Importance of Good Governance for Economic

Prosperity

Edward C Prescott21 March 2014

• Nearly all of Asia doing well

• The notable exception is North Korea

GDP per Capita (Current USD)

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

$0

$5,000

$10,000

$15,000

$20,000

$25,000

South Korea

North Korea

Five Asian Economies have joined the set of the most advanced

industrial economies after experiencing growth miracles

Japan & Four Asian Tigers

0.2

0.4

0.6

0.8

1

Per Capita GDP relative to US (PPP)

Some Are ExperiencingGrowth Miracles

China: Detrended GDP per Adult

2002200320042005200620072008200920102011201260

80

100

120

14020

07=

100

Last 10 years US and EU Losing Ground Relative to Trend

They Need to Reverse theirBad Policy Regime Shift

How is Spain Doing?• Poorly as this figure shows

• This is detrended GDP per adult– Flat line is growing at trend– There will be above trend growth for a

while associated with a shift to a better policy regime– There will be a recession and convergence

to a lower growth path associated with a shift to a worse policy regime

10

Spain

Trend

Real

2002

Q4

2003

Q2

2003

Q4

2004

Q2

2004

Q4

2005

Q2

2005

Q4

2006

Q2

2006

Q4

2007

Q2

2007

Q4

2008

Q2

2008

Q4

2009

Q2

2009

Q4

2010

Q2

2010

Q4

2011

Q2

2011

Q4

2012

Q2

2012

Q480

85

90

95

100

105

110

GDP per adult (2007-Q4 =100)

Asian Industrial Countries Doing Fine

• Growth is at trend of 1.85% a year–Means doubling every 39 years

• Trend is common across countries and is due to growth in the stock of useful knowledge

• Level differences at a point in time are due to differences in policy regimes

12

Japan

2002-Q4

2003-Q2

2003-Q4

2004-Q2

2004-Q4

2005-Q2

2005-Q4

2006-Q2

2006-Q4

2007-Q2

2007-Q4

2008-Q2

2008-Q4

2009-Q2

2009-Q4

2010-Q2

2010-Q4

2011-Q2

2011-Q4

2012-Q2

2012-Q4

90

92

94

96

98

100

102

104

106

GDP per adult (2007-Q4 =100)

Real

Trend

13

Japan Did Well During the Koizumi Administration

19901992

19941996

19982000

20022004

20062008

201080

90

100

110

120

GDP per 15-64 Years Old

Koizumi Administration

14

Government Purchase of Goods and Services as Percent of GDP

1 2 3 4 510%

12%

14%

16%

18%

20%

22%

Koizumi Administration

15

The U.S. Economy

• Not doing well

• No recovery yet or likely in the future

• The following figure shows this

2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 288

92

96

100

104Detrended GDP per Adult

2007

-II=1

00

Path to Greater Prosperity

• Based on McGrattan and Prescott (Minneapolis Fed Staff Report 374, Oct 2013)– Use theory that has been tested through

successful use– Life tables used• (worker/retiree falls from 3.4 to 2.0)

– Consistent with national income, product, and capital accounts as well as balance sheet facts

– Results are robust (see Appendices)

Proposed Policy Regime Change

1. Have mandatory savings for retirement2. Eliminate capital income taxes3. Broaden tax base and lower the

marginal tax rate4. Phase in reforms so all birth-year

cohorts are made better off5. Leave welfare programs and local public

good shares the same

Simple Way to EliminateUS Capital Income Taxes

• Savings not part of taxable income• Saving withdrawals part of taxable income• With these changes, the US income tax is a

consumption tax• With individual savings account, the US has

moved far in this directionWhat will happen with this policy regime?

US Detrended GDP per Capita

2002

2006

2010

2014

2018

2022

2026

2030

2034

2038

2042

2046

2050

90

100

110

120

130

Growing at trend from 2013-I

Growing at trend from 2007-II

M-P Reforms from 2007-II

2007

=10

0

Economic Problems are Political

• To conclude, it is time for the Spanish and American people to agree to a good policy regime, institute it, stick with it, and enjoy the benefits