Question

What happened to the capital output ratio and capital labour ratio of the USA over the last 20 years, why has this happened? (HINT: Productivity of Capital)

Answer 1

Investments in business have been low for the past few years. Hence, the increase in the capital stock is not up to the level of the increase in the GDP and the employment rate. There has been a consistent increase in the capital-labor ratio. This is because of the availability of cheaper and efficient capital goods. Higher capital ratio means higher productivity and a better standard of living per worker. But, slow business investments in the past few years have led to a slowdown in the growth of the capital stock. One school of thought argues that weak business investments are because of the excess investments prior to the recession whereas the other school of thought argues it reflects weak growth in output because of deficient demand. Undergrowth with respect to capital investments implies that the US economy is poised for large investments if the current pace of expansion continues. It has been observed that capital investment is presently below the long term trend in relation to both output and labor. The two major concerns in this area are:

1. The trend of capital accumulation is unstable. A persistent fall in productivity growth would lead to required lower capital accumulation and could make the current rate of capital accumulation sufficient.

2. The recent investments might be underrated. This implies the current capital ratios would be underestimated.