Review

Many people are concerned that the costs of production in a number of key industries, such as agriculture, will exceed the price of the product, thus destroying entire sectors of the nation’s economy. This concern has been the basis for numerous public policy actions, including tariffs and import quotas to protect domestic producers from foreign competition and Government guaranteed minimum prices to producers of farm commodities.

There have recently appeared claims that developments in the Eurodollar market have contributed substantially to the current expansion of the U.S. money supply (M1). These claims imply that the Eurodollar system is a source of monetary disturbances which the Federal Reserve System cannot offset. On the basis of these claims, it is sometimes then asserted that the recent weakness of the dollar in foreign exchange markets has been due to an expansion of M1 caused by transactions in the Eurodollar market.

John Doe and Jane Smith each earned $15,000 in 1976 and each paid $2,403 in Federal personal income taxes. The Internal Revenue Service collected $4,806 from John and Jane. If John and Jane had been married during 1976, however, they would have jointly paid $6,092 in Federal income taxes. Getting married would have cost John and Jane $1,286 in additional 1976 Federal income taxes. This example points out one of the peculiarities of the present Federal income tax structure; under certain circumstances two working people would pay more taxes if they are married than if they are single.

This volume contains the papers presented at the October 7, 1977 conference on “U.S. Productive Capacity: Estimating the Utilization Gap,” held in St. Louis, Missouri. The conference, cosponsored by the Center for the Study of American Business and the Federal Reserve Bank of St. Louis, examined the current and projected estimates of U.S. productive capacity and utilization.

Potential output measures the real GNP that would be associated with operating the economy at some specified level of labor utilization. The concept offers answers to two basic types of questions: What would be the level of GNP if unemployment was at a specified level? (Or what would unemployment be if GNP were at some specified level?) And what will unemployment be at some point in the future if GNP grows at some specified rate? (Or what will GNP be if some specified unemployment target is achieved at some point in the future?)

The concept of the output attainable by the economy if resources were fully utilized has interested economists for many years. This measure of maximum sustainable output, usually called “potential GNP,” has been a useful tool for analyzing policies designed to bring about the full utilization of labor and capital resources.

Since the early 1960s, the level and the rate of growth of potential output have become increasingly important subjects. While policymakers’ and the public’s acceptance of these concepts has become widespread, since the early 1970s there has been considerable controversy concerning the measurement of potential output and its growth. By 1973 it had become clear to many observers that the Council of Economic Advisers’ (CEA) measure of potential output was too high. That measure showed slack in the economy equal to $30 billion (1972 dollars) while many observers thought the economy was operating at or above its potential, at least in the early part of the year.

The topic of this conference is indeed an important one. Although currently the United States economy suffers from considerable excess capacity, both in labor and in product markets, we hope that this condition will not last forever. What I would like to discuss this afternoon is the state of utilization and the extent of imbalance in different markets, and possible strategies for avoiding bottlenecks during this recovery.

As the papers presented at this conference demonstrate, there is a divergence of views as to whether current measures of capacity utilization overstate or understate the amount of untapped capacity remaining in the economy. I want to sidestep this issue, concentrating instead on one widely used measure of capacity utilization: the Federal Reserve Board’s capacity utilization rate for manufacturing. In particular, I want to discuss a simple model which can be used to project manufacturing capacity utilization, as published by the Board, over the next couple of years.

These two studies have performed a timely service in reminding us that a major rise in natural resource costs can have a sizable negative impact on potential GNP. The purpose of this note is not to question that central proposition. Rather, it is to argue that (1) the impact on potential GNP takes place only gradually as production techniques and consumption patterns change, not all at once as these studies imply, and (2) that the ultimate impact may not be as large as the 4 or 5 percent estimated in these studies.

It would be difficult to identify a more important macroeconomic issue (and one about which there was more disagreement) than recent developments affecting the level and rate of growth in the nation’s productive capacity. Knowledge of the gap between actual and potential output is of immediate relevance to the design of short-run stabilization policy, and recent projections of slower growth in productive capacity and the possible relation to slower growth in capital stock appear to have heightened the interest of both the Administration and Congress in tax reform keyed to expanding incentives for capital spending.

I find myself in a somewhat unenviable position. The three papers you heard this morning represent three different approaches to the measurement of U.S. productive capacity. The three conclusions that emerged differ quite significantly from one another—almost to the point of being contradictory. It is virtually an impossible task as a discussant, therefore, to be nice to all of the authors since if one agrees with one, one will probably have to disagree with another. The easiest way out perhaps is to play the role of a Devil’s Advocate to all three papers, and so I will try to catch the Devil by the ideological tail first.