Increased growth and a higher standard of living in the long run often are cited by political leaders as primary policy goals. We will take a closer look at government policies that may be useful in raising a country’s long-run standard of living whether changing the form of government – democratic or nondemocratic – affects the long-run growth rate of an economy.
Policies affecting the Saving Rate
The Solow Model suggests that the rate of national savings is a principal determinant of long run living standards. However, this conclusion doesn’t necessarily mean that the policymakers should try to force the saving rate upward, because more saving means less consumption in the short run. Indeed, if the “invisible hand” of free markets is working well, the saving rate freely chosen by individuals should be the one that optimally balances the benefit of saving more, against the cost of saving more.
Despite the argument that saving decisions are best left to private individuals and the free market, some people claim that Americans save too little and that US policy should at raising the saving rate. One possible justification for this claim is that existing tax laws discriminate against saving by taxing away part of the returns to saving; a “pro-saving” policy thus is necessary to offset this bias. Another view is that Americans are just too shortsighted in their saving decisions and must be encouraged to save more.
Now, here comes the question of ‘what policies can be used to increase savings?’ If saving were highly responsive to the real interest rate, tax breaks that increase the real return that savers receive would be effective. For example, some economists advocate taxing households on how much they consume rather than on how much they earn, thereby exempting from taxation the income that is saved. Although saving appears to increase when the expected real return available to savers rises, most studies find this responsive too small.
An alternative and perhaps more direct way to increase, the national saving rate is by increasing the amount that the government saves; in other words, the government should try to reduce its deficit or increase its surplus. Many economists also argue that raising taxes to reduce the deficit or increase the surplus will also increase national saving by leading people to consume less. However, believers in Ricardian equivalence contend that the tax increases without changes in current or planned government purchases won’t affect consumption or national saving.
Policies to Raise the Rate of Productivity Growth
Of the factors affecting long-run living standards, the rate of productivity growth may well be the most important in that – according to the Solow Model – only ongoing productivity growth can lead to continuous improvement in output and consumption every year. Government policy can attempt to increase productivity in several ways.
Improving infrastructure: Some research findings suggest a significant link between productivity and the quality of a nation’s infrastructure – its highways, bridges, utilities, dams, airports and other publicly owned capital. The construction of the interstate highway system in the United States, for example, significantly reduced the cost of transporting goods and stimulated tourism and other industries. In the past 25 years the rate of US government investment in infrastructure has fallen, leading to a decline in the quality and quantity of public capital. Reversing this trend, some economists argue that might help achieve higher productivity.
Building Human Capital: Recent research findings point to a strong connection between productivity growth and human capital. The government affects human capital development through educational policies, worker training or relocation programs, health programs, and in other ways. Specific programs should be examined carefully to see whether benefits exceed costs, but a case may be made for greater commitment to human capital formation as a way to boost productivity growth.
One crucial form of human capital, which we haven’t yet mentioned, is entrepreneurial skill. People with the ability to build a successful new business or to bring a new product to market play a key role in the economic growth.
Encouraging Research and Development: The government also may be able to stimulate productivity growth by affecting rates of scientific and technical progress. The US government directly supports much basic scientific research. Most economists agree with this type of policy because the benefits of scientific progress, like those of human capital development, spread throughout the economy, Basic scientific research may thus be a good investment from society’s point of view, even if no individual firm finds such research profitable.
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