Investing for Productivity and Prosperity

Board on Science, Technology, and Economic Policy

National Research Council

NATIONAL ACADEMY PRESS
Washington, D.C.
1994



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Investing for Productivity and Prosperity Investing for Productivity and Prosperity Board on Science, Technology, and Economic Policy National Research Council NATIONAL ACADEMY PRESS Washington, D.C. 1994

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Investing for Productivity and Prosperity NATIONAL ACADEMY PRESS 2101 Constitution Ave., N.W. Washington, DC 20418 NOTICE: The project that is the subject of this report was approved by the Governing Board of the National Research Council, whose members are drawn from the councils of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The members of the board responsible for the report were chosen for their special competences and with regard for appropriate balance. The report has been reviewed by a group other than the authors according to procedures approved by a report review committee consisting of members of the National Academy of Sciences, the National Academy of Engineering, and the Institute of Medicine. The National Academy of Sciences is a private, nonprofit, self-perpetuating society of distinguished scholars engaged in scientific and engineering research, dedicated to the furtherance of science and technology and to their use for the general welfare. On the authority of the charter granted to it by the Congress in 1863, the Academy has a mandate that requires it to advise the federal government on scientific and technical matters. Dr. Bruce M. Alberts is president of the National Academy of Sciences. The National Academy of Engineering was established in 1964, under the charter of the National of Sciences, as a parallel organization of outstanding engineers. It is autonomous in its administration and in the selection of its members, sharing with the National Academy of Sciences the responsibility for advising the federal government. The National Academy of Engineering also sponsors engineering programs aimed at meeting national needs, encourages education and research, and recognizes the superior achievements of engineers. Dr. Robert M. White is president of the National Academy of Engineering. The Institute of Medicine was established in 1970 by the National Academy of Sciences to secure the services of eminent members of appropriate professions in the examination of policy matters pertaining to the health of the public. The institute acts under the responsibility given to the National Academy of Sciences by its congressional charter to be an adviser to the federal government and, upon its own initiative, to identify issues of medical care, research, and education. Dr. Kenneth Shine is the president of the Institute of Medicine. The National Research Council was organized by the National Academy of Sciences in 1916 to associate the broad community of science and technology with the Academy’s purposes of furthering knowledge and advising the federal government. Functioning in accordance with general policies determined by the Academy, the council has become the principal operating agency of both the National Academy of Sciences and the National Academy of Engineering in providing services to the government, the public, and the scientific and engineering communities. The council is administered jointly by both academies and the Institute of Medicine. Dr. Bruce M. Alberts and Dr. Robert M. White are chairman and vice chairman, respectively, of the National Research Council. This report was supported by a grant from the Alfred P. Sloan Foundation. This report is available from: Board on Science, Technology, and Economic Policy National Research Council 2101 Constitution Avenue, N.W., Room NAS 246 Washington, DC 20418 202-334-2200 FAX 202-334-2419 Copyright 1994 by the National Academy of Sciences. All rights reserved. Printed in the United States of America

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Investing for Productivity and Prosperity BOARD ON SCIENCE, TECHNOLOGY, AND ECONOMIC POLICY Chairman A. Michael Spence Dean, Graduate School of Business Stanford University John A. Armstrong Vice President for Science and Technology (retired) IBM Corporation Visiting Professor Massachusetts Institute of Technology James F. Gibbons Dean, School of Engineering Stanford University George N. Hatsopoulos President and Chief Executive Officer Thermo Electron Corporation Dale Jorgenson Frederic Eaton Abbe Professor of Economics Harvard University Paul R. Krugman Professor of Economics Massachusetts Institute of Technology Ralph Landau Consulting Professor of Economics Stanford University James T. Lynn Chairman and Chief Executive Officer (retired) Aetna Life & Casualty Burton John McMurtry General Partner Tech Venture Investors Ruben Mettler Chairman and Chief Executive Officer (retired) TRW, Inc. Donald E. Petersen Chairman (retired) Ford Motor Company Michael E. Porter Professor Harvard Business School James M. Poterba Professor of Economics Massachusetts Institute of Technology George M. Whitesides Department of Chemistry Harvard University Staff Stephen A. Merrill Executive Director Sandra McDermin Administrative Assistant

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Investing for Productivity and Prosperity Preface In 1991 the National Academies of Sciences and Engineering established the Board on Science, Technology, and Economic Policy (STEP) under the National Research Council (NRC) on the premise that dialogue among the technical, business, and academic and economic policy communities could broaden and deepen understanding of the relationships between science and technology and economic performance. The Academies believed that this understanding could, in turn, help the nation’s economy to grow faster and provide challenging work and rising incomes. The economists, technologists, scientists, and former policymakers convened with the generous support of the Alfred P. Sloan Foundation and the NRC agreed at the outset that growth depends on several factors, among them skilled private and public sector management, adequate investment in human capital and physical infrastructure, a supply of financial capital at affordable cost, and conditions enabling investors to take a long-term view of growth opportunities. The board decided as a priority to address the latter two ingredients, not because they are more important than the others but because an environment conducive to long-term investment is a prerequisite for technological innovation and because capital availability and allocation have been the subject of vigorous debate and new research, including debate and research by members of the STEP board. The board’s deliberations began with an inaugural conference entitled “Capital Allocation and Investment Performance in the U.S. Economy ” in Washington in September 1992. The program included original presentations by George Hatsopoulos and James Poterba on U.S. investment performance, Michael Porter on capital allocation systems in the industrial economies, and Ruben Mettler on private management strate-

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Investing for Productivity and Prosperity gies for controlling the cost of capital and commentaries by Peter Peterson, Robert Rubin, Ralph Landau, Dale Jorgenson, Margaret Blair, and Warren Rudman, among others. The conference considered both the level of corporate investment in the United States in historical and comparative terms and how investment is allocated among different kinds of assets. These contributions and the conference discussions will appear shortly in a separate volume. Fourteen months of discussion followed as the board weighed additional evidence and policy options. During this period economic conditions changed markedly. The United States emerged from a prolonged recession, the corporate sector underwent sweeping restructuring resulting in significant job losses but also improved efficiency and competitive posture, and the Japanese and German economies stalled. The board discussed whether its original concerns were still valid. Notwithstanding this reversal of national fortunes, we concluded that the U.S. economy continues to suffer from inadequate saving, underinvestment, and excessive although not universal pressure for private investments to generate high short-term returns and that these conditions, if not changed, will seriously impede the fulfillment of Americans’ material needs and expectations. The board estimates that it will take considerable time, probably a decade or longer, to change the economy’s course. Corporate management has a crucial role, but we also call for continued emphasis on federal deficit reduction, interim and longer term changes in tax structure and regulatory policy, and agreement on measures of progress. It will be clear to the reader that this essay is not a report of original scholarly work. It is rather the consensus reached by a group, diverse in background, about a set of major economic growth issues on which there are fairly broad differences of opinion and philosophy. Our goal in producing it is to try to ensure that these issues are and remain on the national agenda. In our view, this requires not only persuading policymakers in government to take a longer term view of economic growth but also enabling an informed public to participate in the discussion of policy choices. The board is indebted to Ralph Landau, Ruben Mettler, George Hatsopoulos, Michael Porter, and James Poterba for their extraordinary contributions to this report; to the board’s executive director, Stephen Merrill, who served as principal staff officer on this project; and to Sandra McDermin, who provided editorial assistance. A. Michael Spence Chairman