It is possible that millions of American entrepreneurs, managers, and employees who believe that their productivity is rising are dead wrong. It may also be that people who see productivity gains in their own companies commit a fallacy of composition when they project it onto the broader economy. And it is conceivable that 4% annual economic growth, 4.9% unemployment, 1.4% annual inflation, plus 1.6% annual real wage gains are all serendipitous events, stemming from lucky breaks on the dollar, the end of the cold war, or the balanced budget. Perhaps, but there is another explanation.
Thanks to globalization and the spread of information technology, the structure of the U.S. economy is changing fast, allowing for speedier growth without igniting corrosive inflation. How much faster, we don't as yet know.
It all depends on what happens to productivity, the elixir of growth. Manufacturing productivity has been booming at a 3.5%-plus rate for years. Until the early 1980s, service productivity kept track with that of manufacturing. Then it stopped and fell behind. What changed? The information economy emerged and began, Pac-Man like, to eat up larger segments of the whole economy. Because government statistics couldn't pick up the surge in information processing, a wedge opened between productivity as measured by the old statistical system and the reality of the New Economy.
What is amazing is that even the old statistical system is now showing evidence of accelerating productivity gains. The figures show that productivity has been growing at a 2.2% growth rate since last year, twice the level of the 1970s and 1980s. More striking is the current productivity surge so late in a business cycle, with a 2.7% gain in the second quarter and perhaps as much as 3% in the third. Moreover, business investment is still rising more than twice as fast as consumer spending. The previous time we had an investment-led expansion of the current magnitude was in the late 19th and early 20th centuries, also a period of globalization and technological change.
The New Economy is uncharted territory. Certainly Corporate America has delivered surprising earnings growth, quarter after quarter, in large part due to the lower inflation and faster growth of the restructured American economy. Surely the rich equity prices and high multiples reflect the new earnings potential. If productivity is now growing at 2% instead of the 1% rate of the 1980s and early 1990s, it can support high profits and stock prices as well as tighter labor markets without inflation.
To caricature the New Economy as predicting an end to recessions or justifying overpriced stocks is ridiculous. No New Economy adherent argues that an economy that can safely grow at 3% to 3.5% annually will be able to expand indefinitely at, say, 4%, without setting off inflation. This is what Federal Reserve Chairman Alan Greenspan said in his recent testimony before Congress. The speed limit of the economy depends on productivity. Greenspan is assessing the scope of the productivity payoff from globalization and information technology. He is right to do so.