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The Positive Sum Strategy: Harnessing Technology for Economic Growth (1986)

Chapter: Microeconomics and Productivity

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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Suggested Citation:"Microeconomics and Productivity." National Research Council. 1986. The Positive Sum Strategy: Harnessing Technology for Economic Growth. Washington, DC: The National Academies Press. doi: 10.17226/612.
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Microeconomics arid Productivity DALE W. JORGENSON The explarzatzon for the "Great Growth Slowdown" in the U.S. economy is a decline in the rate of productivity growth. This decline can be traced to the staggering increases in energy prices since 1973. The prospects for increasing productivity growth and capital formation by means of talc policy appear to be very remote. Thus, there seems to be little doubt that one should be pessimistic about fixture U.S. economic growth. The purpose of this chapter is to analyze the `'Great Growth Slowdown.', As will be seen, this is a problem that divides economists in terms of points of view but unites them in terms of interest in the slowdown and its causes. I will begin by discussing the relevance of slower economic grown to current . . . . Issues In economic pa Icy. In my view, there are presently three competing schools of thought in the debate over the govemment's fiscal policy. The moderate school of thought is put forward by the Congressional Budget Office (CBO), the principal analytical arm of the U.S. Congress on budgetary matters. CBO has taken the somewhat pessimistic view that economic growth in the United States will continue at something like 3 percent per year in real terms. Three percent growth is relatively low by historical standards. Over the Tree decades from 1948 to 1979, the growth of value added for the U.S. economy was about 3.5 percent. For the two decades between 1929 the beginning of the Great Depression and 194S, Me growth of the U.S. econ- only was only around 2 percent, according to Christensen and Jorgenson (19701. It is easy to be a pessimist on the basis of historical experience. The implications of 3 percent growth are that radical steps will be required to cut the government deficit. It will be necessary to slow the growth of defense 57

58 DALE W. JORGENSON spending and to cut out cost-of-living adjustments in transfer programs. It may also be necessary to increase taxes. Certainly, no halfway measure would be legitimate. That is the moderate point of view. Proceeding from the moderate to the extreme, we encounter the inter- mediate point of view of the Office of Management and Budget (OMB), the agency responsible for the administrations proposals on the budget. The OMB view is that U.S. economic growth will continue at 4 percent on an annual basis. Even this view supports the need for fiscal action. According to OMB, the federal deficit will remain very large in the absence of a substantial cut in the government budget. It will be possible to achieve the budget reductions, mainly by cutting nondefense expenditures. It will not be necessary to have a tax increase. Retuming to historical experience, a 4 percent growth rate occurred in two of the seven postwar business cycles. In the immediate postwar period (1948 to 1953) grown averaged almost exactly ~ percent. During the period 1960 to 1966, growth averaged 4.5 percent. Four percent growth is certainly conceivable; however, growth at this rate would represent a substantial im- provement over the postwar average and a large increase over the experience of the most recent business cycle (1973 to 19791. We now come to the extreme view on U.S. economic growth, which is associated with the so-called "supply-siders." The supply-side school pro- jects U.S. economic growth at 5 percent. Obviously, this is completely outside the range of historical experience, at least during the postwar penod. If we could conjure up a vision of the U.S. economy's growing at 5 percent, then we would not have to worry about the federal deficit at all. We could continue expanding the defense budget. We would not have to cut back substantially on transfer programs. Economic growth would generate suff~- cient revenues to pay for the increase in federal spending. While economic growth is an important political issue, it does not seem to be a partisan issue. In my assessment, the Congressional Budget Office represents moderate opinion and is directed by Rudolph Penner, a well-known Republican. The Office of Management and Budget reflects the Republican mainstream and [as of this writing is directed by David Stockman, formerly a Republican congressman from Michigan. The supply-side view has come to be the radical opposition on Be right. A prominent supply-sider is Paul Craig Roberts, assistant secretary of the Treasury in Be first Reagan ad- minis~aiion. The debate over economic grown, in other words, is taking place within Be Republican party. My objective here is to sort out the issues Mat underlie divergent views on future prospects for U.S. economic growth. For this purpose I analyze grown trends in decree steps. First, ~ present a macroscopic view of the economy that begins win the output of Be economy as a whole. I then decompose the output of Be economy into output levels for individual in-

MICROECONOAfICS AND PRODUCTIVITY 59 dustnal sectors, which provides a microscopic view of the economy. Finally, I provide an explanation for patterns of economic growth in terms of an econometric model of production at the sectoral level. The macroscopic view of the economy represents a "top-down" approach. The sources of growth at the aggregate level present something of a mystery to economists. It is very difficult to explain the slowdown in U.S. economic grown at the aggregate level, since the unexplained residual productivity growth turns out to bear the major burden of explaining the growth slowdown. The second mode of analysis that I present is a '`bottom-up" approach. Using this approach I analyze growth at the level of individual industrial sectors, focusing on the causes of the productivity slowdown at the level of specific industries. For this purpose I discuss the implications of a sectoral model of productivity growth. Finally, I conclude with an assessment of growth prospects for the U.S. economy. GROWTH AND PRODUCTIVITY Table 1 presents an analysis of U.S. economic growth at the aggregate level. ' The first row in this table presents growth rates of the economy over the postwar period by business cycle. Beginning with the entire postwar period from 1948 to 1979, we see that growth was about 3.5 percent. As we trace out the business cycles over the postwar period, we see that economic growth was at an all-time low from 1957 to 1960, the last of the Eisenhower years. This was followed by the most rapid growth of the postwar period, under the Kennedy-Johnson administration. Since 1966, growth has been below the average, at 3 percent, and there was a decline of about 1.5 percent between the postwar peak and the period from 1966 to 1979. In other words, the growth slowdown has been with us for a very long time. To decompose growth into its sources, I use a simple piece of arithmetic to allocate growth among three components. The 3.5 percent growth rate of the U.S. economy is made up of growth in productivity plus the contributions of capital and labor inputs. It is easy to see from the first column of Table 1 that the most important source of economic grown is the contribution of capital input. Capital input accounts for about half of the growth that has taken place. The contribution of labor input is the least important, and the rate of productivity growth comes out in between. Growth in capital input reflects increased stocks of capital equipment and structures that result from investment. Growth in labor input reflects expan- sion in employment, hours worked per employee, and the upgrading of the labor force through greater education and experience. Productivity grown is defined as the residual between the growth of output and the contributions of capital and labor inputs. In engineering terms, productivity growth is the increase in the efficiency with which economic resources are utilized.

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62 DALE w. JORGENSON Proceeding to the last period in this analysis, 1973 to 1979, growth has slowed, relative to the postwar average, by about half a percentage point However, if we view the growth slowdown relative to the 1960-1966 peak, the slowdown is almost 1.5 percentage points. This is the Great Growth Slowdown. The difference in perspective regarding the postwar average and the 1960-1966 peak accounts for much of the divergence in views among economists as to the severity of the growth slowdown. It is important to emphasize that there has been a growth slowdown and that it began in 1966. However, economists did not begin to focus attention on the growth slowdown until 7 or 8 years later. The slowdown became a major topic for professional discussion during, the late 1970s. During the last period in this analysis, 1973 to 1979, consciousness of the growth slowdown became most acute. In order to obtain additional perspective on the interrelationships between productivity and economic growth, it is useful to look at developments outside the United States. Rapid economic growth in the industrialized countries through 1973 has resulted in unprecedented levels of world economic pros- penty. An extreme example is provided by the growth of the Japanese econ- omy. During the period 1960 to 1973, the Japanese economy grew at the astonishing rate of 10.9 percent per year.2 This growth was sufficient to quadruple the Japanese national product and to move Japan from the ranks of the developing countries to its current status as a major industrial power. The largest industrialized economies of Europe participated fully in the great economic boom of the 1960s and early 1970s. The economies of France and West Germany expanded at rates of 5.9 and 5.4 percent per year, re- spectively, during the period 1960 to 1973. Rapid growth in West Germany followed the "economic miracle" of 1952 to 1960, when Ge~any's econ- omy expanded at 8.2 percent per year, exceeding Japan's growth of 8.1 percent per year during the same period. From 1960 to 1973 Italy's economy grew at 4.8 percent per year, and even the United Kingdom's economy expanded at a respectable 3.S percent per year. The leading industrialized countries of Europe more than doubled their national products during the postwar period. In Norm America, the U.S. economy expanded at the rate of 3.8 percent per year from 1960 to 1973, and Canada's grew at 5.1 percent per year. In Europe rapid economic grown tool: place with negligible growth in hours worked, while in North America hours worked increased at approximately 1.5 percent per year. The 1960s and 1970s also witnessed rapid growth among developing coun- tnes. Expansion at rates in excess of 5 percent per year were not uncommon. To take another extreme example, South Korea's economy grew at 9.7 percent per year during the period 1960 to 1973, achieving rates of economic expansion almost up to Japanese standards.

MICROECONOMICS AND PROD U=IV~ 63 The impact of the first oil crisis on economic growth in industrialized counmes was disastrous. Growth in the Organization for Economic Coop- eration and Development (OECD) countries as a whole plummeted to 2.6 percent per year from 1973 to 1979. Growth in the United States dropped less than in most OECD countries and remained slightly above the OECD average. Growth in Japan fell from the double-digit rates of the 1960s and early 1970s to 3.9 percent per year—almost the same as the expansion in the United Kingdom, the growth laggard among industrialized countnes, from 1960 to 1973. The rate of growth in West Germany fell to 2.4 percent for the period 1973 to 1979, and growth in France during this period was only 3. ~ percent per year. What accounts then for the growth slowdown? Relative to the postwar average, the contribution of capital input in the United States has hardly decreased. The contribution of labor input has, if anything, increased. There- fore, the whole of the explanation for the slowdown is in the decline in growth of the efficiency with which resources are used. The Great Growth Slowdown is a slowdown in the rate of productivity growth. Productivity, again, is output per unit of input and, therefore, corresponds to the engineer's concept of efficiency. Of course, this concept of efficiency is being applied to the economy as a whole, what I have referred to as the top-down approach to growth analysis. The difficulty with this analysis is fairly obvious. The contribution of capital input can be associated with investment, and investment can be at- tributed to changes in tax policy and changes in government budgetary policy. The contribution of labor input can be associated with basic demographic forces. The rate of productivity grown is what economists refer to as the unexplained residual. It is the part of growth that is not accounted for by the things that we know how to explain. That is an unsatisfactory state of affairs and requires a more careful look at the rate of productivity grown itself. Returning to Table 1, the last section, which is labeled "reallocations," provides a decomposition of the rate of productivity growth. Previously, referred to this as Me bottom-up approach. Concentrating on the period 1948 to 1979, we can see that the aggregate productivity grown of 0.9 percent per year is made up of four components. First, there is a weighted sum of productivity grown rates at the sectoral level. Second, there is the reallocation of value added among sectors, and, finally, there are the reallocations of capital and labor inputs among industrial sectors. The first question to ask is: What is the meaning of productivity grown at We sectoral level and how does it compare with productivity grounds at We aggregate level? Bow concepts of productivity correspond to We engi- neering notion of efficiency. At We sectoral level economists analyze growth of output in terms of the contributions of capital and labor inputs and the

64 DALE W. JORGENSON contributions of inputs produced by other sectors. Capital and labor inputs are the so-called primary factors of production Hat generate the whole of economic activity. Inputs produced by over sectors include the raw materials and the energy that are produced by one set of businesses and supplied to others. The concept of output at the sectoral level, versus the aggregate level, is much closer to the engineering concept of output. For example, steel is not measured in terms of value added, which is an economist's abstraction, but in terms of tons of steel. The output of the motor vehicle industry is not measured in terms of value added in the motor vehicle industry, again an economist's abstraction, but rather in terms of vehicles produced. The output of the petroleum industry is measured in terms of barrels of petroleum, and so on. The idea of productivity grown at the sectoral level is much closer to the engineering concept of efficiency and is a much easier concept to appreciate at an intuitive level. In Table 1 we see that the sectoral rates of productivity growth account for almost all of the aggregate productivity grown, at least if we concentrate on the postwar period as a whole. Reallocations reflect the movement of resources either from less productive to more productive uses, or the reverse. In fact, a change in the composition of output in the economy has contributed to the aggregate growth rate of productivity. Regrettably, this has been offset by reallocations of capital and labor to less productive uses, so Hat reallocations essentially cancel out. How can resources be allocated to less productive uses? This appears to contradict some fundamental economic law. Consider the following example, however. In the smokestack industry crisis of the 1970s and early 1980s, many highly paid workers, steelworkers for example, have been displaced. They have ended up on the unemployment rolls, or perhaps working at McDonald 's. Their wages are, say, one-third the wages they received as steelworkers. This is a reallocation of labor from a highly productive use to a less productive use. If the steel industry is contacting, the reallocation of workers produces a negative contribution to aggregate productivity growth. For the postwar period these reallocations cancel out. Next, consider He growth slowdown again. Sectoral rates of productivity grown became negative during the period 1973 to 1979. We were losing efficiency in He production of output at the level of individual industrial sectors. How could this happen? Massive efforts to conserve energy resulted from the high energy prices of the early 1970s. In the search for cost re- duction, engineers were forced to return to technologies that had not been used for 20 or 30 years. This reduced costs but also produced a decline in sectoral productivity grown. During the period 1973 to 1979, the reallocation of output away from energy-intensive sectors toward less-energy-intensive sectors produced a tre-

MICROECONOMICS AND PROD UCTIV~ 65 mendous boon for aggregate productivity grown. Offsetting the loss in pro- duct~vity growth of 1.5 percent was a gain from the reallocation of value added of 1.0 percent. The reallocations of capital and labor input were not very significant. The decline in sectoral productivity growth that actually took place accounts for three times the reduction in aggregate growth and is itself more than sufficient to explain the Great Grown Slowdown. If we look at sectoral productivity growth rates going back to 1966, which is the high-water mark of growth in the United States, we find that sectoral productivity growth for the average industry has been essentially zero. The positive growth of the 1960s and early 1970s has been completely offset by the decline in productivity growth that occurred during the middle and late 1970s. The bottom-up approach to growth analysis is as unsatisfying from the intellectual point of view as the top-down approach. Using this approach, one residual, the rate of productivity growth at the aggregate level, is fumed into residuals at the level of individual industries, which also require furler explanation. If aggregate productivity growth is a mystery, then sectoral productivity growth is a deeper mystery. Resolving this mystery requires an econometric model that explains variations in the rate of productivity growth at the sectoral level. ENDOGENOUS PRODUCTIVITY GROWTH The task that remains is to explain productivity grown at the level of individual industnes. For that purpose I will employ an econometric model in which the rate of productivity grown is itself a function of Me relative prices of all the inputs that are used at the level of individual industrial sectors. The list of those inputs includes capital and labor inputs (~e only inputs that appear at the aggregate level), electricity, nonelectrical energy, and the materials that are used in producing output. For each industry the model of production is based on a sectoral price function that summarizes both possibilities for substitution among inputs and patterns of productivity grown. Each price function gives the price of output of the corresponding industrial sector as a function of the prices of capital, labor, electricity, nonelectrical energy, and materials inputs and time, where time represents the level of productivity in the sector.3 Obviously, an increase in the price of one of the inputs, holding the prices of the other inputs and He level of productivity constant, necessitates an increase in the price of output. Similarly, if the productivity of a sector improves and the prices of all inputs into the sector remain the same, the price of output must fall. Price functions summarize these and other relationships among He prices of output; capital, labor, electricity, nonelectrical energy, and materials inputs; and the level of productivity.

66 DALE W. JORGENSON The sectoral price functions provide a complete model of production pat- terns for each sector, incorporating both substitution among inputs in response to changes in relative prices and productivity growth in the use of inputs to produce output. To characterize both substitution and productivity growth, it is useful to express the model in an alternative and equivalent form. First, the shares of each of the five inputs—capital, labor, electricity, nonelectrical energy, and materials in the value of output can be expressed as functions of the prices of those inputs and time, again representing the level of pro- ductivity.4 Second, to these five equations for the value shares can be added an equation that determines productivity growth as a function of the prices of all five inputs and time. The resulting equation is an econometric model of sectoral productivity growth.5 Like any econometric model, the relationships determining the value shares of capital, labor, electricity, nonelectrical energy, and materials inputs and the rate of productivity growth involve unknown parameters that must be estimated from data for the individual industries. Included among these un- known parameters are biases of productivity growth that indicate the effect of change in the level of productivity on the value shares of each of the five inputs. For example, the bias of productivity growth for capital gives the change in the share of capital in the value of output in response to changes in the level of productivity, represented by time. Productivity growth is said to be capital using if the bias of productivity grown for capital is positive. Similarly, productivity growth is said to be capital saving if Me bias of productivity growth for capital is negative. The econometric model for each industrial sector of the U.S. economy includes an equation giving the rate of productivity growth as a function of the prices of the five inputs and time. The biases of productivity growth with respect to each of the five inputs appear as the coefficients of time, repre- senting Me level of productivity, in the five equations for the value shares of all five inputs. The biases also appear as coefficients of the prices in Me equation for the negative of sectoral productivity growth. The dual role of the bias of productivity growth—expressing the impact of a change in productivity in Me value share of an input and the impact of a change in the price of that input on Me rate of productivity growth is Me key to an assessment of the dete~inants of productivity grown. A classi- fication of industries by patterns of the biases of productivity grown is given in Table 2. The pattern Mat occurs win the greatest frequency is capital- using, labor-using, electricity-using, nonelectrical-energy-using, and mate- rials-saving productivity grown. This pattern occurs for 8 of the 35 industries included in Me table. For this pattern the rate of productivity grown decreases with Me prices of capital, labor, electncity, and nonelectrical energy inputs and increases win the price of materials input. The pattern Mat occurs next most frequently is capital-saving, labor-using, electricity-using, nonelec~i-

MICROECONOMICS AND PROD UCTIV17Y TAME 2 Classification of Tousles by Bides of ~~Uchvi~ Grow Pattern of Biases Capital-using Labor-using Electncity-using Non-electncal-energy-using Materials-saving Capital-using Labor-saving El ectoc ity - us ing Non-electrical-energy-using M aten al s -us ing 67 Industries Tobacco, textiles, apparel, lumber and wood, printing and publishing, fabricated metal, motor vehicles, transporta- tion Capital-using Labor-using Electncity-using Non -electucal-energy-saving Materials-saving Capital-using Labor-using Electricity-saving Non -electrical -energy- using Matenals-saving Capital-using Labor-saving Electncity-using Non-electucal -energy - saving Materials-using Capital-using Labor-using Electncity-saving Non-electnc al -energy- saviD g Matenals-saving Capital-using Labor-saving Electucity-saving Non-electucal-energy-using Matenals-saving Capital-saving I=bor-using Elecmcity-using Non~lectrical~energy-using Materials-using Capital-saving Labor-using Electncity-using Non-electacal-energy-using Matenals-saving Electrical machinery Metal mining, services Nonmetallic mining, miscellaneous rnanufactunng, gov- e~nment enterprises Construction Coal niining, trade Agnculture, crude petroleum and natural gas, petroleum refining Food, paper Rubber; leather, instruments; gas utilides; finance, insur- ance, and real estate Continued on next page

68 TABLE 2 (Continued) DALE W. JORGENSON Pattern of Biases Industries Capital-saving Labor-using Electucity-saving Non -e lee tri cal -e nergy -using Materials-using Capital-saving Labor-saving Electricity-using Non-electncal -e nergy -using Materials-using Capital-saving Labor-using Electricity-saving Non-electrical-energy-using Materials-saving Capital-sav~g Labor-using Electricity-using Non- electrical-energy- saving Materials-saving Capital-saving Labor-saving Electricity-using Non-elec~ical-energy-using Matenals-savung Capital-saving Labor-saving Electncity-saving Non-electrical~nergy-saving Matenals-using Chemicals Transportation equipment and ordnance, communications Stone, clay, and glass; machinery Primary metals Electric utilities Furniture SOURCE: Dale W. Jorgenson, The role of energy in productivity grown, in J.W. Kendrick, ea., International Comparisons of Productivity and Causes of the Slowdown (Cambndge, Mass.: Bal- linger, 1984), Table 7-3, pp. 303-304. Repnuted win permission. car-energy-using, and matenals-saving productivity grown. This pattern oc- curs for 5 industries. For this pattern Me rate of productivity grown decreases win We prices of labor, electncity, and nonelectrical energy inputs and increases win the prices of capital and materials inputs. These two patterns Of productivity grown differ only in the role of Me price of capital input. Productivity grown is capital-using for 20 of the 35 industries included in Me table. The first and most important conclusion to be drawn is Mat the price of capital input plays a very significant role in the determination of productivity growth. A decline in Me price of capital input stunulates pro-

MlCROECONOMICS AND PROD Ugly 69 ductivity growth in 20 of the 35 industries and dampens productivity growth in only 15. Alternatively and equivalently, productivity growth results in an increase in Me share of capital input in the value of output, holding the relative prices of all inputs constant, in 20 of Me 35 industries. Productivity growth results in a decrease in the share of capital input in only 15 of the . . nc ustnes. Next, we can examine the role of prices of labor, electricity, nonelectrical energy, and materials inputs in the determination of tile rate of productivity grown. Productivity growth is labor-using for 26 of the 35 industries included in the table and labor-saving for 9 of the industries. Productivity growth is elecmcity-using for 23 of the 35 industries and elecmcity-saving for 12 industries. Similarly, productivity growth is nonelec~ical-energy-using for 28 of the 35 industries and nonelecmcal-energy-saving for 7 industries. Finally, productivity growth is materials-using in only ~ of the 35 industries and materials-saving for the remaining 27 industnes. To clarify Me analysis furler, let me analyze Me mechanism of produc- tivit~r grown that underlies this econometric model. The basic idea is very simple; when Mere are radical changes in the price of an input, the engineers and businessmen who are running the economy have an incentive to econ- omize on the use of that input. Substitution away from an expensive input results in a new path for the development of technology. This path is as- sociated with higher or lower productivity grown rates. It happens that if capital and labor prices increase, then the associated technical developments result in lower productivity growth rates. When taxes on capital go up, the rate of productivity grown in the average industry falls. Similarly, when wage rates rise in the average industry, the rate of productivity grown falls. If energy prices increase, again, We rate of productivity growth declines; only an increase in the price of raw materials stimulates productivity grown. That is characteristic of Me wide range of U.S. industries that are included In this rnicroeconomic analysis. GROWTH PROSPECTS The sharp decline in economic grown In industrialized countries presents a problem comparable in scientific interest and social importance to Me problem of mass unemployment in the Great Depression of Me 1930s. Con- ventional methods of economic analysis have been tried and found to be inadequate. Clearly, a new framework will be required for economic un- derstanding. The analysis in this section contains some of the elements that will be required for an analysis of the prospects for Me U.S. economy in the last half of the 1980s. My analysis of the sources of variations in rates of productivity growth for Me U.S. economy begins with the evolution of U.S. tax policy over Me

70 DALE w. JORGENSON period 1948 to 1979. Under current tax law, taxpayers are permitted to deduct depreciation as an expense in amving at their taxable income. Taxpayers are also allowed to reduce their tax liability by means of an investment tax credit based on purchases of equipment. As tax rates at corporate and personal levels have increased, provisions for capital recovery under the tax code have become increasingly significant for economic policy. These provisions also have an important impact on stimulating or retarding changes in the level of . . proc activity. The effective tax rates for all corporate investment for each year of the period 1948 to 1979 are listed in Table 3, along with effective tax rates for structures and for equipment separately. If capital-consumption allowances were precisely equal to economic depreciation and the investment tax credit were equal to zero for all assets, the effective tax rate would be the same for all assets and equal to the statutory tax rate. The statutory tax rate is included in Table 3 as a basis for comparison with the effective tax rates under U.S. tax law. As seen in the table, the effective tax rate was below the statutory rate in every year. The ratio of the effective tax rate to the statutory rate is given in the final column of Table 3. The ratio of the effective tax rate on corporate investment to the statutory rate fluctuated between 70 and 80 percent over the period from 1948 to 1961. When the investment tax credit was first adopted in 1962, the ratio of the effective tax rate to the statutory rate dropped to 55 percent in that year from 76 percent in 1961. When the investment tax credit was repealed in 1969 and 1970, the effective tax rate climbed to 78 percent of the statutory rate in 1969 and to 87 percent of the statutory rate in 1970. Reinstitution of the investment tax credit in 1971 reduced the effective tax rate to 60 percent of the statutory rate in that year and to 48 percent in the following year. Lib- eralization of the investment tax credit in 1975 reduced the effective tax rate to 43 percent of the statutory rate. The effective tax rate fell to 12.S percent in 1977 as the rate of inflation decreased, and rose to 19.2 percent in 1979 as the rate of inflation increased. The main conclusion to be drawn from Table 3 is that the effective tax rate under U.S. tax law has been below the statutory tax rate throughout the period 1948 to 1979. The effect of inflation under any given set of tax provisions for capital recovery is to increase the effective tax rate. This occurs Trough an increase in We discount rates applied to future capital- consumption allowances. However, tax provisions have been revised at fre- quent intervals, and major revisions occurred in 1954, 1962, 1970, and 1975. The impact of those revisions has been to reduce effective tax rates very dramatically, especially in 1962 win the adoption of We investment tax credit and more generous capital-consumption allowances and, in 197S, win We liberalization of the investment tax credit. Since Me effective tax rate increases win rate of inflation, a decrease in

MICROECONOMICS AND PRODUCTIVITY TABLE 3 Effective Corporate Tax Rates, 1948-1979 71 Effective Corporate Tax Rate Statutory Year Total Equipment Structures Tax Rate Ratio (1)/(4) . 1948 0 264 0.302 0.200 0.380 0.696 1949 0.266 0.307 0.200 0.380 0.699 1950 0.303 0.346 0.226 0.420 0.720 1951 0.389 0.436 0.310 0.510 0.762 1952 0.398 0.445 0.322 0.520 0.766 1953 0.418 0.460 0.348 0.520 0.803 1954 0.366 0.400 0.312 0.520 0.704 1955 0.370 0.405 0.311 0.520 0.712 1956 0.379 0.411 0.325 0.520 0.728 1957 0.394 O.429 0.335 0.520 0.758 1958 0.377 0.408 0.330 0.520 0.725 1959 0.412 0.111 0.355 0.520 0.792 1960 0.411 0.442 0.356 0.520 0.790 1961 0.397 0.428 0.346 0.520 0.764 1962 0.285 0.250 0.345 0.520 0.548 1963 0.265 0.219 0.344 0.520 0.509 1964 0.237 0.189 0.324 0.500 0.474 1965 0.213 0.160 0.309 0.480 0.444 1966 0.274 0.247 0.324 0.480 0.570 1967 0.269 0.240 0.323 0.480 0.560 1968 0.259 0.221 0.330 0.480 0.539 1969 0.372 0.378 0.361 0.480 0.716 1970 0.416 0.429 0.394 0.480 0.867 1971 0.289 0.244 0.367 0.480 0.603 1972 0.229 0.157 0.357 0.480 0.478 1973 0.251 0.188 0.383 0.480 0.536 1974 0.281 0.221 0.394 0.480 0.586 1975 0.206 0.131 0.345 0.480 0.430 1976 0.161 0.081 0.320 0.480 0.336 1977 0.128 0.041 0.308 0.480 0.266 1978 0.180 0.099 0.335 0.480 0.376 1979 0.192 0.121 0.397 0.460 0.418 1980 0.243 0.185 0.352 0.460 0.528 SOURCE: Dale W. Jorgenson and Martin A. Sullivan, Inflation and corporate capital recovery, in C. Hulten, ea., Depreciation, Inflation anal the Taxation of Income from Capital (Washington, D.C.: The Urban Instinlte, 1981), Table 11, p. 196. Repnnted with permission. the rate of inflation to levels below those prevailing since 1973 would reduce the effective tar; rate substantially. The decrease in Me rates of inflation in the prices of assets from 12.8 percent in 1975 to 5.6 percent in 1976 and 7.7 percent in 1977 brought the effective tax rate down to 16.1 percent in 1976 and 12.8 percent in 1977. These tax rates can be compared with the statutory rate of 48 percent in both years. The increases in the rate of inflation

72 DALE W. JORGENSON in 1978 and 1979 brought effective tax rates up to 18.0 percent in 1978, and to 19.2 percent in 1979. The effective tax rates on corporate income are inversely correlated with rates of productivity grown for the U.S. economy as a whole. Effective tax rates declined sharply between 1960 and 1966; Me rate Productivity growth attained its postwar peak of 1.80 percent during this penod. Effective tax rates rose dramatically from 1966 to 1969; the rate of productivity grown declined to 0.08 percent per year dming this period. Effective tax rates declined from 1969 to 1973; the rate of productivity growth revived to 0.78 percent per yea}. The most striking change in the relative prices of capital, labor, electricity, nonelectrical energy, and materials inputs that has taken place since 1973 is the staggering increase in the price of energy. At first blush the finding that higher energy prices are an important determinant of We slowdown in eco- nom~c grown after 1973 seems paradoxical. In studies of sources of aggregate economic growth, energy appears as both an output and an input for individual industries but cancels out for We economy as a whole.6 It is necessary to disaggregate the sources of economic growth to the sectoral level in order to define an appropriate role for energy. Within a disaggregated framework for analyzing economic growth, it is not sufficient to decompose the grown of sectoral output among the contn- buttons of inputs and We grown of productivity. It is essential to explain the growth of sectoral productivity. In the absence of such an explanation, the growth of sectoral productivity is simply an unexplained residual between the growth of output and the growth of capital, labor, electncity, nonelectrical energy, and materials inputs. Finally, the direction and significance of the influence of energy prices on productivity growth at the sectoral level must be determined empirically. From a conceptual point of view, energy prices can have positive, negative, or zero impacts on sectoral productivity grown. From an empirical point of view, the influence of higher energy prices is negative and highly significant. There is no way to substantiate this empirical finding without an econometric model of productivity growth. The analytic steps outlined here—disaggregation of the sources of eco- nomic growth to the sectoral level; decomposition of the rate of growth of sectoral output into productivity growth and the contnbunons of capital, labor, electricity, nonelectrical energy, and materials inputs; and modeling the growth of productivity have been taken only recently. Although much additional research will be required to provide an exhaustive explanation of We slowdown of economic growth in industrialized counmes within the new framework, it is nonetheless useful to employ this framework in assessing future grown prospects for indusmal~zed countries. The Arab oil embargo of late 1973 and early 1974 resulted In a dramatic increase in world oil pnces. Between 1973 and 1975 crude oil import prices

MlCROECONOMICS AND PRODUCT7Vm 73 increased by two and a half times in real terms for the seven major OECD counwies—Canada, France, West Germany, Italy, Japan, the United King- dom, and the United States.7 Japan was the country most affected by the oil price increases and experienced a tripling of crude oil import prices in real terms. Among European countries France was not far behind Japan in the increase in the real price of crude oil imports. Real energy prices to final users increased considerably less than real oil prices in all major OECD countries. The average increase for the seven countries from 1973 to 1975 was 23.9 percent. Japan and Italy were at the high end of the range with increases in excess of 50 percent. Meanwhile, Canada experi- enced only a 3.9 percent increase under a regime of price controls on domestic petroleum and natural gas. Similar controls in the United States did not prevent an increase of energy prices to final users of 23 percent in real terms. In late 1978 We hanian revolution sent a second wave of oil price increases through world markets. Between 1978 and 1980 crude on import prices almost doubled in real terms for the seven major OECD counmes. Real energy prices to final users climbed by 33.5 percent for those counmes. Again, Japan was hard hit win an 80.3 percent increase, and Canada experienced an increase of only 8.7 percent. For We United States the price increase was 34 percent, and major European counties had increases below the average. Slow grown In productivity at We sectoral level is associated with higher prices of capital input for 20 of We 35 industries Cat make up the producing sector of We U.S. economy. This helps to account for We high productivity growth of the period 1960 to 1966, the slow grown of the following penod, 1966 to 1969, and the revival of productivity grown during the period preceding the first oil crisis, 1969 to 1973. From 1960 to 1966 tax policy stimulated productivity grown; from 1966 to 1969 tax policy retarded productivity grown; and from 1969 to 1973 tax policy again acted as a stimulus to productivity grown. The slower grown of productivity is also associated with higher prices of electricity for 23 of the 35 industries listed in Table 2; similarly, slower growth of productivity is associated win higher prices of nonelectrical energy for 28 of We 35 industries. Real energy prices began to rise in the early 1970s and increased dramatically after We fast oil shock in 1973 and again after die second oil shock in late 1978. These price trends resulted in the substitution of capital, labor, and materials inputs for inputs of electricity and nonelectrical energy, Hereby reducing He energy intensity of production. At He same time He energy price trends contributed to a marked slowdown in productivity growth. CONCLUSION The overall conclusion of this chapter is that it is no longer necessary for analyses of productivity growth to focus on the "unexplained residual." The econometric model presented here makes the rate of productivity growth

74 DALE W. JORGENSON itself endogenous. Given that variations in the rate of productivity growth are associated with changes in the growth rate of the a:,~regate economy, the mode} provides a full explanation of the slowdown at the aggregate level. Let us return now to He dispute I perceive among the three contending schools of thought in Washington He Congressional Budget Office, which is associated win future growth prospects in the range of 3 percent a year; the people at OMB, associated with a 4 percent grown rate; and, finally, He radical supply-side view, associated win a grown rate of approximately ~ percent. What underlies these different views? Frankly, it is very hard to understand the views of the supply-siders. The OMB view is that changes in tax policy, which began with the incoming Reagan administration in 1981, will stimulate growth by increasing, capital formation. However, those talc cuts were fol- lowed by the deepest recession in investment that has occulted in the postwar period. In the last two years, the United States has had the strongest recovery in the postwar period. Dunng the whole of the Reagan administration the United States has had a growth of capital stock that is just about comparable to what prevailed during the period 1973 to 1979, He period during which the growth slowdown was most severe. The OMB view, therefore, does not bear very much weight. We come back to He Congressional Budget Office view, which suggests that real growth in the United States is permanently lodged at a relatively low level, around 3 percent a year. This is a consequence of the permanent increase In energy pnces. The difficulties associated with large deficits and the associated high, real interest rates are still with us. Moreover, the prospects for increasing pro- ductivity grown and capital formation by means of tax policy appear to be very remote. I come down on the side of the Congressional Budget Office There seems to be little doubt Hat one should be pessimistic about future U.S. economic growth. NOWS 1. The methodology employed by Fraumeni and Jorgenson (1985) is based on that of Jorgenson (1980). Data sources are described by Fraurneni and Jorgenson (1980, 1985) and by Gollop and Jorgenson (1980, 1983). Comparisons among patterns of economic growth in industrialized countries are given by Chris- tensen et al. (1980. 1981). The price function was introduced by Sasnuelson (1953). 4. The sectoral price functions are based on the translog price function introduced by Christensen et al. (1971, 1973). The tsanslog price function was first employed at the sectoral level by Bemdt and Jorgenson (1973) and by Berndt and Wood (1975). References to sectoral production studies incorporating energy and materials inputs are given by Be~dt and Wood (1979). 5. This model of sectoral productivity growth is based on that of Jorgenson (1983). Estimates of the unknown parameters of this model, including biases of technical change, are presented by

MICItOECONOMICS AND PROD UCTIVIn' 75 Jorgenson (1984). A useful survey of studies of energy prices and productivity growth is given by Berndt (1982). 6. A leading proponent of this view is Denison (1984). 7. Compansons of energy prices and energy demand patterns in industrialized countries are given by Fujime (1983). Projections of U.S. energy demand are given by Hogan (1984). REFERENCES Berndt, Emst R. 1982. Energy price increases and the productivity slowdown in linited States manufacturing. Pp. 60-89 in Federal Reserve Bank of Boston, The Decline in Productivity Growth. Boston. Berndt, Ernst R., and Dale W. Jorgenson. 1973. Production structures. Ch. 3 in Dale W. Jorgenson and Hendrik S. Houthakker, eds., U.S. Energy Resources and Economic Growth, Washington D.C.: Energy Policy Project. Be~dt, Ernst R.. and David 0. Wood. 1915. Technology, pnces. and the derived demand for energy. Review of Economics and Statistics 56(3):259-268. Belt, Ernst R., and David 0. Wood. 1979. Engineering and econometric interpretations of energy- capital complementanty. American Economic Review 69(3):342-354. Christensen, Laurits R.. and Dale W. Jorgenson. 1970. U.S. real product and real factor input, 1929-1967. Review of Income and Wealth 16(1):19-50. Christensen, Launts R., Diane Cummings, and Dale W. Jorgenson. 1980. Economic growth, 1947- 1973: An international companson. Pp. 595-698 in J. W. Kendrick and B. Vaccara, eds., New Developments in Productivity Measurement and Analysis. Studies in Income and Wealth, vol. 41. Chicago: University of Chicago Press. Christensen, Laurits R., Diane Cummings, and Dale W. Jorgenson. 1981. Relative productivity levels, 1947-1973. European Economic Review 16(1~:61-94. Christensen, Launts R., Dale W. Jorgenson, and Lawrence J. Lau. 1971. Coniugate duality and the transcendental logarithmic production function. Econometrica 39(3):255-256. Christensen, Laurits R., Dale W. Jorgenson, and Lawrence J. Lau. 1973. Transcendental logarithmic production frontiers. Review of Economics and Statistics 55(1):28-45. Denison, E. F. 1984. Accounting for slower economic growth: An update. Pp. 1~5 in J. W. Kendriclc, ea.. International Comparisons of Productiviry and Causes of the Slowdown. Cam- bndge, Mass.: Ballinger. Fraumeni, Barbara M., and Dale W. Jorgenson. 1980. The role of capital in U.S. economic growth, 1948-19~76. Pp. 9-250 in (I. von Furstenberg. ea., Capital Efficiency and Growth. Cambridge, Mass.: Ballinger. Fraumeni, Barbara M., and Dale W. Jorgenson. 1985. The role of capital in U.S. economic growth, 1948-1979. In A. Dogramaci, ea., Behavior And lnterpretanon of Productiviry Measures. Boston: Mariinus Nijhoff. Fujime, Kazuya. 1983. Structural changes in energy demand in the OECD nations with emphasis on the U.S. and Japan, and a cyclical behavior in oil markets. Energy Laboratory Working Paper No. MIT-EL 83-015WP. Cambridge: Massachusetts Instinlte of Technology. Gallop. Frank, and Dale W. Jorgenson. 1980. L'.S. productivity growth by industry, 1947-1973. Pp. 17-136 in J. W. Kendrick and B. Vaccara, eds.. New Developments in Productivirv Mea- surement and Analysis. Studies in Income and Wealth, vol. 41. Chicago: University of Chicago Press. Gallop, Frank, and Dale W. Jorgenson. 1983. Sectoral measures of labor cost for the United States. 1948-1978. Pp. 185-235, 503-520 in J. E. Tnplett. ea., The Measurement of Labor Cost. Studies in Income and Wealth, vol. 44. Chicago: University of Chicago Press. Hogan, William W. 1984. Patterns of Energy Use. Harvard University. Energy and Environmental Policy Center. Carnbndge, Mass.

76 DALE W. JORGENSON Jorgenson, Dale W. 1980. Accounting for capital. Pp. 251-319 in G. von Furstenberg, ea., Capital Efficiency and Growth. Cambridge, Mass.: Ballinger. Jorgenson, Dale W. 1983. Modeling production for general equilibrium analysis. Scandinavian Journal of Economics 85(2):101-112. Jorgenson, Dale W. 1984. The role of energy in productivity grown. Pp. 270-323 in J. W. Kendrick, ea., Iruern~nonal Comparisons of Productivity and Causes of the Slowdown. Cambridge, Mass.: Ballinger. Earlier, less detailed versions of this material appeared in American Economic Review 74(2), May 1978: 2~30; and in The Energy Journal 5(3), July 1984: 11-25. Jorgenson, Dale W.' and Mamn A. Sullivan. 1981. Inflation and corporate capital recovery. Pp. 171-238, 311-313 in C. Hulten, ea., Depreciation, Inflation and the Taxation of Income from Capital. Washington, D.C.: The Urban Institute. Samuelson, Paul A. 1953. Prices of factors and goods in general equilibnum. Review of Economic Studies 21(1):1-20.

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This volume provides a state-of-the-art review of the relationship between technology and economic growth. Many of the 42 chapters discuss the political and corporate decisions for what one author calls a "Competitiveness Policy." As contributor John A. Young states, "Technology is our strongest advantage in world competition. Yet we do not capitalize on our preeminent position, and other countries are rapidly closing the gap." This lively volume provides many fresh insights including "two unusually balanced and illuminating discussions of Japan," Science noted.

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