Signs of impending slowdown are all around. With turmoil worldwide and U.S. corporate profit growth slowing, the stock market has dropped by about 17% since its July peak. The economy generated only 69,000 jobs in September, even while the collapse of Long-Term Capital Management suggests that the U.S. financial sector may be shakier than many had assumed.
Is this the end of the so-called New Economy? Hardly. The New Economy has never been about sunny skies forever. Rather, it has always been a good-news/bad-news story. The same forces that create the conditions for faster growth in the long run also lead to volatility and turbulence in the short run--and right now we are seeing the dark side.
Let's summarize the good news first. The conventional wisdom has been that the U.S. was a mature, slow-growth economy, doomed to 2%-to-2.5% annual growth for the indefinite future. Instead, a striking wave of technological innovation--centered in information technology but not limited to it--combined with globalization has reenergized the U.S. economy.
BEST AND WORST. Over the past three years, growth in gross domestic product has averaged 3.7%. Rising productivity has boosted both real wages and profits. And core inflation has fallen from 3% to 2.4%, despite an unemployment rate well below 5%. If the current pace of technological innovation continues, it seems likely that the U.S. economy can sustain a long-run average growth rate of 3% or more.
But the bad news is that while the economy remains on a path to long-term prosperity, there will also be wide swings--long booms punctuated by deep busts. Indeed, globalization and technological change can help create the conditions for financial crises and sharp recessions.
A New Economy recession would be different from the recessions the U.S. has seen over the past 25 years. In those that occurred in 1974-75, 1981-82, and 1990-91, productivity plummeted as businesses could not cut costs and boost efficiency fast enough when demand fell. This time around, by contrast, companies are taking advantage of new technology to aggressively revamp their operations at the earliest indications of a slowdown, thus keeping productivity high. Moreover, job-cut announcements in the first nine months of 1998 are already running about 50% ahead of last year's pace, according to calculations by outplacement firm Challenger, Gray, & Christmas. With earnings under pressure, more such cuts are likely.
But these job cuts, even if they lead to increased efficiency, could exert a strong downward pull on the economy in the short run. Indeed, the historical record from the first half of the 20th century suggests that scary downturns are often associated with periods of rapid productivity growth. From 1900 to 1950, the widespread introduction of such new technologies into the economy as electricity, the automobile, and radio sent productivity soaring, and doubled the real income of Americans. But that same 50-year period also included the worst downturn: the devastating Great Depression of the 1930s.
Today, it's clear that both globalization and technological change are creating new risks. The increased interconnectedness of the global economy means that economic or financial disturbance in Asia or Russia can be transmitted much faster and more powerfully to the rest of the world. Witness the signs of a liquidity crunch in the U.S., thanks in part to the flight to quality that began in Asia.
Beyond that, the current dependence of the U.S. economy on high-tech spending raises disturbing questions. Today, about 30% of U.S. economic growth comes from high tech, primarily business capital spending and consumer purchases of home computers. As a result, a mild slowdown in the economy could quickly expand into a major downturn if prudent execs delay technology purchases and worried consumers cut back on discretionary spending, such as purchasing a second computer.
In the short run, there's little doubt that the U.S. economy will be dragged down by the global crisis. But it's what happens to productivity and growth in the long run that really matters--and that will be the true legacy of the New Economy.