Innovation and Capital Formation in Today’s Policy Environment

Innovation and Capital Formation in Today’s Policy Environment

Finn E. Kydland

University of California, Santa Barbara

Nazarbayev University, Astana May 22, 2015

Real GDP per capita Real GDP per capita

•Theoretical background (i)

Aggregate production function GDP_t = Z_tF(K_t,L_t)

Technology for converting inputs of capital and labour into output of goods and services

Technological progress

• Main driving force for economic growth:

Innovation and technological change (Z in the production function).

Lead to future productivity growth.

• But, to take advantage of technological change:

Need investment in new capital, physical (structures and equipment) and human Government policy may be a crucial factor, positive or negative, for growth Examples:

Argentina in 1990s and early 2000s Ireland in 1990s and early 2000s

•Theoretical background (ii)

Suppose the government has an unchanging objective to maximize some measure of the present value of citizens’ welfare over time Theoretical implication:

The resulting optimal government policy is inconsistent over time; it requires a

commitment mechanism to ensure its

implementation. Otherwise, there’s a strong temptation to change policy in the future.

• Where is that temptation theoretically the greatest?

Increase tax on physical and human capital (especially relevant in the current situation with large and growing debt/GDP ratios)

Partially renege (default) on government debt, say, through surprise inflation (also relevant, for the same reason)

Real GDP per capita Real GDP per capita

• But, as the example of China demonstrates:

Consistent policy not sufficient

• Summary Remarks

Significant risks exist for the continuation of low growth in many important nations Major cause: Uncertainty about future government policy

Reasons for slow growth in various parts of the world in the past half-dozen years have been quite different

Designing policy for the Longer Run much more important than short run We need ways to avoid the “time- inconsistency disease”

Enough uncertainty in the world as is;

extra government uncertainty is bad