Returning to the '90s Economy

It is fashionable these days to deride everyone who ever used the phrase “New Economy” to describe what was going on in America in the 1990s. Even Alan Greenspan, who repeatedly argued that we were experiencing something new and different in the ability of the economy to produce goods and services—a sustained increase in efficiency, or productivity—is coming in for criticism from economists who contend he failed to realize that those gains resulted from a temporary, cyclical upswing in productivity that would soon prove reversible.

To the extent that New Economy advocates claimed that the business cycle was dead, they deserve the scorn now heaped on them. But it is important not to lose sight of the facts that much in the American economy did change in the 1990s, and that those changes are proving durable.

Start with the business cycle. Certainly, business cycles are still with us. And probably always will be, so long as Keynes’s famous “animal spirits” inevitably career from irrational exuberance to irrational pessimism, bringing periods of overinvestment and share price bubbles, followed by periods of shrunken investment and share price undershoots.

But there is good evidence that due to developments in the 1990s, recessions are becoming shorter and shallower, as information in final markets is transmitted by new information technology with sufficient speed to avoid massive inventory buildups in the face of declining sales. It will take another recession before we can be certain that the duration and scale of these events will remain less punishing. But, with any luck, we won’t have that experience for several years.

At least, not if economists have got it right. One oddity of the current business scene is the wide difference between the views of serious businessmen and those of learned economists. The former, with their eyes on their share prices, and under pressure to meet earnings expectations in the current quarter, are as gloomy as I have ever known them, which is why they are reluctant to spend on new plant and equipment.

Economists, meanwhile, are holding grimly to their cheerier view that the economy will continue to grow, avoiding a double-dip recession. Best estimates are that growth over the past year has averaged a bit more than 3 percent, which is the annual rate that the economy is deemed able to sustain without triggering inflation. Consumers may be telling pollsters that they are less confident than they were a few months ago, but their real incomes are rising as are the value of their houses. With mortgage rates at record low levels, home owners are expected to continue converting equity into cash, to the tune of about $100 billion in the second half of this year. Economists reason that much of that money will find its way into the shops and pockets of homebuilders, giving the economy a boost until business spending recovers. Consumers seem able to grumble and spend at the same time.

When businessmen unzip their corporate wallets, the infrastructure additions and improvements that powered the 1990s productivity advance will be enhanced. Remember: many dot-com firms may be gone, but the Internet and the Web remain. Information technology experts Jason Dedrick, Vijay Gurbbaxani, and Kenneth Kraemer point out that in the years between 1986 and 1993 the information technology (IT) capital of an average firm increased from $4,000 per worker to $27,000 per worker, with high returns on that investment, especially in the consumer durables manufacturing sector.

That bodes well for the future. Rebecca Blank and Matthew Shapiro (dean of the public policy school at the University of Michigan and professor in that university’s economics department, respectively), in a data-laden paper, conclude that “the U.S. labor force is well poised to sustain the gains in output and productivity” realized during the expansion of the 1990s. Although a debate still rages about the cause and sustainability of the productivity gains of the 1990s, the evidence suggests that Greenspan, who only recently pointed out to a small group that productivity is continuing to improve at a relatively rapid pace, has it right. We may not have licked the business cycle, but we do seem to have set in place the infrastructure that will keep productivity moving ahead, with lags to permit new techniques to be absorbed into corporate structures and worker habits.

Another durable product of the 1990s is an increased understanding of the policies needed to enable the economy to grow steadily and relatively inflation-free. Again, it would be foolish to say that we are now complete masters of our economic fate. There will always be “shocks”—some unfavorable, such as a rapid run-up in oil prices, others favorable, such as a decline in health care costs. But it would be equally foolish to pretend that we know no more now about how to make an economy function well than we did at the opening of the last decade.

According to economists Alan Blinder and Janet Yellen, both of whom have served as Clinton appointees on the President’s Council of Economic Advisers and as governors on the Federal Reserve Board, we learned many lessons in the last decade, among them that “tight government budgets and (relatively) easy monetary policy can create a pro-investment macroeconomic climate by holding down real interest rates. The resulting high rates of investment should then push up productivity and real wages.” It was just such a set of fiscal and monetary policies in the 1990s that explains the capital deepening reported by Dedrick and his associates.

All of which suggests that the current nervousness about the future of the American economy may be appropriate for those trying to guess at its short-run performance, and the timing of the end of the bear market. But those who think in longer-run terms should take heart: the legacy of the 1990s includes more than the broken hearts of the dot-com entrepreneurs.

Note: This column is indebted to two sets of essays, appearing in Alan Krueger and Robert Solow (eds.), The Roaring Nineties: Can Full Employment Be Sustained?, and in Jeffrey Frankel and Peter Orszag (eds.), American Economic Policy in the 1990s.

This article appeared in London’s Sunday Times on October 6, 2002, and is reprinted with permission.