Why Western Europe, New Zealand, and Japanese Economies are Depressed Relative to The U.S. Economy
Page updated 20 Sep 2007
Abstract from Professor Edward Prescott's Guest Lecture presented at the Treasury on 25 May 2006.
Professor Edward Prescott
Arizona State University
Edward C. Prescott holds the W. P. Carey Chair in Economics and is a Regents’ Professor at Arizona State University. He also is the Senior Monetary Advisor at the Federal Reserve Bank of Minneapolis. Prior to joining the Arizona State University faculty he held faculty positions at the University of Minnesota, the University of Chicago, Carnegie Mellon University, and the University of Pennsylvania.
He was awarded the 2004 Nobel Prize in Economics jointly with Finn Kydland ‘for their contributions to dynamic macroeconomics: the time consistency of economic policy and the driving forces behind business cycles.’ In addition to this honor he was awarded the 2002 Erwin Plein Nemmers Prize in Economics, elected a Fellow of the American Academy of Arts and Sciences in 1992, elected a Fellow of the Econometrica Society in 1980, and selected to be a Guggenheim Fellow for 1974-75. Students at Rochester selected him to deliver the inaugural Linonel McKenzie Lecture in 1990 and in 1997 students at the University of Pennsylvania selected him to deliver the inaugural Lawrence R. Klein Lecture. In addition he was selected to deliver the 2002 American Economic Association Richard T. Ely Lecture.
His contributions go well beyond macroeconomics. He is noted for his contribution to general equilibrium theory in particular recursive competitive equilibrium and the extension of valuation equilibrium theory to an important class of environments with private information. He is also noted for his contributions to financial economics and banking. In his and Stephen Parente’s book ‘Barrier to Riches’ the thesis is developed that countries are poor because they have policies that result in barriers to efficient production.
The Western European countries along with Japan and New Zealand have living standards that are depressed by about 30 percent relative to the United States. The economic reason that Western Europe is depressed is well known. Western European countries have higher marginal effective tax rates on labour income and as a result their labour supply is depressed 30 percent more than is the U.S. labour supply. My measure of labour supply is market hours per working-age person. Productivity, that is output per hour, is the same in Western Europe as it is in the United States. Japan and New Zealand both have the same marginal effective tax rate on labour supply and as a result the same labour supply – about 25 hours per week per working-age person. Productivity, however, in these countries is only 70 percent of U.S. productivity.