Global: The End of the New Economy Stephen Roach (New York) Morgan Stanley
It now seems as if history will judge the latter half of the 1990s to have been an aberration. It wasn't supposed to have been that way, of course. America's boom was widely presumed to have ushered in a period of unbridled prosperity that the rest of the world became increasingly desperate to emulate. Built on a foundation of IT-led productivity enhancement, the New Economy was widely thought to have broken all of the old macro rules. Sustained vigorous growth -- without inflation and business cycles -- became the new norm. A powerful e-based connectivity was presumed to have created new synergies between businesses, workers, and consumers. Corporate earnings power was judged to be virtually unlimited, especially for those enterprises that embraced the scale and scope that only new e-based platforms could deliver. The New Economy was all that and more. The New Economy had its champions from all walks of American life. It wasn't just the entrepreneurs of Silicon Valley, or the venture capitalists and Wall Street underwriters who did their bidding. Nor was it the legions of investors who reaped the bounty of once unfathomable wealth as the Nasdaq surged toward 5000. The New Economy also found its supporters in serious academic circles. And, of course it had the imprimatur of America's most powerful policy maker -- Federal Reserve Chairman Alan Greenspan. No public official anywhere in the world championed the cause of the New Economy more so than Alan Greenspan. During the latter half of the 1990s, the Fed's unbridled enthusiasm was translated into action -- a willingness to push the envelope on its traditional anti-inflation resolve and tolerate a much faster growth rate in the real economy. The New Economy brought Washington, Wall Street, and Main Street together as never before. It was the dawn of what promised to be a glorious future. That future now appears to be in tatters. Its demise began with the excesses of the Nasdaq -- a classic asset bubble that ended up infecting the real economy. Businesses went to excess in both IT spending and white-collar hiring, believing that capital markets would reward those who moved most aggressively to embrace the precepts of the New Economy. Consumers made a similar mistake, concluding that the Nasdaq represented a new and permanent source of saving. Traditional wage-based saving rates were taken to their lowest levels in 70 years. But then the bubble popped -- as they always do. And the real-economy excesses had to be unwound. Suddenly, the IT and managerial talent of the late 1990s -- dubbed by the gurus as the "intangibles" that could generate open-ended earnings power and wealth -- became the excesses of bloated corporate cost structures. And the free-spending lifestyles of the American consumer were drawn into question, especially by an aging generation of saving-short baby boomers. As the US economy screeched to a virtual standstill in the first half of 2001, the New Economy was gasping for air. September 11 was the final blow, in my opinion. It shattered the na�vet� and innocence that encouraged Americans to buy into the hype of the New Economy. It was a transforming event that struck at the heart of many of the new pillars of the macro landscape -- especially business operating costs, IT connectivity, globalization, and personal security. Post-September 11, the cost of doing business has gone up in America. The cost of shipping, insurance, inventory carry, perimeter office security, and now mailroom security has risen as a result -- and probably by a significant margin. At the same time, the recent outbreak of the lethal Nimbda compute virus has heightened concerns over cyber-terrorism; the necessary upgrade of e-based network security is hardly a trivial cost. The increasingly frictionless world of globalization has also been dealt a blow; this reflects the functional equivalent of a new tax on cross border connectivity -- increased expenses for border security, shipping, insurance, and a higher risk premia reflecting fears of another attack. As a result, there is now "sand in the gears" of globalization that has the potential to constrain the growth of trade flows, capital flows, and globalized supply chains. Moreover, I am sympathetic to the notion that perceptions of personal security have been fundamentally altered by only the second attack on American soil since the War of 1812. Like it or not, there is now good reason to believe that many of the most critical building blocks of the New Economy have been drawn into serious question. Under these new circumstances, it will be exceedingly difficult to recreate the magic. Nor have these changing circumstances escaped the ever-observant eye of Alan Greenspan. In congressional testimony on 17 October, he conceded the point on higher business operating expenses in the aftermath of 11 September. But since he argued that any retrofit would be a one-off increment to business costs, he is suggesting that the underlying productivity trend should remain basically intact, once an upgrade is complete. Never mind the distinct possibility that any such retrofit could take years to complete. This sounds to me like someone who is looking for an exit strategy from his infatuation with the New Economy. At the same time, the Washington DC-based McKinsey Global Institute has just completed a massive study on productivity, which breaks the macro numbers down into a fairly detailed industry-by-industry basis. These findings provide yet another key reason to challenge the presumed link between IT and productivity. Like the findings of Northwestern professor Robert Gordon, the McKinsey analysis suggests that the incidence of productivity paybacks from massive investments in IT has been mainly confined to technology producers and just a few other industries -- namely retail trade and the securities business. By their reckoning, the IT payback -- long thought to be the backbone of the New Economy -- was evident in only 31% of the private nonfarm economy. The results of the McKinsey study are also consistent with the productivity critique that I have long been associated with -- that efficiency gains of white-collar knowledge workers have been confused with an unmeasured IT-induced lengthening of work schedules. In the end, sustained white-collar productivity enhancement is less about breakthrough technologies and more about newfound efficiencies in the cerebral production function of the high-value-added knowledge worker. Evidence of a narrow IT payback suggests that a large portion of America's white-collar economy has been left out of the so-called revolution of the New Economy. All this is not to turn the clock back and argue for the imminent demise of the New Economy. Instead, a new note of realism has been injected into the debate. It's not about the innovative and dramatic technological breakthroughs of the Information Age. It's about applications and macro impacts -- and whether there has truly been a revolution in the means by which aggregate, economy-wide production and income generation is achieved. With the benefit of hindsight, it was all too easy during the latter half the 1990s. The Nasdaq bubble made it even easier. But those days of innocence are now over. The bubble popped and the world tilted on 11 September. And now it's time to see what the New Economy is really made of. I suspect that the heavy lifting has only just begun.
