Knowledge that Transforms

T HERE is fair agreement among scholars familiar with the economy of the Peoples' Republic of China (China) that there is stability in the retail price index. It is admitted that this index is biased downward because there were years of high black-market prices. However, they say that such issues are not central because (1) the basic necessities were available and rationed at stable prices; (2) the index is biased downward when prices are rising, and biased upward when prices are falling.' The contention of these scholars is both serious and important. It makes a very major difference how we look at the performance of the Chinese economy. Below in table 11 the price indices are presented which represent Chinese official claims. Perkins has attempted to verify the weighting system of the retail price index by reconstructing the index, and he states:

It has been argued recently that the size of the holdings of foreign exchange by commercial banks provides a better measure of the adequacy of international means of payments than the size of official reserves.' At first glance this appears obvious for it is these commercial holdings of foreign exchange which are used directly for financing international exchange while official reserves are used only to finance imbalances in countries' balance of payments which result from the maintenance of relatively exchange The argument becomes less clear, however, when one stops to question what is meant by the adequacy of international means of payments. Within a free market context, what does it mean to say that commercial holdings of foreign exchange are inadequate? The commercial interests involved clearly can not feel that their foreign exchange holdings are inadequate (apart from a desire to have higher wealth positions in general) for otherwise they would simply exchange domestic for foreign currency until their foreign currency holdings were no longer inadequate. In other words, from the point of view of commercial banks and traders, at any point in time would merely mean a temporary disequilibrium situation. traders on both sides of the market felt their foreign currency holdings to be inadequate then they would in effect merely swap currencies with one another (a practice now common between central banks). the size of the desired swaps did not match on each side of the market, then under flexible rates the price of the relatively scarce currency would be bid up until desired holdings equalled actual holdings, i.e., until foreign currency holdings were adequate. As Yeager has put it, If no authority concerned itself with gold and foreign exchange, and if private persons, firms and dealers such as banks, found their holdings inadequate, they would bid for additional amounts, thus depressing the home currency on the exchange market, stimulating exports relative to imports, and making available the quantity of foreign exchange desired at the new level of exchange rates. 2 Under a fixed rate system the increased demand for foreign currency would be reflected in official reserve losses. In either case, observed foreign currency holdings would always reflect desired or adequate holdings except for the effects of transitory disequilibrium. We could, however, meaningfully speak of inadequacy in terms of a discrepancy between desired and actual holdings if a free market does not exist. In other words, where exchange controls, etc. effectively prevent traders from satisfying their demands for foreign balances then we could unambiguously say that observed holdings were inadequate. As is brought out in Heller's figures,3 the rapid expansion of holdings of foreign currencies by banks in industrial Europe as postwar exchange controls were loosened suggests that there was considerable inadequacy at the beginning of the period. one accepts the argument put forward here that one can meaningfully speak of an inadequacy of commercial holdings of foreign exchange only where traders do not face free markets for foreign exchange, then inadequate commercial holdings of foreign exchange are themselves a reflection of an inadequacy of official reserves (at least from the point of view of the country in question). In other words, inadequacy of commercial holdings of foreign exchange is a reflection of impediments placed on the foreign exchange market which in turn reflect that the government of the country in question feels that its official reserve holdings are below their desired level, i.e., that they are inadequate. At first glance Heller's figures would seem to contradict this argument. Over the 1951 to 1966 period the global ratios of official reserves to imports and banks' foreign exchange holdings to imports show quite different trends, the former falling by almost one half while the latter almost tripled. Hence, Heller's conclusion that, while according to

This result does not mean that double-deflated real value added estimates should be accepted uncritically. For one thing, a double-deflated index is an external -that is, it is a weighted average involving some negative weights. This characteristic gives leverage to errors so that, for example, small percentage errors in the index of gross output appear as much larger percentage errors in real value added. Error arising from the use of a fixed weight linear approximation to the theoretically correct Divisia index is likely to grow more rapidly for a double deflated index than for an output index built up directly from input indexes.3 Also, double-deflation is invalid in the presence of technical change of most sorts. Because real value added is a residual in the double-deflation technique, the technique attributes all increase in output due to technical advance to value added. If the production function shifts with time according to

SINCE 1953, Congress has enacted several changes in the income tax laws which provide subsidies to investment. Depreciation rules were amended in 1954 to allow taxpayers to use various accelerated depreciation methods, such as sum of the years digits or double declining balance, as a substitute for straight line depreciation. In 1962 the tax laws were changed to shorten the lives over which assets could be depreciated, and to provide a tax credit on investment in equipment. The 1954 acceleration and the tax credit were suspended in 1966 and reimposed in 1967. Although these subsidies have been incorporated in many econometric and theoretical studies of investment behaviour, the latter have been concerned exclusively with the partial equilibrium impacts on investment and on the interaction between investment and income in a short-run Keynesian framework.' Partial equilibrium effects are certainly of interest and the use of these subsidies for countercyclical purposes has been emphasized by recent policy decisions. However it should be recalled that one of the major reasons for instituting these policies was to stimulate economic growth. Consequently in this paper an attempt is made to analyse in a general equilibrium context the long-run steady state implications of investment subsidies in general, and of the tax credit and of a change in depreciation methods in particular. Of course this method ignores all problems arising from cyclical fluctuations in aggregate demand.

HE major contention of this paper is that T American railroad investment behavior in the period 1897-1914 is best understood by emphasizing the role of financial factors, in spite of the fact that the accelerator theory from its inception has been most successfully applied to railroad investment in precisely this period [3, 11, 12]. (This was also true in Tinbergen (17) although Tinbergen preferred a model using profits as the explanatory variable.) This argument is also in direct contradiction to the recent explanation of railroad investment behavior in this period advanced by Kmenta and Williamson [10] . The argument rests upon significant changes in railroad finance which occurred at the beginning of the period. These permitted easier access to funds from sources external to the individual companies and likewise permitted more internal funds to be used for capital formation. This encouragement of investment due to easier financing was ended, however, by the Panic of 1907. These financial changes are sufficient to vitiate any form of the accelerator explanation of investment behavior which depends upon a fixed accelerator coefficient and a fixed lag structure of investment response to changes in demand for the period 1897-1914 as a whole. The argument is tested by comparing the effectiveness of alternative regression equations in explaining the investment behavior indicated by new estimates of railroad capital formation prepared for this study. Tihe new estimates are designed to remedy the defects existing in those published by Ulmer [18] . The results of the testing may be summarized most easily by reference to the Kmenta-Williamson hypothesis that investment behavior in American railroads is best explained by models appropriate to the various phases of the industry's life cycle. The model they chose to explain investment behavior in the phase 1897-1914 is described by the equation I = a, + a2 (RX.K_.) where I = net investment in 1929 dollars (Ulmer's estimates), X = output in 1929 dollars, and K = net capital stock (first of year). One conclusion of this paper is that this particular model is inferior to a model emphasizing the costs of financing investment. Of more general significance is the fact that models of investment behavior which incorporate financial variables and which have performed satisfactorily for more recent periods in the railroad and other industries also do quite well in the period 1897-1914. This disputes the notion that it is more efficacious to take separate phases of industry life cycles in order to explain investment behavior.

T HE use of aggregate production functions of the Cobb-Douglas type to explain the sources of growth, and of differences in growth rates, in recent years among eight European countries and the United States is discussed in this paper. Output is related to inputs of labor and capital, together with a residual not accounted for by these factor inputs, whether measured conventionally or in efficiency units. Until recently such procedures, when applied to European countries, required the use of balance-sheet data to measure capital, but our ignorance of prices and valuation methods implicit in such data has been a serious weakness. Thanks mainly to the enterprise of Simon Kuznets, Moses Abramovitz and their co-workers, supported by the Social Science Research Council, historical series on gross investment have recently become available for some European countries. For such countries the capital stock can now be estimated by cumulating investment expenditures in constant prices, along lines pioneered by Raymond Goldsmith for the United States. Despite uncertainties surrounding deflation procedures and the paucity of data for estimating useful lives, such capital estimates are, I believe, greatly to be preferred to figures resting on balance-sheet valuations. The availability of these new data prompted the present study, preliminary results of which are given in this paper.