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The Effect of Recent Macroeconomic Policies on Innovation arid Productivitr CHARLES B. REEDER Smaller federal deficits, lower interest rates, anal a weaker dollar all are considered necessary and "good" for the economy, but some of the drive to improve efficiency anal productivity will be lost without the spur offoreign competition. This is the dilemma that policyrnakers must contend with as they weigh the pros arm cons of various policy choices. While economic theory has not been able to link macroeconomic policies to the behavior of individual firms in the specific areas of innovation and productivity, there nevertheless are some remarkable developments taking place today in these areas that, I believe, are in response to He consequences of recent macroeconomic policies. An examination of these developments will not produce a true theory of innovation based on macroeconomic policy, but it should improve our understanding of the process particularly the way in which market forces often produce unintended results. The point at which my analysis begins is Be recent changes in government economic policies designed to stimulate saving and investment and simul- taneously curb inflation (Reaganomics). These policies included significant reductions in marginal tax rates for individuals, major changes in laws af- fecting corporate savings Trough depreciation, and an unrelenting effort on the part of the Federal Reserve Board to limit the ~,~owth of the money supply. There has been, and will continue to be, a debate among economists as to the wisdom of these policies, but few can deny that Hey produced He 89

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9o CHARLES B. REEDER intended results at the macro level albeit Dim significant time lags and with some undesired side effects. Foremost among these results were the following: ~ The gross private saving, rate for the nation increased by approximately 2 percentage points between 1982 and 1984, and in 1984 was the highest since the end of World War IT. Outlays for investment in nonresidential structures and equipment soared 20 percent in 1984 in real terms, the largest 1-year increase since We end of World War II. Business fixed investment was the fastest-growing segment of GNP in 1984 and played a major role in the strong recovery from the 1981-1982 recession. The rate of inflation, as measured by the GNP deflator, fell from 9.6 percent in 1981 to 3.8 percent in 1984 even though real economic activity was growing at 6.8 percent. From an analytical standpoint these results can be regarded as first-order results of the shift in economic policies that occurred in 1981. Second-order results were the sharp increase in the federal deficit, the persistence of high real interest rates, and the spectacular rise in the value of the dollar. The budget deficit increased from $58 billion in 1981 to $195 billion in 1983, real interest rates (the spread between nominal interest rates and the rate of inflation) remained in We 6 to ~ percent range even though nominal rates declined, and the value of the dollar rose over 30 percent from December 1981 to December 1984. Of these results, the most important in teens of innovation and productivity were the rise in the dollar and the resulting surge in imports to the United States. In 1984 total non-oil imports soared 30 percent and all U.S. manu- facturers felt the pressure of this competition from abroad. Economists tend to focus on the macroeconomic results of macroeconomic policies, i.e., how tax cuts create large deficits, how large deficits cause interest rates to rise, how high interest rates attract foreign capital to finance We deficits, how the inflow of capital raises the value of the dollar, and so on. But businessmen operate in a different world. Hey see the world at He micro level, where they must compete with foreign-produced goods at prices set by producers whose costs are largely denominated in depreciated cur- rencies relative to the dollar. In this situation they must do whatever they can to survive, and since they cannot control the value of the dollar, they tum to what they can control- their own costs of production. On the labor front they have demanded and gottenlower wages as the price of keeping jobs in the United States. On the capital front they have sought whatever new equipment is available to improve productivity and reduce unit costs. Their need for capital has coincided with exciting new developments in He telecommunications field, In computers, robots, lasers, and so on. Most of

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RECENT MACROECONOMIC PONCIES: EFFECT ON INNOVATION & PROD Utah 91 these products have applications in manufacturing, but the service industries also have been able to take advantage of them. Without delving into the specific products and their applications, the basic point is that industry has been goaded into a massive cost-reduction and productivity-improvement effort as a response to the results of macroeco- nomic policies aimed at stimulating saving and investment while controlling inflation. The full consequences of this effort are not yet fully visible because of the continued depressing effect on U.S. production of imports, but the day will come when the dollar declines and growth in other countries ac- celerates. At Hat time U.S. manufacturers will see their operating rates rise and their productivity soar because the increased output will be produced with fewer employees and with the most modern plant. These results were among those desired at the time new macroeconomic policies were undertaken, but the architects of those policies did not expect Rat the path from cause to effect would be so roundabout from tax cuts and high interest rates to large deficits, a strong dollar, soanug imports, and Be resulting actions of individual firms as Hey struggled to meet the com- petition from abroad. These results could not have been achieved without earlier R&D efforts by entrepreneurs and large organizations, but the funding and encouraging of R&D - either by government or private sources was not Be driving force. The marketplace was the force. These developments have both positive and negative aspects for the nation. The positive aspect is that innovation is being encouraged and that Amencan industry is becoming more efficient. The negative aspect is that our industrial structure is being reshaped drastically, and Here is a real risk that costly long-tenn mistakes will be made. Because there are two sides to this issue there is no simple way to deal with it at the policy level. Smaller federal deficits, lower interest rates, and a weaker dollar all are considered necessary and "good" for the economy, but some of Be drive to improve efficiency and productivity will be lost without He spur of foreign competition. This is the dilemma that policymakers must contend with as they weigh the pros and cons of various policy choices. In summary, these observations do not constitute a new theory in and of themselves, but the linkages described here are not generally recognized by those who are concerned about the theory of innovation and how macro- econornic policy may affect decisions at the level of the fimn. Additionally, government policymakers also should recognize that there are secondary and tertiary consequences of their policies, and in some cases the unintended results may be more effective than the direct consequences.

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