Prosperity and depression are relative concepts. Today both France and Japan are depressed relative to the United States; equivalently, the United States is prosperous relative to these countries. I say these countries are depressed relative to the United States because their output per working-age person is 30 percent less than the U.S. level. An interesting and important policy question is: Why are these countries depressed? The answers for these two countries turn out to be very different. The United States is prosperous relative to France because the U.S. intratemporal tax wedge that distorts the trade-off between consumption and leisure is much smaller than the French wedge. I will show that, if France modified its intratemporal tax wedge so that its value was the same as the U.S. value, French welfare in consumption equivalents would increase by 19 percent. Consumption would have to increase by 19 percent now and in all future periods to achieve as large a welfare gain as that resulting from this tax reform. The United States is prosperous relative to Japan because production efficiency is higher in the United States. In the United States, total factor productivity is approximately 20 percent higher than in Japan. If Japan suddenly became as efficient in production as the United States, its welfare gain in consumption equivalents would be 39 percent. Equally interesting and important are big changes over time in relative output (per working-age person) across countries. Why are New Zealand’s and Switzerland’s economies depressed by over 30 percent relative to their 1970 trend-corrected levels? Both of these countries have small populations, but depressions are not restricted to small countries. Japan, with its 125 million people, is now depressed by 20 percent relative to its 1991 trend-corrected level. On the prosperity side, why are Ireland and South Korea so prosperous now relative to their 1970 trend-corrected levels? This lecture is concerned primarily with big international differences among relatively rich industrial countries and changes in these differences over time. The countries that receive primary attention all have market economies and healthy, well-educated populations. In the countries considered, the variations in aggregate output per working-age person are large, and reasonably good measures of the factor inputs are available. This permits, in many cases, the identification of the change in policy or the difference in policy that gave rise to prosperity or depression. This is in contrast to business-cycle theory, which provides little guidance to policy except for the important policy implication that a stabilization effort will have either no effect or a perverse effect. The output variations studied and analyzed in this lecture are big: an order of magnitude larger than the much-studied business-cycle fluctuations. The variations studied, however, are an order of magnitude smaller than the muchstudied differences between the richest and poorest countries. Surprisingly, only recently have depressions been systematically studied from the perspective of growth theory, which is the theory used * University of Minnesota and Federal Reserve Bank of Minneapolis. I thank my colleagues at the University of Minnesota and the Federal Reserve Bank of Minneapolis for helpful discussions and comments. In particular, I thank Tim Kehoe, Ellen McGrattan, and Nancy Stokey for their help. I also thank Martin Weale and Franck Portier for providing some British and French tax information used in this lecture. Thanks also go to Sami Alpanda and James MacGee for research assistance and helpful discussions. This lecture draws heavily on collaborative research with Fumio Hayashi. I thank the Economic and Social Research Institute, Cabinet Office, Government of Japan and the U.S. National Science Foundation for financial support. The views expressed herein are those of the author and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.

During the downturn of 2008-2009, output and hours fell significantly, but labor productivity rose. These facts have led many to conclude that there is a significant deviation between observations and current macrotheories that assume business cycles are driven, at least in part, by fluctuations in total factor productivities of firms. We show that once investment in intangible capital is included in the analysis, there is no inconsistency. Measured labor productivity rises if the fall in output is underestimated; this occurs when there are large unmeasured intangible investments. Microevidence suggests that these investments are large and cyclically important.

The US Bureau of Economic Analysis (BEA) estimates that the return on investments of foreign subsidiaries of US multinational companies over the period 1982–2006 averaged 9.4 percent annually after taxes; US subsidiaries of foreign multinationals averaged only 3.2 percent. BEA returns on foreign direct investment (FDI) are distorted because most intangible investments made by multinationals are expensed. We develop a multicountry general equilibrium model with an essential role for FDI and apply the BEA's methodology to construct economic statistics for the model economy. We estimate that mismeasurement of intangible investments accounts for over 60 percent of the difference in BEA returns.

Historically, the average return on S&P stocks has far exceeded the average return on short-term U.S. government debt. Rajnish Mehra and Prescott (1985), for example, found that the average difference was 6.2 percent per year in the 1889–1978 period. They tried to account for this difference by assuming it is a premium for bearing nondiversi � able aggregate risk but found that risk accounted for only a tiny fraction of the difference. They concluded that there is an “equity premium puzzle.” Here, we reexamine this puzzle, taking into account some factors ignored by Mehra and Prescott (taxes, regulatory constraints, and diversi� cation costs) and focusing on long-term

A unified growth theory is developed that accounts for the roughly constant living standards displayed by world economies prior to 1800 as well as the growing living standards exhibited by modern industrial economies. Our theory also explains the industrial revolution, which is the transition from an era when per capita incomes are stagnant to one with sustained growth. This transition is inevitable given positive rates of total factor productivity growth. We use a standard growth model with one good and two available technologies. The first, denoted the capital as inputs. The second, denoted the does not require land. We show that in the early stages of development, only the Malthus technology is used and, due to population growth, living standards are stagnant despite technological progress. Eventually, technological progress causes the Solow technology to become profitable and both technologies are employed. At this point, living standards improve since population growth has less influence on per capita income growth. In the limit, the economy behaves like a standard Solow growth model.

Our thesis is that poor countries are poor because they employ arrangements for which the equilibrium outcomes are characterized by inferior technologies being used, and being used inefficiently. In this paper, we analyze the consequences of one such arrangement. In each industry, the arrangement enables a coalition of factor suppliers to be the monopoly seller of its input services to all firms using a particular production process. We find that eliminating this monopoly arrangement could well increase output by roughly a factor of 3 without any increase in inputs.