Yes, Virginia, There Will Be Recessions

The U.S. economy has been growing for more than seven years. Even the widespread turmoil in Asia seems so far to have done nothing more than slow it down a bit. Does the dawning of The 21st Century Economy mean that we have seen our last recession?

The clear answer is no--you might as well ask whether a car can be built that never has an accident. Despite its current strength, the U.S. still could easily be sent into a downturn by any one of a number of different shocks. A collapse of the Japanese economy, say, could devastate U.S. financial markets and send the economy into a tailspin. Another steep plunge in the stock market, on top of the nearly 900-point drop in the Dow since July, could have an equally large negative impact by causing consumers to stop spending. Or the economy could be taken down by some unexpected event, just as the oil price shocks of the 1970s and the gulf war triggered recessions.

But even a deep recession or a stock market crash would not be a sign that the productivity gains of the 1990s are a myth, or that The 21st Century Economy is illusory. Quite the contrary--history suggests that eras of rapid technological progress and productivity increases are often accompanied by economic volatility, not stability.

Consider, for example, the first half of the 20th century, perhaps the most impressive period of technological progress yet seen. During this 50-year stretch, a series of breakthrough innovations--from autos to telephones--dramatically transformed the way people lived. And with the productivity of labor rising at an average rate exceeding 2% per year, living standards soared for almost everyone. Average real income per capita in 1950 was more than double that of 1900, and life expectancies rose from 47 years to 68 years, an incredible difference.

PLANT GROWTH. But that same 50-year stretch included the Great Depression and 11 smaller recessions. In particular, the Depression came right after the boom of the 1920s, a decade when manufacturing output per hour exploded by 63%. During the 1920s, the economy grew at a 6% annual rate, driven by the new technologies of the day: autos and radio. The number of autos on the road tripled during the decade, and by 1930 more than 40% of households had radio sets, up from virtually none at the beginning of the decade.

High productivity growth did not protect the country from the Great Depression. To the contrary: There is evidence that the productive capacity of the economy outran the ability of consumers to absorb the goods pouring out of the factories. This was particularly true in the auto industry, where producers such as General Motors Corp. and Ford Motor Co. competed for dominance by constantly building new factories in a bid for market share. "By the end of the 1920s, there was huge overcapacity in autos," notes Rick Szostak, an economic historian at the University of Alberta. "Once the auto market was saturated, there weren't other products to pick up the slack."

In some ways, there are uncomfortable parallels between the 1920s and 1990s. Today, a single sector, high tech, accounts for about 25% to 30% of growth--much the way a single sector, autos, drove growth in the 1920s. And it was softness in auto sales, starting in the summer of 1929, that helped trigger the stock market crash, just as today's stock market plummets whenever tech sales sag.

But other lessons from the 1920s and 1930s offer some assurance. Most economists agree that the initial downturn in 1929 was greatly worsened by bad policy decisions--notably an increase in protectionism, combined with a tight-money policy at the Federal Reserve Board. Most central bankers now understand that the right immediate response to a financial crisis in an otherwise sound economy is to pump money into the financial system rather than take it out.

The second lesson is that a powerful technology boom need not be stopped even by a deep downturn. From 1929 to 1937--through the worst of the Depression and a weak recovery--labor productivity actually rose 1.1% a year. By comparison, the recessions of the 1970s and 1980s--during an era of slow technological progress--produced devastating declines in productivity.

Indeed, the next downturn will provide a stern test for The 21st Century Economy. If productivity falls sharply during the next recession, that will suggest that the recent gains were only a temporary spike, and that the skeptics were correct. But if productivity continues to rise, that will be a clear sign that The 21st Century Economy is a good bet.

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