By Laura D'Andrea Tyson
Early last year, when technology mania gripped global equity markets, I wrote a BusinessWeek column extolling the virtues of the New Economy. A lot has changed since then. Driven by a breathtaking dive in Nasdaq stocks, the net worth of the average American has declined for the first time in more than a half-century. After an unprecedented number of years in positive territory, the economy's growth rate has plunged from about 6% between June, 1999, and June, 2000, to around zero today. And faltering consumer confidence, disappointing corporate profits, and mounting layoffs point to a continued slowdown or outright recession over the next few months. So it's probably time for New Economy enthusiasts like me to reassess the evidence.
Is there a New Economy? Not in the sense that the business cycle is dead, earnings don't matter for stock valuations, only new dot-com companies will survive, or the rules of economics have changed. I never believed any of these propositions, although a disconcerting number of analysts, investors, and pundits apparently did. But I continue to believe, as many economists do, that improvements in information technology have already increased the efficiency and productivity of the U.S. economy, with additional benefits to come as both old and new companies adapt their operations to make the most of the new technologies.
The productivity numbers tell the most convincing story. According to a recent study by the Council of Economic Advisers, labor productivity accelerated by 1.6 percentage points from 1995 to 2000, compared with its growth from 1973 to 1995. The lion's share of this acceleration stemmed from more investment in information technology and efficiency improvements made possible by this technology.
SOBERING LESSONS. Most of these productivity gains occurred outside the computer sector and were highest in large service industries like wholesale and retail trade, finance, and business services. From 1989 to 1999, those sectors that added the most value through information technology enjoyed the largest productivity gains, with a 50% acceleration after 1995.
Such long-term good news tends to get swamped these days by cyclical concerns about "overinvestment" in information technologies. As companies throughout the economy scale back estimates of future demand, investment in IT has plunged. But these cyclical effects should not be confused with secular trends. The history of previous technological revolutions indicates that however deep the current cyclical downturn proves to be, the diffusion of the information technologies should mean a prolonged increase in the growth of productivity and living standards.
But economic history also has some sobering lessons about technological revolutions. As Robert J. Shiller argues in last year's chillingly prescient book Irrational Exuberance, each wave of technological change over the last 120 years--from railroads to electricity to cars--has seen share prices of new technology companies soar, only to fall precipitously. During the past six years, the Internet phase of the IT revolution has succumbed to this pattern. Supportive capital markets--especially the explosion of venture-capital funds and initial public offerings--and the suspension of norms of due diligence and valuation sent share prices of New Economy companies to unprecedented heights.
In the past year, these prices have fallen with astonishing speed, wiping out more than half of the previous five years' gains. Never has so much wealth been created or destroyed so fast.
GLOBAL TIES. Information technologies themselves have contributed to the speed and severity of the turnaround in at least two ways. First, scholars in the field of behavioral finance have found that additional information can foster overconfidence and biased judgments on the part of investors, especially novices. Add to that the illusion of control fostered by online trading and the inherent increase in risk associated with technological change, and the bubble and collapse of New Economy stocks during the past few years are easier to understand.
Second, information technologies, along with a reduction in capital-market controls, have increased cross-border capital flows, making national economies more interdependent. A recent International Monetary Fund study finds that the relationship among equity prices in different countries has grown closer and that worldwide factors have become more important relative to local factors as determinants of share prices. The globalization of capital markets helps explain both the "winner take all" surge in the market capitalization of technology stocks during 1999-2000, and their dizzying synchronous drop around the world during the past year.
The New Economy will survive both the collapse of New Economy stocks and the cyclical downturn. Financial markets are not a reliable indicator of the economic benefits of technological revolutions. Laura D'Andrea Tyson is dean of the Haas School of Business at the University of California at Berkeley.