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The New Economy Finally Gets Some Respect
Conventional wisdom can be comforting, but it can be suffocating, too. For the past three decades, conventional wisdom has held that the U.S. economy could not grow faster than 2% to 2.5% a year without setting off inflation. This slow-growth view was institutionalized in Washington by the Federal Reserve, propagated in academia by economics departments, and evangelized on Wall Street by forecasters.
Until now. In the past few months, a mass conversion has taken place, with economists and policymakers rejecting slow-growth economics for a New Economy paradigm. Fed Chairman Alan Greenspan endorsed the shift in thinking when he testified recently that the U.S. can now safely grow at 3% annually over the long term. If fresh economic thought requires a long journey of escape from conventional thinking, as John Maynard Keynes once observed, then America has just experienced a gigantic intellectual jailbreak.The Dangers of Cynicism
The consequences are immense. Over the last three years, if growth had been 2.5% rather than the 4% it was, the country would have lost $600 billion in output and 2 million people would have been put out of work. Even if growth averages a milder 3%, rather than 2.5% over the next decade, every man, woman, and child in the country will still be about $3,000 richer. That adds up to $879,000,000,000. Such is the power of the New Economy.
But convincing people of that shift has been long in coming. Institutional and intellectual resistance has been fierce. Few have been willing, until recently, to admit that information technology is replacing the old industrial manufacturing base, doubling the productivity growth rate, to 2%, and allowing for faster growth. Some economists were simply wedded to their traditional models, which showed productivity stuck at 1% and inflation rising when unemployment dipped below 6%. Others couldn't see the technological forest for the trees and denied the revolutionary implications of changes in computing and telecommunications. One prominent economist went so far as to argue that air-conditioning was a more important innovation than PCs in economic life. Still others demanded hard data on productivity before jumping.
BUSINESS WEEK saw the implications of the information revolution for growth long before most economists. And for good reason. In times of fast change, journalism can be more prescient than academia. The magazine had reporters actually on the ground covering business. And it wasn't wedded to any particular economic models or ideology. When businesspeople began talking about the huge gains in productivity they were achieving thanks to information technology, it was clear something had changed. This was years before official statistics showed productivity rising. In 1994, in "Why Are We So Afraid of Growth?," "The Information Revolution," and "The Real Truth About The Economy," BUSINESS WEEK described the early signs of an emerging New Economy. By late 1997, in "What The New Economy Really Means," incipient signs of higher productivity growth were appearing in the statistics.
By keeping an open mind and listening to executives, the magazine was able to get an early look at how innovation was changing the economy. While much of the economics Establishment remained cynical about the impact of computers in the early '90s, another shift was already under way: from PCs to the Internet. A tidal wave of innovation was at hand, as big as anything seen in the 19th or early 20th century. Yet the pundits, including many in Europe, remained removed from the real world, locked into their orthodoxies. It was fashionably safe to be cynical. America's economy was all bubble.com, destined to crash and burn.
The shift to New Economy thinking reached critical mass early this year, when the business expansion moved into its ninth year. By then, higher productivity was consistently showing up in government figures, growth had chugged along at 4% for three years (too hot for Greenspan, who is more comfortable at 3%), unemployment remained around 4%, and inflation was still dormant. Economists who wanted hard productivity numbers had them. Others, waiting for inflation to soar, threw in the towel. The stock market didn't crash. And corporate profits started rising again, despite little pricing power. It all added up to the New Economy.
Cynics remain. Some are reduced to saying that the New Economy advocates turned out to be right but for the wrong reasons. Not so. The argument never rested on "unmeasured" productivity growth, as they wrongly claimed. Others still insist on raising straw men--for example, denying that the business cycle is dead. It isn't. Who said it was? What is true is that because of productivity gains, the economy can now operate at a higher speed limit without inflation.A Note of Caution
But precisely because the New Economy is now becoming the new orthodoxy, it is time to sound a note of caution. Some stocks are considerably overvalued and a correction could set in. An economic downturn is ultimately inevitable, and with so much growth dependent on one sector--information technology--it could be severe indeed. So it was in the 1930s following the automotive revolution and in the 1870s after the boom in railroads. And finally, it remains to be seen what happens to productivity when growth slows.
Our own hunch is that the Internet will lead to further productivity gains as businesses restructure their operations. But promoting the New Economy also requires wise policy from Washington. We need to support basic research and education at all levels, the seed corn of innovation. We need sound fiscal policy, not the ideological demagoguery we usually get. The economic landscape looks fundamentally changed. Let's nurture the New Economy--not screw it up.