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Bigger or Better?

Perspectives on Economic Growth

edited by Walter Heller
Random House, 240 pp., $1.95 (paper)

The tax rise passed last June by a reluctant Congress, five months before a presidential election, marked the end of a story that began four years ago when the previous Congress—with considerably less reluctance—voted a major tax cut in spite of an impending Federal deficit: The New Economics is now clearly having its way. Perspectives on Economic Growth is the product of the group that masterminded and guided these operations. Indeed, this collection of essays has been dedicated to President Kennedy “who initiated and inspired this volume”; they have been edited by Walter Heller, who served under Kennedy as Chairman of the Council of Economic Advisors; and one of the contributors, Arthur Okun, now occupies this post. Mr. Okun recapitulates the computations that demonstrate how the 1964 tax reduction fended off the impending recession, and he shows how fiscal policies which aim to close the gap between actual and potential capacity, employment, and consumption helped to sustain continuous economic growth. No word about the sharp price rise of 1964-1966, which is just as well, since the President’s exhortation against the wage-price spiral is the only new anti-inflationary weapon that has been unveiled in recent years. Moreover, James Tobin, the author of the central piece, “Economic Growth as an Objective of Government Policy,” served, at the time Heller was Chairman, as one of the three members of the Council. The Preface emphasizes that seven other contributors have also had “Washington experience.” Warren Smith, for example, who writes on Monetary Policies for Economic Growth,” was appointed a member of the Council after this book was published.

The collection aims to present what it calls “the latest thinking and findings among the main stream of professional economic thought.” All nine essays reflect much satisfaction with past accomplishments, as well as a readiness to face continuing responsibilities in guiding the United States toward a better, or at least a richer, future. There are solemn references to “the (economic) profession” as undertaking certain tasks. Indeed, the authors exalt “high growth” as a means to “improve the image of the US abroad whereby aiding those friendly, and confounding those hostile to America and to Western values.” The authors, then, speak authoritatively on the subject of economic growth not only as technical economists, but also as representatives of Washington thinking.

In practical terms the problem of economic growth, as Tobin says, is the question of the present versus the future. The size of the Gross National Product depends at any given time on the amounts of labor, capital, and natural resources employed, as well as on the state of the technology used in various branches of the economy to transform the so-called primary inputs into the final outputs. As time goes on, the amounts of labor and of capital (but not of natural resources) increase, and technology advances; the Gross National Product grows.

Most of the services and goods which make up the annual National Product are consumed; that is, they are used to satisfy all kinds of current private and public needs. Some part of them is, however, added to the existing stock of capital, in the form of new or enlarged factories, dams, roads, and many other kinds of facilities. This new investment leads to an increase in national income. Next year’s larger income is, in its turn, again apportioned between consumption and additional investment. And so the process of economic expansion goes on and on and on. Population growth naturally plays an important part in it, adding, however, not only to the number of hands that can be employed in production, but also to the number of consumers that have to be clothed, housed, and fed.

Far from being independent of each other these different factors contributing to growth are interrelated in many different ways. The contribution of additional manpower to increasing output depends, for example, on the amount of capital equipment with which it operates. This explains why, in underdeveloped countries that are unable to equip their additional workers with the tools they need, the rising population contributes little if anything to national income while adding steadily to the number of mouths to be fed.

Investment not only consists of new physical facilities, but also can take the form of educational and training operations that transform untrained into skilled or professional labor, in the same way as iron ore is transformed into pig iron and then into steel. In the chapter on “Investment in Human Capital and Economic Growth,” William Bowen shows that, by 1964-65, annual education expenditures were nearly one third as large as annual investment in tangible physical capital.

Technological advance itself depends to a certain extent on new investment. For example, if they are to become practically useful, new and more efficient methods of generating atomic energy must first be “embodied” in newly constructed atomic generating plants. Some of these simply replace worn-out thermal installations but most represent new investment in additional generating capacity required to satisfy additional demand. Had the demand for electric energy expanded less rapidly or not at all, the introduction of the new technology would have proceeded at a much slower pace.

CONSTRUCTION of abstract “models” intended to describe in mathematical terms the complex interrationships governing the process of economic growth has become one of the favorite occupations of economic theorists. Unfortunately, the lack of detailed factual knowledge of conditions existing in the real world forces the model builder to base many if not all of his general conclusions on all kinds of a priori assumptions, chosen for their mathematical convenience rather than for their correspondence to observed facts. James Tobin and Robert Solow, the two most distinguished theorists in Heller’s group, make, in any case, the best of it.

One theoretical conclusion, which delights the model builders so much that they refer to it as the “Golden Rule” is that, in the very long run, the highest attainable level of per capita consumption depends on technological advance, not on increased saving and investment. The argument is certainly correct. It is analogous to saying that one can accelerate a car by pressing on the gas. But the top speed that can be thus attained is ultimately limited by the design of the car’s motor. In the long run, it is the improvement of this design that counts in achieving higher speeds, not greater pressure on the accelerator.

Having explained so much, Solow with words, and Tobin with calculus, both leave the long-range considerations aside and turn to the important question, how much of its potential consumption our generation could or should be ready to sacrifice in order to increase—via productive investment—the consumption level of the next and later generations. In fact, such a choice is being made all the time by every private individual when he decides, in each stage of his life, how much to spend, and how much to put away, or possibly to borrow, and how much, finally, to leave to his children. Corporate management, being placed ahead of the stockholders on the stream of national income, diverts a substantial part of the flow into investment even before the stockholders themselves have a chance to decide what to do with it.

And still higher up, there is the government. It invests directly in education, health, roads, and “defense,” but what is also important—as Warren Smith explains in his essay—it can, by means of monetary and fiscal policies, influence the consumption and investment decisions of business and private households. Moreover, it can even affect and modify the results of these decisions after they have been already taken.

But why should this be so? Because, answer Walter Heller and his associates, as a result of individual and corporate decisions, too large a portion of current national income is allocated to current consumption, and insufficient provision is made for higher levels of income and consumption in the future.

It should be said that the authors of the Perspectives on Economic Growth do not commit the error of the unsophisticated “growth men” who favor higher incomes in the future, without being prepared to sacrifice the standard of living of the present generation. This simply amounts to saying that one would like to see the national economy be more productive in the future than it is today. Hardly anyone would disagree with that, although, as we shall see below, there still exists room for serious disagreement concerning the way one should measure “productivity” and interpret the “level of consumption.”

However, like most other proponents of faster economy growth they tend to take the desirability of a greater rate of investment for granted. They center their attention on description of the various government-saving and tax incentives to private savers and investors that could achieve it. The only specific argument which is intended to demonstrate that the prevailing rate of saving and investment would be too low if the government did not step in, is that the private individuals and the capital market reflecting their attitudes systematically underestimate the benefits that would accrue to the future generations by sacrificing present consumption. I shall return to this argument later.

The real question is whether public interest indeed demands, as Heller argues, that the present generation be made to sacrifice some of its consumption in order to enable the coming generations to have more, in the same way as the rich are now made to give up some of their income to the poor by means of progressive income tax and other measures aimed at reducing economic inequality. In an underdeveloped country like India, population growth tends to outstrip the slow rise of national income so that the standard of living of the next generation might conceivably be even lower than that of the present generation. There a policy averting such a decline through larger allocations of current output to productive investment would be justified by the principle of equalization of income. But in a developed country like the United States, continuous and possibly even accelerated technological advance alone can be expected to bring about a steady growth in per capita consumption. According to Robert Solow’s own estimates, which do not deviate in this respect very much from the otherwise quite different estimates of Edward Denison,1 in the postwar years between three quarters and one third of the increase of the per capita income in the United States was brought about by technological advance, not by increased saving and investment.

Under these circumstances a policy designed to encourage investment would tend to increase still more the disparity between the present standard of living and the much higher standard of living of future generations. If we are consistent in applying the principle that it is desirable to have equalization of income, we should, on the contrary, favor in this case policies designed to shift income in the opposite direction. Within the limits of the existing technical possibilities, present consumption should be encouraged, and saving and investment discouraged. Economic policies that transfer income from the upper to the lower income groups by means of taxation and other methods tend, moreover, to have precisely this effect, since the poor save a much smaller part of their income than the rich do.

  1. 1

    The Sources of Economic Growth in the United States and the Alternatives Before the U.S. Committee for Economic Development, New York, 1962.

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