We examine Henry Ford's introduction of the five-dollar day in 1914 in an effort to evaluate the relevance of efficiency wage theories of wage and employment determination. We conclude that the Ford experience strongly supports the relevance of these theories. Ford's decision to increase wages dramatically is most plausibly the consequence of labor problems of the kind efficiency wage theorists stress. The structure of the five-dollar day program is consistent with the predictions of efficiency wage theories. There is vivid evidence that the introduction of the five-dollar day resulted in substantial queues for Ford jobs. Significant increases in Ford productivity and profits accompanied the new regime.

The experience of first Japan and now Europe and the USA suggests that Hansen's concept of secular stagnation is highly relevant. Recovery has been anemic and follows a generation of financially unsustainable and often lackluster growth. Investment demand has declined while the supply of saving has increased, leaving the economy vulnerable to liquidity traps. Although some US indicators have improved, forward real rates have declined sharply, European prospects remain muddled, and the zero-bound will likely constrain again during the next recession. Infrastructure and private investment are the best ways to both minimize the risk of secular stagnation and raise demand.

Dale Jorgenson has bestowed a great honor and no small challenge by inviting me to give this lecture: a great honor because of the distinguished list of economists who have preceded me; a challenge because of the standard they have set, and because there is no greater challenge for any economist than providing a coherent account of significant events to his scientific peers. I am sometimes asked by friends about the differences between academic life and life as a public official. There are many. Two stand out. First, as an academic, the gravest sin one can commit is to sign one’s name to something one did not write. As a public official it is a mark of effectiveness to do so as often as possible. Second, as an academic, if a problem is too hard and does not admit of a satisfactory solution, there is an obvious response: work on a different problem. That is not a luxury that one has in government. I have been reminded of this often in recent years as we have grappled with financial crises in a number of what had previously been considered emerging markets with unrestrained futures. Anyone who doubts the social importance of what economists do should consider the debates surrounding these crises. Hundreds of millions of people who expected rapidly rising standards of living have seen their living standards fall; hundreds of thousands if not millions of children have been forced to drop out of school and go to work; hundreds of billions of dollars of apparent wealth has been lost; the stability of large nations as nations has been called into question; and the United States has made its largest nonmilitary foreign-policyrelated financial commitments since the Marshall Plan. Almost all the issues involved in understanding, preventing, and mitigating these crises are the stuff of economics courses and research: fixed versus flexible exchange rates, moral hazard and multiple equilibria, speculation and liquidity, fiscal and monetary policies, regulation and competition. What economists think, say, and do has profound implications for the lives of literally billions of their fellow citizens. Whether it is discussing the role of derivatives in signaling exchange-rate commitments with Chinese Premier Zhu Rongji, or discussing an NBER working paper on inflation targeting with the Brazilian central bank governor Arminio Fraga, or discussing alternative approaches to bankruptcy law with Indonesia’s economic team, or optimal debt durations with the Mexican authorities, I am consistently struck by the impact of the kind of research discussed at the AEA meetings. The future well-being of the world’s people in large part will depend on how the ongoing process of global integration works out. This is a strong statement, but one that is supported by the global economy’s post-World War I failure and its post-World War II success. Central to global integration is financial integration: the flow of funds and of capital across international borders. And as the events of the late 1920’s and early 1930’s remind us, central to global disintegration can be international financial breakdowns. Today, I want to reflect on the issue of global financial integration in light of the dramatic and largely unpredicted events of recent years. It is perhaps a good time for reflection: there has been enough repair that priority can shift from * U.S. Department of the Treasury, 1500 Pennsylvania Avenue, Washington, DC 20005. This lecture reflects many things I have learned from experiences I have shared with colleagues in the United States government and governments around the world. I thank Brad DeLong, Marty Feldstein, Stephanie Flanders, Ken Rogoff, Andrei Shleifer, and Ted Truman for useful comments and suggestions. I am especially grateful to Nouriel Roubini and Stephanie Flanders for valuable discussions and assistance in the preparation of this lecture. The usual disclaimer applies.

While modern economic theorists have produced a variety of explanations for the failure of wages to fall in the face of unemployment, Keynes emphasis on relative wages has not been reflected in most contemporary discussions. This short paper suggests that relative wage theories in which workers' productivity depends primarily on their relative wage provide the best available apparatus for understanding actual unemployment and its fluctuations. Such theories are very closely related to the efficiency wage theories that have received widespread attention in recent years.

Almost all of the serious economic work on savings decisions within the past decade has relied on some variant of the life cycle hypothesis in which savings arise out of individual choices of an optimum lifetime consumption path. This paper reexamines the incidence and welfare consequences of capital income taxes within a realistic life cycle model. The results suggest that the elimination of capital income taxation would have very substantial economic effects. For example, a complete shift to consumption taxation might raise steady-state output by as much as 18 percent, and consumption by 16 percent. The long-run welfare gain from such a shift would for plausible parameter values exceed $150 billion annually. Stated somewhat differently, shifting to consumption taxation would raise the lifetime utility of the representative consumer by the equivalent of about six years' income in the new steady state. These estimates dwarf estimates of the static welfare cost of taxation, and significantly exceed even extreme previous estimates of the dynamic loss. This study departs from earlier analyses of the effects of taxes on capital income in several respects. Probably the most important difference between this treatment and most preceding ones lies in the assumptions about the interest elasticity of saving. It is shown below that the common two-period formulation of saving decisions yields quite misleading results. A more realistic model of life cycle savings demonstrates that, for a wide variety of plausible parameter values, savings are very interest elastic. This implies that shifting away from capital income taxation would significantly increase capital formation, making possible long-run increases in consumption. Many studies of the welfare effects of capital income taxation have ignored the general equilibrium effects of increased capital formation. In an economy with life cycle savings, there is no presumption that the undistorted growth path corresponds to any sort of social optimum. As Peter Diamond has shown, life cycle savings can lead to a steady-state capital intensity either greater or less than the Golden Rule level. More generally, it is clear that there is no reason to believe that a life cycle economy will maximize any particular intertemporal social welfare function. A fundamental tenet of welfare evaluation is that preexisting distortions must be considered in evaluating the consequences of tax changes. The results presented in this paper take explicit account of the nonoptimal character of the no-tax steady state. This explains in large part why such a sizeable welfare effect of capital taxes is found. In an economy far from the Golden Rule level of capital intensity, there are substantial gains in steady-state consumption achievable through increased capital formation. Section I of the paper examines the aggregate savings function in a continuous-time life cycle framework. The second section clarifies the differences between wage and consumption taxes. An aggregate production function is added to complete the model in the third section. The effects of changes in capital taxes on both steady-state incidence and welfare are considered within a general equilibrium framework. The final section of the paper discusses some implications of the results and suggests areas which appear to warrant further study. *Assistant professor of economics, Massachusetts Institute of Technology, and research analyst, National Bureau of Economic Research. I am grateful to Alan Auerbach, Martin Feldstein, Laurence Kotlikoff, to the participants in the NBER Workshop on Business Taxation, and to the Harvard Public Finance Seminar for useful discussions. James Poterba and James Buchal performed the numerical calculations.