economy and 'new economy' in the united states and germany
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Economy and 'New Economy' in the United States and Germany Economy and 'New Economy' in the United States and Germany
Phillip J. Bryson [email protected]
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ECONOMIC SYSTEMS
Phillip J, Bryson*
Economy and "New Economy" in theUnited States and Germany
The expression "New Economy" is used inconsistently. This article reviews the drivingforces of the US boom of the 1990s, examining the changes introduced in the period
and before, focusing on the IT sector and new technologies. The "New Economy" is notjust the new sectors, but changes in the overall economy emanating from them. These
changes will not evaporate in an economic slowdown. Comparisons of the USA withGermany and Europe illustrate that the "New Economy" will also continue to develop
there on the foundations already laid.
Since the US economy is an engine of growth forthe world and its large market is a beacon to the
exporters of many nations, much of the world is inter-ested in having some notion of where the economy isand whither it is tending. Having the leading economyof Europe, Germany is of critical importance for theEuropean Union and also represents a significantglobal force.
On both sides of the Atlantic observers havewondered whether the United States may be leadingthe world into a new economic era. The USeconomy's continuing strong performance has estab-lished new parameters and possibilities for economicsuccess, even to the extent that many believe theyhave discovered a "New Economy". The service-oriented economy, now based on information andother technologies, has undergone changes sosweeping that the very nature of economic activityseems to be based upon new rules.
Is that New Economy anywhere on the horizon inGermany, or is it a part of Germany's future? TheGerman and American economies may be out ofcyclical synchronization, and perhaps that isfortunate. But with the international spread oftechnologies, they can be expected to tend toward acommon level, with the German economy showingthe way for Europe.
The question as to whether the economy can ap-propriately be described as "new" can be addressedin the context of the current North American prosper-ity, encompassing not only the bright possibilities,but also the distinct perils of its future. Of the twopropositions addressed by this paper - that theeconomy has changed in terms of its fundamentalstructure and that the changes have produced a
'Associate director, The David M. Kennedy Center for InternationalStudies, and Professor of Economics, The Marriott School, BrighamYoung University, Provo, Utah, USA.
boom - the former seems more significant. Especiallysince the boom has recently been approaching eithera new phase or an end. Again, the main question iswhether fundamental changes have permanently al-tered the nature of and prospects for growth andchange.
This article will first examine the productivity andperformance of the US and German economies. It willthen review the foundations laid in the past througheconomic reorganization, strategic investments, andinternational realignment, before looking at the role ofhigh tech and the internet, the sectors generally andinappropriately labeled the "New Economy". It thenfocuses on the relationship between trade and growthand whether the combined old and new sectors areincreasingly open, and goes on to address the intan-gibles of economic growth: corporate governance,the regulatory environment, and business confidence.Next, the stock market, the wealth effect, and theboom are investigated as is the question whetherbusiness cycles are history. Subsequently, theweaknesses and potential problems of the USeconomy in this new millennium are considered:savings rates, imports, personal indebtedness, andthe durability of positive expectations. In conclusionan answer is presented to the question: "Whither theNew Economy in the USA and in Europe?"
Current Productivity and Economic Performance
The economy of the United States enjoyed solidexpansion during the 1990s. Was that expansion, to-gether with its effects and causes, sufficient to war-rant the designation "New Economy"? In Germany, aperiod of fiscal trial following reunification with itsleveraged Eastern resuscitation, appears now to bemoving toward full economic reinvigoration. The Eu-ropean community is also coming under the influenceof currency convergence. One should be warnedagainst drawing inferences about the strength or po-tential strength of the European economies based
180 INTERECONOMICS, July/August 2001
ECONOMIC SYSTEMS
upon the market value of the euro from its introduc-tion through the period of decline that followed. Atthe same time, although the new currency will reducetransactions costs within Europe significantly, thenew monetary regime will not alone produce a Euro-pean "New Economy".
When the American economic boom began in theearly 1990s, the foundations of economic renewalhad already been laid, but it was later in the decadethat the resurgence became apparent, then robust.Those foundations will be discussed below. Throughthe larger part of the decade, it became" increasinglyapparent that the American economy was generallystronger than it had been in a very long time.
Germany, newly reunited and a leading player in theEuropean Monetary Union, appeared on track for abrilliant future in 1990. But when the reconstructioncosts for the former German Democratic Republicwere much higher than the Kohl government antici-pated, German fiscal policy was impacted heavily. Atthe same time, the high costs of the social marketeconomy reflected the structural inflexibility ofGermany's social welfare policies, which had becomeresponsible' for distressingly high unemployment.These phenomena are commonly referred to as"Eurosclerosis", which is not exclusively a Germanphenomenon. Nor has this complex of problems beenovercome, although the German economy is nowbreaking out of the stagnation of the 1990s.
The American Decade
As the nineties began, the US economy appearedto be stagnating. At that point in time, still well beforethe onset of the Asian crisis, it was probably aconsensus among professional observers that theAsian model had proved successful and that it mightalready be too late for Americans to learn from theJapanese and the Koreans.1 Thurow was convincedthat a national strategy or national industrial policyreflecting the Japanese virtues would be essential tothe survival of US global competitiveness.2 PorterWrote that the government's role in generating inter-national competitiveness was a vital, "if not the mostimportant, influence" in national economic perform-ance. The policies of the Japanese and Koreangovernments were "associated with the successthese nations' firms have enjoyed".3
At the height of the gloom and doom discussion,the United States was just about to enter a period ofeconomic expansion of record-breaking power andlongevity. That boom would be fundamentallydifferent from those preceding it. The long expansionsof the 1960s and 1980s had been flawed by infla-tionary tendencies when employment levels were high
or were beset with high levels of both inflation andunemployment.4 In.the boom of the 1980s hugefederal budget deficits had grown out of an expan-sionary fiscal policy offset by the tight monetary policyresponse to the inflationary period of the seventiesand its aftermath.
In the boom of the nineties, fiscal policy has beenrestrictive and monetary policy accommodative. Theresult has been the longest period of economic ex-pansion in US history, featuring a Utopian concatena-tion of declining unemployment, wage and price sta-bility, rising productivity, and strong economicgrowth. Productivity growth in the US, reports Krug-man, has accelerated, "perhaps from the 1 percentper annum norm of recent decades to 2 percent ormore."5 He indicates that in 1995 the rate of growthof potential US output would have been put at slight-ly more than 2 percent by the conventional view, andthe natural unemployment rate estimated at notmuch less than 6 percent. "It now seems plausiblethat the rate of potential growth is around 3 and thenatural rate below 5".6 If this improvement is sustain-able, output in 2005 will be nearly a quarter greaterthan would have been projected only a few yearsago.
Krugman sees this as a strong performance, butscarcely finds it miracle-like. He suggests that the USeconomy would not appear nearly as dramatic if theEuropean and Asian situations were not relativelyweak. In his view, no single European nation7 canbecome as strong as the United States, or evenJapan, so the future of Europe will be determined by
1 Lodge, obviously an advocate of the Asian model, found that theUS government has "not pursued long-term economic goals...it hasalso operated on market principles under which it is not the role ofgovernment to plan for the competitiveness of the economy in theworld" Cf. George C. L o d g e : Korean Development and WesternEconomics, Boston 1996 (revised), Harvard Business School, p. 8. Itwas his view that American firms were operating under the disad-vantage that "the overriding responsibility of managers is not to thenation but to shareholders...not with the long-run health of the enter-prise they theoretically own (sic !) but with quick and generous returnsto their clients" (ibid.) Lodge snared the view, quite popular at thetime, that "a critical function of the government-business partnershipwas the identification of particular industrial sectors" (ibid., p. 9) in anindustrial targeting policy. He praised the "Confucian perspective"that the planning bureaucracy should and would provide leadershipto "provide for, to enrich, and to educate the people. Bureaucrats arenot merely government functionaries, but leaders, intellectuals, andteachers" (ibid., p. 10).2 Lester T h u r o w : Head to Head: The Coming Economic BattleAmong Japan, Europe, and America, New York 1993, Warner.3 Michael E. Po r te r : The Competitive Advantage of Nations, NewYork 1990, The Free Press, p. 126.4 United Nations: World Economic and Social Survey 1999: Trendsand Policies in the World Economy, New York 1999.5 Paul . K r u g m a n : Can America Stay on Top?, in: Journal ofEconomic Perspectives, Vol.14 (2000), No.1, pp. 169-175, here p.170. •6 Ibid.
INTERECONOMICS, July/August 2001 181
ECONOMIC SYSTEMS
the continent's ability to engender cohesion and self-confidence. However, the euro and monetaryintegration will not alone place Europe in anascendant position in a North Atlantic balance ofpower.
As we will see below, the American performancecan be traced back to technical creativity. Anexcellent measure of this creativity and its impact onthe internet economy's boom in the 1990s is thenumber of patents granted in the USA. There hasbeen an explosion in the number of patents granted inthe United States in recent years. Considering thatsome information technologies are changing sorapidly that the pursuit of patent protection can beviewed as meaningless for those areas, the largenumbers of patents applied for and granted isespecially impressive. Discoveries in the informationeconomy are at the heart of what has happened in theUS economy.
Figure 1Patents Granted Since 1900
o1900 1910 1920 1930 1940 1950 1960 1970 1980 1990
S o u r c e : Department of Commerce (Patent and Trademark Office);see Economic Report of the President, 2000, p. 122.
The German Recovery
Immediately following German reunification, acampaign to reconstruct the new Bundeslander waslaunched. Since taxpayers were promised that no taxincrease would accompany reunification, the recon-struction was financed by public debt. Unfortunately,the costs were much higher than expected. The ratioof public spending to GDP increased from about 46%in 1989 to almost 5 1 % by 1996.8 The ratio of publicdebt to GDP increased from just under 42% to nearly61% in those years. Budget deficits of the FederalRepublic were also high in the 1990s, but came downfrom 3.4% of GDP in 1996 to 2.6 % in 1997 and 1.7 %in 1998.9
Reconstruction outlays based on federal borrowingwould have proven much more inflationary, had theynot been countered by high interest rates. Unfortu-
nately, the long-standing structural unemploymentproblem in the Federal Republic was exacerbatedby the resulting tight-money situation. On occasion,Western German unemployment has exceededeleven percent; in the east, the rate has been close to20 % in recent years.10
In the aftermath of the reunification decade, theGerman finance establishment is on a "consolidationcourse" to restrict spending and reduce public sectordeficits. The Federal Republic's goal is to achieve abalanced budget by no later than 2006. Tax reduc-tions, also on a "quite impressive scale",11 have beendesigned to stimulate private spending. Higher taxeson energy consumption are to encourage economicuse of energy resources. The reduction of deficits anddebt are to reduce "squeezing out" by taking pressureoff bond markets. High interest rates have been nogreat problem for the inflation-combating Germans,but other countries in the region, fearing capitaloutflows, have also had to maintain higher interestrates than they desired.
While Germany labored under the strain of reunifi-cation, another very significant development was inprocess. German corporate governance, traditionallybased on commercial and industrial finance throughthe banking system, began to show a preference forchange. The development of the German stockmarket, the Dax, as a means inter alia of generatingventure capital for high tech and information indus-tries, began to support the development of a nascent,New Economy.
Economic Reorganization andStrategic Investments in the USA
The period following the Second World War wascharacterized by excess capacity generation in theUnited States, a process which carried on into the
7 There are obvious pitfalls that must be avoided in comparing acountry like Germany to the United States, or even the continent ofEurope to the USA, as Rothschild reminds us. Cf. Kurt W.R o t h s c h i l d : Europe and the USA: Comparing What with What?,in: Kyklos, Vol. 53 (2000), No. 3, pp. 249-264. To set the reader's mindat rest, I will not be making refined, statistical comparisons ofeconomic outcomes, but will be looking primarily at prospects thatmight be implied at some future point by today's inputs, e.g. as aresult of investments etc. See the end of the paper where Stierle isquoted, showing that measures such as Europe's investments in ITequipment lag behind those of the USA, but can be expectedultimately to match those of the latter.8 Hermann R e m s p e r g e r : Is There a New Economy in Germany?,in: Deutsche Bundesbank: Auszuge aus Presseartikeln, No.14, 20March 2000, pp. 14-18.9 Federal Ministry of Finance: German Stability Program: December1999 Update, Berlin 1999.10 Federal Ministry of Finance: The Economic Situation in the FederalRepublic of Germany, Berlin 2000, Monthly Report Nos.1-2.11 Hermann Remspe rge r , op. ci t , p. 16.
182 INTERECONOMICS, July/August 2001
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1970s.\ Stock prices were generally depressedbecause a substantial share of the capital stock wasunderutilized; there was little demand for the productsof numerous industries and changing technologies leftcapacities obsolete in others. Nevertheless, managersrefused to downsize their activities; in fact, theycontinued to increase their investments. The resultwas that share prices remained low and unproductiveassets accumulated. What better incentive could beprovided for corporate takeovers than making theprice of ownership low and the accumulated assets ofownership large?
In the 1960s, many large conglomerates had beenformed; their parent companies brought largenumbers of separate and disparate businesses undersingle management. The corporate decision-makingpowers were located at conglomerate headquarters,but particular managerial information and specificmanagerial knowledge were located in the dispersedand separate corporate divisions. So while noting thelow ratio of share prices to corporate assets, compet-itive managerial outsiders monitored firms that wereexcessively large and unmanageable. They feltconfident they could take over such firms andproduce greater profits and higher share prices. Ascorporate debt could be arranged with facility,leveraged takeovers and buyouts became the order ofthe day.
A good share of the American public saw the 1980sera of mergers and acquisitions as a game ofcorporate greed and intrigue but, as a precursor of theexpansion of the nineties, it should be seen12 as apreparatory period of industrial restructuring and as aprocess of forcing many inefficiently managed firms tomake their departure from the industrial scene. Theeffect was that the value of public equity in the UnitedStates more than doubled (from $1.4 to $3 trillion in adecade), the decline in productivity was reversed, realincome was increased over the period by about athird, and record levels were established for expendi-tures on research and development.
As a part of this process, major investments werebeing made that would prepare the economy for theexpansion that followed and provide a new techno-logical foundation for future growth. In the periodfrom 1970 to 1995, total private gross fixed invest-ment started out at below 15% of GDP. It increasedto 16.4% in 1974, to 18.8% in 1979, then stayedaround 17 or 18% until the mid-1980s. By 1989 it
was back down to 15.3 and by 1994 to 14.6% ofGDP. So these expenditures were substantial fromabout the mid-1970s into the 1990s.
, Strategic investments also undergird the boomdecade of the 1990s in the United States. Table 1reviews US private fixed investment and two of its keycomponents:- first, expenditures for informationprocessing equipment and software for selectedyears between 1960 and 1999; second, expendituresfor industrial equipment. In this period the share ofprivate investment dedicated to informationprocessing equipment and software began to growslowly with the initially tentative application of newtechnologies. Thereafter, it increased dramatically andmonotonically as a percentage of total investment.Approximately six and one-half percent of total privateinvestment expenditures in 1960 were for informationprocessing equipment and software. By 1999 theshare had increased to nearly twenty-six percent ofthe total. Private fixed investment overall was a risingshare of GDP throughout the period. The strength ofthese investments, particularly as they provided theinformation foundation of the New Economy, were thefoundation of the US economic expansion of the1990s. The boom was really based more, on invest-ments in computer equipment and software than ontraditional equipment, and the growing use of ITtechnologies began to produce new economicoutcomes.
Table 1US Private Investment in Information Processing
and Industrial Equipment, 1960-1999($ billions)1
Year
1960
1970
1975
1980
1982
1984
1986
1988
1990
1994
1998
1999
PFI(PrivateFixed
Investment)
75.7
.. 150.4
236.5
484.2
531.0
670.1
740.7
802.7
847.2
1034.6
1460.0
1577.4
IPE(InformationProcessingEquipment
and Software)
4.9
16.7
28.2
69.6
88.9
121.7
137.6
155.9
176.1
233.7
356.9
407.2
IPE/PFI(IPE as%ofPFI)
6.47
11.10
11.92
14.37
16.74
18.16
18.58
19.42
20.79
22.59
24.45
25.81
IE(Industrial
Equipment)
9.3
20.2
31.1
60.4
62.3
67.6
74.8
83.5
91.5
113.3
150.2
151.4
IE/PFI(IE as%ofPFI)
12.3
13.4
13.2
12.5
11.7
10.1
10.1
10.4
10.8
11.0
10.3
9.6
12Zoltan J. Acs and Daniel A. G e r l o w s k i : ManagerialEconomics and Organization, New Jersey 1996, Prentice-Hall.
1 Quarterly Data at Seasonally Adjusted Annual Rates.
S o u r c e s : Economic Report of the President, 2000, Table B-16, p.326; and own calculations.
INTERECONOMICS, July/August 2001 183
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The German Economic Realignment
Will the economic upswing already declared un-derway by the German economics establishment bemore than merely cyclical in character? Remsperger,Stierle and others are hopeful that it will shift thegrowth trend of the economy upwards.13 They areconvinced that is what happened in the United Statesin the 1990s and that with a willingness to pursue ap-propriate policy initiatives, that result will follow in theFederal Republic.
There are high hopes in most of Europe thateconomic integration, developing in Europe since theestablishment of the European Coal and SteelCommunity in 1950 and evolving through othersubsequent institutional variants, will continue to be adriving force in an increasingly unified economy. TheEuropean integration process creates and divertsinternational trade. Trade is created by expanding theinternal market of the community at the same time asit is being diverted from wonted patterns betweencommunity members and outsider nations. Thisrealigned trade generates net benefits in the form oflower prices for consumers and larger markets andenhanced trading possibilities for producers. Theconsumer benefits derived from trade expansion arelarger to the extent that community producers canoperate at price and quality levels close to those ofworld class producers, which is often the case inEurope. Additionally, expanding trade will promotestructural adjustments in industry and result in costsavings and greater competitiveness for producers asthey incur economies of scale and scope. Advocatesof integration tend to believe that the larger integrationbenefits stem from these dynamic effects, which havebeen at work for some time as European integrationhas progressed. Such effects are currently beingcomplemented by the monetary integration that willreduce transactions costs in integrated markets.
As industries take advantage of new competitivepossibilities, they will likely experience a sustainedincrease in industrial productivity. This is also part ofEurope's hope for a New Economy, but it cannot beexpected to develop without the technical amelio-ration of the information industries. If the "newness"of the New Economy is not merely some beneficialbut ephemeral aberration, it will prove susceptible totransplantation. Obviously, the characteristics of theUS economy of the 1990s and thereafter will besubject to replication in technical fields and in relevantindustries. They will be so in Europe and Asia at anearly date, especially in Germany, the economicleader of the European Union.
The Role of High Tech and the Internet
The internet and e-commerce have been ofundeniable importance in the so-called NewEconomy. Following as a logical extension of thecomputer's capabilities, the development of theinternet economy has been the most importantfeature of the boom of the 1990s.
At the beginning of this new century, the servicesector provides the largest number of jobs andgenerates nearly two-thirds of GDP in the UnitedStates. Knowledge-based industries such as finance,insurance, business, legal and other professionalservices have led the growth of the services sector.We shall briefly review analyses of the contributions ofthe high tech industries to economic growth in thefollowing.
The capital market provides evidence of the impactof information technology (IT) on the economy. In thefirst half of 1999, the venture capital industry raised$25 billion at an annual rate. Approximately two-thirdsof this total, over $16 billion, went to the IT sector,and of this roughly $12 billion went into Internetcompanies. In terms of market capitalization, the IThardware sector now accounts for about 14 percentof the US total; a decade ago it was only six percent.Today's software component of about 9 percent wasat a mere two percent in 1989. Of the total value of USstocks, those in the internet sector represent about4 percent.14
Role of the New Economy inUS Economic Growth
The dramatic diffusion of computer-based tech-nologies was possible in good measure because ofthe rapid decline in the prices of computer equip-ment. Jorgenson and Stiroh15 argue that this resultednot in economy-wide technical change (creatinggreater output from the same inputs), but in massivesubstitution of computers for labor and other; equip-ment in home and business sector use. Normally, intechnical productivity measurement the use of capitalequipment produces "spillovers", residual economicgrowth beyond that directly attributable to capitaland labor. Interestingly, the economic expansion of
13Cf. Hermann Remsperge r , op. cit.; and Michael. H. S t i e r l e :New Economy - Wunschtraum oder Realitat, in: Wirtschaftsdienst,Vol.80, No.9, Sept. 2000, pp. 549-556.14 Economic Report of the President, Washington 2000, pp.104-105.15 Dale W. J o r g e n s o n and Kevin J. S t i r o h : InformationTechnology and Growth, in: American Economic Review, Vol.89(1999), No.2, pp. 109-115.
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the 1990s did not produce an increase in total factorproductivity, or in output per unit of factor input.
Jorgenson and Stiroh show that from 1948-1973,output grew 3.4 percent per year, with capital andconsumers' durables producing 43 percent and laborproducing 32 percent of the total growth. Total factorproductivity accounted for. the remaining 25 percent.But output growth slowed sharply after 1973, andregistered another, smaller decline after 1990.
The rate of growth of output was 2.4 percent peryear from 1990 to 1996. Note that computerscontributed to growth in this period as a "service flow"to households as well as directly as an investmentgood. Since 1990, computers have been responsiblefor almost.a sixth of the annual 2.4 percent outputgrowth: they represented nearly 20 percent of thecapital input's contribution to growth and 14 percentof the services contribution of consumer durables.The bottom line of research by Jorgenson and Stirohis that computer-related gains are fundamentallychanging the economy, but not by producing growthspillover effects to the economy as a whole. Returnsto the economy's investments in IT equipment havebeen captured by computer. producers and usersthemselves as they substitute this equipment for otherinputs.
It does appear that the "New Economy" is respon-sible for an increase in system-wide productivity.From the middle of the seventies, productivity clearlyslowed down, prohibiting a growth of incomes. But itwas expected that the introduction of newtechnologies, especially in information processingand telecommunications, could reverse this trend.Advocates of the idea of a New Economy pointed tothe lag between the implementation' of newtechnologies and the appearance of productivityeffects. Heilemann16 et al. show that the quarterlyproductivity rates since about 1995 do in fact seem toindicate an upward shift in the trend. The time periodin question is a brief one, so it is difficult to be certainwhether the rather dramatic increases will in fact besustained. There have been periods of increasingproductivity in the past, especially in the last phasesof cyclical upturns, that did after a time prove to havebeen strictly temporary.
Characteristics of the New Economy
The separate question of whether there is more tothe New Economy than increasing productivity andrapid growth is also of great significance. The issue isthat the New Economy constrains the managers offirms to behave according to different principles. Let
us consider just three of the major changes that raisethe question whether there must be a new economicsto address the analytical riddles of the New Economy.
First, it is argued that the notion of profit maximiza-tion cannot be applied as is traditionally done.17 Theinformation economy incurs fixed costs of produc-tion, but having generated at the outset the informa-tion that can be used for various production and mar-keting purposes, the marginal costs of such informa-tion products, normally to be equated to marginalrevenues, are zero. Thus,'some would claim the rulesof neoclassical economics no longer hold, a proposi-tion hard to take seriously.18
Second, the classic question of whether the firmshould make or buy a product, component, or ser-vice, cannot be answered in the New Economy in thetraditional way. As a result of being incapable of ad-dressing these problems in the new ways now appro-priate, a number of major firms have encountered ex-treme difficulties. Finally, because it has become pos-sible in this electronic age to separate pureinformation characteristics from the information asso-ciated with production, it becomes possible to for-mulate decisions to use and/or to sell for both kindsof information, and business decision-making as-sumes new dimensions. But Shapiro and Varianforcefully defend the view that in spite of importantchanges in the economic system, analysis does notrequire "a brand new economics";19 current analyticaltools can address these new issues quite adequately.
Much of the "newness" of this economy, of course,arises from the growing share of world commercetransacted on-line. The magnitude of transactionscosts savings achieved through the new mediummight prove to be of revolutionary proportions and therapid growth of e-commerce has convinced many thatwe are seeing a New Economy. These developingphenomena will not prove different in Germany orother leading world economies as techniques are
16 Ullrich H e i l e m a n n , Roland D o h r n , Hans Dietrich vonL o e f f e l h o l z and Elke S c h a f e r - J a c k l e l : Der Wirtschafts-aufschwung der Vereinigten Staaten in den neunziger Jahren - Rolleund Beitrag makrodkonomischer Faktoren, Essen 2000, Rheinisch-Westfalisches Institut fur Wirtschaftsforschung, p. 36.17 See, for example, Peter K a l m b a c h : Eine neue Wirtschaft imneuen Jahrtausend?, in: Wirtschaftsdienst, Vol.80 (2000), No.4, pp.210-217.18 Never mind that zero marginal costs are not a problem in the non-competitive situation often expected to prevail in the new economy.One simply selects the point on the (downward sloping) demandcurve at the output where marginal revenues equate to zero.19Carl S h a p i r o and Hal R. V a r i a n : Information Rules: AStrategic Guide to the Network Economy, Boston (Mass.) 1999,Harvard Business School Press.
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ECONOMIC SYSTEMS
replicated and routinized. One sign that the economy-wide adjustments to this new economic era are beingmade is the growth of mergers and acquisitions inEurope. These phenomena permit scale economies tocapture the new cost-reducing aspects of infor-mation, and for this reason they have become evermore significant in Germany, Europe and Asia.
Expanding Exports and Ballooning Imports
Over the past few decades, the economy of theUnited States has become increasingly open.Measuring the economy's openness as the ratio of allexported and imported goods and services to theGDP, the United States had reached 29.3% in 1998,compared to Japan's 18.1%. Heilemann et al.20
indicate that even the openness ratio of the euro zone,if calculated exclusive of intra-European Union trade,would not be much higher.
These analysts also note that US trade with thedeveloping countries (40% of the total) is significantlylarger than Germany's (16%); while the share ofAmerican trade with the countries transitioning fromplan to market is only about one percent, Germany'sis about 10 percent.
The contribution of US exports to the growth ofGDP has increased in recent years, but has not beenas rapid as that of its famed imports. The appreciationof the dollar on foreign currency markets, the verymodest prices of petroleum imports before the rejuve-nation of OPEC in 1999, and more than robustconsumer demand have all contributed to the hugebalance of trade deficits long characteristic of UStrade.
As the US economy has become more tightlyintegrated with world markets, it has been increas-ingly apparent that trade is a prime driver of economicgrowth. Frankel and Romer21 show that the effect oftrade on income is quantitatively larger; it is moresignificant and robust than we have generallysuspected. Globalization and the increasingly openworld _economy played an important role in 1990sprosperity.
Jones22 attributes US economic growth since 1950to "increases in educational attainment, increases inresearch intensity, and the increased openness anddevelopment of the world economy." He concludesthat when these increases cease and a steady state isreached, growth per capita "can be expected to fall toa rate of approximately 1A its post-war average."
In more recent research, Frankel and Romer23 takea new approach to demonstrating the contribution of
trade to growth. Because the obvious existence ofcorrelation between trade and growth cannot proveanything about causation, they look to specificgeographic characteristics which have importantimpacts on trade and are plausibly uncorrelated withother income determinants. Measures of importantgeographic characteristics, viz., country size,distance from trading partners, whether they have acommon border, or whether they are landlocked,become determinants of overall trade and are used toestimate instrumental variables establishing the effectof trade on income. Their conclusion is that a "rise ofone percentage point in the ratio of trade to GDPincreases income per person by at least one-halfpercent".24 Income is enhanced by trade because thelatter promotes the accumulation of capital, bothphysical and human. Moreover, trade increases theoutput associated with a given capital stock. Fromtheir results they also infer that within-country tradeproduces higher incomes, since larger countries withmore substantial internal trade have higher incomes.Like international trade, within-country trade raisesincome at given levels of capital as well as throughcapital accumulation. Since their results fail todemonstrate that ordinary least-squares estimatesoverstate the positive effects of trade, they concludethat trade has a large and robust, though only moder-ately statistically significant, positive effect on income.The interpretation they suggest for their researchresults is that the case for the benefits of trade isstrengthened.
The Intangibles of Economic Growth
Much has been said about the role of the govern-ment in maintaining an appropriate economic envi-ronment and sustaining through judicious policy therobustness of the economy. MacAvoy25 looks back tothe Reagan era, emphasizing the importance ofderegulation and the reduction of government inter-vention in the marketplace. Heilemann et al.26 findthat "it is natural to see in the liberalization, the
20 Ullrich H e i l e m a n n , Roland D o h r n , Hans Dietrich vonL o e f f e l h o l z and Elke S c h a f e r - J a c k l e l , op.cit., p.38.21 Jeffrey A. F ranke l and David Romer : Trade and Growth: AnEmpirical Investigation, NBER Working Paper No. W5476, 1996.22 Charles I. J o n e s : The Upcoming Slowdown in U.S. EconomicGrowth, NBER Working Paper No. W6284, 1997.23 Jeffrey A. F ranke l and David Romer : Does Trade CauseGrowth?, in: American Economic Review, Vol.89 (1999), No.3, pp.379-399.24 Ibid., p.394.25 RW. MacAvoy (ed.): Deregulation and Privatization in the UnitedStates, Hume Papers on Public Policy 3, Edinburgh 1995, EdinburghUniversity Press.
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deregulation and privatization, and the institutionalchanges of the eighties important causes for theboom of the nineties." One should be cognizant ofthe efforts made during the Bush administration toovercome the fiscal insufficiencies of those and di-rectly prior years. Opinion polls would seem to sug-gest the inference that all of the growth impetus ofthe past eight years is exclusively due to the eco-nomic management of the White House.
In a sweeping study of new evidence on economicgrowth, Temple27 addresses the proximate causes ofeconomic growth, beginning with investments inphysical capital, human capital, R&D, and even "widerinfluences on growth." Under these latter rubrics, heexamines "government size" and "social and politicalfactors." Pertaining to size, one could argue that highlevels of social security transfers and governmentconsumption could impair an economy's growthperformance, but the studies reviewed by Temple didnot deliver any compelling evidence of this. Anegative link between growth and governmentconsumption has been tested, but as yet no corre-lation between the two "leaps out from the data".28
Theoretical papers have begun to test the relationbetween social institutions and incentives. Although itis impossible to measure such concepts as socialcapital or social capability, Temple sees progress inresearching these issues. Social and political influ-ences on growth might be measurable as latentvariables related to observable indicators. Someattempts are being made to measure these variablesas related to economic development in the advancedmarket economies. Temple argues that simpleanalytical techniques have a great deal of potentialand that recent theoretical work reinforces the casefor further study.29
Perhaps we will one day have more quantitativeunderstanding of the effects of such policies asderegulation. In the meantime, although many do notdoubt that governmental activities have an importantimpact on growth, it is certainly difficult to demon-
26 Ullrich H e i l e m a n n , Roland D o h r n , Hans Dietrich vonLoe f f e l ho l z and Elke S c h a f e r - J a c k l e l , op.cit., p.25.27Johnathon Temp le : The New Growth Evidence, in: Journal ofEconomic Literature, Vol.37, No.1, March 1999, pp. 112-156.28 Ibid., p.145. According to Temple: "Perhaps the only promisingmacro approach is that of Hall and Jones (1997), who find that highgovernment consumption lowers the level of income, and also pointout that in their framework, endogeneity is likely to mean that theeffect is understated." Cf. Robert E. Hal l and C. I. J o n e s :Fundamental Determinants of Output per Worker across Countries,Stanford University, manuscript 1997.29 Ibid., p.148.
strate or quantify it. We will for a time be left toexercise non-empirical judgment in attempting toevaluate these factors.
The Stock Market, the Wealth Effect,and the Boom
The boom of the nineties, according to Heilemannet al.,30 was driven by private consumption, which inturn experienced a fillip in the form of continual,relatively strong population growth. The growthcontribution of private consumption expendituresrepresented more than two percentage points (or twothirds) of GDP growth. Changes in the age structure ofthe population produced direct economic effects ofconsiderable magnitude. The number of school-agechildren, for example, increased again in the 1990s,which produced in that decade an additional 1.5million jobs in the public schools and another 600,000in private schools. In the past two major boomperiods in the United States, a one percent increase inpopulation has produced a growth rate increase ofthree percent per year.
The popular media have reported that the "wealtheffect," stemming from the continuing, dramatic in-crease in share prices, encouraged heavy consump-tion expenditures. So heavy were these expenditures,that private savings remained very small, even be-coming negative as the nineties came to an end. Thecommon wisdom was that people no longer felt theneed to save, since their stock market earnings wereincreasing so dramatically. Even where consumerswere without significant shareholdings, many wereenrolled in private retirement programs and could ob-serve their potential retirement income increasingsubstantially. One would certainly expect such gainsto encourage current consumption.
In the decade beginning in 1990, US householdssaw their real net worth increase by nearly $15 trillion,or by more than 50 percent. Of total wealth creation inthat decade, more than 60 percent was produced byrising stock values.31 One might be suspicious thatthis wealth effect was not the sole force drivingconsumption in the 1990s because stock holdings arehighly concentrated and could not directly affectdecisions for all consumers. About half of corporatestocks are held by the top 1 percent of equity holders,whereas only 4.1 percent are held by the bottom
30 Ullrich H e i l e m a n n , Roland D o h r n , Hans Dietrich vonL o e f f e l h o l z and Elke S c h a f e r - J a c k l e l , op.cit.31 James M. P o t e r b a : Stock Market Wealth and Consumption, in:Journal of Economic Perspectives, Vol.14, No.2, Spring 2000, pp. 99-118, herep.99.
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80 percent of households.32 The consumption thatdrove the boom was not merely that of the smallminority who held significant amounts of shares.
Poterba's review of empirical studies on thisquestion suggests a consensus finding that stockmarket gains affect consumer spending by a value ofabout 0.03. This is significant, since even ifconsumers had spent not three cents, but just 1 centof each additional dollar of stock market gains from1989 to 1999, the decade's total consumer expendi-tures would still have been $96 billion (approximately1.5 percent) higher. In reviewing the consumptionexpenditures of the upper income brackets, Poterbashows that luxury goods were in heavy demand.
Lower income groups consumed heavily as well,made confident not only by gains in share values, butby strong general growth as well, although he admitsthat "there is little empirical evidence at this stage toqualify such an affect".33 Heilemann et al. are not veryimpressed with this wealth effect argument, attribut-ing the consumption boom instead to the period's fa-vorable interest rates, which motivated spending fordurable goods.
As the market became ever more favorable toshareholders, potential capital gains grew. Nationalincome accounting does not calculate capital gains aspart of personal income, but if it did, savings would bethe residual after deducting consumption from,income plus capital gains. As capital gains grow,effective savings grow as well. If these capital gainsare not considered part of income, savings are verylow or even negative. Heilemann et al. would remindus that capital gains are not really experienced untilthe shares that produce them are actually sold andthe cash is in hand. To the extent that they spent morefreely, Americans enjoying large potential capital gainsin this period were behaving as if they were counting"illusory" gains as,income.
When "Black Friday," April 17th, 2000, introducedan extended process of market adjustment, shares onthe Dow had not been nearly as inflated in terms ofprice/earnings ratios as on the NASDAQ where shareprices were clearly overvalued and underwent adistinct market correction. The big concern at thattime was whether the economy could yet enjoy a "softlanding" after having soared through the nineties. Ifshareholders were to perceive their capital gains asthreatened and were to reconsider their consumption
activity on that basis, reduced consumer spendingcould end the boom quickly.
Are Business Cycles History?
In the recent past, an impression that the businesscycle is largely a thing of the past seems to have beengaining currency. Some see fortuitous changes in theeconomic environment as tending to make the USeconomy recession-proof. Zarnowitz34 presents andevaluates some of the arguments that certain of thefactors which promote productivity growth in theeconomy also tend to promote greater economicstability. He presents seven arguments for the claimthat cycles are obsolete, most of which would applyto Germany as well as to the United States.Unfortunately, according to Zarnowitz, all of thesearguments "leave ample room for counterarguments".35
• Downsizing and rationalization are asserted tohave enhanced the general stability of the economy.But through cost-cutting and more effective produc-tion, effective downsizing leads to growth and, ulti-mately, to subsequent opportunities for "upsizing."Inflationary pressure and other cyclical problems mayalso return with the recovery, for as the economy be-comes expansive again, upward wage adjustmentsand associated inflationary pressure will usually fol-low.
• Breakthroughs in information technologies are alsothought to stabilize the economy as they induceincreased investments and business profits. But theseproductivity-enhancing effects have yet to bedocumented quantitatively, and any specific linkbetween information technologies and the stability ofeconomic growth remains unclear.
• It is supposed that improved inventory control,especially through just-in-time managementtechniques, has helped to stabilize the economy. ButZarnowitz finds that constant dollar inventory invest-ments in the 1990s remained about as "volatile and ascyclical" as in the past.
• The growth of the service economy adds stability,since the more volatile manufacturing andconstruction sectors have declined in significance.This is probably true,; but with growing internationalcompetition in services, they are also becoming morecyclical.36
• Deregulation of financial and other industries is
' Ibid., p.101.
'Ibid., p.116.
34 Victor Z a r n o w i t z : Theory and History Behind Business Cycles:Are the 1990s the Onset of a Golden Age?, in: Journal of EconomicPerspectives, Vol.13 (1999), pp. 69-90.35 Ibid., p.70.
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believed to have added stability. More competition inairlines, trucking, banking, etc., has enhancedproductivity growth, but it is unlikely that furtherderegulation will promote further stability.
• Discretionary macro policies could also be thesource of greater cyclical stability. Macro-economiccontrol through interest-rate adjustments has beenquite effective in recent years as compared to theearlier effort to manage money growth. But policyagents cannot always anticipate and avert businessrecessions or financial crises, and policies can still be"wrong, mistimed, or bungled".37 .
• The most sweeping argument is that the wholeprocess of globalization has reduced instability. Theopening of new foreign markets reduces our depen-dence on domestic demand as the primary factor inmaintaining prosperity. Large-scale importation ofresources and products reduces inflationary pressurefrom domestic markets in periods of rapid expansion.Globalized capital markets are broader and moreliquid, reducing the risk of market bubbles andcrashes. But at the same time, we have also seenadded stock market volatility and vulnerability of thegeneral economy to financial and foreign currencymarket instability like that experienced in the Asiancrisis.
The extension of national into world markets maylend greater impetus to economic recovery andgrowth, but that does not guarantee that instabilitiescan be kept out of the brave new, worldwide system.
Weaknesses and Potential Problems
The United Nations38 assumes that the UnitedStates economy will slow down in the near future. Forthem, the only issue is whether good policy and fortu-itous environmental factors will make the landing asoft one. Because the labor market has become verytight, because of the "high valuation of the stockmarket," it is impossible that the recent growth ofconsumption could be indefinitely sustained. 1999witnessed some decline in the economy's utilizationof capacity and growing pressure on profit margins,so it is expected that some sectors may already beseeing a slowdown in investment.
36 Fosler and Stiroh found that whereas the growth of services hadmerely slowed down in earlier downturns, in the 1981-82 and 1990-91 recessions, services in the business and consumer sectorsactually declined. C'f. G. Fos ler and K.J. S t i r o h : A SectoralPerspective on Economic Stability, in: Business Economics, Vol.33,No.4, October1998, pp. 46-52.37Victor Z a r n o w i t z , op.cit., p.71.38 United Nations, op.cit.
The US stock market and financial markets aredeeper and more liquid than those in other countries,so that in the past few years, after the onset of theAsian Crisis, a large pool of capital began to flow fromthe emerging markets to the United States. A boom inequity prices occurred as capital flowed in". Thisfurther stimulated the domestic economy via theincreased consumer demand it helped produce.Lower interest rates meant that consumption needn'tbe crowded out by the boom in the markets for capitalequipment and high tech products.
The so-called wealth effects discussed above havebeen enhanced by boom conditions in real estatemarkets. The latter, as usual, accompanied the stockmarket boom, increasing the sense of wealth throughincreased home values. But the consumption frenzyof recent years has extended well beyond thoseAmericans with growing portfolios. Even where therehas been no participation in stock market capitalgains, the consumption of US households were thedriving force of the boom. The level of consumer debtargues that the nation has been on a consumptionbinge which extended the expansion.
The consumption binge also explains the huge netimport situation in the US balance of payments. Theworldwide perception of US economic strength haskept the dollar strong in foreign exchange markets,giving American consumers very favorable terms oftrade. Other countries have also benefitted from thestrong dollar, since the US economy has provided therest of the world with a robust export market. At thesame time, through the greater part of the expansionperiod the US economy enjoyed very favorable inter-national commodity prices, especially those ofpetroleum products, until the resurgence of OPEC in1999.
Unfortunately, the question about the expansion isnot whether, but only for how long it can be sustained.Increasing energy prices can be expected to spill overand drive up the prices of numerous other products ofwhich energy is an important component. Fortunately,higher energy prices alone could not undo such astrong expansion; unfortunately, higher energy pricesare not the only factor currently working against theboom's extension.
Increasing tightness in labor markets promptedinterest rate increases by the Fed after mid-1999. In atight labor market, the likelihood of significant wageincreases impacting price indices was much moreapparent. Higher interest rates discourage theconsumption of durable goods and put a damper on
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aggregate demand. All of this threatens at a timewhen we have been watching a sluggish or stumblingstock market through much of the year 2000.
Through 2000 we observed that the weak Euro ismerely the mirror image of the dollar's strength, in turna reflection of the global perception of US economicstrength. When the consumption binge ends and theeconomy slows, it will become apparent that thedollar can change places with the Euro quite quickly.When that change occurs, dramatically increasedimport prices will further constrict consumption andraise the prices of imported commodities and manyothers whose production requires imported parts andmaterials. This too will prove ballast for an economywith clipped wings.
All of, this is merely to suggest that the expectedslowdown could be something other than a soft land-ing.39 With good fortune, long-term economic adjust-mentSrWill be made gently and gradually, so that anupward flight might be resumed before too long. Letus hope that is the case, since not only the prosperityof the US is involved; a hard landing could spreadhardship through all the global trade and financialnetworks.
Whither the New Economy?
The use of the expression "New Economy"throughout this paper demonstrates the author's viewthat, when limited to a few, glamorous high-techsectors, the term is misused. We have in fact only oneeconomy. If the new sectors^ of the economy do notinteract with and change economic processes in theold sectors, creating a whole new economic structure,we should not talk of a New Economy. Since a seriesof Kondratieff-type changes have in fact spread theirinfluence through the entire economic organism, theterm should be applied to the whole economy.
It should come as good news that even if the NewEconomy is not recession-proof, its effects will notevaporate in a slowdown. As we watch the diminutionof near-term prospects and await the arrival of somepainful adjustments, we may be assured that theinternet economy and its companion, the relentlessprocess of globalization, are here to stay. They will
39 Paul K rugman expresses the dangers inherent in today's condi-tions cleverly: It is tantalizing to speculate about the tone of publicdiscourse in five or ten years if those who assert that America is nowa "bubble economy" like that of Japan a decade ago turn out to beright. It is very easy to imagine how, in retrospect, many economicsins that are now widely regarded as trivial - negative personalsavings, a large trade deficit, the role of highly leveraged investors inour financial markets - could be reinterpreted as the American equiv-alent of "crony capitalism," fatal flaws that ensured the subsequentpunishment. Op.cit., p. 174.
serve as the basis of a recovery, of an expansion, andof future well-being.
The benefits of the service and internet economywill continue to spread, affecting our partners andcompetitors on the global scene. Global trade andfinance will be important agents in the enhancementof prosperity. At the same time, the prestige theUnited States has enjoyed early in this bold new erawill inevitably have to be shared. Germany and Europewill continue to become more closely integrated in thenew economic structures.
Stierle40 admits that Europe lags behind the USA interms of the consistency and high level of the growthprocess, i.e. the macro performance of the economy.Moreover, the share of new technologies in the ag-gregate capital stock, the ratio of IT and high-techproducts to the gross domestic product is substan-tially lower in the leading European countries than inthe United States., and the contribution of these newsectors to national growth is also smaller east of theAtlantic. Per capita expenditures for information andcommunications technologies in 1999 were only a lit-tle over half as much in Europe as in the USA, andthe number of internet users per 100 citizens wasnearly three times higher in the United States. Stierleassures us, correctly, that this gap will be greatly re-duced in the next few years, just as the gap, for ex-ample, in the use of mobile telephones narrowed,
-then disappeared. Stierle is certainly not the only Eu-ropean who would tell us41 that the growth of the in-ternal European market, its continuing liberalizationand deregulation, the introduction of the euro, andcontinually increasing competitiveness, will all en-hance European dynamism. This is all symbolicallymanifest in the European Commission's strategic ini-tiative "eEurope 2002" to make the use of the inter-net a more integral part of education programs andto promote e-commerce among member countries.
A parallel development will be the full adoption ofthe euro; its establishment may prove more compe-tition for the dollar than Americans would wish. If theEuropeans continue on the path of economic recoveryand expansion and the US continues, hopefully, withits soft landing, the euro could replace the dollar asthe engine of growth in the world economy. But forboth the Europeans and the United States, the adjust-ments required by the next few years of the global-ization process will prove demanding. Progress isalways demanding.
40 Michael H. S t i e r l e , op.cit.41 Ibid., p.557.
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