The New Economy Vs. The Bubble Economy

For five years, at least, American business has been in the grip of an apocalyptic, holy-rolling exaltation over the unparalleled prosperity of the "new era" upon which we, or it, or somebody has entered. Discussions of economic conditions in the press, on the platform, and by public officials have carried us into a cloudland of fantasy... Clear, critical, realistic and rational recognition of current problems and perplexities is rare. (Sept. 7, 1929)

Seventy years ago, just weeks before the Great Crash, BUSINESS WEEK made its first appearance with this editorial. The resonance is uncanny. Then, a great debate swirled around the effects of the fast-paced, technology-driven economy of the 1920s. Today, a similar debate is under way, and BUSINESS WEEK is at the forefront of those arguing that information technology is transforming America, and much of the world, into a New Economy. Opposing this are those who see only a Bubble Economy at work, with inflated asset values driving growth--until they inevitably pop. So far, the debate over the New Economy has been marked by the same kind of emotion and caricature that appears to have defined the battle over the "new era." It is time, again, to clarify what the New Economy is and what it isn't, what it can do and what it can't do.

The heart of New Economy thinking is that the safe speed limit for the U.S. economy has increased--somewhat--in recent years. The speed limit for any economy is defined as the fastest economic growth rate that won't ignite inflation. The speed limit is the sum of two numbers--the growth in population and productivity. Population growth in the U.S. has been stable at about 1% for years. But measured productivity, which rose at about 1% a year between 1973 and 1995, has since doubled to about a 2% annual rate, thanks to new technologies and globalization. That surge in productivity means the U.S. economy can now grow at a sustained long-term trend rate of about 3% annually without increasing inflation. That's up from about 2% to 2 1/2% a year in the previous two decades.

America's economic speed limit has been lifted, but it has not disappeared. The economy can go faster but it can also go too fast, slow down, or even stop. Technology-driven economies, be they "new era" or New Economy, share common characteristics--fast-paced innovation, high productivity, new business models, high growth, low inflation, high equity prices. But they are also times of excess, volatility, and dislocation.

That's the danger facing the New Economy today. For the past three years, the pace of growth has exceeded even the higher new speed limit. Now there are signs of excess. Leverage is at record highs, be it margin debt, consumer credit-card debt, or corporate borrowing. Bank regulators are worried about lax loan standards. Many businesses are hiring wildly and chasing unrealistic growth projections. Many investors are day-trading themselves into penury, paying for incredible multiples on a wing and a prayer. Indeed, the nation as a whole cavalierly accepts foreign capital inflows that equal an amazing 5.8% of gross domestic product, a historic high, making the dollar vulnerable.

The Federal Reserve is trying to rein growth back to trend (the new 3% trend) with two rate hikes and appears to be succeeding. Asset prices are easing, and with that consuming spending will slow. The stock market has been flat for six months, and Net stocks have gone through a big correction. Executive cocktail chatter is of options being underwater, consumer confidence is falling, and the housing market is cooling. It all spells soft landing. The alternative, of course, is a serious recession. With the Internet providing huge opportunities to cut jobs and save costs, the next surge in unemployment could be disturbing.

A sober look at the New Economy shows that it can generate more growth and jobs than economists thought possible. This is no small thing. But even though the New Economy can go faster, it can also slow down, or even go into reverse.

Before it's here, it's on the Bloomberg Terminal.