The "New" New Economy
Towards the end of the 1990s, economists came to believe that the United States economy had changed significantly, thanks to the growing use of computers and the rise of the Internet. Dubbed “The New Economy,” it was supposed to boost employees’ living standards while at the same time increasing employers’ profits, thanks to the resulting rise in productivity. New lines of business rapidly developed, limited only by budding entrepreneurs’ imagination and the willingness of investors to back them with venture capital. The stock market soared in anticipation of these newfound opportunities and their potential for creating wealth and economic well-being.
What a difference a decade makes! While the Internet is, indeed, very much a part of our business and personal lives, and productivity gains for the most part remain extant, there is a feeling out there, perhaps exemplified by the bursting of the stock market bubble more than four years ago and the market’s concomitant failure to surpass its previous peaks, that many of these promises will not be fulfilled. In the words of that venerable song by the late Peggy Lee, people are asking, “Is that all there is?”
It would appear that the New Economy has been replaced by the “New” New Economy. Something new is again transforming the U.S. economy. In this case, it’s where good news in one sector – say for employers – is becoming bad news for another – for example, their employees. This is not meant to imply that we are returning to what some economists years ago described as “class warfare.” But it does suggest that our government can no longer rely on the marketplace alone to generate and maintain prosperity – even if it happens to stumble on a mix of monetary and fiscal policies that manage to moderate a recession and/or to contain inflation.
The past four quarters are a case in point. As you can see from Chart 1, after logging in a rather impressive growth rate of 7-1/2 percent in the third quarter of 2003, the economy has slowed progressively since. Especially significant is the fact that in each of the past four quarters, according to estimates prepared by the Commerce Department, actual sales to final consumers grew by less than the overall gross domestic product. This means that business was producing more than it was selling, since the difference between final sales and the top-line GDP represents inventory accumulation.
Ordinarily, such a development would not be particularly worrisome, considering that the economy is less than three years away from the end of a recession, and that many firms might find it prudent to build inventories in anticipation of rising consumer demand. The use of computers and the Internet referred to above has probably made most companies confident that they can add to stockpiles without overdoing it. However, the sharp slowdown in the overall pace of economic activity in the second quarter – especially the weakness demonstrated in the month of June – suggests that something else is happening that is more than ephemeral.
To prove the point, the third quarter got off to an even less auspicious start with payroll employment rising by the smallest amount in almost a year. This is clearly visible in Chart 2, which also shows that fewer than half of the 278 industries surveyed by the Labor Department added people to their payrolls – the smallest share since the end of last year and something that rarely happens to an economy that is supposedly in the third year of an economic expansion. This comes on top of an extremely weak pace of job creation throughout this upswing (Economic Report – March/April 2004).
Not surprisingly, the average worker’s pay has failed to keep pace with inflation. In the 12 months through July 2004, weekly pay for rank-and-file workers, who make up some 80 percent of the workforce, rose by almost a percentage point less than did consumer prices over the same period, meaning that most employees’ buying power has declined – a rather unusual development for this point in an economic expansion. This would seem to call into question expectations for enough of a rise in consumer demand to justify continued inventory building.
Part of the reason for this weakness in the demand for workers stems from the ongoing gains in productivity referred to earlier. Because of significant changes in technology combined with huge investments made by business during the 1990s as part of the New Economy, many firms are still finding that they can do more with the same or fewer employees. Where a warm body is needed, companies are turning to “outsourcing,” or hiring workers based in other countries. These workers are being used to handle tasks where face-to-face, or hands-on, contact is unnecessary. Call centers, software writing, radiology, computer-aided design for autos and buildings, as well as number-crunching for security analysis and accounting are just some of the positions that have been outsourced so far.
Besides the paucity of job creation, which has obviously restrained the growth in personal incomes, consumers’ buying power has also taken a hit from a pickup in the rate of inflation (see the previous issue of this Economic Report). While a lot of the initial surge in inflation might have been due to the jump in energy prices, as can be seen in Chart 3, energy use is so ubiquitous, its higher price has spread to other sectors, such as food, clothing, and health care. Meanwhile, the rise in long-term interest rates has reduced the ability of many households to refinance their mortgages, which in the past has enabled them to supplement the lack of growth in buying power from such mainstays as wages and salaries (Chart 4). This year’s decline in the stock market has also depressed incomes for the 50 percent or more of the population that invests.
What we appear to have here is a “New” New Economy, one that has become increasingly fragile. Any unexpected development, whether it’s a jump in energy prices, a new terrorist threat, a downdraft in stock prices, an increase in interest rates – even uncertainty over the forthcoming elections – can send consumers reeling and business sales slowing. Since consumers make up the lion’s share of domestic economic activity, such a slowing in buying is quickly followed by reductions in new hiring by business – not to mention stepped-up layoffs, which, in turn, prompt less spending, and so it goes.
For their part, business people, to twist the words of another old song, are accentuating the negative and eliminating the positive. Uncertainty is a way of life for business – the only certainty is taxes and competition – but many executives today seem to be more dour than usual. Business people can recite chapter and verse about all the uncertainties they face nowadays: the economy, Federal Reserve policy, long-term interest rates, energy costs, taxes, the stock market, the elections, compliance with the provisions of Sarbanes-Oxley, and, of course, terrorism.
The impact of higher energy prices on people’s buying power, and thus on overall economic growth is particularly disturbing. We pride ourselves on being much more energy efficient than we used to be. Indeed, according to estimates prepared by the Energy Dept. we use only about half as many BTUs today to produce a dollar of real GDP than we did 30 years ago. This should have minimized the impact of the recent rise in energy prices – especially considering that, in real terms, when compared with prices of everything else in the consumer’s market basket, energy costs are still well below their peaks of the early 1980s.
But the lack of growth in personal incomes – a byproduct of the unusually slow pace of job creation during the current economic expansion, along with the fact that many higher-paying jobs have been replaced by lower-paying positions – plus the fact that large numbers of people have been out of work for so long, they have simply stopped looking – have made people more susceptible to a jump in energy prices than they might have in the past.
To ameliorate the negative effects of the “New” New Economy, Washington might want to consider a number of options. Some of these suggestions might be anathema to those economists who have grown accustomed to dealing with economic policies that have eschewed what used to be called “fine tuning,” while others might concern those business people who would resent Washington telling them how to run their companies.
To those in the first camp, I would say that fine tuning never went away, witness how the Fed has been conducting its monetary policy of late by publicly agonizing over such details as how much and when to change its overnight lending rate. To those in the second group, I would point out that through its tax policies and regulations (most recently Sarbanes-Oxley), Washington has been a part of business’ lives for over a century, so why should some additional tinkering with tax policy be problematic?
My suggestions focus on tax incentives and deterrents to achieve more favorable outcomes than at present. Keep in mind that the use of such incentives and deterrents has long been embedded in our tax laws – probably going back some 90 years, when the federal income tax was first enacted. In my view, Washington should provide tax incentives for companies that create new jobs here at home, and tax deterrents for those that outsource. The government can use the same mechanism to rein in health care costs and to make us less dependent on energy – especially energy that originates from unstable areas of the globe. Entrepreneurs, people who take more risks than usual, should be given special tax treatment. And the Fed might just want to err on the side of more, rather than less, inflation – at least for a while longer.
Say what you want about rising prices – they do spur spending. And when push comes to shove, this is what the “New” New Economy needs most right now.
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Dr. Irwin Kellner is the Weller Professor of Economics at Hofstra University and Chief Economist at North Fork Bank and CBS MarketWatch.