Economic Report of the President

straint on growth. Finally, policies that directly influence wage anprice setting can play a role in some nations in lowering actual anexpected inflation.Supply-Oriented PoliciesAs discussed in Chapters 1 and 2 with respect to the U.S. economy, supply-side measures can make a significant contribution to improvedeconomic performance. Beyond the direct benefits that suchmeasures can provide by increasing the efficiency with which resourcesare allocated, they can also serve to reduce the costs of restrictivedemand policies. If flexibility in labor or product markets isincreased, the effectiveness of demand restraint in slowing inflationalso improves. If productivity growth is enhanced, not only does potentialoutput rise but higher levels of capacity utilization can also beachieved, since cost-push inflation is reduced.There is no master plan of supply-side policies that will be equallyuseful to all countries, given their different institutional arrangementsand structural relationships. Earlier chapters of this Report discussa number of policy approaches appropriate to the United States,and many of these may also be useful in other countries. Two approaches,in particular, stand out as important in most countries.First, policies are needed to raise the share of GNP that is investedin new plant and equipment. Higher investment is necessary to raiseproductivity growth, to increase domestic energy production, and toaccelerate the economic restructuring that higher oil prices andglobal shifts in patterns of comparative advantage have made necessary.A potential problem exists with respect to greater investment, aproblem which some have called the "low-growth trap." The argumentis that if restrictive demand policies are used to fight inflation,investment will also be reduced because the existence of unutilizedcapacity will make companies unwilling to undertake investments thatmay not be needed until the more distant future. Lower investment,in turn, would reduce productivity growth and potential output, andhence reinforce the need for demand restraint. Thus, the final outcomemight be a prolonged period of stagflation.While there are indeed difficulties in trying to increase investmentduring a period of demand restraint, one need not accept the "lowgrowthtrap" argument. Low rates of capacity utilization do, by themselves,have a negative effect on investment. Other factors, however,are also important and can offset this effect. As was emphasized earlierin this chapter, the recent oil shock has been absorbed in a waythat has limited the erosion of profitability and cash flow to enterprises,and thus has supported investment. Moreover, the need for restructuringmay require substantial investment even in sectors where195