NEW THINKING ABOUT THE NEW ECONOMY
Is this a wonder economy, or what? Fast growth, dynamite profits, super-low unemployment, and tame inflation. We're sticking out our necks, but, as we've argued before, the good news is not just a one-quarter phenomenon. What we are seeing is further evidence that there is indeed a continuing trend toward a new economy--one based on information technology and globalization that yields a lot more productivity. If so, it means that the economy has jumped to a higher plane of sustainable growth--at least 3% annually, not 2.5%. That half a percentage point improvement changes a lot of things.
This is what we know. The breakthrough probably began in 1995. Check the data: All sorts of intriguing stats started to turn up. Economic growth accelerated. Unemployment dropped. Real wages began to edge up. O.K. so far. But then inflation fell. Profits rose, and profit margins expanded. That's a sequence that most economists--whether monetarists, Keynesians, or supply-siders--said was impossible.
What happened? Productivity. In 1995, corporate spending on information technology skyrocketed. The big surprise was that investment in computers and software rose to account for an amazing three-quarters of the increase in all business investment. The Internet captured Corporate America's attention. Networking finally united all the systems, and voila! Productivity began to take off. There is no other way to explain how companies without any pricing power can raise profits and wages at the same time. Manufacturers have been racking up 4% to 5% productivity gains for nearly a decade. Two years ago, the service sector kicked in, defying the conventional wisdom that productivity gains in services were hard to generate. Banks, insurance companies, architects, and others harnessed information technology to do more with less (page 30).
The implications are enormous. An extra half a percentage point or so of real growth over time would allow for the first significant rise in living standards in decades. It would permit a reduction in taxes, as government revenues rise. It could finance some of the impending Social Security deficit and alleviate a bit of the pressure on Medicare. It may even ease welfare reform by providing jobs for those able to work.
The international implications of a new economy are equally enormous. Faster growth means that the balance of power will be far different in the 21st century than many would believe. The "America in decline" attitude of Asian chauvinists would have to be reevaluated. In fact, the center of gravity of world growth could shift back from the Pacific Basin to a more even distribution between Pacific and Atlantic regions. Already, Britain appears to have made the leap into the new economy. By 1995, it too was experiencing higher growth and declining unemployment with lower inflation and rising corporate profits. The Netherlands, Sweden, and Finland have also tied their economies to the new economy.
How long can the growth bulls roar? We don't really know. The soaring dollar could counteract productivity gains and hurt U.S. exports. The growing trade deficit could trigger a dollar problem. European and Asian economic expansion could end the excess global capacity that restrains costs in the U.S. And the Federal Reserve could get itchy fingers, although Alan Greenspan's behavior to date has been exemplary.
But the shift to information technology and globalization is just beginning. With productivity growth at 2.4% for nonfinancial corporations over the past year, it's barely back to its old pre-OPEC level. Back then the U.S. had years of great prosperity, with little inflation. It could happen again. The business cycle is not dead, but, from now on, it may be operating around a higher trend line of sustainable economic growth. Think about it.