Lower Capital Stock Research Articles

Rolling Back the Public Sector - Differential Effects on Employment, Investment and Growth

The macroeconomic effects of different ways of rolling back the welfare state are analyzed. Cutting public spending on market goods induces a lower interest rate, a higher wage, a lower capital stock and a fall in employment. Cutting public employment or the labor income tax rate leads, in contrast, to a lower wage, a higher interest rate and a higher capital stock. Employment rises on impact. If the extra revenues of rolling back the welfare state are handed back via a lower tax rate rather than a lump-sum subsidy, both cutting public employment and cutting public spending on market goods induce an investment boom. Making the tax system less progressive by cutting tax credits and the labor income tax rate induces an investment boom as well. The effects of endogenous growth, adjustment costs for investment and non-Walrasian labor markets on these results are considered as well.

The Finnish Corporate Income Tax Reform and the Financial Strategy of Firms: A General Equilibrium Approach

This paper simulates the effects of the recent Finnish corporate tax reform with a computable general equilibrium model. It shows that the impact of the reform on the capital stock depends on the reactions of firms. If the financial strategy is changed to prefer dividend distribution and share issues, the cost of capital falls and the capital stock increases. On the other hand, if the criterion of financial policy is to minimise the welfare loss of current shareholders, the earlier financial behaviour should be continued. In that case,the induced higher cost of capital leads to a lower capital stock. The overall welfare evaluation of the tax reform is not sensitive to the regime shift: the reform should not have been implemented. This is because the increase in interest income taxation distorts saving decisions, expands the net foreign debt of the economy and weakens the terms of trade.

Capital market imperfections in a monetary growth model

We consider a monetary growth model essentially identical to that of Diamond (1965) and Tirole (1985), except that we explicitly model credit markets, a credit market friction, and an allocative function for financial intermediaries. These changes yield substantially different results than those obtained in more standard models. In particular, if any monetary steady state equilibria exist, there are generally two of them; one of these has a low capital stock and output level, and it is necessarily a saddle. The other steady state has a high capital stock and output level; either it is necessarily a sink, or its stability properties depend on the rate of money creation. It follows that monetary equilibria can be indeterminate, and nonconvergence phenomena can be observed. Increases in the rate of money creation reduce the capital stock in the high-capital-stock steady state. If the high-capital-stock steady state is not a sink for all rates of money growth, then increases in the rate of money growth can induce a Hopf bifurcation. Hence dynamical equilibria can display damped oscillation as a steady state equilibrium is approached, and limit cycles can be observed as well. In addition, in the latter case, high enough rates of inflation induce the kinds of “crises” noted by Bruno and Easterly (1995): when inflation is too high there are no equilibrium paths approaching the high-activity steady state.

The integration of Germany: Real economic adjustment

With institutional and monetary integration having been accomplished, the adjustment process in the real economy becomes the dominating issue of German Unification. The paper analyses the integration effects the growth aspect and the political economy of transition. From an allocation point of view, the economic integration of the two Germanies can be viewed as merging a capital rich and a labor rich economy. With the capital stock of the ex-GDR being largely obsolete, capital has to flow into the ex-GDR. An estimate of the size of the ex-GDR capital stock after adjustment is the upper bound for the capital requirement. Trade and sector structure will have to adjust to fit into the international economy. The necessary structural change is analyzed. With an export share of 25 percent, Eastern Germany is not yet fully integrated in the world economy. Growth theory predicts and historical experience confirms that countries with similar technical skills and technology as well as a relatively low capital stock per head have realized high growth rates. From that perspective and in analogy to the 1948 reform in West Germany Eastern Germany has a high growth potential. At the core of the adjustment process is the restructuring of industry involving the reorganization of existing firms as well as their privatization. The paper analyzes the role of the Treuhand in the restructuring as well as other issues in the political economy of transition such as the J-curve of output and the role of markets versus the political process.

AFTERMATH OF THE THRIFT CRISIS: BALANCING THE ECONOMY'S BOOKS

The thrift crisis has presented the federal government with a cleanup bill of unparalleled magnitude. Estimates of the present‐value cost range from $90 billion to $140 billion. Most observers acknowledge that the economic cost of the crisis already has occurred in the form of lost investment opportunities and a lower capital stock. Fewer acknowledge, however, that full payment of the cost can be made only through a reduction in private sector claims to wealth so as to match the misuse of deposits and soured loans made by thrifts. Some of that reduction has occurred through equity write‐downs in businesses and thrifts, but much of the necessary reduction has yet to occur. The necessary reduction constitutes an increased tax burden.The thrift insolvencies, coupled with deposit insurance and bankruptcy of the Federal Savings and Loan Insurance Corporation (FSLIC), threw the economy's books out of balance: Claims on real assets in the form of insured deposits exceeded the value of assets owned by thrifts and insurance reserves of the FSUC. In the absence of deposit insurance, a write‐down of claims would have occurred through the market mechanism and the bankruptcy courts. In the presence of deposit insurance, the write‐down must be through taxation and the political mechanism. Recently enacted legislation will effect the writedown by spreading the taxation over time through debt finance, relying primarily on future taxes to service the debt. The desirability of debt finance hinges on whether the legislation also will prevent a recurrence of future crises. Critics maintain that prevention must entail reform of deposit insurance.