[well, some of us said so at the time... Mark]
Editorial comment: New economy myths
Published: January 12 2001 20:16GMT | Last Updated: January 12 2001 20:28GMT
What is the hype that once we heard? What is it now? Simply absurd. With the
GoldmanSachs internet stock index down by three-quarters from its peak and the
record-breaking US economic expansion in grave peril, the words "new economy" will
give investors nightmares. Many will conclude that the idea was oversold - and is
now over. That it was oversold is true. That it is altogether over is not.
The "new economy" or "new economic paradigm" contained a number of distinct strands.
What united them was the view that they had come together in the US economy of the
second half of the 1990s. To distinguish what may still be true from what we know to
be false, that skein of ideas must be unravelled.
On analysis, four narrower notions emerged: that the business cycle was dead; that
capital markets now worked in unprecedented ways; that we were living in an era of
unique technical progress; and, finally, that information technology had
fundamentally altered the way the economy works.
The business cycle is decidedly alive. That should not surprise anybody. Yet the
view that business cycles were dead rested on several correct presumptions about the
US economy: labour markets had become more competitive; global competition had
reduced the pricing power of both trade unions and big business; the need for
inventories had diminished; and monetary policy was far more credibly oriented
towards price stability than in the inflationary 1960s and 1970s.
What this analysis forgot, however, is that cycles can occur - and frequently have
occurred - in flexible economies with credible monetary anchors. All that is needed
is a big investment expansion fuelled by expanding credit and a strong stock market.
Indeed, the firmer the belief that the business cycle is dead, the greater the
confidence and the likelihood of business cycles.
Bubble analysis
The capital markets have certainly hummed to a different tune in the 1990s. But
internet mania looks like an only slightly less irrational version of the South Sea
Bubble. Some rationalisations for the prices of stocks were as ludicrous as the
prices themselves. Nor was bubble analysis restricted to the dotcoms. Just look at
telecommunications.
Yet behind this ludicrous hype, important changes did take place. In particular, the
rise of venture capital has made it far easier for entrepreneurs to create valuable
new companies. While capital markets are as prone as ever to excessive swings
between optimism and pessimism, they do also seem better able to support and promote
innovation.
The notion that information technology represents the greatest transformation since
the industrial revolution is historically illiterate. The technological changes
between 1880 and 1940 exceeded, in both scope and intensity, all that has happened
since.
Technological revolution
Those changes included new sources of energy (electricity and petroleum), new
industries (motor vehicles and pharmaceuticals) and new products (cars, washing
machines, telephones, radio, television, penicillin). These profoundly altered what
was produced and how. They also transformed the way people lived. Against all that,
what are the personal computer and even the internet?
True, it does seem likely - although not yet certain - that the very low growth of
productivity of the 1973-95 period has come to an end. But it is necessary, once
again, to beware the exaggeration. Remember that economic growth between successive
cyclical peaks was 3.3 per cent a year in the 1980s, against about 3.1 per cent in
the 1990s.
Finally, even if information technology is not more important than all the
innovations that went before it, as some believe, the rise of the "weightless
economy" does have revolutionary implications. It makes information and knowledge
the most important economic commodity.
But information, as economists have long known and many businesses are finding out
for themselves, is a peculiar commodity. If the marginal cost of providing an
additional customer with a commodity is zero, standard models of a competitive
economy start to break down. This change creates huge challenges for traditional
business models, for the organisation of companies and for public policy in relation
to intellectual property and competition.
What then is left of the new economy? The tales of unprecedented stability,
unmatched technical progress and ever soaring stock markets were fairy stories. But
all is not hype. The inflationary postwar era seems over, as does the stagnant
productivity of the 1970s and 1980s and the easy domination by established
companies. The information economy is real, if neither as revolutionary nor as
profitable as some hoped. The economy is not new, but it is not simply old, either.
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