Productivity Growth

   As discussed earlier, capital deepening has played a significant role in U.S. productivity growth. Over the past 10 years, the United States is second only to Canada in its annual growth rate of real private investment. Real investment in the United States over this period increased at an annual rate of 5.1 percent, nearly double the average rate of the other G7 countries (excluding Canada). The United States has been able to accomplish this level of investment because of its open and transparent investment environment.

   While capital deepening played an important role in the productivity gains experienced in the late 1990s, so did advances in information technology. To benefit from the IT boom, firms had to invest large amounts in computers, software, and employee training. From 1995 through 1999, U.S. investment in information-processing equipment and software increased at an average rate of around 20 percent per year, and total investment grew faster than in any other country in the G7. To help fund these investments, the United States received substantial flows of financial capital from abroad during this period. While the United States might have invested in IT capital without access to international financial markets, and while Europe may not have invested more even if it was more open to international capital flows, it is almost certain that the United States was able to use its open investment environment to finance the increase in IT capital.

   Access to international financial markets tends to lower borrowing costs and enable a country to increase capital investment rates without increasing domestic savings. This outcome would not be possible if businesses had access only to domestic financing.

   International openness has also contributed in other ways to recent efficiency gains in the United States. Since the early 1990s, the United States has increased its openness to international trade. From the North American Free Trade Agreement (NAFTA) (signed into law in 1993) to the Trade Act of 2002 and the renewal of Trade Promotion Authority in the same year, the United States has worked to break down trade barriers. Lower trade barriers have in turn increased the level of international competition in product markets. Some U.S. companies have suffered from the increased competition; some have benefited. The increased competition forces firms to seek new ways of doing business to remain competitive, and because of this, international trade may contribute to growth in innovation.