The New Economy: Myth or Reality?

In 1997, the debate on Productivity Growth in the 1990s  took a new twist as data for 1996 and 1997 appeared to show a significant increase in the rate of productivity growth. For example the latest data for the third quarter of 1997 showed that productivity was growing at a annualized rate of 4.0% in the business sector and a whopping 9.3% in the manufacturing sector  (see the BLS Web Site for the latest productivity report). While the annualized growth rate data might be distorted by a particular good quarter, the actual quarter-on-quarter annual rates of growth showed similar large increases of productivity growth: the actual productivity growth between the third quarter of 1996 and the third quarter of 1997 was 2.4% for the business sector and 4.6% for the manufacturing sector, well above the dismal rates of 1.0% observed in the early 1990s. These new data led a number of authors to argue that we had entered in a new era of sustained productivity growth; one heard a lot of talk about a  "New Economy" where a "New Paradigm" of high growth and low inflation holds.


For a critique of the New Economy hypothesis see three recent articles by Paul Krugman, one on Slate, one on Fortune magazine and the last on the Harvard Business Review.

The main arguments in favor of the New Economy hypothesis can be found in an article by Shepard in Business Week .

Another strong critique of the New Economy has been presented  an article by Alan Blinder, a profesor of economics at Princeton and former Fed Vice-Chairman.

The views of Fed Chairman Alan Greenspan on this debate are presented in a a speech he gave in September 1997 and another speech in October 1997.

The views of another influental Fed Governor, Laurence Meyer, are presented in a speech he gave in September 1997. Meyer's views are the subject of a NYT article.

For another skeptical view on the productivity boom, see the arguments by Stephen Roach, chief economist at Morgan Stanley in three different pieces on Nov 19, 1997, Aug 1, 1997, and Aug 5, 1997 and a recent long essay he wrote on  The Boom for Whom: Revisiting America's Technology Paradox (this latter piece is in PDF format).

A view from Stanford economist Robert Hall.

The skeptics argue that the economy's recent good performance can be explained by temporary factors. Specifically:

The increase in productivity growth in 1996-97 is too recent to argue that it represents a new long-run trend in productivity; for example, productivity growth was very modest between 1990 and 1995. Two good years do not make a trend.

A sharp slowdown in health-care inflation to less than 3% has helped restrain overall inflation and boost corporate earnings. But medical costs are likely to start rising again.

Worker anxiety has held down wage growth to barely 3% annually,  keeping up profits without raising prices. But tight labor markets will soon ignite wage inflation.

The soaring dollar has made imports much cheaper since 1995, dampening inflation. But with the dollar stable against major currencies, import prices may stop falling.

The drop in interest rates since 1990 has pumped up profits even at  inefficient companies. But with rates already low, more such easy gains will be hard to come by.