How U.S. policy can promote higher economic growth

James A. Schmitz, Jr. | Senior Research Economist
Preston J. Miller | Former Vice President and Monetary Adviser

Published July 1, 1997  | July 1997 issue

Recently, the Federal Communications Commission issued new rules that will bring sweeping changes to the multibillion dollar telecommunications industry. The rules are intended to introduce free market principles to an industry that has been heavily regulated for six decades.

Needless to say, the rules do not please everyone—change rarely does. Many critics say that the new rules do not move far enough toward deregulation and that much work remains. Regardless, the changes are still important, and not just because of their impact on the telecommunications industry—they are also good for the economy.

We will leave for others to argue the success or failure of the FCC's attempt to deregulate the telecommunications industry; what we will argue for is the soundness of such an attempt. Such efforts at deregulation—including, for example, those under way in the electricity industry—can play a big role in reviving this country's modest labor productivity growth of recent years.

This conclusion comes from recent evidence comparing countries across the world that suggests that economic growth depends, most importantly, on whether a country's institutions promote or retard the use of world knowledge. In other words, does a country allow the free transfer of new ideas that will inspire more efficient production and, hence, more growth? Or does the country erect barriers, such as tariffs and regulations, that protect certain groups and, ultimately, drag down the country's rate of economic growth?

While this research has been based on comparisons across countries, recent U.S. history suggests it applies equally to the United States. For example, over the past two decades, the airline, trucking, railroad and securities industries, among others, have been variously deregulated and, as a result, competition has grown and the industries have experienced rapid drops in prices and strong gains in productivity.

There have been other changes. One example is in the area of trade policy, where a high-profile case has been the lowering of trade barriers associated with the North American Free Trade Agreement. Other negotiations to lower trade barriers with South America are under way.

Equally important are the battles that have been fought against reregulation and the erection of trade barriers. In many markets, like steel and autos, the United States has maintained its commitment to open markets despite great pressure to limit trade. As a result, the United States more quickly adopted new methods than its European counterparts. U.S. car producers, for example, adopted Japanese "lean" production well before its more closed European rivals. The steel and iron ore industries also provide illustrations of this phenomenon.

While much has been accomplished, there is still more to do. And the telecommunications industry is a case in point. One recent study has suggested that the industry's productivity has been stifled by regulation. If history holds true, effective deregulation will boost productivity and spur economic growth.

At first glance, the policy prescription that we advocate—open trade, deregulation and increased competition—seems merely like a reiteration of well-accepted economic principles. However, these principles are more often preached than practiced, and many policy-makers are not necessarily convinced of their wisdom. Governments are often tempted to engage in policies that, for example, protect certain industries from foreign competition or, in the case of internal markets, make it difficult for innovative companies to compete in established industries.

U.S. history, along with recent economic research, points to a clear policy prescription for the United States: The government must constantly refocus its efforts on policies that reduce resistance to competition and increase the use of world knowledge.

This article is based on Miller and Schmitz's essay,
"Breaking down the barriers: How U.S. policy can promote higher economic growth," published in the Minneapolis Fed's 1996 Annual Report.