Markets were disappointed by the U.S. Federal Reserve Bank’s decision to cut interest rates by only 0.5%. A large number of traders had expected that a reduction of 0.75% would be the trigger that would restore consumer and investor confidence and accelerate the turnaround of the U.S. economy. Whilst recognizing the risks of a continued slowdown, the Fed decided to opt for gradualism and, in so doing, banished the hope of a rapid V-shaped recovery for both the stock market and the real economy.
With industrial production weakening, it has become evident that U.S. manufacturing and high tech have been in a virtual recession for roughly five months. Some traumatized observers have begun to suggest that not only will quick recovery elude us, but the U.S. economy could copy the Japanese pattern of protracted stagnation. Just as Japan failed to adjust after the real estate and stock market bubble of the eighties, so too, it is surmised, will the U.S. fail to recover from the bursting of the tech bubble of the nineties. Could
we be entering a decade of U.S. inaction and stagnation?
My guess is that this is highly unlikely, and that the comparison with Japan is tenuous at best. Granted, the United States is suffering from the effects of unbridled enthusiasm and faith in the Internet revolution that blinded many investors to the basic rules of economics and investing. Moreover, the fear of Y2K and the rather lax attitude of the U.S. Fed encouraged excesses that have recently began to weigh heavily on the U.S. economy. Nevertheless, this surge in high tech investment has had real and positive transforming effects on the way business is conducted, costs are controlled and consumers serviced.
It may be too early to celebrate a real, lasting structural change in productivity, but preliminary numbers do suggest the likelihood that recent technology investments will help fuel higher growth in the future. The Internet is real and the revolution in telecommunications technology has merely begun. Who knows where biotechnology and the life sciences will take us? Let us not forget that electricity and the internal combustion engine survived the Great Depression.
It is unlikely that the world will deplore the disappearance of hundreds of companies selling pet food or tulip bulbs over the Internet. Nor will anyone be saddened by the plight of many tie-burning techies who fell for the idea of instant wealth offered by the prospect of a huge IPO. Yet for all its foibles, the Internet revolution will not vanish. And as Alan Greenspan stated in 1999: ‘With all of its hype and craziness, it’s something that at the end of the day is probably more plus than minus.’ The same could not be said of Japan’s real estate bubble. Nor was Japan’s stock market boom related to investments in key transforming technologies.
The differences with Japan are even more apparent in the financial sector. As imperfect as it may be, the United States has a well-developed, competitive and deep capital market unbridled with the cross-shareholdings that characterize the Japanese economy even today after a decade of so-called reform. Many U.S. banks may have seen a weakening of their loan portfolios in recent months, but the U.S. banking industry is generally healthy — a word most Japanese banks have long forgotten. The United States had its savings and loans disaster a little more than a decade ago but it found a way to resolve it. Japan continues to procrastinate and obfuscate.
Herein lies another fundamental difference which argues against the Japan scenario for the U.S. economy. The Japanese political system seems designed to perpetuate inaction, whereas the U.S. political system is extremely sensitive to consumer and investor pressures. It is unlikely that a party could keeps its hold on power for a full decade of deflation. President Carter presided over years of stagflation only to be booted out of office after a single term. President Bush Sr. was voted out of office partly because he forgot that ‘it’s the economy, stupid.’ U.S. economic tradition is based on adjustment, worker and capital mobility. Does anyone really believe that these features will dissipate with the current slowdown or even recession?
It is possible that investors will be nervous coming out of this cycle and reluctant to increase investment rapidly. Some very good ideas may be lost because the downturn will have deterred risk-taking. In a recent study of manufacturing, Josh Lerner of Harvard and Samuel Kortumy of Boston University conclude that venture capital generates more innovation per capita than corporate R&D. They show that, between 1978 and 1982, firms funded by venture capital conducted 3% of the research but filed 8% of patent
applications. In 1998, they carried out 5% of the R&D but accounted for 14% of the patent applications. Venture capital is likely to play a lesser role in the early stages of an eventual economic recovery than it has in recent years. The pick-up in economic growth will probably follow a U-shape rather than a more reassuring V, but, barring major external shocks, that excludes a Japanese situation and bodes well for a more solid, steady pace of growth down the road. No matter how you look at it, Japan and the United States are very different countries in very different economic situations.