Certainly, the Federal Reserve deserves some credit. The Fed moved aggressively as the economy deteriorated, slashing short-term rates by a record amount within a year. Fed officials believe that both faster access to real-time information and greater interdependence wrought by the revolution in information technologies have accelerated the pace at which changes in economic conditions take hold and reverberate. The dramatic series of rate cuts reflected this belief, and the economy's reaction confirmed it, providing compelling evidence that monetary policy is a powerful counter-cyclical tool. The authorities of the European Central Bank, and others who argue that central banks should limit their policy interventions to maintain price stability, would be well advised to heed this lesson.
Improvements in business decision-making rendered possible by information technology also deserve some of the credit for the quick rebound. Today, real-time data systems allow companies to identify and correct imbalances between supply and demand far more rapidly than in the past. In previous business cycles, inventory imbalances inadvertently were allowed to build to such an extent that their correction necessitated deep, prolonged slowdowns. Contrary to what some New Economy enthusiasts were claiming just two years ago, the power of IT does not mean that the business cycle is dead. The human beings using these technologies continue to be subject to errors of judgment, animal spirits, and herd mentality, all of which shape a business cycle. But the new technologies may well make these cycles shorter and shallower. The resulting reduction in volatility could mean lower risk and equity premiums and improved growth prospects.
The remarkable performance of the U.S. economy in the previous year also suggests that a virtuous cycle of strong investment in IT and greater competition has fostered a significant and sustainable improvement in productivity. From 1995 to 2000, productivity in the nonfarm business sector grew at an annual rate of 2.5%, compared with 1.4% from 1972 to 1995. When the economy stumbled and New Economy euphoria faded, there was growing concern that the productivity gains of the second half of the 1990s would prove to be temporary. The productivity record during the economic slowdown provides a much brighter picture. Even as output declined, productivity growth remained positive every quarter, a combination not experienced in other recessionary periods of the past half-century. Based on the latest estimates, productivity grew at nearly 2.0% in 2001, lower than its 3.3% rate in 2000, but far higher than the rate expected on the basis of previous cyclical slowdowns.
A growing number of research studies strongly suggest that at least some of the pickup in productivity growth in the 1995-2000 period will be sustained. First, scientists expect the technical power of IT to continue to grow at an astonishing pace. Moore's Law--that the power of computer chips doubles every 18 months--appears likely to stay in force for at least another decade. Second, IT investments in the late 1990s are driving changes in business organization and behavior. These will take years to fully develop. Third, according to a study by Hal R. Varian of the University of California at Berkeley, only some 60% of U.S. companies have introduced Internet business solutions, and many of these companies have not yet fully implemented them.
Many business leaders do not share the sense of optimism expressed by economists. The divergence in views is understandable. For many companies, the returns on expensive investments in IT have failed to materialize. The rapid diffusion of information technology has rendered overall markets more harshly competitive and undermined pricing power. While productivity held up surprisingly well in 2001, corporate earnings plummeted by more than 20%, compared with the year before. Even the forecasters who are most bullish about the pace of recovery this year do not anticipate a return to the earnings growth or equity values realized in the last two years of the roaring 1990s.
Like previous technological upheavals, the IT revolution is likely to yield the greatest benefits not to investors but to workers, in the form of higher real wages, and to consumers, in the form of enhanced product selection, quality, service, and lower prices. No wonder so many of America's investors and chief executives remain anxious about the future, even as economists--not usually known for their optimism--celebrate the economy's remarkable performance. Laura D'Andrea Tyson is dean of London Business School.