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Special Issue The Region Federal Reserve Bank of Minneapolis 1996 Annual Report Breaking Down the Barriers to Technological Progress How U.S. policy can promote higher economic growth Special Issue The Region Volume 11 Number 1 March 1997 ISSN 1045-3369 Federal Reserve Bank of Minneapolis 1996 Annual Report Breaking Down the Barriers to Technological Progress How US. policy can promote higher economic growth By Preston J. Miller, Vice President and Monetary Advisor and James A. Schmitz Jr., Research Officer The views expressed herein are those o f the authors and n o t necessarily those o f the Federal Reserve Bank o f M inneapolis o r the Federal Reserve System. The Region President’s Message A lthough frequently portrayed as “preoccupied” w ith price stability, for some tim e now the Federal Reserve Bank o f M inneapolis has conducted and sponsored research aim ed at understanding the determ inants o f econom ic grow th for, after all, it is grow th that raises standards o f living. We are p roud that this research includes the w ork o f a leader in the field, Ed Prescott, a University o f M innesota Regents Professor and consultant to our bank. This year’s annual report essay, authored by Preston Miller and Jim Schmitz, reflects Prescott’s leadership. This year’s essay argues that openness to technological progress is the key to eco nom ic grow th in the U nited States. That is, the developm ent and im plem entation o f new production and organizational technologies are prim arily responsible in the United States for raising productivity and, thereby, econom ic growth. This view suggests th at by reducing resistance to technological progress, governm ent policies can make a significant contribution to econom ic growth. Further, the scholarship sum m arized in this essay suggests th at the U nited States is already doing m any o f the “right things.” This is because policies such as deregulation, openness to foreign trade and prom otion o f vigorous com petition encourage the use and adaptation o f new technologies. The U nited States has generally adhered to these p rinci ples, and one key in achieving sustained and, indeed, m ore rapid grow th going forw ard is to rem ain com m itted to policies w ith a track record o f increasing productivity. As always, a num ber o f staff contributed im portantly to the developm ent o f this essay, bu t a special acknowledgm ent is due Dave Fettig, who perform ed yeom an service in the preparation o f this piece. Gary H. Stern President i The Region Economic growth is about equal to the growth of labor productivity plus the growth of labor intensity. Labor intensity—essentially, a measure of how hard the population is working— is unlikely to contribute much to economic growth in the coming years. For the United States, then, labor productivity is the key. 0 The Region Federal Reserve Bank of Minneapolis 1996 Annual Report Breaking down the barriers to technological progress How U.S. policy can promote higher economic growth By Preston J. Miller, Vice President and Monetary Advisor and James A. Schmitz Jr., Research Officer In the past year, politicians from all bands of the political spectrum struck a common chord in declaring that the outlook for U.S. economic growth is unsatisfactory. They pointed out that economists both inside and outside the government predict growth in U.S. real gross domestic product per capita of only about 1 percent to 1.5 percent per year. They declared that the electorate should not be satisfied with this outlook for growth and argued that poli cy changes should be sought to improve it. We agree. We should never be satisfied with modest real growth. And since policies are never ideal, there is always scope to change them in ways to promote more growth. The question, of course, is how to improve U.S. policy. U.S. economic growth has depended primarily on growth in labor productivity, and by labor productivity we mean output produced per hour worked. Unfortunately, it appears that labor productivity growth has been very slow. It follows, then, that the less than opti mistic forecasts of economic growth are essentially extrapolations of expected slow labor productivity growth. Searching for higher economic growth, therefore, becomes a search for higher labor productivity growth. Labor productivity depends, in part, on the capital—both physical and hum an— employed per person in a country. Some argue that an increase in inputs, such as more physical capital (by encouraging higher savings rates) or more hum an capital (by encouraging higher education), is the answer. While these factors are im portant, for the United States they are expected to have little impact in coming years. 3 The Region But labor productivity growth also depends on the available state of technology, which refers to the efficiency with which a given set of inputs is employed— this is what econ omists term total factor productivity. It has long been known that improvement in the state of technology, known as technological progress, is a key factor in growth in labor productiv ity. O ur search then leads us to focus on technological progress. So far, so good: To improve economic growth we need greater technological progress. As noted above, economists have understood this for some time. W hat has not been so clear, however, is the answer to the question: How can government policy prom ote technological progress? O ur view is that the state of technology in a country depends, in part, on the pool of world knowledge at a given time and, perhaps m ost importantly, on the country’s institutions that promote or retard the use of this knowledge. Technological progress, therefore, depends on the rate at which world knowledge grows and on how a country’s institutions evolve— whether they provide greater (or fewer) incentives over time for employing the expanding world knowledge. Government policy, then, can have its biggest impact by ensuring that it provides institutions with incentives to use and adapt world knowledge. This view is based on theories that suggest that some countries have such relatively poor states of technology because groups in those countries erect barriers to the use of world knowledge. These barriers, like tariffs and regulations, serve to protect groups that stand to lose from the use of new world knowledge. Ultimately, such barriers serve to drag down the country’s rate of economic growth. Recent evidence shows that the new theories have merit, that is, that the state of a country’s technology is related to such policies as, for example, deregulation and openness to trade. But do these studies, many of which are based on cross-country data, have any applicability to the United States? After all, the United States arguably has the “best” institu tions as regards providing incentives to use new knowledge; the United States is already rel atively open to new products and ideas. We argue that recent U.S. history strongly suggests that these studies do have applicability here. Recent policy changes (like deregulation in many 4 The Region U.S. labor productivity mostly depends on the available state of technology, which refers to the efficiency with which a given set of inputs is employed. Improvement in the state of technology, known as technological progress, is a critical factor in labor productivity. Our search then leads us to focus on technological progress. industries), and continued com m itm ent to certain existing policies (like keeping the auto and steel industries open to trade), have led to large gains in the use of world knowledge and gains in labor productivity. Moreover, we argue that there are other potential changes that can further improve U.S. institutions, but in order for that to happen, U.S. policy m ust stay focused, generally speaking, on technological progress. Also, in an era of the so-called global economy, U.S. pol icy m ust not be swayed by arguments calling for the protection of U.S. industries— such poli cies are bound to retard economic growth. The key to economic growth is labor productivity growth, which is driven by technological progress Economic growth is about equal to the growth of labor productivity plus the growth of labor intensity. Labor intensity— essentially, a measure of how hard the population is working— is unlikely to contribute much to economic growth in the coming years, meaning that the frac tion of people working and the hours they are working are already relatively high, and any further increases will add little to growth. For the United States, then, labor productivity has been, and will continue to be, the key. As described earlier, the less than optimistic view of future growth is based on expected slow labor productivity growth. [For more on labor inten sity and labor productivity, see story on page 6.] To better understand the potential role of policies to stimulate labor productivity growth, it helps to adopt a simple conceptual framework to identify the prim ary sources of labor productivity. The framework, the aggregate production function, is widely used in eco nomics. It assumes that total output depends on inputs and the state of technology. Inputs include labor, physical capital, such as machinery, and hum an capital, such as the education levels of labor. The state of technology refers to the efficiency with which a given set of inputs is employed. A comm on assumption is that if all inputs are increased by some percentage, that output also increases by the same percentage (this property is known as constant returns to scale). It follows from this assumption that the growth in labor productivity depends on 5 T he Region Labor productivity is the key to economic growth The wealth of a nation, as Adam Smith recognized two cally equal to the growth in labor intensity plus the centuries ago, lies not in the amount of gold or silver growth in labor productivity because the growth identity amassed within its borders, but in the goods and ser holds only for small changes.) vices it can produce to meet the needs and wants of its Labor intensity is a measure of how hard a popula people. For people to experience an increase in their tion is working. It is determined by three factors. The standard of living— for them to be able to meet more of first is the labor force participation rate, which is the their needs and wants— more goods and services must percentage of people of working age who are in the be produced. labor force. The second is the employment rate, the There are two ways such an increase in production percent of all participants in the labor force who are can come about. One way is to use existing resources employed. The third is average hours worked, or the more intensively, for example, to use more labor. number of hours the average employed person works in Another way is to use such resources more productively, a week. that is, to produce larger quantities of useful goods or Since 1964, labor intensity has contributed little to growth: In spite of the fact that a higher proportion of services from each worker. In real economies, increased output comes from women work out of the home, the overall labor partici combinations of these two approaches. But the greatest pation rate rose only at an annual rate of 0.4 percent part of the increase in output comes from the fact that for the period since 1964. This modest increase was par we use labor more productively, more efficiently, than tially offset by a drop in average hours worked, which at midcentury. In other words, economic growth, by declined at an annual rate o f -0.4 percent. Finally, the which we mean growth in per capita output, has been employment rate did not change at all. In the future, driven primarily by labor productivity growth. This is these three components of tabor intensity, taken indi likely to be true in the future as well. The less than vidually or collectively, are unlikely to contribute much optimistic view about growth, then, is a view that labor to economic growth. Though increases in labor intensity did little to productivity growth will be slow. A simple equation, in words, can help us understand increase output in the last three decades, and are not the determinants of growth in per capita output. Per likely to do so in the foreseeable future, labor produc capita output can be divided into two parts: tivity growth is another story. It accounts for the bulk of the growth in per capita output since 1964: Real per _ Output — Population — — Hours Worked — "Per Capita Output " capita output increased at a 1.9 percent annual rate, Output "Labor Productivity" Hours Worked • — Population — "Labor Intensity" while labor productivity increased at a 1.4 percent annual rate. Given the muted outlook for labor intensi ty, it is likely that labor productivity growth will also account for the bulk of future economic growth. It follows, then, that economic growth is about What is the likely future course of labor productivity equal to the sum of the growth of its two parts; that is, growth? In the accompanying chart we see that labor the growth in per capita ouput is about equal to the productivity growth averaged 2.8 percent over 1964 to growth of labor productivity plus the growth of labor 1973; since then it has grown much more modestly— 1.1 intensity. (The growth in per capita output is not identi percent per year. The slowing in the trend growth of The Region Labor Productivity Growth Index 1992 = 100 is correct that the Consumer Price Index is biased upwards by more than 1 percent per year, then esti mates of Labor productivity are biased downward by close to that amount. Actual increases may have been greater than reported due to imperfect measurement of price Levels. b. Two economists, Slifman and Corrado 1996, ana lyzed official U.S. data and found that these data imply that productivity has declined in the service sector. Such a decline is counterintuitive; it does not jibe with readily apparent increases in service sector productivity. Hence, there may be measurement problems in the pub lished data. 2. Acceleration may take time to occur. a. Historically, it has taken time for major, earthlabor productivity during the 7 0 s remains, to a large shaking innovations to have an impact on aggregate extent, a puzzle. Since this is the case, a conservative productivity. It takes time for firms and workers to prediction is that labor productivity's recent perfor learn and adapt to such fundamental change. Some mance will continue in the future. This, then, is how the argue that the computer revolution fits into this story. less than optimistic view of future labor productivity (David 1990 has described the slow response to devel growth, and economic growth, are derived. opment of electricity at the turn of the century.) Consistent with this explanation that large productivity Productivity growth may well have begun to pick up gains from computers are on the horizon is the rise in Some observers argue that the recent Labor productivity stock market values. Market expectations of future pro figures are misleading. They argue that in recent years ductivity gains may be what is driving up corporate there has been a sizable opening of international trade, earnings predictions and thus driving up equity values. important industries have been deregulated, corpora We do not know with certainty why labor productivi tions have been restructured and there has been an ty growth since 1973 has been so slow. A conservative explosion of new technologies related to computers, prediction is to assume its current growth trend will telecommunications and medicine. All of these have continue at a rate of a bit more than 1 percent a year. strengthened the economy and made it more produc This implies that growth in real per capita income also tive. These critics argue that reported U.S. statistics for will be at a rate of slightly more than 1 percent a year. labor productivity have not accelerated for a number of However, if the arguments of the critics of official data reasons: 1. There may be serious mismeasurement are correct, future labor productivity growth could well a. Productivity measures are derived from measures exceed the conservative prediction. In any case, given labor productivity's poor recent performance, it is pru of the value of output, adjusted for changes in the gen dent to consider policy changes that might increase eral price level. If the Boskin Commission's conclusion labor productivity growth. The Region So far, so good: To improve economic growth we need greater technological progress. But how can government policy promote technological progress? the rate of technological progress and the rate of increase in capital intensity (capital per unit of labor). In 1957, Robert Solow published an im portant paper in which he concluded that in the United States, for the period 1909-1949, “output per m an hour doubled over the interval, with 87.5 percent of the increase attributable to technical change [technological progress] and the remaining 12.5 percent to increased use of capital” (p. 320). In other words, growth in labor productivity was driven primarily by technological progress and not by the expan sion of capital inputs available to workers. In brief, using available data on hours, capital intensity and output, Solow was able to derive a measure of the state of technology, and then to compute the contribution of both increases in capital intensity and increases in the state of technology (that is, technological progress) to economic growth. This accounting exercise for U.S. labor productivity growth has been repeated many times in the last 40 years. For some exercises, hum an capital has been added as an input. Refinements of Solow’s exercise have not changed the basic conclusion that, in the United States, technological progress has played a major role in driving labor pro ductivity growth (see King and Levine 1994 for review). So, given the importance of technological progress for labor productivity growth, we tu rn naturally to seek its determinants. The next two sections will include a summ ary of some of the economic literature on this subject. Some theories about the determinants of the state of technology and technological progress Again, the state of technology gives us the level of efficiency with which a country employs a given set of physical and hum an capital inputs. W hat does this depend on? It depends, in part, on the state or pool of knowledge available in the world. But it also depends on the extent to which a country’s institutions promote or retard its citizens from employing this knowledge. It follows that technological progress depends on the rate at which world knowledge grows and on how a country’s institutions evolve—whether they provide greater (or fewer) incen- 8 The Region tives over time for employing the expanding world knowledge (see Parente and Prescott 1994). In what follows, we will focus on what determines the extent to which a country uses available world knowledge. We leave for others to discuss what determines the rate at which world knowledge grows. Now, there are many “natural” reasons why a country may not fully use all world knowledge at a given time, even if a country’s institutions are very well designed. Natural impediments can arise as new technologies are adapted to local conditions; for example, new agricultural technologies m ust be adapted to local climatic conditions. Another natural impedim ent is that the rate of diffusion may depend on the levels of other production inputs, such as hum an capital. As an example, although hum an organ transplant surgery is general knowledge, not all countries have the trained surgeons, professional staff and equipm ent to perform it. Griliches’ (1957) classic study of hybrid corn illustrates why the rate of diffusion of new technologies can differ across locations due to natural impediments. The new m ethod of production had to be adapted to local area conditions because of climate and soil differences; hence, it hit some areas first and over time spread to others. Moreover, his study also dem on strated the complementarity discussed above: The rate the m ethod diffused within an area was related to farmers’ education levels. While the importance of these natural impediments cannot be denied, these reasons are not sufficient, in our view, to explain why some countries employ so very little of the world knowledge pool at a given time. The culprit here is very often the policies and institu tions that restrict citizens from employing world knowledge more fully. These restrictions on the use of new knowledge are constructed (with the help of government) by groups that stand to lose if the knowledge is employed. Economic historians, in particular Mokyr (1990, pp. 209-272), assign a major role to these restrictions on the use of world knowledge in their attempts to explain differences in growth across nations. Mokyr (1990, p. 12) states: In every society, there are stabilizing forces that protect the status quo. Some of these 9 The Region forces protect entrenched vested interests that might incur losses if innovations were introduced, others are simply don’t-rock-the-boat kinds of forces. Technological cre ativity needs to overcome these forces. Mokyr (1990, p. 16) also notes that technologically progressive societies are the exception. Usually, the forces opposing technological progress are stronger than the forces striving for change. To give an idea of the type of restrictions that are imposed, a clear example is the dif fusion of new innovations in construction. One innovation in the industry occurred when engineers came to understand that wider spacing of wall studs would not influence the struc tural integrity of homes. W ith wider spacing there would be need for fewer materials and, of course, less labor. While this particular innovation was costless to introduce, it diffused very slowly. Oster and Quigley (1977) argued that it was likely construction workers, applying pressure on building code administrators, that blocked the adoption of this and other laborsaving technologies. They also showed that the procedures (that is, institutions) for choos ing administrators influenced whether construction workers were able to restrict the new methods. Groups use many other means, in addition to regulations imposed by government, to restrict the use of world knowledge. Tariffs or, more generally, restrictive trade practices are a key m ethod. W ith trade barriers, groups are able to continue producing with outdated methods by erecting barriers to imports produced with new additions to world knowledge. Regarding theory, Olson (1982, especially chapter 5) has discussed how trade and factor mobility may limit the effectiveness of special interest groups. Holmes and Schmitz (1995) have recently formalized these ideas about trade and resistance. They study a simple model where a special interest group can spend resources to block a new technology that threatens its privileged position. If there is no trade, the group may very well find it worthwhile to spend these resources. If, however, there is trade, so that the good can be produced elsewhere with new technology and shipped to the country, the special interest is likely to abandon its resistance (see also Parente and Prescott 1996 for recent models). 10 The Region Our view is that technological progress depends on the rate at which world knowledge grows and on how a country’s institutions evolve— whether they provide greater (or fewer) incentives over time for employ ing the expanding world knowledge. Recent evidence suggests these restrictions on use of knowledge, laid out in regula tions (like those in the building industry) and supported by tariffs, have a large impact on the state of technology in a country. We now turn to this evidence. Recent evidence supports the new views There are large differences in the state of technology across countries, suggesting different countries access the world knowledge pool to varying degrees. While this has been known for some time (for example, Denison 1967 found this in his comparison of the United States and Europe; see King and Levine 1994 for a review of this literature), recent studies using many more countries find the same result. Three such studies are King and Levine (1994), Klenow and Rodriguez-Clare (1996) and Hall and Jones (1996). Recent studies also find that the state of technology in a country is related to gov ernm ent policies. As mentioned, Hall and Jones calculate the state of technology for a large num ber of countries (for the year 1988). They show that variation in the state of technology is related to measures of policies and institutions. For example, their list of policies included measures of government support of production (including the extent to which government enforced private contracts), the type of economic organization employed (capitalist vs. sta tist) and openness to international trade. Hall and Jones find that differences in policy explain a large fraction of differences in the state of technology. In particular, openness to interna tional trade is found to lead to much higher levels of the state of technology. Hall and Jones’ work supports the above view that differences in the state of tech nology are caused by differences across countries in restrictions on the use of world knowl edge. By showing that openness to trade influences the state of technology, it lends support to the views above. The evidence is indirect, though. Openness to trade could be increasing the level of the state of technology through other mechanisms than the one we suggest, that is, by reducing restrictions on use of world knowledge. Other research attempts to show through more direct means that restrictions on the use of world knowledge cause big differences in the state of technology. One example is li The Region Recent evidence suggests that restrictions on use of knowledge, laid out in regulations and supported by tariffs, have a large impact on technological progress in a country. The Region Schmitz (1997), who studies a particular restriction on technology: the requirem ent that gov ernment, rather than the private sector, produce investment goods in a country. A num ber of countries have imposed this restriction, including Egypt, India and Turkey. He estimates that this restriction has had large impacts on the state of technology and labor productivity in those countries. Other direct evidence is provided by McKinsey and Co., who have compared the labor productivity of various industries across the United States, Europe and Japan (these are summarized in Baily 1993, and Baily and Gersbach 1995). They find that productivity is often higher in the United States, and one of the reasons they give is that there are typically fewer regulations and restrictions on business practices in this country. For example, consider the retail sector. McKinsey argues that retail productivity is m uch higher in the United States than Japan. One of the reasons is that there are limits on the size of store that can be opened in Japan. These limits on store size effectively restrict some of the new retailing technologies, like better inventory management, since a larger store is better able to exploit this technology. These restrictions on size are maintained by lobbying and political pressure of small stores in Japan (such stores have had a rough time against such large retailers as Wal-Mart in this country). Before turning to whether this has anything to do with the United States, we should m ention that there are economists who, in trying to explain growth, do not place as much emphasis on how a country’s institutions influence the incentives to use and adapt world knowledge. In particular, these economists have argued that the state of technology plays a m inor role, if any, in explaining differences in output per worker across countries, and claim that varying levels of capital—both physical and hum an— explain differences in output. We are not persuaded by these arguments, based on two sets of studies: One set directly criticizes the research and the other takes its conclusion as an assumption— that is, that all countries have the same state of technology— and finds that differences in physical and hum an capital cannot account for unequal cross-country productivity levels. [For a further examination of this debate, see page 14.] 13 The Region Another view about economic growth As we mention in the accompanying essay, there are across countries than does MRW's. Hence, human capi some economists who do not place such emphasis on tal is less likely to have a big role in explaining differ how institutions influence the incentives to use and ences in labor productivity. And this is what KRC find. adapt world knowledge. For example, in a recent arti That is, when KRC use the expanded measure of human cle, N. Gregory Mankiw argues that the state of tech capital, they find that differences in technology once nology plays a minor role, if any, in explaining differ again play a big role in cross-country productivity dif ences in labor productivity across countries. He states, ferences. "Put simply, most international differences in living KRC have other problems with MRW's treatment of standards [author's note: labor productivity] can be human capital. In particular, they object to the nature explained by differences in accumulation of both of the accumulation technology for human capital. human and physical capital" (1995, p. 295). (See also Fixing this accumulation technology adds still more to Chari, Kehoe and McGrattan 1996.) the role of the state of technology, and less to capital, What evidence does Mankiw have for his claim? His evidence is from his work with Romer and Weil (Mankiw, in explaining labor productivity differences across coun tries. After these changes in the treatment of human Romer and Weil (MRW) 1992). MRW perform an capital, KRC are essentially back to the old view about accounting exercise, like that by Denison (1967) the key role of the state of technology. decades earlier, but find that nearly all differences in labor productivity are due to differences in capital, both physical and human. We are not persuaded by the MRW evidence due to A second consideration for why we don't accept MRW's findings is based on recent work of Prescott (1996). He supposes that atl countries use the same state of technology and asks whether differences in two types of considerations. One is a critique of the inputs of physical and human capital can, in plausibly MRW study itself. The other is a demonstration that calibrated growth models, account for differences in counterfactual implications follow from the assumption cross-country labor productivity levels. He finds that that all countries have the same technologies. they cannot. Furthermore, he argues that such models First, as Klenow and Rodriguez-Clare (KRC) show, the MRW result is fairly fragile. For example, KRC take have two other counterfactual implications: 1. They imply capital-output ratios should be relatively exceptions to the measure of human capital employed higher in rich countries than in poor ones. Prescott by MRW. One objection is that MRW use secondary argues that evidence, such as Kuznets (1967), suggests, school enrollment rates to construct their measure of a if anything, the opposite is true. human capital stock for each country. A more compre 2. They imply that the real rate of return on capital in hensive measure would use, for example, primary and rich countries should be lower than that in poorer post-secondary school enrollment rates to construct countries because richer countries have relatively more stocks. Primary enrollment rates, not surprisingly, vary capital. Prescott argues that there appear to be only much less than secondary, so a more comprehensive small differences in real rates of return between rich measure of human capital turns out to vary much Less and poor countries. The Region One study reveals that variation in the state of technology among countries is related to measures of policies and institutions. For example, such policies included measures of government support of production (enforcement of private contracts), the type of economic organization employed (capitalist vs. statist) and openness to international trade. What, if anything, does the new evidence have to teach the United States? In some im portant ways the U.S. economy is unlike many economies in the cross-country studies that provide much of the new evidence. First, it already has relatively good policies and institutions. Most observers would probably rate the United States as having the best institutions in regards to prom oting competition among businesses. Second, the United States economy contributes m uch to the world knowledge pool. It is a major spender on research and development, which is one key to growth in that pool. Though both these facts suggest the United States has little to gain from policy changes, and little to learn from the recent studies, we argue that recent U.S. history strongly suggests otherwise. U.S. policy changes have indeed led to large gains in access to world knowledge. And there is more to do. Openness to technological progress has led to substantial labor productivity gains... Recent U.S. history suggests that policy changes, and continued com m itm ent to existing poli cies, have led to large gains in the use of world knowledge and gains in productivity. One im portant area of change has been the large num ber of industries that have been deregulat ed over the past two decades. These include airlines, trucking, railroad, the securities indus try and long-distance phones. As a result of deregulation and increased competition, these industries have experienced rapid drops in prices and strong gains in productivity (see, for example, W inston 1993). A study by Olley and Pakes (1996) of the U.S. telecommunications industry suggests that labor productivity growth spurted after the industry was deregulated and that the growth was fueled by the introduction of new technology. It suggests that the state of technology had been stifled by regulation. There have been other changes, for example, in the area of trade policy. (See Miller 1993 on the relationship between trade policy and economic growth— including the refer ences therein.) A high-profile case has been the lowering of trade barriers associated with the 15 The Region At first glance, the policy prescription advocated in this essay—open trade, deregulation and increased competition—seems merely like a reiteration of well-accepted economic principles. However, these principles are more often preached than practiced, and many policy-makers are not necessarily con vinced of their wisdom. N orth American Free Trade Agreement (NAFTA). Other negotiations to lower trade barriers with South America are under way. While these changes are im portant, so, too, have been the battles fought to continue existing policies that foster growth. Regarding trade policy, in many markets, like steel and autos, the United States maintained its com m itm ent to open markets. There was great pres sure to limit trade in these markets and there were some programs that did slow imports. On balance, however, the markets were kept open. As a result, the United States more quickly adopted new m ethods than, for example, its European counterparts (as the above ideas sug gest). U.S. car producers adopted Japanese “lean” production well before its more closed European rivals (see Holmes and Schmitz 1995). In the steel industry and, in particular, the iron-ore industry, the United States also kept its markets open in the face of increasing international competition. As a result, as the international price of taconite fell in the early 1980s, the Minnesota industry was able to dou ble its labor productivity in a fairly short period. This was accomplished not with new machines and the like, but in part by changes in work practices. ... but there’s more to do While much has been accomplished, there is still more to do. For example, deregulation has begun in telecommunications, but m uch remains to be done; reform of the electricity indus try has just started; and there is also the recent drive to end “corporate welfare,” including subsidies to producers. Im portant areas under study are: tort reform, liability reform and increasing competition in prim ary and secondary education. This is not to say that reform is not difficult. Even if a policy change would lead to large productivity gains, it still, most likely, would harm some groups. These groups may well seek access to the political market to block reform. Recognizing this, the current adm inistra tion has developed some programs to help defray the costs borne by groups so affected. Their policies of retraining workers who lose jobs due to NAFTA is one such program .1 The Region Technological progress is a key element of economic growth, and to encourage technological progress, the United States must constantly refocus its efforts on policies that reduce resistance to technology and increase the use of world knowledge. Breaking down the barriers At first glance, the policy prescription advocated in this essay— open trade, deregulation and increased competition— seems merely like a reiteration of well-accepted economic principles. However, these principles are more often preached than practiced, and many policy-makers are not necessarily convinced of their wisdom. Governments are often tem pted to engage in policies that, for example, protect certain industries from foreign competition or, in the case of internal markets, make it difficult for innovative companies to compete in established industries. Recent U.S. history strongly suggests that the lessons being learned from cross-country comparisons of labor productivity and growth apply to the United States. In brief: Technological progress is a key element of economic growth, and to encourage technological progress, the United States m ust constantly refocus its efforts on policies that reduce resis tance to technology and increase the use of world knowledge. Endnote 1M ost of the reforms we have discussed involve less gov ernment. We do not want to tip the balance too m uch here. Government m ust play an im portant role in ensuring a produc tive economy. For example, antitrust is an im portant role for gov ernment. Just as trade ensures open markets across borders, antitrust can ensure that monopolization doesn’t reduce compe tition at home. 17 The Region Bibliography Baily, M artin. 1993. Com petition, regulation, and efficiency in service industries. Brookings Papers on Economic Activity, M icroeconomics, pp. 71-130. Baily, M artin, and Gersbach, Hans. 1995. Efficiency in m an u facturing and the need for global competition. Brookings Papers on Economic Activity, Microeconomics, pp. 307-47. Boskin, Michael, J. Chairman, Advisory Commission to Study the Consum er Price Index. 1996. Toward a more accurate measure o f the cost o f living. Final report to the Senate Finance Committee. Chari, V.V.; Kehoe, Patrick; and M cGrattan, Ellen. 1996. The poverty of nations: A quantitative exploration. Staff Report 204. Federal Reserve Bank o f Minneapolis. David, Paul. 1990. The dynam o and the computer: An histori cal perspective on the m odern productivity paradox. American Economic Review 80 (May): 355-61. Denison, Edward. 1967. W hy growth rates differ: Post war expe riences in nine western countries. W ashington, D.C.: The Brookings Institution. Griliches, Zvi. 1957. H ybrid corn: An exploration in the eco nomics of technological change. Econometrics 25 (October): 501-22. Hall, Robert, and Jones, Charles. 1996. The productivity of nations. W orking Paper 5812. N ational Bureau of Economic Research. Mankiw, N. Gregory. 1995. The growth o f nations. Brookings Papers on Economic Activity, pp. 275-310. Mankiw, N. Gregory; Romer, David; and Weil, David. 1992. A contribution to the empirics of economic growth. Quarterly Journal o f Economics 107 (2): 407-37. Miller, Preston J. 1993. The high cost of being fair. Annual Report. Federal Reserve Bank of Minneapolis. Mokyr, Joel. 1990. The lever o f riches: Technological creativity and economic progress. New York: Oxford University Press. Olley, G. Steven, and Pakes, Ariel. 1996. The dynamics of p ro ductivity in the telecommunications equipm ent industry. Econometrica 64 (6): 1263-98. Olson, M ancur. 1982. The rise and decline o f nations: Economic growth, stagflation and social rigidities. New Haven: Yale University Press. Oster, Sharon, and Quigley, John. 1977. Regulatory barriers to the diffusion of innovation: Some evidence from building codes. Bell Journal o f Economics 8 (Autumn): 361-77. Parente, Stephen L., and Prescott, Edward C. 1994. Barriers to technology adoption and development. Journal o f Political Economy (April): 298-321. ----------------------- . 1996. M onopoly rights: A barrier to riches. W orking Paper. Federal Reserve Bank of Minneapolis. Prescott, Edward. C. 1996. Notes on barriers to riches. W orking Paper. Federal Reserve Bank of Minneapolis. Holmes, Thomas J., and Schmitz, James A. Jr. 1995. Resistance to new technology and trade between areas. Federal Reserve Bank o f Minneapolis Quarterly Review 19 (Winter): 2-17. Schmitz, James A. Jr. 1997. Governm ent production of invest m ent goods and aggregate labor-productivity. W orking Paper. Federal Reserve Bank of Minneapolis. King, Robert G., and Levine, Ross. 1994. Capital fundam ental ism, econom ic developm ent, and econom ic growth. Carnegie-Rochester Conference Series on Public Policy 40 (June): 259-92. Slifman, L., and Corrado, C. 1996. Decomposition of produc tivity and unit costs. Occasional Staff Study. Board of Governors of the Federal Reserve System. Klenow, Peter, and Rodriguez-Clare, Andres. 1996. The neo classical revival in growth economics: Has it gone too far? Discussion Paper. Federal Reserve Bank of Minneapolis. Kuznets, Simon. 1966. Modern economic growth: Rate, structure and spread. New Haven: Yale University Press. Solow, Robert. 1957. Technical change and the aggregate p ro duction function. Review o f Economics and Statistics 39 (August): 312-20. W inston, Clifford. 1993. Economic deregulation: Days of reck oning for microeconomists. Journal o f Economic Literature 31 (September): 1263-89. The Region Statement of Condition (in millions) December 31, 1996 December 31, 1995 $ 168 144 19 639 7 5,946 480 54 0 119 19 $ 203 180 20 450 4 6,894 563 70 3 62 18 $7,595 $8,467 $5,503 $5,990 721 5 653 6 453 32 11 741 6 411 0 1,082 29 10 $7,384 $8,269 ipital: Capital paid-in Surplus 107 104 99 99 Total capital 211 198 $7,595 $8,467 Assets Gold Certificates Special drawing rights certificates Coin Items in process of collection Loans to depository institutions U.S. government and federal agency securities, net Investments denominated in foreign currencies Accrued interest receivable Prepaid interest on Federal Reserve notes Bank premises and equipment, net Other assets Total assets Liabilities and Capital Liabilities: Federal Reserve notes outstanding, net Deposits: Depository institutions Other deposits Deferred credit items Statutory surplus transfer due U.S. Treasury Interdistrict settlement account Accrued benefit cost Other liabilities Total liabilities Total liabilities and capital 19 The Region Statement of Income (in millions) D ecem ber 31, $454 21 4 389 Total interest income 1995 $375 11 3 Interest income: Interest on U.S. government securities Interest on foreign currencies Interest on loans to depository institutions D ecem ber 31, 1996 479 Other operating income: Income from services Reimbursable services to government agencies Foreign currency (losses) gains, net Government securities gains, net Other income 44 16 (42) 1 1 42 14 27 0 1 Total other operating income 20 84 Operating expenses: Salaries and other benefits Occupancy expense Equipment expense Cost of unreim bursed Treasury services Assessments by Board of Governors Other expenses 61 6 7 4 10 29 60 4 7 3 11 28 117 113 Income before cumulative effect of accounting change 292 450 Cumulative effect of changes in accounting principles 0 Total operating expenses (20) $292 Net income prior to distribution Distribution of net income: Dividends paid to member banks Transferred to surplus Payments to U.S. Treasury as interest on Federal Reserve notes Payments to U.S. Treasury as required by statute $430 $ $ 6 8 216 6 1 423 0 $292 0 62 $430 The Region Statement of Changes in Capital (in millions) For the years ended D ecem ber 31, 1996, an d D ecem ber 31, 1995 Capital Paid-In Balance at January 1, 1995 (1.97 million shares) Net income transferred to surplus Net change in capital stock issued (.01 million shares) $ 98 Balance at December 31, 1995 (1.98 million shares) $ 99 $196 1 _____ 1 $ 99 $198 8 8 (3) Statutory surplus transfer to the U.S. Treasury Balance at December 31, 1996 (2.1 million shares) $ 98 1 1 Net income transferred to surplus Net change in capital stock issued (.15 million shares) Surplus (3) 8 $107 8 $104 These statements are prepared by Bank management. Copies of full financial statements complete with footnotes are available by contacting Public Affairs at (612) 340-2446. Total Capital $211 The Region 1996 Minneapolis Board of Directors 1996 Helena Branch Board of Directors Jean D. Kinsey Chair Lane W. Basso Chair David A. Koch Deputy Chair M atthew J. Q uinn Vice Chair Class A Elected by M em ber Banks Appointed by the Board o f Governors Dale J. Emmel President First National Bank of Sauk Centre Sauk Centre, M innesota Lane W. Basso President Deaconess Research Institute Billings, M ontana Jerry B. Melby President First N ational Bank Bowbells, N orth Dakota M atthew J. Q uinn President Carroll College Helena, M ontana William S. Pickerign President The Northwestern Bank Chippewa Falls, Wisconsin Class B Elected by M em ber Banks Dennis W. Johnson President TMI Systems Design Corp. Dickinson, N orth Dakota Clarence D. M ortenson President M /C Professional Associates Inc. Pierre, South Dakota Appointed by the Board o f Directors Federal Reserve Bank o f Minneapolis Donald E. Olsson Jr. President Ronan State Bank Ronan, M ontana Ronald D. Scott President and CEO First State Bank Malta, M ontana Sandra M. Stash M ontana Facilities M anager ARCO Anaconda, M ontana Kathryn L. Ogren Owner Bitterroot Motors, Inc. Missoula, M ontana Class C Appointed by the Board o f Governors Federal Advisory Council M ember James J. Howard Chairman, President and CEO N orthern States Power Com pany Minneapolis, M innesota Richard M. Kovacevich Chairm an and CEO Norwest Corporation Minneapolis, M innesota Jean D. Kinsey Professor of C onsum ption & Consum er Economics University of M innesota St. Paul, M innesota David A. Koch Chairman Graco Inc. Golden Valley, M innesota The Region Minneapolis Board of Directors Seated (from left): Dennis W. Johnson, Jean D. Kinsey, James J. Howard, Dale J. Emmel; standing (from left): William S. Pickerign, Jerry B. Melby, David A. Koch, Clarence D. Mortenson, Kathryn L. Ogren Federal Advisory Council Member Richard M. Kovacevich Helena Branch Directors Seated (from left): Ronald D. Scott, Donald E. Olsson Jr.; standing (from left): Matthew J. Quinn, Sandra M. Stash, Lane W. Basso 23 The Region Advisory Council on Small Business, Agriculture and Labor Eric D. Anderson Business Agent United U nion of Roofers, W aterproofers and Allied W orkers Eau Claire, Wisconsin Clarence R. Fisher Chairm an and President U pper Peninsula Energy Corp. Upper Peninsula Power Co. H oughton, Michigan James D. Boomsma Farmer Wolsey, South Dakota Thomas Gates President and CEO Hilex Corporation Eagan, M innesota Gary L. Brown President Best W estern Town ’N C ountry Inn Rapid City, South Dakota Jeanne Davison Owner Butterfield Farms Hokah, M innesota William N. Goldaris Vice President Globe Inc. Minneapolis, M innesota Howard H edstrom Partner H edstrom Lumber Co. Grand Marais, M innesota Dennis W. Johnson, Chairm an President TMI Systems Design Corp. Dickinson, N orth Dakota Dean A. Nelson (Resigned September 1996) Former President American Bank Whitefish, M ontana Virginia Tranel Rancher Billings, M ontana Harry W ood President H.A. & J.L. W ood Inc. Pembina, N orth Dakota I Advisory Council on Small Business, Agriculture and Labor Seated (from left): Dean A. Nelson, Thomas Gates, Virginia Tranel, James D. Boomsma, Clarence R. Fisher; standing (from left): Harry Wood, Jeanne Davison, Gary L. Brown, Dennis W. Johnson, Eric D. Anderson, William N. Goldaris The Region Officers Federal Reserve Bank of Minneapolis December 31, 1996 Gary H. Stern President Colleen K. Strand First Vice President Melvin L. Burstein Executive Vice President, Senior Advisor and General Counsel and E.E.O. Officer Sheldon L. Azine Senior Vice President James M. Lyon Senior Vice President A rthur J. Rolnick Senior Vice President and Director of Research Theodore E. Umhoefer, Jr. Senior Vice President Scott H. Dake Vice President Kathleen J. Erickson Vice President Creighton R. Fricek Vice President and Corporate Secretary Karen L. G randstrand Vice President Edward J. Green Senior Research Officer Caryl W. Hayward Vice President William B. Holm Vice President Ronald O. Hostad Vice President Bruce H. Johnson Vice President Thomas E. Kleinschmit Vice President Richard L. Kuxhausen Vice President David Levy Vice President and D irector of Public Affairs Kinney G. Misterek Assistant Vice President Susan J. Manchester Vice President H. Fay Peters Assistant General Counsel Preston J. Miller Vice President and M onetary Advisor Richard W. Puttin Assistant Vice President Susan K. Rossbach Vice President and Deputy General Counsel Paul D. Rimmereid Assistant Vice President Charles L. Shromoff General Auditor David E. Runkle Research Officer Thomas M. Supel Vice President James A. Schmitz Jr. Research Officer Claudia S. Swendseid Vice President Kenneth C. Theisen Assistant Vice President Warren E. Weber Senior Research Officer Richard M. Todd Assistant Vice President Robert C. Brandt Assistant Vice President Jacquelyn K. Brunmeier Assistant Vice President James T. D eusterhoff Assistant Vice President Debra A. Ganske Assistant General Auditor Thomas H. Turner Assistant Vice President Niel D. Willardson Assistant Vice President M arvin L. Knoff Supervision Officer Robert E. Teetshorn Supervision Officer Michael Garrett Assistant Vice President Jean C. Garrick Assistant Vice President Peter J. Gavin Assistant Vice President Linda M. Gilligan Assistant Vice President JoAnne F. Lewellen Assistant Vice President Helena Branch John D. Johnson Vice President and Branch Manager Samuel H. Gane Assistant Vice President and Assistant Branch Manager