Gary H. Stern
Federal Reserve Bank of Minneapolis
American Farm Bureau
Midwest Presidents & Administrators Conference
Red Wing, Minnesota
July 25, 1997
Good morning. It's a pleasure to have this opportunity to address you on issues of mutual concern. We at the Federal Reserve Bank of Minneapolis have had a longstanding interest in agriculture and its central role in the economy of the Ninth District. Considerable space in our regional publication, the fedgazette, is devoted to the sector. In addition, we have long been involved in issues related to economic growth and questions such as: why do some nations' economies grow more rapidly than others? Why do some regional economies far outpace the performance of others? What contribution can government policy make toward economic growth?
These questions are important because to a considerable extent growth determines a country's standard of living. That is, given its population, or a path of population over time, the more rapidly the economy expands, the higher living standards will climb. Growth, therefore, is largely the key to economic well being.
Despite its significance, we do not know as much about growth as we might like. Nevertheless, in my remarks this morning I would like to review with you some of what we do know about this critical subject, with emphasis, in particular, on the role of government policy. Actually, I should say "roles" of government policy, for government can contribute constructively to growth both on the aggregate level and through appropriate micro policies and programs. Let me now move on to some specifics about these issues.
Although the U.S. is well into its seventh consecutive year of economic expansion, some observers remain uneasy about the health of the economy. They claim, among other things, that recent performance does not measure up when compared with that of the first twenty-five years of the postwar period.
In assessing this claim, I think it important and appropriate to look both at objective measures of business activity and at more general indicators of economic well being. The thrust of this analysis is that the assertion that our recent economic performance does not measure up to the past is at least questionable. Indeed, our economy has performed well in recent years, and many have benefited in the process.
By many, although not all, objective measures of economic performance, the US economy has done and is continuing to do well. Nationwide, unemployment is a relatively low 5 percent of the labor force, and it is a good deal lower in many of the states of the Ninth Federal Reserve District. Perhaps more importantly, since its low in 1991, employment has increased by about 13.5 million workers, or at a rate of more than 2 million net new jobs per year. Moreover, sizable gains in employment are not a new phenomenon in our economy; for example, from the end of the recession in 1982 to the end of the succeeding expansion in 1990, about 20 million jobs were added.
I do not intend to inundate you with statistics, so let me just add that, in addition to employment gains, the past six plus years have been characterized by modest inflation, thriving corporate profits, strong financial markets, and sustained economic growth. To a considerable extent, similar language can be used to describe the period from 1982 to mid 1990 as well. In short, objective measures say we have done well over an extended period.
If we put aside the statistics and consider products and services that have proliferated over the past decade or two, the increase in our prosperity becomes ever clearer. Specifically, I am thinking about how commonplace VCRs, CD players, computers, boats, snowmobiles, jet skis, air travel, mutual funds, and long distance communication have become. And it is not just high income families that avail themselves of these products and services for, if that were the case, the markets for and volumes of these products would be far smaller than they in fact are.
Anecdotal evidence also testifies to the strength of the expansion. In meetings with business and other community leaders, we are told constantly of severe labor shortages, of renewed strength in commercial construction activity, and, in some locations, of very tight housing markets. Clearly, a lot has been going on in the economy, and much of it is positive. There is a school of thought which says that many of the newly created jobs are in the service sector and are relatively low paying. This statement is half right. The service sector of the economy has grown rapidly but, according to the Council of Economic Advisers, many new jobs in services are in relatively well-paid managerial and professional positions.
It is important to ask how this favorable performance has come to pass? This is not an easy question to answer for, if we knew the formula, we could bottle and sell it. But at least three factors can be cited as significant, if not all inclusive, contributors to this period of sustained growth: they are technology, trade, and government policy. Let me discuss each of these factors in turn.
For some time, it has been recognized that improvement in the state of technologythat is, technological progressis a key factor determining economic growth. This is because the available state of technology, which refers to the efficiency with which a given set of productive inputs is employed, influences the productivity of labor. In short, technological progress raises labor productivity, which in turn raises growth.
Research has shown that the state of technology in a country depends, in part, on the pool of world knowledge available at a given time and, perhaps more importantly, on internal institutional arrangements that promote or retard the use of this knowledge. Technological progress, therefore, depends on the rate at which world knowledge grows and on the extent to which a country's institutions provide incentives for employing that expanding world knowledge. Recent evidence shows, further, that the state of technology of a country is related positively to factors such as openness to foreign trade and to deregulation. That is, it appears that the more an economy participates in trade and the less regulated it is, the better its state of technology: competitive pressures undoubtedly hasten adoption of new technology.
Conversely, countries which erect barriers to the use of world knowledgebarriers which limit international trade, constrain business practices excessively, or reduce competitiontend to have relatively poor states of technology. In taking such actions, countries usually are not trying to resist technology so much as protect a particular industry or sector from competition or change.
According to this reasoning, openness to foreign trade is positive for economic growth because of its implications for technological progress and labor productivity. But this reasoning aside, empirical studies that have looked at trade alone have concluded that it has a distinctly positive effect on a nation's growth and living standards. In this connection, it is interesting to note that both US exports and imports have increased annually at double digit rates, in inflation adjusted terms, since their lows of the early 1980s. Our exports have grown over this period from about 8 percent of GDP to nearly 12 percent at present, while the import-GDP ratio has climbed comparably from roughly 9 percent to 13 percent. To be sure, these observations do not demonstrate causality, but the economy has certainly done well as trade has expanded, and we should bear this in mind when issues like NAFTA arise. The record seems sufficiently impressive to suggest that we should encourage growth in trade to the extent possible.
The third factor earlier identified as contributing to economic growthnamely, government policyis relevant in several ways, one of which has already been touched upon. Government policy can have an appreciable impact on technological progress by ensuring that a country's organizations and institutions have incentives to use and to adapt world knowledge. In this regard, the commitment in the US to measure more carefully the costs and benefits of regulations, to deregulation of several industries, and to open trade have undoubtedly been positive for technological progress and productivity. A second aspect of government policynamely, progressive steps taken in recent years toward balancing the federal budgethas been positive as well, largely, I suspect, through their favorable implications for business capital investment.
I would be remiss if I did not add that the Federal Reserve, through our conduct of monetary policy, has also contributed to the favorable performance of the economy. Notably, in this decade as well as through much of the expansion of the 1980s, inflation has been contained to moderate rates, a characteristic shared by the way by the long expansion of the economy during the 1960s. Causality is difficult to demonstrate in economics, but we nevertheless seem to be building a considerable body of evidence which suggests that, at least in the United States, modest inflation and prolonged periods of growth go hand in hand. I suspect that one key in this relation is the stability provided by a low inflation environment. In such an environment, there is less uncertainty about the future, and business and consumers can make decisions and take actions with confidence. Such an environment is likely to favor savings and investment, to the long-run benefit of economic performance.
The evidence about the relation between low inflation and economic growth is directly relevant to the Federal Reserve and our responsibility for monetary policy because there is widespread agreement that inflation is ultimately a monetary phenomenon; it results from a long-term pattern of money creation which is excessive relative to the economy's ability to produce goods and services. Further, there is agreement that the supply of money is determined by the central bank in the long run. Thus, with policy which limits money creation appropriately, the Federal Reserve can in fact achieve and maintain low inflation.
The role of government policy, however, goes beyond encouragement of trade and technological progress, and beyond sound monetary and fiscal policies, important as they may be. As I suspect you recognize full well, government provision of certain public goods, including transportation infrastructure, can be critical in fostering development and growth.
Transportation infrastructure is particularly important to the economy of the Ninth Federal Reserve District since we are far from export ports, such as New Orleans and Portland. Moreover, transportation costs are the principal wedge between world prices of wheat, corn, and soybeans and farm gate prices. The more expensive transportation is, the less Ninth District farmers receive.
Fortunately, the US has the lowest cost transportation system in the world for agricultural products. By way of example, it costs Brazilian farmers more than twice as much to move soybeans 300 miles from western Parana state to the coast as it does to move Ninth District soybeans 1,500 miles to the Gulf Coast. And US port charges are about half of Brazilian port charges.
The Mississippi and Missouri rivers have played a central role in the economic development of the region for more than a century. Steamboats linked St. Paul with the rest of the nation, went as far up the Minnesota River as Mankato, and 4-foot draft steamwheelers clawed their way up the Missouri as far as Montana in the 1880s. But the development and maintenance of the 9-foot channel in the Mississippi between the wars has been the most important factor for low-cost movement of Ninth District agricultural products. Locks and dams at St. Paul, Hastings, Red Wing, between Wabasha and Winona, as well as near Trempealeau and La Crosse, Wisconsin have helped to facilitate the large shipment of district products downriver and inputs such as fertilizer upriver.
The Mississippi, to be sure, provides a fundamental physical underpinning to the prosperity of Ninth District agriculture. But successful utilization of this resource has depended as well on government infrastructure investmentsthe channel, locks, and damscited earlier.
So the government can and has, in fact, played several significant roles in fostering economic growth. Macroeconomic policies, which have promoted stability, have provided a sound underpinning on which the private sector has thrived. Further, we have had an environment generally favorable to technological progress, a key element in productivity improvement. And, finally, government infrastructure investment has played a positive role as well, to the benefit of many sectors of the economy.