By Christopher Farrell
The U.S. economy has taken a drubbing the past two years. The high-tech stock market bubble popped. Corporate profits vaporized amid dramatic cutbacks in business investment. Then came the first synchronized global recession in decades, the unprecedented terrorist attack on September 11, and war in Afghanistan. Markets were down two straight years for the first time in three decades. Unemployment moved sharply higher, with nearly 2 million corporate layoff announcements last year and some 12% of the workforce currently underemployed or out of work.
Small wonder alarms bells sounded along the New York-Washington power corridor that the U.S. economy might sink into Japanese-style stagnation at best and a 1930s-era American depression at worst.
Hold on. The best guess of the economic forecasting fraternity, including the nation's chief economist, Alan Greenspan, is that the 2001-02 recession will be the mildest on record. The drumbeat of economic news is increasingly positive, from the rebound in consumer confidence to a spurt in new orders for durable goods to the plummeting price for memory chips.
Gross domestic product expanded at a surprising 0.2% annual rate in the fourth quarter, an unexpected gain largely driven by retailers, manufacturers, and wholesalers slashing inventories at a $121 billion rate, almost double the third quarter's pace. Even if the GDP growth estimate is revised down in subsequent weeks, the Federal Reserve was confident enough to leave its benchmark interest rate unchanged at its first policymaking session of the year on Jan. 29-30 (see BW Online, "Recession? What Recession?").
What gives? I'm not ready to abandon the notion of a New Economy. The technology-led productivity boom, the rise of the capital markets, and myriad organizational innovations geared toward creating a more flexible, responsive corporation conspired to limit the first downturn of the Information Age. "One of the tenets of the New Economy is that there would be recessions, but that they would be short and relatively mild," says Mark Zandi, chief economist at Economy.com, an economic consulting firm. "The economy is more productive and flexible."
Or, as Greenspan recently characterized downturns in this era: "Contractions initially may be steeper, but because imbalances are more readily contained, cyclical episodes overall should be less severe than otherwise would be the case."
Info tech is key. The rapid innovation and diffusion of advanced information and communications technology have paid off in a sustained improvement in business productivity. Executives can tap into unprecedented power. Toward the end of the 1950s, some 2,000 computers were processing 10,000 instructions per second, according to a paper by economists Bradford DeLong and Lawrence Summers of the University of California, Berkeley, and Harvard University, respectively. Today, 300 million computers process several hundred million instructions per second.
Of course, gee whiz high-tech gear didn't stave off a downturn. But when the economy took a nosedive, management raced to wring additional efficiencies from their investments in computers and other information hardware and software. Those efforts are paying off. The nonfinancial productivity number ran at around a 2.6% annual rate during the current downturn, compared with a string of negative statistics in the recessions of the early '80s and '90s.
Technology has improved inventory-management techniques, allowing companies to liquidate their inventories at an astonishing pace, so much so that inventories may be running somewhat below sales.
The information economy may have modulated the traditional commercial and residential real estate boom-and-bust cycle, too. "I think builders and the real estate market in general have better information and controls than before," says Zandi. "The commercial construction cycle is very modest, and supply and demand are very balanced in the residential market."
The dominant role the stock and bond markets play in financing Corporate America also muted the downturn. The investor pool of risk capital dwarfs the money parked in banks, and global capital markets can react far faster than stodgy, bureaucratic banking behemoths. Investors are quicker than banks to withdraw money from failing companies when they sense inept management, switching cash into companies with far better profit prospects.
Thanks to the capital markets, this recession saw no credit crunch, a parlous state of affairs when battered banks refuse to lend to even creditworthy customers -- let alone marginal ones. The junk-bond market stayed open for business, while households refinanced some $1 trillion in residential mortgage debt last year. The capital markets also encourage widespread risk-sharing as investment securities are sliced, diced, and sold to different pools of investors.
Indeed, today's common depiction of the late-1990s stock market as the greatest asset bubble in history is more myth than reality. Certainly, extreme enthusiasm drove high-tech stock prices into the stratosphere, especially in the dot-com arena. The approximately 80 tech companies in the Standard & Poor's 500-stock index were overvalued, but the remaining companies in the benchmark index weren't.
The stock market appears fully valued at the moment, although much of the recovery since late September has simply brought the stock prices back to their pre-September 11 level. "I disagree with the idea that the stock market was a bubble," says Jeremy Siegel, finance professor at Wharton School of Business and author of Stocks for the Long Run. "The stock market has held its own."
The mild downturn demonstrates the benefits of a healthy balance sheet. The federal government was running a substantial surplus before trouble reached these shores, which has made it easy for Washington to support the economy. Even though Congress failed to approve a fiscal stimulus package late last year, the government's $275 billion surplus of last March will likely fall to a $50 billion deficit this year. Critical fiscal support for a faltering economy accounts for that swing. And with inflation essentially nonexistent in a high-tech economy, the Fed has had plenty of room to aggressively ease monetary policy.
THE ENRON FACTOR.
Of course, forecasting that the worst is over is risky. The biggest menace may be the fallout from the Enron debacle. The energy company's financial disaster and unfolding scandal threatens to undermine investor faith in management. The stock market has stumbled as disillusioned investors scrutinize company earnings, with the stocks of Anandarko, Tyco International, Williams, General Electric, American International Group, and the like being hit.
Even more worrisome, disgust over Enron's systemic duplicity is casting a pall over policies that have nurtured competition and high-tech investment -- from deregulation to open borders to unfettered capital markets. But many forces are gearing up to contain the catastrophe, from investors favoring companies with clean balance sheets to congressional committees lobbying for accounting reforms.
So far, though, Enron doesn't appear to have derailed the nascent recovery, which is expected to build steam later in the year. Once again, America has witnessed the promise of a highly flexible, productive information-driven economy. Coupled with a healthy federal balance sheet, the recession will be over soon -- and New Economy naysayers will retreat.
Today's Strong Productivity Growth Stands Out
Productivity growth during recessions, measured as percentage change in nonfarm business productivity, annual rate
DATA: UBS Warburg
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online
Edited by Beth Belton