Exercise 17.1 :
Is there a "New Economy"?

Since the mid-1990s there has been increasing talk of a "new economy" in the United States, characterized by increases in labor productivity, continuing economic growth, and low inflation. Is there really such a thing as a "new economy," and if so, what are the forces that are shaping it?

The term "new economy" grew out of the dramatic technological changes and accompanying economic strength in the U.S. during the 1990s. Standard economic theory suggests that low unemployment rates, fueled by high levels of consumer and business spending, can not be sustained without an increase in inflation. However, by the year 2000 the U.S. was enjoying continued low inflation rates at the same time that output was growing rapidly and unemployment rates were reaching 30-year lows. This seeming contradiction between theory and reality led many journalists, analysts, and economists to claim that we were experiencing new economic forces—a new economy—that required a different way of viewing the world. As a Business Week article in October, 2000 characterized it,

"the idea was that America was undergoing an economic transformation. Technological innovation, combined with the globalization of business and a financial system that provided venture capital, were energizing the economy by boosting productivity. In this New Economy, fast growth would no longer lead to inflation, as it did so often in the old. The reason: Productivity growth from investment in technology would cut costs. And the opening of new markets around the world and fierce competition would further put a lid on prices and wages. The business cycle wasn't dead, but it had dramatically changed."

By 2000, in the midst of nine-year economic expansion, even Alan Greenspan, the influential but cautious Chairman of the Federal Reserve, was regularly highlighting the forces that seemed to be fundamentally changing the structure of the U.S. economy. He noted in particular that new technologies, especially those relating to computing and information, were responsible for permanently changing the pace of innovation, productivity, and competition, in the process creating a vibrant, growing economy with low unemployment rates and low inflation.

But is this really a "new" economy? Perhaps, but it's too early to tell. As Greenspan noted, it is clear that technological innovations "have begun to alter significantly how we do business and create economic value." But whether these innovations continue into the future will depend on both the private decisions of businesses and the public decisions of economic policymakers like Congress and the Federal Reserve. To the extent that these decisions promote continued increases in productivity, the accompanying cost reductions and economic growth will bring new opportunities to increase the living standards of Americans from all walks of life—without raising inflation. Whether such noninflationary growth can be sustained indefinitely remains to be seen, but it's clear that during the last decade we witnessed a transformation in the U.S. economy that hadn't been seen in decades.

References:

The Next Downturn: Will a New Economy Bust Follow the New Economy Boom?
Business Week Special Report, October 9, 2000
http://www.businessweek.com/2000/00_41/b3702001.htm

Structural Change in the New Economy
Remarks by Alan Greenspan, Chairman of the Board of Governors of the Federal Reserve
National Governors' Association, 92^nd Annual Meeting, State College, Pennsylvania, July 11, 2000.
http://www.federalreserve.gov/boarddocs/speeches/2000/20000711.htm

Exercise 17.2 :
What's new about the "New Economy?"

During the 1990s, some economists claimed that technological advances had permanently transformed the U.S. economy, producing ongoing economic growth and low inflation. The dramatic decline in the stock market, the ensuing economic recession, and sluggish recovery during the past few years led many to question this view, and with it, the notion of a "new economy." If there really is a new economy, what are its characteristics and how are they different from those of the "old economy?"

One claim made by proponents of the "new economy" view in the 1990s appears to be valid. Continuing advances in information technology have led to permanent increases in worker productivity that fundamentally changed both production and consumption processes in the economy. The pace of product innovation has quickened, the easy availability of pricing information has increased competition, inventory management systems have reduced variability in output, the availability of customer service has improved, and information access has transformed the way we make decisions and purchase goods and services. At the same time, technological advances have led to new costs, such as learning to use new technology, replacing outdated equipment, and the increased risk of loss of privacy and financial fraud.

Yet, for all of the changes that technological advances have brought, the "new economy" retains many of the fundamental characteristics of pre-1990s market economies. Business cycles remain an economic reality, as evidenced by the fall-off in business spending on new capital in 2000 and the start of the economic recession that followed in 2001. Policymakers still must be concerned about inflation and unemployment, especially if productivity growth rates slow down, and despite the growth of the Internet and Internet-related businesses, business fundamentals remain the key to long-term success. Technological innovation simply helps businesses carry out their tasks faster, cheaper, and more accurately. Ultimately, only those firms who are able to most effectively harness technology to boost their profits will survive. Nowhere is this more evident than in the manufacturing sector, where technology has allowed firms to produce more with less labor input. While this has led to fewer manufacturing jobs, manufacturing output remains strong.

So, what's new about the "new economy?" While the stock market boom and long economic expansion of the 1990s elicited claims of ongoing, limitless prosperity, those views have been tempered by the sobering economic reality of the past few years. What remains is the recognition that technological advances, in particular advances in information technology, have led to long-term increases in productivity growth which, according to Robert Formaini and Thomas Siems of the Federal Reserve Bank of Dallas (2003) "ultimately lead to higher living standards and fewer and milder periods of declining output, making our economy more resilient and flexible."