OLD DOGMAS AND THE NEW ECONOMY
These are the dog days of economic dogma. Withering in the blistering heat of the New Economy, many assumptions about the way things work are drying up and blowing away. It's not that the business cycle has been banned or recessions outlawed. They haven't. But the shape, character, and strength of the economy have certainly changed--for the better. This is the second installment in a series we call "The End of Conventional Wisdom." In the past, we have challenged accepted notions about the noninflationary rate of unemployment, the impact of raising the minimum wage, and the remarkable health of corporate profits (BW--May 12).
Here's more for the boneyard. Conventional wisdom says inflation can't actually fall when economic growth is strong and unemployment is low. Demand for goods and services, including labor, inevitably pushes up costs and prices. Well, sometimes not. With the economy running at 4% for the past year, the producer price index has declined six months in a row. That hasn't happened in the 50 years for which we have data. The core PPI is down to nearly 0% growth year over year. Consumer inflation is also decelerating. For the past six months, the overall consumer price index has been running at an astoundingly low 1.4%.
Conventional wisdom says corporations cut their capital spending late in the business cycle. Growth in capacity falls behind industrial production, prices rise, and inflation ensues. Not this time. Thanks to great corporate profits, real business spending for plant and equipment has grown three times more rapidly than the economy over the past five years. The result? The key capacity utilization rate, instead of rising, is down from 83.9% in 1994 to 83.5% so far in 1997.
Conventional wisdom says Americans are terrible savers. Comparing current savings to current income, the official number still looks low. Yet thanks to the appreciation in the value of their equity holdings, households are now $3 trillion richer than three years ago. Last year, mutual funds distributed $173.7 billion in capital gains and dividends to shareholders. Throw in the rising value of homes and the spendthrift boomer appears to be a more responsible adult.
Conventional wisdom, in its supply-side version, says you can't grow your way out of a big budget deficit without big tax cuts. But we have. First, serious spending caps were put on Congress. Then marginal rates on income taxes were hiked at the very top. With the New Economy roaring, tax revenues flooded into Washington. The deficit is largely being paid down by a fast-growing economy and the rich, who pay most of the income and capital-gains taxes in the U.S.
Enough. The fact is that major changes in the dynamics of growth are detonating many conventional wisdoms. Globalization and information technologies are making companies supercompetitive, generating solid profits that are fueling stocks. Government statistics may not capture rising productivity, but healthy corporate profits at a time of little pricing power do. It is the Dow, the S&P 500, and NASDAQ that are telling us old assumptions should be challenged in the New Economy.