve relationship
between inflation and unemployment. If there ever was a short-run trade-
off, conditions for it have worsened considerably, and it is probably simply
a statistical artifact.
Government spending increased substantially in the United States in Me
1970s, but more significant was the change in its composition, both by level
of government and by type of expenditure. By the late 1970s, exclusive of
interest on the national debt, the federal ~,ovexnment was spending more on
transfer payments to individuals than on purchases of goods and services
(see Table 11. By dollar volume, the federal government's major role by
1980 was to redistribute income, not provide goods and services. While the
result was a sharp reduction in poverty, the cost was staggering because the
benefits were not targeted very effectively toward the poor. Accompanying
the growth of spending, was the large increase in effective marginal tax
rates the tax paid on incremental income. The fraction of American tax-
payers subject to high marginal tax rates quadrupled between 1966 and 1980.
No longer were high marginal tax rates exclusively the right of the rich.
While somewhat controversial with respect to measurement problems, the
rates of saving and investment in the United States, I believe, have declined
substantially, and, in addition, there has been a bias toward shorter-lived
assets. The share of GNP devoted to net nonresidential investment fell from
the already dangerously low level of 7 percent in the 1950s and 1960s to
only 2 percent in the late 1970s. It fell precisely at a time in which it should
have been rising to equip the additional (primarily young and inexperienced)
20 million workers with the capital and technology to make them productive.
While unemployment remains a problem, an amazing achievement of our
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MACROECONOMICS. TECHNOLOGY, AND ECONOMIC GROWTH
43
economy in the 1970s was that we absorbed 20 million additional workers
into the labor force. This influx occurred primarily because of the maturing
of the baby-boom generation and the substantial increase in the number of
second earners in families, primarily working women.
Other major structural changes occurred In the U.S. economy. Besides
the demographic bulge described above, the changes included a shin in output
away from manufacturing to services, the growth of world trade (sparked by
venous rounds of tariff reductions), the move from fixed to flexible exchange
rates, and the energy price shocks.
Economic policy was also changing. The Kennedy-Johnson tax cut of
1964 was the first major attempt to manage aggregate demand when the
economy was not even in a recession. The growth rate was too low, it was
argued, and a tax cut could stimulate it. In the early 1960s, inflation in
various sectors was dealt with by federal jawboning and threats, such as the
proposal to dump excess supplies of government commodities onto the market
if prices rose too rapidly. The Federal Reserve Board through 1979 continued
activist attempts at managing demand through frequent changes in monetary
policy.
The 1970s were also marked by schemes to control wages and prices in
an attempt to control modest inflation, such as the administrative bureaucracy
spawned by various-guidelines under the Carter administration. The notion
Tat you could hold down wages and prices and control inflation through
moral suasion and presidential support for cooperation between businessmen
and unions was at best naive. Thousands of price decisions are made daily
and an attempt to keep ~ large subset of them under control would have led
to a governmental nightmare so costly as to be beyond any possible gain.
Since only about 20 percent of our labor force is unionized, it was strange
to believe that hammering the wage demands of the larger unions could be
the primary method of controlling inflation.
The 1970s also saw the growth of government regulation of energy matters
and new social regulations that attempted to correct perceived market failures
in such areas as pollution, safety, and health. Fortunately, a general move
to deregulation in traditionally regulated activities began in the late 1970s
under President Carter.
Where were we headed with these economic policies? It is useful to recall
various proposals made only a few years ago. One example is the proposal
for a national reconstruction bank to help revitalize American industry. An
appointed group of business and labor leaders would decide where tens of
billions of dollars of badly needed capital would be allocated. Fortunately,
we were saved from such a policy, perhaps by the results of the election of
1980. One need only look at recent attempts in the United Kingdom, New
Zealand, Mexico, and France, among others, to gain some perspective on
direct government capital allocation schemes.
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MICHAEL J. BOSKIN
ineffective as long as they are anticipated. The new classical macroeconomists
conflict with Keynesian analysis in their judgment of the fluidity of market
adjustments, the extent to which a full set of markets exists, whether markets
clear quickly at competitive pnces, the length of infonnation and recognition
lags, and how expectations are formed.
Clearly, the failure of Keynesian theory to explain Me major economic
problems of the 1970s was a compelling reason for the emergence an
acceptance of at least some components of new classical macroeconomics.
Many of the new analyses stress the importance of a longer time honzon,
the role of expectations, and the role of incentives in the behavior of firms
and households, and therefore, the overall economy.
Focusing on expectations and time horizons has important implications
for both monetary and fiscal policies. Consider what happens when an activist
(Keynesian) demand-manager uses a particular short-run macroeconometuc
model (call it Model A) to guide the choice of money growth over, for
example, a decade. As Lucas (1981) notes:
If we can see that Model A gives us an inaccurate view of the "long-run," then we have
conceded that it leads us to bad short-run decisions because these decisions are sufficient
to dictate our long-run situations as well. (This is not a hypothetical story of the 1980s,
is it? It is a history of the 1970s.)
A parallel critique of He efficacy of tax cuts to spur spending was elab-
orated by Barro in the so-called Ricardian equivalence theorem. Briefly, the
argument is that for a given level of government spending, a tax cut really
does not increase the wealth of consumers, but merely postpones their taxes,
because the present value of future taxes to pay the interest on the new debt
will equal the size of the tax cut. Under some fairly strong assumptions about
the types of taxes available to the economy, bequest behavior, and other
things, Barro demonstrates that there will be no changes in spending and,
therefore, no stimulative effect through fiscal policy. Note the impact of
expected future taxes and the desire to undo a shift of liabilities to future
generations by spending less oneself and increasing bequests. Thus, while
only illustrative, the work of the new classical macroeconomists casts con-
siderable doubt on the traditional fiscal and monetary remedies for fine-
tuning the economy's fluctuations.
While Keynesians, monetarists, and new classlca1 macroeconomists were;
debating He efficacy of demand management in controlling economic fluc-
tuations, a substantial amount of research has also addressed the effects of
economic policies on incentives to work, save, and invest. The work of
Feldstein, Jorgenson, Heckman, Hall, Hausman, and Boskin, among many
others, has revealed that changes in real after-tax refilms to saving, invest-
ment, and labor supply have had far greater incentive effect on those factors
of production than had previously been ~ought. These studies and others
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MACROECONOMICS, TECHNOLOGY. AND ECONOMIC GROWTH
47
gradually began to have some influence in macroeconomics, as relative pnces,
as opposed to just short-run income flows, began to be included in the
analyses. The change in emphasis away from short-te~ cash flows to relative
prices and away from aggregate demand management to concern about the
economy's potential to produce more output and the increasing concern over
the slowdown in productivity growth brought with them the name "supply-
side economics." The effects of taxes, inflation, and other government pol-
icies on the factors of supply are complex. The studies in the 1970s and
early l980s form the empirical base for supply-side economics and the counter
to the Keynesian argument that the level and structure of tax rates, as well
as other policy variables, were of only second-order importance relative to
the size of the tax take. Supply-side economics was oversold by many in
the recent political-economic history of the United States. There never was
evidence that the response to a broad across-the-board tax cut, for example,
would be large or immediate enough to be self-financin:,. Debates continue
about how large these incentive effects are and how quickly they occur, i.e.,
what policies will get the biggest bang for the buck. Thus, the growth and
productivity slowdown, and new theoretical and empirical research by econ-
omists, shifted emphasis in economics toward renewed attention to what was,
after all, its original question: the causes and consequences of long-term
economic growth.
Before turning to a partial research agenda concerning the ma~roeconomy,
technology, and economic growth, let me just add that in addition to Me
intramural disputes among Keynesians, monetansts, new classical macro-
economists, and supply-side growth advocates, a very important set of de-
velopments occurred that have influenced the thinking of economists about
both short-run economic fluctuations and long-ran issues. This is the tre-
mendous internationalization of both trade and capital flows.
Until recently, the overwhelming majority of economic analyses, whether
Keynesian or monetanst, with or without rational expectations, were done
in the context of closed economies. The conclusions of many of the traditional
analyses are subject to substantial alteration when one opens up the economy
to trade and capital flows. For example, the stimulative impact of fiscal
policy, guise aside from any Ricardian equivalence issues, is substantially
dampened if there are rapid movements of capital in response to interest
differentials and substantial trade responses to changes in relative prices of
currencies. For example, consider an economy, such as that of the United
States, in which taxes are cut to stimulate aggregate demand. The full impact
of the demand stimulus will be offset substantially because the deficit will
cause a small increase in interest rates, attract foreign capital, appreciate the
dollar, and deteriorate net exports. Indeed, in the 1981-1982 recession, Filly
47 percent of the decline in U.S. real GNP was in net exports! Thus, the
demand stimulus will be substantially offset.
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48
MICHAEL J. BOSKIN
Also, the substantial flows of capital put a severe brake on the extent to
which, at least in the short term, fiscal policies (such as deficit financing of
government spending) will drive up interest rates, since as interest rates start
to nse, foreign capital will be attracted and domestic capital will remain
home, thereby offsetting some of the drag in capital markets caused by the
deficit. Currently, for example, fully one-half of He huge federal government
deficit is being offset by foreign capital flowing into the United States and
less U.S. private capital flowing abroad. How long this will continue no one
knows, but it is a stark reminder that, at least in the short run, analyses based
on a closed economy can be substantially mistaken.
RECENT ECONOMIC POLICY
While the reduction in inflation and marginal tax rates, the increased
investment and saving incentives in He 1981-1982 tax reforms, and reor-
dered budget priorities are substantial achievements, much remains to be
done to improve the prospects for long-run growth. Our budget dilemma
may ultimately cause severe problems for capital formation, and there is a
possibility that He pro-capital-formation tax changes may be repealed. Much
controversy surrounds the likely impact of large current and prospective
budget deficits on capital formation and growth.
Table 2 shows the base-line budget projections of He Congressional Budget
Office, assuming no changes in the laws governing taxes or entitlement
spending and including the off-budget spending of $15 billion. (lust to give
an idea of He problems in government budgeting, we now have an official
category called off-budget spending, though it Is only a minute fraction of
the total off-budget spending!) But the government does numerous other
things Hat do not get included In He category of off-budget spending. Also
shown in Table 2 is the debt held by the public as a percentage of GNP and
TABf E 2 Base-line Budget Projections, Concessions Budget Office
(fiscal year)
1983 1984 1985
Actual Actual Base 1986 1987 1988 1989
Total deficit,a
$ billions 208 185 214 215 233 249 272
Deficit as % of GNP 6.4 5.2 5.6 5.2 5.2 5.1 5.2
Debt held by public,
as % of GNP 35.4 36.7 39.6 41.8 44.0 46.0 41.9
NOTE: Assumes no change in laws governing taxes or entitlement spending.
Includes off-budget deficit of $15 billion or 0.3 percent of GNP per year.
SOURCE: Congressional Budget Office, The Economic and Budget Outlook, Fiscal Years 1985-1989
(Washington, D.C., Feb. 1984).
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MACROECONOMICS, TECHNOLOGY, AND ECONOMIC GROWTH
TABLE 3 Long-term Social Security and Medicare Deficits (Effect of 1983
Amendments on Actuanal Balance of OASDI and Medicare, Alternative
Assumptions, 75-year Penod, percent of taxable payroll)
49
Indexing of Taxable
1983 Amendments. Amounts or Indexing and
Pre-1983 Intennediate Dissipation of Dissipation of
Amendments Assumptions Surplus Surplus
Social Security -1.80 0.02 -0.60 -1 .20
Medicare - 5.21 - 5.21 - 5.21 - 5.21
Total -7.01 -5.19 - 5.81 - 6.41
SOURCE: Author's calculations arid 1983 Annual Report of the Trustees of the Social Secured
Administration .
how it is expected to rise under current law. Clearly these are very large
deficits. The administration forecasts much lower deficits, partly because it
is somewhat more optimistic about what it is going to be able to do on the
spending side, and because it assumes that interest rates will fall substantially
over the next few years (down to 5 percent). If you take the administration's
forecast for the 1989 or 1990 budget and assume that interest rates are going
to be what they are today, you would add about $70 billion to that fiscal
year's deficit.
Lest anyone think our current fiscal dilemma will be resolved in the course
of this decade and that we can then breathe a deep sign of relief, we have
impending a major conundrum with respect to the financing of our Social
Security and Medicare systems (see Table 31. (Recall that we had a major,
bipartisan Social Security reform in 1983.) Table 3 shows the Social Security
and Medicare deficits before the 1983 amendments and the Social Security
actuanes' intermediate assumptions, and other measures. The Social Security
actuaries make assumptions about economic grown, inflation, unemploy-
ment, life expectancy, fertility, how many workers there will be relative to
the number of retirees, and other such things, and from those they calculate
the likely future condition of the retirement fund, disability fund, and Me
hospital-insurance fund that is part of Social Security (Medicare). Prior to
1983 Me Old Age and Survivor Disability Insurance (OASDI) Fllnd, com-
monly called Social Security, was running an average 1.S percent deficit
over Me 75-year projection period as a fraction of taxable payroll. On average,
that 75-year projection includes a deficit in the 1980s, a huge surplus in
retirement and disability funds starting in about 1990 that will run for about
25 years and then start to decline, and then an absolutely eno~ous deficit
when the baby-boom generation retires early in the next century. So that 1.8
percent average masks deficits of 5 to ~ percent in the year 2030 and surpluses
in the retirement and disability funds that are projected to build up to 5 to
7 times outlays by 2015. Prior to the 1983 amendments, it was not commonly
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so
MICHAEL J. BOSKIN
pointed out that the long-term deficit in Medicare was several times that in
retirement and disability. That is primarily because the tax rate for Medicare
was very low and not scheduled to rise as the tax rate was for retirement
and also because of the presumed increase in the cost of medical care.
The 1.8 percent deficit disappears under the intermediate assumptions (colt
2 in Table 31. But the 1983 amendments did two things that are going to be
extremely difficult to live by politically. One is that we are now taxing Social
Security benefits for well-off retirees. Half of a retiree's Social Secunty
benefits are included in taxable income at an income of above 532,000 a
year. But that number is not indexed. So eventually we are going to be taxing
middle-class retirees, and it is unclear to me that we will be able to avoid
indexing, the exempt amounts. If we index the exempt amount we will lose
about a third of the financial solvency we gained in the OASDI system.
Second, we should also remember that our Social Secunty system has
never been able to run a surplus. As soon as we start running substantial
surpluses we have either raised the benefits or, less commonly, lowered tax
rates. The results will be very interesting if we keep the funds separate and
do not allow the retirement fund to bail out Medicare when it starts running
very large deficits in the next decade. If we do keep the funds separate, as
was originally intended, we could use the surplus to try to dissipate the need
for a huge Social Secunty tax increase early in the next century. If we do
that, we are going to see, as I mentioned, a surplus in OASDI of 5 to 7
years of Social Security benefits. It will be such a large surplus that it may
equal the national debt; indeed, the Social Secunty Administration may own
all the government bonds. If we did still better and ran a higher suIplus or
we brought some spending under control, we would have to ask ourselves
whether we want the Social Security system to stab owning other assets,
such as corporate shares. But have no fear. Medicare will bail us out of that
dilemma. We face enormous long-term deficits in Medicare, deficits that
will test not only our political acumen but Me moral fiber of our county in
the next 20 years.
What are We impacts of budgets and deficits on investment, technical
changes, and growth? First, I think all economists would agree ~at, ulti-
mately, at full employment, large deficits, net of the interest component (the
so-called primary deficits, relative to the size of the economy that run for a
very long period must be inflationary. There is no need for the current budget
deficit to be inflationary for the next year or two. Bllt if we run primary
deficits of several percent of GNP for a very long period, some strange things
are going to happen. To analyze that, examine Table 4. This table indicates
where the ratio of privately held federal government national debt (what is
called debt held by the public or by Me private sector as opposed to the
Federal Reserve and government agencies) to GNP is headed if we continue
to non deficits as a share of GNP, net of the interest component, of several
percent and run the real interest rates and growth rates that are being forecast.
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MACROECONOMICS, TECHNOLOGY, AND ECONOMIC GROWTH
TABLE 4 Some U.S. Fiscal Episodes
51
1975 - 1979a 1984 - 1989
.
Do 23.4% 37%
-
CBO Baseline Adminis~aiion
d, average 3.7 1.8 1.4
g, average 3.5 3.8 4.0
i (net of monetization) 6.0
GNP deflator 7.2
r -1.2 3.6 2.4
g - r 4.7 0.2 1.6
Dc 79% 900% 88%
cow: Bet D represent Me debt-G~ moo, d We deficit (net of mtemst)-G~ moo, r We m~ interest
rate, and g the grown of real GNP. Then, by defluiiion,
D' = at + art—g:)dt;
for a fiscal program with constant d and constant r and g, D will evolve toward an equilibrium Dc
(if g > r) of D = d
g - r
add declined smadily from World War II to 1974.
The ratio of the federal government debt to GNP evolves over iune de-
pending on this primary deficit and Me relationship of the real rate of interest
and the growth rate. For example, if we start out with a positive national
debt, and We real interest paid on Me national debt exceeds Me grown rate,
then the interest payments will grow more rapidly Man GNP, and if nothing
else has changed, eventually the interest payments, in an explosive pattern,
will gobble up aB of the budget, then ah of GNP, then all of national wealth.
In the more usual case of the growth rate's exceeding the rate of interest,
the debt-GNP ratio will evolve according to the equation
D/GNP = d + (r—got.
Thus, the equilibrium ratio of Me debt to GNP, given constant primary deficit
(d), real interest rate (r), and growth rate (g), is simply given by d/(8—r3.
Table 4 presents some estimates of two recent major fiscal episodes in the
United States. First, we see the substantial increase in the equilibrium debt-
GNP ratio toward which we were headed if fiscal policy had not been changed
In the 1975-1979 period, a period generally regarded as the begging of
the increase of the ratio of debt to GNP after the substantial postwar decline
in this ratio. Second, and more important for this discussion, we see where
we are headed staging currently. We can see that under current projections
the ratio of debt to GNP is heading toward an equilibrium that is many fumes,
not only current GNP, but Me ratio of the entire value of the capital stock
of He United States to GNP! This latter number is around three, so it is clear
Cat either Me private sector will have to increase its wealth-income ratio by
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52
MICHAEL J. BOSKIN
TABLE 5 Effective Tax Rates for All Assets, 1965-1982, Selected Years
Auerbacha Hulten-Robertsonb
1965 35.7 26.3
1970 49.7 52.3
1975 37.0 32 1
1980 31.9 33.1
1981 17.7 4.7
1982 24.6 15.8
aAlan Auerbach, Corporate taxation In the United States, Brookings Papers on Economic Activity,
Vol. 2 (Washington, D.C.: The Broolcings Institution, 1983). Auerbach assumes a 4 percent real
after-tax rate of rental and forecasts inflation based on past values.
bC. Hulten and J. Robertson, Corporate Tax Policy and Economic Growth, Unload Institute Discussion
Paper (Washington, D.C.: The Urban Insatiate, December 1982). These estimates assume a 4 percent
real aher-tax rate of return and, for 1981 and 1982, a 6 percent rate of inflation.
an enormous increase in saving, or Me rest of the world will have to buy up
We T-bills that we float, or if neither of these alternatives is available and
we persist in our current fiscal policies for the indefinite future, the Federal
Reserve will have to buy up Me bonds as the lender of last resort, Hereby
re-igniting ~nflanon. Can we reasonably expect foreigners to continue to
finance our deficits ad infinitum? ~ believe it would be imprudent of us to
operate on the assumption Mat this is possible, let alone desirable. Eventually,
foreign Sirens and individuals will have a progressively higher fraction of
their wealth in dollar-denominated assets, which will mean that furler in-
creases in dollar-denom~nated assets will be even more nsky. Thus, we can
expect the flow of foreign capital into Me United States, ceteris Paribas, to
slow. Nor do ~ foresee such a huge increase in our saving rate as to increase
the capital output ratio by such a large amount. In shoe, the current fiscal
policy, if continued, is either inflationary or unsustainable. This does not
mean Cat we have no time whatsoever to deal with the problem, but the
longer we delay in cutting spending or adopting a last-resort tax increase,
the worse the problem will become as the interest burden rises still furler.
Thus, my conclusion is that while we had an investment boomlet in the
United States in 1984, largely as a result of the proinvestment tax policies
enacted in the 1981 tax laws, eventually our large deficits will crowd out
our own investment. Currently, they are probably playing some role in crowd-
ing out our net exports.
Table 5 indicates the decline in effective tax rates on marginal investment
due to He Economic Recovery Tax Act (ERTA) of 1981 and He Tax Equity
and Fiscal Responsibility Act (TEFRA) of 1982. This decrease was sub-
stantial and must be part of He explanation for the resurgence, once out of
He recession, of investment. Ano~er reason for He resurgence is that He
extended invesunent tax credit and the accelerated cost recovery system
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MACROECONOMICS, TECHNOLOGY, AND ECONOMIC GROWTH
TABLE 6 Role of Federal Deficit in National Saving and Investment (as
percentage of GNP)
53
Capital
Net State-Local Federal Net Outflow (-) Net
Private Surplus/ Su~plusl National or Foreign Domestic
Saving Deficit Deficits Saving Inflow (+) Investment
(1) (2) (3) (4) (5) (4 + 5)
1950- 1959 7.2 - 0.2 0.0 7.0 - 0.2 7.0
1960- 1969 7.9 0.0 - 0.3 7.6 - 0.5 7.1
1970-1979 7.1 1.0 - 1.8 6.3 0.0 6.4
1982 5.3 1.0 -4.8 1.5 +0.3 1.8
1983 5.9 1.3 -5.4 1.8 ~ 1.0 2.8
1984 7.4 1.4 -4.8 4.0 1 2.6 6.5
aLianonal Income and Product Accounts (NIPA) basis.
SOURCE: U.S. Department of Commerce, NationalIncome and Product Accounts of the United States
(Washington, D.C.: U.S. Government Prinung Office, venous years).
(ACRS) are available only on domestic investment. This, in turn, has prob-
ably also been a cause of We decrease in U.S. capital exports, which again
has been part of the reason for relieving some of Me potential pressure of
deficits on interest rates.
Current net saving and investment figures for Me private economy are
shown in Table 6. Clearly, while we have had an investment boomlet, our
net national saving and net national investment are still quite modest relative
to our history and to Nose of our major trading partners.
Finally, Table 7 reports alternative ways of reviewing Me share of society's
resources devoted to the present as opposed to Me future. It becomes clear
that, for a variety of reasons, the U.S. economy has been consuming a huge
TABLE 7 Alternative Measures of National Saving Behavior, Selected Years
National Household
Income Consumption
Accounts Rate
Basis, Net Household GoverTunent out of NNP-
National Consumption Consumption Government
Saving Rate Rate (2) ~ (3) Consumption
Penod (1) (2) (3) (4) (5)
1951-1960 13.4% 64.3% 22.3% 86.6% 82.7%
1961-1970 13.8 63.7 22.5 86.2 82.2
1971-1980 12.3 65.3 22.4 87.7 84.1
1981-1984 8.6 68.2 23.4 91.6 88.9
NONE: NIPA data adjusted to treat durable purchases (household and government) as saving and
imputed rental flow on household durables, plus govem~nent tangible assets on consumption. Net
national product (NNP) adjusted to include imputed rent and exclude depreciation on household
durables and government tangible assets.
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54
MICHAEL }. BOSTON
fraction of its net national product in recent years and that our national saving
rate has plummeted.
What do I conclude from all of these figures? My tentative conclusion is
that we still have an investment problem in the United States, that we will
probably have to finance investment by our own domestic saving,, and that
we have an equally severe savings problem. Economic policies designed to
encourage consumption at the expense of saving and investment have marked
U.S. fiscal history far too long. It is time we consolidated those policies
begun in 1954 (and continued in 1962, 1978, and 1981) to move our tax
policy toward neutral consumption taxation and our overall fiscal policy
toward achieving appropriately measured budget balance over periods longer
than cycles in economic fluctuations. Such policies would renew the prospect
of a hi ,h-savin~ and high-investment economy, which in turn could lead to
a higher rate of technological change and economic growth.
Let me note that many of the links in this chain of argument are based on
less-than-firm footing. Much more research needs to be done, for example,
on the determinants of saving and investment in the United States, on the
potential links between investment and technical change, and so on. It is my
opinion that we badly need to rededicate our economic policies to promoting
our lon~-term growth and international competitiveness and that these, in
turn, will ultimately require much higher rates of national saving and in-
vestment In plant and equipment as well as research and development ire the
United States.
CONCLUSION AND PARTIAL RESEARCH AGENDA
While short-tenn fluctuations in the economy can be quite costly, active
demand management may be extremely difficult and counterproductive, and
at the very least, f~ne-tuning is unlikely to be productive. Inflation and high
and rising tax rates have eroded incentives to produce income and wealth
and are probably part of the explanation for productivity declines. More
importantly, however, the sources of long-term growth in the economy have
less to do win short-te~ macroeconomics than with "second-tier macro-
economics." This is certainly only my casual judgment, but the composition
of government spending, the structure of taxes, and the effects of monetary
and fiscal policies on the composition of output are likely to be more important
to the determinants of our long-term grown rate, generation of new tech-
nology, and rising standards of living than minor changes in the policies
designed to mitigate economic fluctuations. Further, while there probably
are links among the overall macroeconomic climate and innovation, technical
change, and economic growth, it will not be easy to establish more than
anecdotal evidence of a relation. Therefore, it is my conclusion that a much
greater emphasis should be placed on the effects of these second-tier policies
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MACROECONOMICS, TECHNOLOGY, AND ECONOMIC GROWTH
55
on physical and human capital formation, research and development expen-
ditures, and therefore, innovation, technical change, and economic growth.
In addition to various and very important microeconomic issues relating
to technology and economic growth, a short macroeconomic research agenda
would include the following:
Analyses of the effects of the composition of government spending, at
He federal, state, and local levels;
2. Further analysis of the effects of alternative tax structures on invest-
ment, human capital investment, and R&D spending;
3. The relationship of investment and technical change through learning
arid embodiment, and the diffusion of technology in general;
4. Renewed studies of the sectoral details of technical change and its
relationship to aggregate economic growth;
5. Analyses of broad macroeconomic policies to promote innovation and
the generation and adoption of new technologies, e.g., comparative inter-
national and historical studies;
6. Analyses of the impact of foreign trade and capital flows on investment
and technical change both in the United States and abroad and at both the
aggregate and industry level.
In conclusion, ~ hope this discussion proves useful to readers who are not
economists. It was designed to introduce a variety of controversies and issues
and to provoke discussion and comment. ~ have deliberately avoided any
attempt to be encyclopedic and have stressed my own judgments and impres-
sions, which should be taken for what they are, one economist's opinion.
Let me stress, however, the enormous stake that our economy and society
have in issues of technology and economic grown. I do not believe that we
can continue to go along merrily assuming that the technology will be gen-
erated and disseminated, and that our own long-term growth will be assured
via some mysterious exogenous process. It is likely that economic policies
do affect the generation and dissemination of new technology and our rate
of investment in improving the quality of our labor force, both of which
have the capacity to affect our long-term growth rate. A difference of even
half a percentage point in the long-term growth rate can dramatically ~ans-
form a society over a generation or two. It is incumbent upon all of us to
attempt to understand the relationship of macroeconomic policy, technical
chance, and economic growth much better than we do today and to make
sure that this information, as it is generated, is used in the evaluation of
. , .
economic pOllCy.
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56
MICHAEL J. BOSKIN
REFERENCES AND BIBLIOGRAPHY
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December): 1095-1117.
Barro. R. J., and C. Sahasakul. 1983. Measuring the average marginal tax rates from the individual
income tax, Journal of Business (October).
Boskin. M. 1976. Notes on the tax treatment of human capital, U.S. Treasury, Conference on Tax
Research.
Boskin, M. 1978. Taxation. saving and the rate of interest. Journal of Political Economy 86:S3-
S27.
Feldstein, M., and L. Summers. 1979. Inflation and the taxation of capital income in the corporate
sector, National Tax Journal (December).
Fischer. S., and F. Modigliani. 1977. Aspects of the Costs of Inflation. MIT Working Paper
(unpublished).
Friedman, M. 1968. The role of monetary policy, American Economic Review 58(March):1-17.
Hall, R., and D. Jorgenson. 1967. Tax policy and investment behavior. American Economic Review.
Hausman, J. 1981. Labor supply, in H. Aaron and J. Pechman, eds., How Tares Affect Economic
Behavior. Washington, D.C.: Brookings Institution.
Heckman, J. 1974. Shadow prices. market wages and labor supply of married women, Econometrical
Lucas, R. 1981 Tobin and monetarism: A review article, Journal of Economic Literature 19(June):558-
567.
Phelps, E. 1968. Money-wage dynamics and labor market equilibnum. Journal of Political Economy
76(July-August):678-71 1.
Sargent, T. 1979. Macroeconomics. New York: Academic Press.
Sheshinski. E. 1967. Optimal accumulation with learning by doing, in K. Shell. ea.. Essays on tile
Theory of Optimal Economic Growth. Cambridge, Mass.: MIT Press.
Representative terms from entire chapter:
economic fluctuations
