The New Economy Essay

This essay has a total of 2481 words and 14 pages.

The New Economy


THE NEW ECONOMY
It works in America. Will it go global?

It seems almost too good to be true. With the information technology sector leading the
way, the U.S. has enjoyed almost 4% growth since 1994. Unemployment has fallen from 6% to
about 4%, and inflation just keeps getting lower and lower. Leaving out food and energy,
consumer inflation in 1999 was only 1.9%, the smallest increase in 34 years.


This spectacular boom was not built on smoke and mirrors. Rather, it reflects a
willingness to undertake massive risky investments in innovative information technology,
combined with a decade of retooling U.S. financial markets, governments, and
corporations to cut costs and increase flexibility and efficiency. The result is the so-called
New Economy: faster growth and lower inflation.

Most corporate executives and policymakers in Europe and Asia, once skeptical about the
U.S. performance, have taken this lesson to heart. There are still widespread

misgivings about the U.S. model of free-market capitalism. But driven by a desire for
faster growth, combined with a fear of being left behind, the rest of the world is
starting to embrace the benefits of a technology-driven expansion.


But a global New Economy will not happen overnight. True, spending on technology, the most
visible part of the New Economy, while not yet up to U.S. levels, is on the rise
everywhere. Semiconductor sales were up 17% worldwide in 1999, while the number of
Internet users in Western Europe and the Asia-Pacific region is expected to more than
double over the next five years (chart). Even in a developing country such as India, the
software industry is growing at a rate of 50% to 60% annually.


OLD VIRTUES. But the worldwide proliferation of mobile phones and Web accounts by itself
will not bring about a more vibrant global economy. What are also needed are dramatic
changes in core institutions that will translate technology into faster productivity
growth. That means financial markets better able to fund innovation, more flexibility in
corporations and labor markets, a faster pace of deregulation, and increased competition
(table). ''The New Economy is built on old virtues: thrift, investment, and letting market
forces operate,'' says Treasury Secretary Lawrence H. Summers.


There are signs that the process of change has started. With growth picking up in Europe,
and Asia emerging from its slump, Merrill Lynch & Co. is forecasting 3.3% world growth for
2000, with inflation slowing down (chart). Corporate restructuring has begun in Europe and
Asia, financial markets are being rebuilt to support innovation, and there is more
willingness to take risks. ''I'm seeing the entrepreneurial response almost

everywhere,'' says Clyde V. Prestowitz Jr., president of the Economic Strategy Institute.
''It's not Silicon Valley yet, but there's a lot of ferment.'' Even in slow-growing Japan, ''I
think there will be a New Economy,'' says Toshiba Corp. President Taizo Nishimuro,
though he cautions that ''it won't be the same as the U.S.''

Nevertheless, the process of shifting to a fast-growth track is still in its early stages
in most of the world. Europe is at least two or three years behind the U.S., with Asia
lagging even farther behind. While there are pockets of entrepreneurial vigor in places
such as Finland, it has turned out to be an enormous challenge to reshape cultures to
allow more risk-taking in Europe and Asia, where caution is a virtue.


It also takes time for policymakers to adjust to the New Economy. In the U.S., Federal
Reserve Chairman Alan Greenspan, an enthusiastic proponent of technology-driven
productivity gains, resisted great pressure to raise rates in the face of fast growth and
low unemployment. By contrast, the two biggest central banks in Europe, the European
Central Bank and the Bank of England, have adopted a policy of aggressively raising rates
at the slightest hint of inflation, thus choking demand needed to justify business
investment.


Moreover, investment in risky innovation--a linchpin of the New Economy--depends on open
global markets, since national markets do not provide a big enough payoff for taking big
risks. But as shown by the demonstrations against the World Trade Organization in Seattle,
there are groups in every country who feel threatened by free trade. A widespread backlash
against globalization could remove a key underpinning of the New Economy.


Ironically, skeptics also worry that a worldwide investment boom could itself trigger
global inflation. The reason? Slow growth in Europe and Asia in the 1990s helped keep
commodity prices and interest rates low in the U.S., despite strong growth in America. But
as the rest of the world picks up steam, that slack is slowly disappearing. By sometime
later this year or early 2001, unemployment in the major industrialized

economies should drop below the level that triggered inflation in the late 1980s. ''That's
when you get a reasonable test of the New Economy thesis on a global basis,'' says
Stephen S. Roach, chief economist at Morgan Stanley Dean Witter in New York.

But despite these obstacles, a shift to a U.S.-style economic model is looking
increasingly attractive as a guide to development. Based on the American example,
technology-driven growth creates many more jobs than it destroys. Combined with big
productivity gains, that allows the unemployment rate to fall without igniting
inflation--something that would be welcome in European countries that have long struggled
with high unemployment. Faster growth would also ease the long-term burden of funding the
retirement of aging populations in Japan and Europe.


OPEN ACCESS. Moreover, the global economy is not a zero-sum game: Faster growth in the
rest of the world would have a big payoff for the U.S. as well. Commodity prices might
rise at first, but so would exports, bringing down the swelling trade deficits and
creating manufacturing jobs at home. U.S. companies would start to see overseas profits
accelerate.


And then there's the innovation factor. For corporations, the most important justification
for spending big bucks on information technology is that it supports restructuring and
cost cutting. But from a global perspective, a critical benefit of the Information
Revolution is that for the first time it makes data available worldwide. Historically it
has taken years, if not decades, for even the most important technological and business
innovations to spread across national borders.


But that's changing. Now, an engineer in China, say, can log on to the Internet and have
immediate access to the treasure trove of data on U.S. Web sites. More important,

engineers in developing countries can communicate much more quickly with counterparts
in other countries and learn what works and what doesn't. The gains from faster
transmission of innovation can add up to 1% to global growth rates, according to research
by economists Jonathan Eaton and Samuel S. Kortum of Boston University. That's an
enormous potential boost.

But new technology has to be nourished within a larger framework of institutional
changes. For one thing, openness of domestic markets to foreign trade is vital for turning
innovations into real improvements in output. Without competition from overseas, companies
make changes slowly and reluctantly. The big gains only come, according to a 1999 study by
Catherine L. Mann of the Institute for International Economics, ''when trade encourages
and diffuses the fullest uptake of globally available technological innovation by all
firms within an industry.''


Equally important for sustained no inflationary growth is access to well-run financial
markets that can move savings to the most productive investment opportunities, while
cushioning the inevitable excesses to which markets are prone. ''Even small

improvements in the way capital is allocated in an economy have enormous
consequences,'' says Summers. Under a reasonable set of assumptions, an increase in the
efficiency of financial markets that decreases interest rates by 20 basis points can add 6%
to output over several years.

AMERICAN ADVANTAGE. One area where the U.S. excels is the ability to fund innovative
companies at an early stage. U.S. venture capital spending doubled to more than $40
billion in 1999. And according to a study by Kortum and Josh Lerner of

Harvard business school, a dollar of venture capital produces three to five times more
patents than a dollar of research and development spending. ''Venture capital is much
more potent,'' notes Kortum.

Other countries in Europe and Asia are trying to catch up. In China, for example, the
southern city of Shenzhen has just put together its own $120 million venture-capital fund
in an effort to stimulate local high-tech development--just one of several Chinese cities
that has done so. The problem is that the new venture funds in Europe and Asia often have
corporate or government affiliations, which tend to make them less effective. ''They don't
have the autonomy that we associate with U.S. venture-capital funds,'' says Lerner.


And even if the funding is available, it's a slow process to adopt a culture that favors
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