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The rate of time preference in the United States government.

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I discuss in this paper the rising rate of time preference exhibited by the United States government in the late 20th and early 21st century. Paul Samuelson stressed the importance of the rate of interest over 40 years ago. I was a graduate student taking a reading course from him at the time, and I employed Samuelson's insight in my research at the time. I return to the centrality of the interest rate now to show both how Samuelson's work retains its relevance today and how current policies of the US government may pile up problems for America in the 21st century. I first review Samuelson's paper and the use I made of it at the time; then I argue for its application to the 21st century.

Samuelson (1961) derived a result that seems obvious today. In a world in which all capital is embodied labor, then only the interest rate matters for the determination of capital intensity. In the short run, a rise in wages will lead to a substitution of capital for labor, but the effect will be short lived. In the long run, the price of capital goods will rise proportionately to the wage rate. There will be no change in the ratio of capital to labor. Only if the interest rate changes will there be a change in capital intensity.

This proposition extends to a model in which capital is produced by other capital as long as the only primary input is labor. The indirect nature of production does not depend on a linear relationship between the amount of labor used at the last stage of its production and its price, but rather on the lapse of time between production at various stages. Because production takes place over time, there is an interest rate, and this rate is the sole determinant of capital intensity. Samuelson called this a nonsubstitution theorem.

It would be hard to excite graduate students with this insight over forty years later. Samuelson had clarified the nature of the models we use to analyze production, and this understanding has passed into general knowledge. His paper however was intriguing in the early 1960s, and I used it to clarify a murky historical discussion.

Habakkuk (1962) asked in a contemporaneous book why the United States had defied its obvious comparative advantage in agriculture in the early nineteenth century to start industrialization. He answered that the high cost of labor caused Americans to use capital-intensive techniques in manufacturing, leading to high labor productivity. He drew on an extensive historical literature that noted how prosperous and how tall the early Americans were. His inference that these conditions provided the key to American industrialization stimulated a lot of discussion in the 1960s.

I applied Samuelson's insight to assert that high wages were not the cause of American industrialization. The historical issue was not as straightforward as Samuelson's demonstration due to the abundance of fertile American farmland. Wages were high and people were prosperous in the new republic because labor was used in combination with land. To emphasize this point, the dominant occupation at the time was farming. How then could the effects of land be disentangled from the question of capital in manufacturing?

I proposed a solution using a three factor model in which only one factor was mobile. Land was used only in agriculture, and capital was used only in manufacturing. Capital here referred to industrial buildings and machines. Agriculture was assumed to yield its product within a year, and land fertility was a gift of nature rather than the result of prior investments. Labor was the mobile factor, and the relative price of agricultural and industrial goods determined how labor was allocated between the two activities. In agriculture, there were two primary factors, labor and land. In industry, by contrast, there was only one. Industrial capital had been produced some time in the past by labor; as embodied labor it did not constitute a separate primary factor. Samuelson's nonsubstitution theorem was directly applicable (Temin, 1966).

High American wages in this model were the result of abundant fertile land. Wages were high relative to the price of food, and people were tall and healthy as a result. The ratio of wages to the price of agricultural goods however had no effect on capital intensity in manufacturing in this model. Factor proportions in manufacturing were determined by the ratio of wages to the rental of capital. That ratio, by Samuelson's nonsubstitution theorem, was dependent only on the rate of interest. The level of American wages was irrelevant to the question of capital intensity in manufacturing.

The paper that resulted from this insight gave rise to controversy and continued inquiry into the origins of American industrialization that has continued in various guises for forty years. It also stimulated analysis of this limited kind of three good model as it applied to international trade (Jones, 1991). Since the interest rate--to the extent we know it after two centuries--was higher in the United States than Britain, other reasons have been sought to explain the capital intensity of American manufacturing. The tariff...

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