Few business cycles have surprised us as much as the last one. Hardly anyone expected it to last as long, soar as high, end as abruptly, or fall as softly as it has. Yet the greatest surprises are only now being revealed. In the first evaluation of the business cycle of the '90s, BusinessWeek shows that there has been a profound misunderstanding of what actually took place from March, 1991, to December, 2001 (page 50). The analysis explains why the "winner-take-all" view of the New Economy was wrong. It shows that Europeans misperceived that U.S. deregulation and competition sowed the seeds of inequality and poverty. It also helps to explain why consumers were able to keep spending through the downturn to mitigate a serious recession and why chief executives are so fretful today about profits. BusinessWeek's analysis suggests that policymakers, managers, workers, and investors would be wise to separate perception from the reality of what the high-productivity New Economy actually wrought in the '90s. The success of the recovery ahead may well depend on it.
The biggest surprise is that the major winners of the productivity boom were workers, not corporations or investors. Profit growth rose steadily from 1991 to early 1997, but then declined as wage growth picked up steam, especially in the boom years of 4% growth in 1998 through 2000. Blue-collar and service workers saw their real wages rise sharply. One reason is that despite problems with inner-city schools, education levels for the U.S. workforce rose dramatically in the '90s, with 51% getting some college education in 2000, up from 40% in 1991 and 33% in 1982. And globalization, which was supposed to hold down real wages in the U.S., didn't.
The next surprise is the modest return to investors over the decade. During the course of the entire business cycle, investors did very well, but not as well as they did in the business cycle of the 1980s. In the '90s, the average annual real return for the Standard & Poor's 500-stock index was 11.1%, compared with 12.8% for the '80s cycle. That's healthy, but hardly the frothy madness perceived overseas.
BusinessWeek's revised view of the '90s contains both good and bad news. Despite all the talk of the digital divide and the falling behind of the bottom half of society, the fruits of the productivity revolution were more evenly distributed than anyone thought. This opened opportunities to a record number of immigrants, people moving off welfare, and millions of Americans. It also bolstered consumer spending and softened the business cycle downturn when it came.
But as the cycle aged, rising real wages began to squeeze companies of profits. It's no accident that in the boom years, 1998 through 2000, as unemployment fell to 3.9% and wage growth accelerated, companies increasingly resorted to accounting tricks to maintain earnings and stock prices. Many of these earnings are now being restated sharply downward. With the recovery at hand, CEOs are still worried about profits. Yet a burst of capital spending on their part later this year will be necessary to keep the recovery on track.
Fortunately, productivity growth is surging yet again. It grew at an extraordinary 5.2% rate in the fourth quarter of 2001. That's undoubtedly too high to sustain, but even if it keeps going at 2 1/2% or more, companies should be able to boost profits as well as pay higher wages. Then the virtuous cycle of investment, productivity, economic growth, and dividing the pie, so characteristic of the 1990s, can begin again. It turns out the economic strength of the U.S. is deeper and more widely based than anyone, anywhere, realized. That's not a bad place to start a recovery.