All of these individual and corporate investment incentives would be superseded by implementation of a progressive consumption-based tax system.

Changes in the Capital Allocation System

Many businesses are taking steps to mitigate the pressures to forego longer-term investments by establishing closer relations and communicating corporate goals more effectively to stockholders, suppliers, customers, and employees and by increasing the long-term equity stakes of managers and directors. We strongly endorse these trends. In addition, the government should encourage the emergence of a class of long-term high-stakes investors by changing laws and regulations that compel primarily institutional investors to hold diversified small stakes in companies.

Conclusion

Although it may not be desirable to set precise goals with milestones for economic indicators that are imperfectly understood and only partially subject to government control, it is also not enough to talk in general and vague terms about investments in technological development, tangible assets, and human capital. The absence of consensus about desirable levels of saving, nvestment, and productivity growth over the long term leads to a focus on shorter-term problems, with negative economic consequences that will become more severe the longer action is delayed.

The administration, with congressional support, should engage the country in a process of benchmarking to gauge national economic performance and then proposing and implementing measures that move economic policy in the direction of achieving longer-term growth in productivity, employment, and living standards. Growth promotion should be one of the leading criteria by which economic policies are evaluated. Without adequate growth, the legitimate high expectations Americans have for their economic well-being cannot be achieved or sustained.

THE IMPERATIVE OF GROWTH

The National Research Council’s Board on Science, Technology, and Economic Policy (STEP) was formed to address the relationships among science, technology, and economic policy and their effect on the health of the American economy. With the encouragement of the National Acade-



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Investing for Productivity and Prosperity All of these individual and corporate investment incentives would be superseded by implementation of a progressive consumption-based tax system. Changes in the Capital Allocation System Many businesses are taking steps to mitigate the pressures to forego longer-term investments by establishing closer relations and communicating corporate goals more effectively to stockholders, suppliers, customers, and employees and by increasing the long-term equity stakes of managers and directors. We strongly endorse these trends. In addition, the government should encourage the emergence of a class of long-term high-stakes investors by changing laws and regulations that compel primarily institutional investors to hold diversified small stakes in companies. Conclusion Although it may not be desirable to set precise goals with milestones for economic indicators that are imperfectly understood and only partially subject to government control, it is also not enough to talk in general and vague terms about investments in technological development, tangible assets, and human capital. The absence of consensus about desirable levels of saving, nvestment, and productivity growth over the long term leads to a focus on shorter-term problems, with negative economic consequences that will become more severe the longer action is delayed. The administration, with congressional support, should engage the country in a process of benchmarking to gauge national economic performance and then proposing and implementing measures that move economic policy in the direction of achieving longer-term growth in productivity, employment, and living standards. Growth promotion should be one of the leading criteria by which economic policies are evaluated. Without adequate growth, the legitimate high expectations Americans have for their economic well-being cannot be achieved or sustained. THE IMPERATIVE OF GROWTH The National Research Council’s Board on Science, Technology, and Economic Policy (STEP) was formed to address the relationships among science, technology, and economic policy and their effect on the health of the American economy. With the encouragement of the National Acade-

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Investing for Productivity and Prosperity mies of Sciences and Engineering, the STEP board decided to concentrate initially on the role that saving and investment play in achieving the nation’s long-term economic growth objectives, not only investment in the aggregate but also public and private investment in plant and equipment, physical infrastructure, human capital, research and development, and other categories of the nation’s investment portfolio, the size of these investments, their adequacy, directions of change, and their characteristics in relation to those in other industrialized countries. In undertaking its study, the board sought to evaluate and synthesize a great deal of research and analysis done by other scholars and commentators rather than to undertake new research. Some of the material the board consulted is in the forthcoming volume of papers based on presentations at the board’s conference, “Capital Allocation and Investment Performance in the U.S. Economy,” in September 1992. Although the board did not accept all of the findings and recommendations presented on that occasion, we believe they are thoughtful, present interesting and important evidence, and should stimulate discussion. In setting its agenda the board was aware that several other organizations, including parts of the Academy complex, were considering the role of government in promoting the development and application of potentially commercial, productivity-enhancing technologies in the corporate sector.1 This work has led to a number of technology policy recommendations that are not reflected in this report because we are convinced that microeconomic intervention will not produce an adequate rate of productivity growth unless the trends in investment, saving, and cost of capital described here are successfully addressed. The board is also aware that there are wide differences in the capacities of corporate managements to handle the accelerating pace of technological change, although recent business literature suggests that the management learning process is accelerating. Much has happened since the board’s creation. Not only has the economy experienced a prolonged and unusually persistent recession followed by a period of slow growth that only recently has led to significant job creation, but also the private sector has continued to undergo significant restructuring. Manufacturing companies and industries are transforming their structures and becoming flatter, more efficient, and more 1   For example, the Committee on Science, Engineering, and Public Policy of the National Academy of Sciences/National Academy of Engineering/Institute of Medicine, the Council on Competitiveness, the Competitiveness Policy Council Subcouncil on Technology Policy, and the Computer Systems Policy Project.

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Investing for Productivity and Prosperity quality conscious and customer oriented. Other sectors such as banking, commercial real estate, and retailing developed large amounts of excess capacity in the 1980s and are now in the process of shedding it. The reductions in military expenditures in the next several years will reduce government and private sector employment in the defense sector. Like most important developments, these elements of restructuring have positive and negative consequences. On the positive side, the efficiency of much of the American private sector is improving substantially, creating opportunities for competitive strength and growth in a global economy over the longer term. However, restructuring processes of this size may well entail a significant loss of employment in a broad spectrum of job categories, including in higher paying jobs in some industries and companies. These restructuring processes are continuing even as the economy recovers from the most recent recession. Sustained growth in productivity and in job creation is exceedingly important from two perspectives. First, growth in productivity is a prerequisite for raising the nation’s standard of living, especially in an increasingly open, competitive international economy. The U.S. productivity slowdown has been a serious concern for at least two decades. In the 1960s, annual U.S. productivity growth averaged 2.4 percent; it was only 1.3 percent in the 1970s and 0.8 percent in the 1980s. During the same period, the annual rate of increase of private capital formation per employee dropped from 2.6 percent to 0.6 percent, depressing output and real hourly earnings per employee. Indeed, during the past two decades, most of the increase in the standard of living of families is attributable to the increase in two-earner couples and working hours. Second, because the restructuring of major sectors of the economy entails a short-run reduction of jobs, job creation through growth greater than what would occur in a normal recovery from recession is doubly important.2 Ultimately the productivity gains associated with restructuring will generate growth and jobs; in the medium term, probably the next 2 Ralph Landau, “From Analysis to Action,” in the forthcoming companion volume. The current recovery has been characterized by Stephen S. Roach of Morgan Stanley & Co., Inc., as a “productivity-led recovery, in which current hiring has lagged well behind the rate achieved in previous recoveries at the same stage. In the first ten quarters of the last four recoveries, real GDP output on average increased 5.2 percent, of which only 2.9 percent was due to productivity improvement. In the current cycle, the growth of output and productivity are equal at 2.4 percent, whereas a productivity growth rate of 1.4 percent would be expected on the basis of previous experience. This represents a shortfall of perhaps four million new jobs.” See Stephen Roach, “Morgan Stanley Special Economic Study,” January 7, 1994, p. 4. See also Phelps (1993) for a structural interpretation of current unemployment that is consistent with the board’s conclusions.

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Investing for Productivity and Prosperity 5 years, the economy needs an assist. For this reason the board believes that growth in output and the creation of new employment opportunities through market expansion, which includes creation of new and improved products, processes, and services, should be the principal criteria by which economic policies are evaluated during the remainder of this decade. Without adequate levels of such growth, the legitimate high expectations that Americans have for their economic well-being cannot be achieved or sustained. There are two fundamental sources of economic growth—productivity improvement and market expansion. Productivity improvement is the result of technological advances and investments in physical and human capital. International comparisons of productivity growth suggest that there is a strong association between a nation’s rate of investment in new equipment and its rate of productivity growth. For example, according to economists Lawrence Lau and Jong Il Kim, roughly one-quarter of the productivity growth of the United States is directly traceable to physical investment in plant and equipment (Lau and Kim, 1992). An additional one-third is traceable to investments in technology that are accompanied by and embodied in tangible capital, and roughly one-sixth is attributable to improvements in technology that are not connected to investments in tangible assets. Thus, according to Lau and Kim, between two-thirds and three-quarters of U.S. productivity growth is attributable to investment in tangible assets and in more advanced technology.3 These findings are largely consistent with other recent work underscoring the importance of investment in machinery and equipment for growth (Boskin and Lau, 1992; Delong and Summers, 1991; Jorgenson, Gollop, and Fraumeni, 1987; Lau and Kim, 1992). Although recognizing that national investments in public education and infrastructure are important contributors to growth, the board believes that an adequate level of private business investment is essential for sustained economic growth. The changes in management practice and the redesign of organizational structures and processes that characterize the current restructuring of industry are producing encouraging productivity improvements with infusions of capital that are below historical levels. It may be that for 3 The estimates are additive in the Lau and Kim model, but part of the improvement in the quality of labor may also be captured in what Lau calls technical progress. Lau’s work continues and is being extended, for example, to Asian countries and more recent years. His findings on embodied technical change are empirical, and there are scant data on the distribution between embodied and disembodied technical change, but the 1965 estimates of Intrilligator are roughly consistent with these more recent findings.