You Ain't Seen Nothing Yet
In our society, "mature" is a euphemism for getting old. Consultants deride a mature market as one without much potential. And a mature economy, as economists use the term, can no longer sustain the high growth rates of younger, spryer economies. Indeed, as growth slowed in the 1970s and 1980s, mature was exactly the term that many economists applied to the U.S.
Boy, were they wrong. There's nothing old about the U.S. economy today. Instead, there's been an explosion of creativity and entrepreneurial vigor that puts U.S. competitors to shame. Seven years into the expansion, growth is running at a 3.5% rate over the last year, and despite a small dip in the second quarter, productivity is rising at a strong 1.9% rate.
There is growing evidence that the U.S. economy is in the early stages of a powerful new wave of innovation. The leading edge is the information revolution, which permeates every sector of the economy. Over the last year, for example, high tech has taken half a percentage point off inflation and added almost a full point to growth.
But there is much more to come. From the Internet to biotech to cutting-edge technologies that are just now nearing commercialization, the U.S. is riding a groundswell of innovation that could carry it well into the next century (pages 80, 86, 88). "We've never had a period in which innovation has so permeated our lives as in the 1990s," notes Joel Mokyr, an economic historian at Northwestern University who studies innovation. "We have acquired knowledge in at least three or four areas that will be truly revolutionary." Adds Arnold B. Baker, head economist at Sandia National Laboratories: "There's going to be a fundamental change in the global economy unlike anything we've had since cavemen began bartering."
WAGE SURGE. Welcome to The 21st Century Economy. Historically, periods of major innovation have brought profound increases in living standards. The last one, which started with railroads in the 1890s and lasted through the advent of television and jet travel in the 1950s and 1960s, saw a quadrupling of real per capita incomes, propelled by rising productivity.
The 21st Century Economy could see similar income gains, if the latest innovative wave can boost long-term growth to 3%, rather than the 2.3% that most forecasters predict. Even over a period as short as the next ten years, faster growth dramatically changes the economic and financial landscape. Rather than remaining almost flat through 2008, real wages would actually rise by 9%, according to projections prepared for BUSINESS WEEK by Standard & Poor's DRI.
Corporations and investors would prosper as well in this scenario. In The 21st Century Economy, corporate earnings, adjusted for inflation, would rise by 54% over the next ten years, compared with 25% in the slow-growth case. Combined with 30-year interest rates below 4%, that's spectacular news for the stock market.
The innovation boom, and the faster growth rate it could ignite, could make it much easier to address some of the vexing social and environmental problems of the 21st century. For example, a 3% annual growth rate will more than cover the needs of baby boomers' retirement, since it will lead to a 25% bigger economy in 2030. And expensive solutions to global warming, such as cutting carbon emissions, will become easier to bear if the economy is growing faster.
Are such gains really possible? Certainly, the U.S. economy has done far better in recent years than most economists expected, coming close to its spectacular performance of the 1960s. The single best measure of this is the productivity of nonfinancial corporations, which includes 75% of the business sector, from Microsoft Corp. to General Motors Corp., while omitting small businesses and financial companies. Since 1990, the productivity of nonfinancial corporations has risen at a strong 2.1% rate, far above the 1.5% seen from 1973 to 1990, and approaching the 2.4% of the 1960s and early 1970s. Manufacturing has done even better: Since 1990, factory productivity has been soaring at 3.6% annually, the fastest rate in the post-World War II era.
In the long run, the success of The 21st Century Economy will depend on whether technological progress will continue to drive growth, as it has so far in this decade. That would be a big change from the 1970s and 1980s. In those decades of economic stagnation, technology contributed almost nothing to growth, according to calculations by the Bureau of Labor Statistics. The computer revolution had yet to take off, and earlier innovations such as jet travel were no longer new.
But in the 1990s, the innovations have been coming thick and fast. This has changed the calculus of policymakers, enabling Fed Chairman Alan Greenspan to hold down interest rates even in the face of low unemployment. "Signs of major technological improvements are all around us," he observed in his July 21 testimony to Congress. "The benefits are evident not only in high-tech industries but also in production processes that have long been part of our industrial economy."
PAYBACK TIME. In part, the sudden re-emergence of technological progress is the culmination of years of research in disparate fields that are finally reaching critical mass. The Internet, which only became a commercial proposition in the mid-1990s, is the direct descendant of ARPANet, which was based on research funded by the Defense Dept. in the 1960s. The first successful gene-splicing experiment was done in 1973, but biotechnology is only now set to explode. Moreover, different parts of the innovation wave are starting to feed and reinforce one another, as fast computers greatly accelerate the ability of scientists to understand and manipulate genes. Conversely, biological techniques now seem the best foundations for developing tomorrow's newgeneration computers.
The innovation wave is also being given more force by the globalization of the economy. Bright ideas developed in Israel or India quickly find world markets. Technologically savvy immigrants propel high-tech companies in Silicon Valley and elsewhere. And the ever-expanding markets offer the lure of mammoth profits for a successful product that can be sold worldwide. The result: It becomes far more attractive to speed up R&D in hopes of getting a competitive edge.
To be sure, the emergence of The 21st Century Economy does not put an end to recessions, financial crises, or the other ills that afflict market economies. Quite the contrary: Times of intense technological change are often volatile, as corporations and workers try to adjust to new technologies. Indeed, some of the deepest downturns in American history have come during periods of rapid productivity growth such as the first half of the 1900s. And, as the Asian crisis shows, the global economy exposes countries to risks that they did not face before.
Many economists are skeptical of claims that the sustainable growth rate has permanently increased. For one thing, they argue that the low inflation of recent years may simply be the result of a few lucky events, including falling oil prices, rather than any permanent structural change. Most important, they say, government economic statistics do not yet present a clear-cut case that technological progress has accelerated. The biggest productivity gains have come only since 1995, which means that a few bad years could still easily wipe them out.
Skeptics believe that today's hot technologies--the Internet, biotech, and so forth--are inconsequential, in economic terms, compared with past breakthroughs. Fundamental innovations such as electricity and the internal combustion engine, argues Robert J. Gordon of Northwestern University, one of the most articulate critics of the New Economy, "made possible a half-century of rapid growth in productivity that far exceeds what occurred before, what has occurred since, or what is likely to occur in the foreseeable future." And Paul Krugman, a Massachusetts Institute of Technology economist who has consistently attacked the New Economy, recently wrote: "The truth is that we live in an age not of extraordinary progress but of technological disappointment."
Other economists echo Krugman and Gordon's sentiment. "A lot of the easy wins have already been had," says Martin N. Baily, a productivity expert at the McKinsey Global Institute and a former member of Clinton's Council of Economic Advisers. "It's harder to push out the frontier." Adds Robert M. Solow, Nobel laureate from MIT: "You can't expect the great old days to come back."
The experience of the 1970s and 1980s gives some weight to this lack of faith in technology. The productivity slowdown was caused in large part by the failure of some innovations to live up to their early promise. Nuclear energy was supposed to be the big breakthrough of the postwar era--a source of cheap and limitless power. If the so-called Atomic Age had worked out as expected, the oil price rise of the 1970s would have been far less damaging. Indeed, the utility industry was one of the biggest contributors to the productivity slowdown of the 1970s.
Meanwhile, the space program--identified by President John F. Kennedy in 1961 as America's top scientific priority--absorbed a stunning 25% of the nation's civilian R&D dollars in the 1960s. But even though it reached its goal of putting a man on the moon, the program has not yet generated the economic benefits to justify the huge investments--though the increasing importance of communications satellites may change that.
These flamboyant flameouts may be leading the skeptics to underestimate the power of today's technological changes--just as the Great Depression created a generation of economists and investors who worried that another crash was just around the corner. But today's innovations have a better chance of succeeding because they are being developed by the private sector in response to the profit motive, which automatically gives an incentive to seek out technologies that are economically viable. Nuclear power and the space program, by contrast, were creatures of government and of heavily regulated industries, which had no such incentive.
In information technology, profits motivate both buyers and sellers. Businesses are devoting more of their investment spending to computers and information technology, something that would make sense only if managers thought they were getting a real payoff. Over the last four years, business spending on computers has risen by 86%, far outpacing the 40% rise for all other types of investment. Certainly the productivity impact of computers is starting to show up in the numbers. For example, a new analysis from two Conference Board economists, Robert H. McGuckin and Kevin Stiroh, argues that manufacturing industries that use computers heavily have shown a brisk acceleration in productivity growth, from an annual rate of 3.2% in the 1980s to 5.7% in the 1990s.
Even so, much of the benefit of the information revolution is not being captured in the productivity data. Beyond manufacturing, the computer and communications explosion is totally transforming industries that move and process information, such as finance, media, entertainment, communications, and business services. Together, these industries make up about 25% of the economy--yet they are also very poorly measured by government statisticians. After all, how can you count the gains from having 24-hour access to your money at ATMs, or from being easily able to make calls from your cellular phone?
TINY WONDERS. New technologies coming to market will have equally pervasive and radical effects on other parts of the economy. Biotech, now beginning to take off, will have a strong influence on health care, agriculture, and the output of nondurables, such as chemicals and petroleum products--and these things account for a further 15% of the economy. And while many of today's biotech products are expensive, the history of technological innovation suggests that their prices will rapidly fall as production ramps up. Especially in health care, pharmaceutical companies will be under heavy pressure to find treatments that cut costs.
Just ahead are a set of innovations that could transform the economics of a wide range of industries. Microelectromechanical systems (MEMs)--a commercial toddler--will enable tiny sensors, motors, and pumps to be built right into microprocessors, which could have a big impact on transportation, food processing, and home appliances. And scientists are learning how to build up new materials atom by atom, which could transform the entire manufacturing sector, among others. What is exciting, says Peter M. Will of the Information Sciences Institute at the University of Southern California, is the "potential to fundamentally change matter, to create things and materials that can never exist otherwise."
Of course, it's hard to predict which innovations will succeed and which won't. Technologies that look good in the laboratory or on the drawing board can fizzle out due to unforeseen complications, as did nuclear power.
But history says that the odds are good. Out of the last 10 decades, eight have been periods of strong innovation. In the end, the slow-growth 1970s and 1980s will look like the exceptions, not the rule. On the edge of the 21st century, the U.S. economy is anything but mature.