Trends in Investment and Tax Policy: Time for a Change?
Thorning, Margo, Business Economics
INVESTMENT SPENDING in the United States in recent years compares unfavorably with that of other nations and with our own past experience. From 1973 to 1991, gross nonresidential investment as a percent of GDP was lower for the United States than for any of our major competitors. The U.S. saving rate is also significantly lower than other industrial nations: 4.8 percent compared to 19.1 percent in Japan and 10.7 percent in West Germany. Even more disturbing is that annual U.S. investment is only half the level achieved in this country during the 1960s and 1970s. Net private domestic investment averaged 7.4 percent of GDP from 1960 to 1980; since 1991 it has averaged only 3.0 percent.
Reflecting the reduced share of GDP being invested each year, the U.S. capital stock has also grown more slowly. In the three decades prior to 1980, the total capital stock grew at 4.0 percent per year; in the 1980s and 1990s, the rate fell to 2.7 and 1.4 percent, respectively. The stock of equipment, which many experts regard as critical for strong productivity growth, has increased since 1980 only about half as fast as in previous decades. Industrial equipment stocks, which grew at an average rate of 4.3 percent over the 1950-79 period, increased by just 1.2 percent annually in the 1980s and 0.1 percent since 1990.
LINK BETWEEN INVESTMENT AND PRODUCTIVITY
Productivity increases are critical to raising wages for both unskilled and highly-skilled U.S. workers. New York University Professor Edward Wolff's research shows that aggregate productivity growth in the OECD countries outstripped the United States during much of the 1950-90 period.(1) He notes that countries like Japan and Germany, which experienced strong productivity growth in the 1970s and 1980s, showed significant gains in their capital-to-labor ratios. Professor Wolff's study also shows that labor productivity growth is associated with the rate of capital-labor growth and the rate of technological progress.
Professor Wolff argues that U.S. productivity growth rates are depressed by the recent slower growth in the capital-labor ratio - from a peak of 2.0 percent per year in the 1950s to 1.2 percent per year in the 1977-92 period. He emphasizes that the effects of the decline in U.S. capital-labor growth are perhaps even TABULAR DATA OMITTED more pernicious than they appear at first glance. First, an increasing capital-labor ratio will increase labor productivity through capital deepening. Second, there appears to be an important and significant interaction effect between technological advance and capital investment. Thus, a slowing in capital formation may doubly hurt labor productivity growth - directly by slowing the rate of capital deepening and indirectly by slowing the rate of technical advance.(2)
The importance of equipment investment to economic growth is also documented in studies by Lawrence Summers, Undersecretary for International Affairs, U.S. Department of Treasury, and Bradford De Long, Deputy Assistant Secretary for Policy Analysis, U.S. Department of Treasury.(3) Their research shows that, for a broad cross-section of nations, every 1 percent of GDP invested in equipment is associated with an increase in the GDP growth rate itself of one-third of 1 percent -- a very substantial rate of return. Summers and De Long conclude that investment in equipment is perhaps the single most important factor in economic growth and development.
IMPLICATIONS OF SLOW PRODUCTIVITY GROWTH
U.S. family income has been nearly stagnant since the mid-1970s, and in recent years family income has actually fallen. For example, real median household income was $39,869 in 1989; income has declined each year to $36,959 for 1993.(4) These trends in family income have not only made it harder to maintain living standards but have also jeopardized our future economic health and our ability to remain the principal leader in international affairs. In addition, looming in the future is the need to finance the retirement of the "baby boom" generation. …