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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
GDPt = ZtF(Kt,Lt)
Technology for converting inputs of capital
and labour into output of goods and services
• 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 “timeinconsistency disease”
Enough uncertainty in the world as is;
extra government uncertainty is bad