What is the Shape of the New Economy?

 

William D. Nordhaus

A. Whitney Griswold Professor of Economics

Yale University

 

Presentation at the First Plenary Session

of the White House Conference on the New Economy

East Room of the White House

April 5, 2000

                             

 

          President Clinton, it is an honor to participate in this discussion of the shape of the new economy. In my day job, I am a teacher. In that role, I am often asked by my students exactly the questions that you have raised for this meeting. Here is what I tell them.

 

          The first question they ask is, Are we in a new economy. My answer is, definitely yes. Like most economic revolutions in the past, the new economy is centered in a specific technology and radiates outwards from there. In this case, the real news, going on for at least two decades now, is the information technology (IT) revolution, which is the penetration of the big three– computer hardware, computer software, and telecommunications equipment – into our economy.

 

          The headlines have been monopolized by the Internet. The Internet is the tip of the iceberg we see above water. But the invisible part, underwater and behind the headlines, including old elements like payroll and scheduling and new elements like improved price discovery and B2B, is what is really moving the new economy.

 

          Historians remind us that a new economy – a new industrial revolution –  is born every few years. Railroads, electricity, telephony, radio, antibiotics, highway networks, air travel, and television were important historical examples. Our IT revolution is the latest and a most dramatic industrial revolution.

 

          The second question is, can we see the new economy in our economic performance? The answer here is again, definitely yes. We can see it particularly in our productivity statistics. The period after the oil shocks of the 1970s was an economic dark ages in which productivity hardly grew at all.

 

           In the late 1990s, the U.S. economy enjoyed a remarkable improvement in productivity growth, which is actually above the long-term trend of the 20th century. Labor productivity has grown almost 3 percent annually since 1995. In the late 1990s, the broadest measure of productivity, multifactor productivity or MFP, grew at a rate triple that of the 1970s and 1980s.

 

          Again, a close look reveals that the new-economy boom is largely centered in the IT sectors of computers, software, and communications. There is nothing like the productivity growth of computers in recorded history.

 

          How widespread is the productivity rebound? There is a big debate here among productivity specialists. The best evidence is that most of the productivity upturn since 1995 is due directly or indirectly to the IT sectors. There may be some modest increase in productivity growth outside IT, but up to now the speedup in multifactor productivity outside IT is still small.

 

          All this adds up to a major change in the speed limit of our economy. Whereas a few years ago economists believed that the speed limit, or rate of growth of potential GDP, was between 2¼ an 2½ percent per year, the current speed limit appears to be between 3 and 3½ percent per year. That difference represents an extraordinary turnaround in the growth of our living standards.

 

          The productivity rebound is part of the remarkable economic expansion we have enjoyed over the 1990s. It has kept price and wage growth down and allowed the long expansion to continue. A combination of prudent fiscal policy plus intelligent and sometimes gutsy monetary policy has brought good jobs to an increasingly large number of Americans.

         

          We should always remember that a strong job market with low unemployment is the most progressive social policy that we know.

 

          The third question is, Are there any clouds on the new-economy horizon? It is well known that for economists, there is never a sunny day. Two clouds are sufficiently dark to mention in this context.

 

          First, even though inflation has been well-behaved, it seems highly unlikely that the economy can continue its current growth rate without rising inflation. The speed limit has been raised, but there is still a speed limit. Perhaps the economy will slow itself; perhaps the Fed will be forced to slow it; and the timing of the slowdown is unclear. But the betting odds are long against another four years like the last four years.

 

          Second, it is my view that the current level of stock prices is not only unrealistically high but is also economically damaging. Inflated asset values make people feel wealthier than they really are and reduce national saving. An overvalued stock market distorts management decisions, compensation structures, and job choices. Overvalued stock prices make us feel good, but they are not healthy for the economy.

 

          In summary, the new economy is real and impressive, but we can't let this cloud our judgment. I believe the history books will record that the Clinton-Greenspan team (helped by the favorable winds of Fortune) has presided over one of the most successful periods of American economic history. But even the fastest computers cannot tear up the rule book and repeal the need for continued fiscal discipline, alert monetary policy, and realistic expectations about future economic prospects.