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New Economy |
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In economic
history, great myths are often made and sustained not
so much by the difficulty of the subject matter, but
by the failure of the discussants to look at the readily
available data. America's longest business cycle expansion,
which has now been officially certified as running from
March 1991 to March 2001, is a case in point.
In the folklore of the business press, a widely held
explanation has already congealed for the upswing that
led optimists to proclaim the emergence of a "new
economy."
The now conventional wisdom flows as follows: together
with Congress, the Clinton Administration got the ball
rolling by balancing the federal budget, and moving
it towards surplus. This caused long-term interest rates
to fall, which led to an investment boom--especially
in the high-tech sectors--and stimulated such interest-sensitive
purchases as housing.
All that new investment caused productivity to grow
by leaps and bounds. Since productivity the amount of
goods or services that an hour of labor can produce--is
the basis of economic growth, this raised incomes across
the spectrum.
The virtuous circle was completed by the response of
the Federal Reserve: because of the surge in productivity,
we are told, the Fed didn't have to worry about rapid
growth leading to accelerating inflation. Thus the Fed
was able to lower short-term rates, and allow for a
record-long expansion, with unemployment falling to
a 30-year low of 3.9 percent.
Sounds plausible, doesn't it? And familiar. Now let's
look at the numbers. Over the course of the business
cycle, real (inflation-adjusted) interest rates on mortgages
and high-grade corporate bonds fell by only 0.8 percent.
This certainly doesn't look like enough to stimulate
an investment or housing boom, and it wasn't.
Housing barely increased at all, as a percentage of
the economy. And if we look at both investment components
of GDP (investment plus net exports), the investment
share actually declined slightly.
Productivity growth did increase, as compared to the
business cycle of the 80s. But it was still considerably
lower than the growth of the 50s and 60s business cycles.
If we adjust for the increased share of output that
was used up in more rapid depreciation--mostly computers
and software--the productivity growth of the 90s cycle
does not even beat the 70s. And wage growth for a typical
worker was a paltry 0.5 percent a year.
So much for the "new economy." Still, it was
a long expansion, and a pleasant memory compared to
what we are facing right now. So what was behind it,
if the official story doesn't hold up to the numbers?
Most importantly, there was a consumption boom that
was driven by an enormous bubble in the stock market.
Personal savings rates fell to zero as upper-income
householdsthe ones that hold stockssaw the value of
these assets soar.
The Fed's change in policy allowed the expansion to
continue. Prior to 1995, it would slow the economy when
unemployment fell below 6 percent, on the theory that
this was the best we could do.
But this drastically important policy change--even today,
we have millions of additional jobs as a result--could
have been made at any time. It was not a result of 1990s
productivity increases, but rather the Fed's belated
realization that its prior theory was wrong.
Understanding the 1990s expansion, and its collapse,
is vitally important to getting us out of the current
recession. The evaporation of $8 trillion in stock market
wealth translates into more than $300 billion in reduced
consumption.
This means we need a stimulus package more than twice
as large as the one that Senate Democrats are proposing
(the House Republican plan contained hardly any stimulus
at all, consisting mostly of tax breaks for corporations
and high-income households).
Diehard policymakers and economists including many Democrats
still cling to the notion that fiscal conservatism brought
us prosperity. They ache to resume paying off the entire
national debt at the earliest opportunity. Many others
welcome the re-inflation of the stock market bubble--which
still exists, and has lately been growing.
And while the Fed has been doing the right thing by
lowering interest rates since the slowdown began, it
could still revert to its old ways before the recovery
is on track. This is especially true if our overvalued
dollar--another largely unnoticed bubble from the 1990s
expansion--were to drop sharply, raising the price of
imports.
The new economy may be dead, but the mythology that
created it survives. Let's hope that it doesn't cause
us any further trouble.
For more information on this topic, see Dean Baker's
"The New Economy Goes Bust" at http://www.cepr.net/new_economy_goes_bust.htm
Dean Baker and Mark Weisbrot are
co-directors of the Center for Economic and Policy Research,
in Washington, D.C., and co-authors of Social Security:
The Phony Crisis (University of Chicago Press, 2000).
December 08, 2001.
[Source: Znet Daily Commentaries] |
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