The new economy may already be history
By Dean Baker
Published: June 1 2003 19:04
The core of the "new economy" has always been the sharp increase in productivity growth that began in the second half of 1995. Proponents of the new economy, led by Alan Greenspan, chairman of the Federal Reserve, have focused on this upturn in productivity growth as its defining feature. The US had a boom of investment, concentrated in information technology, which unleashed a surge in productivity growth unmatched since the 1960s.
It is therefore striking that new data, suggesting that productivity is no longer growing rapidly, have received little attention. The most recent data from the US Department of Commerce indicate that over the past year, productivity growth has fallen back to the rate of the productivity slowdown of 1973-95. If productivity continues to grow at this pace, the new economy will prove to be just a blip in a longer period of slow growth.
Mr Greenspan and other proponents of the new economy are justified in focusing on productivity growth because it is the most important factor determining living standards over the long run. If the economy could sustain a rate of productivity growth of 2.5 per cent annually - the general consensus for the new economy - living standards can double in little more than a quarter of a century. If productivity grows at the 1.5 per cent rate of the slowdown era, living standards would improve by less than 50 per cent.
While part of the explanation for the neglect of the productivity data may stem from a desire to ignore bad news, a bigger factor is that the main issue is technical in nature. In the past decade, an increasing share of the economy's output has gone to depreciation - the replacement of worn-out or obsolete equipment - as short-lived equipment (for example, computers and software) has accounted for a growing share of investment. In the past year, the share of output going for depreciation has increased by 0.8 percentage points of gross domestic product. While necessary to sustain the economy, the resources that are used to replace depreciated plant and equipment do not directly improve living standards.
If we use a net measure of output - which excludes depreciation - the increase in productivity over the past year would be approximately 1.5 per cent, just 0.2 to 0.3 percentage points above the rate of net productivity growth in the years before the arrival of the new economy. By contrast, the productivity numbers, which report gross productivity growth, showed 2.3 per cent for the last year, only slightly lower than the 2.5 per cent new economy average. But the gross productivity data conceal the fact that the share of output going to depreciation was increasing at a 0.3 percentage point annual rate in 1995. It is currently increasing at almost 0.8 per cent a year.
In short, when the recent numbers on productivity growth are adjusted for depreciation, most of the new economy upturn disappears. It remains to be seen whether the share of output going to depreciation will continue to increase at the same rate but the gross measure of productivity growth may fall as well.
Even before the latest productivity numbers, the new economy had already largely gone out of fashion. The days of ever-rising stock prices seem a distant memory. Plunging retirement plans have sent millions of older workers scurrying for part-time jobs at a point in their lives where they expected to be relaxing on the beach. The stories of oversubscribed dotcom initial public offerings have been replaced by stories of accounting fraud, as tumbling stock prices put an end to the investment boom.
The loss of more than 2m jobs in the past two years has pushed the US unemployment rate up from 4 per cent in 2000 to 6 per cent today. As the labour market has weakened, workers who still have jobs have become far less secure. One result is that the healthy growth in real wages during the boom of the late 1990s has largely evaporated. Real wages are stagnating for most workers; increases are barely keeping pace with inflation and the gap in wages between high-end and low-end workers seems to be growing again.
Even so, the upturn in productivity growth had appeared to persist into the recession and the subsequent period of slow growth. The new data indicate that this last pillar of the new economy may be collapsing. Yet the latest productivity numbers were barely mentioned in most reporting on the economy.
It is important to note that productivity numbers are highly erratic and are often revised substantially. This means that years from now, when we have more complete data, the productivity picture for this past year may appear very different from what current data show.
But, in the meantime, these data are all we have to go on. They show that the slower growth in productivity has now lasted for a full year, rather than just a single quarter. With four quarters of slow productivity growth behind us, economists such as Mr Greenspan should be asking if the new economy is history. If it is, America's economic slowdown may prove to be more persistent than many had hoped.
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