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Importance of Good Governance for Economic
Prosperity
Edward C Prescott21 March 2014
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• Nearly all of Asia doing well
• The notable exception is North Korea
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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
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Five Asian Economies have joined the set of the most advanced
industrial economies after experiencing growth miracles
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Japan & Four Asian Tigers
0.2
0.4
0.6
0.8
1
Per Capita GDP relative to US (PPP)
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Some Are ExperiencingGrowth Miracles
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China: Detrended GDP per Adult
2002200320042005200620072008200920102011201260
80
100
120
14020
07=
100
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Last 10 years US and EU Losing Ground Relative to Trend
They Need to Reverse theirBad Policy Regime Shift
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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
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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)
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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
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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
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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
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14
Government Purchase of Goods and Services as Percent of GDP
1 2 3 4 510%
12%
14%
16%
18%
20%
22%
Koizumi Administration
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15
The U.S. Economy
• Not doing well
• No recovery yet or likely in the future
• The following figure shows this
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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
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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)
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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
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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?
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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
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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