The Imminent U. S. Boom and its Implications for the Global Economy

Robert J. Gordon

Stanley G. Harris Professor in the Social Sciences, Northwestern University, and NBER

Korean Standards Association Conference, Cheju, Korea, July 23, 2003

To Look Forward, We Need Two Components

• First, to understand late 1990s boom and subsequent 2000-2003 U. S. slowdown, recession, and subsequent slow recovery

• Second, to decompose the conflicting elements in today’s U. S. economy and predict out over the next two years.

Understanding the Reasons for 1996-2000 Boom: the “Virtuous Triangle”

• Three elements to 1990s boom, like three sides to a triangle

– #1 Innovation and Hi-tech Investment

– #2 Stock Market Wealth and Consumption

– #3 Productivity Revival and Inflation

The Macro Triangle: The “New Economy” ICT Boom Didn’t Happen in Isolation

• The “triangle approach”

– Why the ICT investment boom and bust?

– Stock market: causes and effects

– Economy-wide factors: productivity growth, inflation, monetary policy

Inflation-productivity-monetary nexus

Stock Market

ICT

Component #1: Innovation and Hi-tech Investment

• Virtuous Circle, Positive Feedback Loops

– Acceleration of Hi-Tech Innovation

• Internet, WWW, Mobile telephones, telecom infrastructure

– Investment boom fed GDP Growth

– Investment boom and GDP growth together generated stock market boom and bubble

Component #2: Stock Market Boom and Consumption

• Fast GDP Growth stimulated growth in income and consumption

• Fast GDP Growth and hi-tech “bubble” caused stock market to triple 1995-2000

• Stock market boom created “wealth effect” that allowed consumption to grow faster than income

Stock Market reduced Saving and Boosted Consumption

Household Savings Rate and the Ratio of the S&P 500 to Nominal GDP

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S&P 500 / Nominal GDP

Component #3: Productivity Revival and Inflation

• Productivity Growth Doubled, 1973-95 to 1995-2000

• Fast Productivity Growth Held Down Inflation

– Real wage growth fell behind

– Growth in unit labor costs was minimal

More on #3: Causes of Low Inflation despite Fast Output Growth and Low Unemployment

• Positive “Demand Shock” should have pushed inflation up

• But offset by beneficial “Supply Shocks”

– Productivity revival

– Strong dollar, falling real import prices

– Low oil prices before 1999

– Medical care “Managed Revolution”

Effects of Low Inflation

• Normally low unemployment would create faster inflation, cause Fed to tighten monetary policy

• With low inflation, no need to tighten

• No change in interest rates, 6.0 percent in late 1994, 6.5 percent in mid-2000

The Benign Fed: Contrast with the Late 80s and Early 90s

Federal Funds Rate and the Output Ratio, 1984-2002

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What Caused the Productivity Growth Revival: A Puzzle

• Much Research on post-1995 Productivity Growth Revival

• Consensus: Major Cause was Boom in ICT Investment– Production of ICT Investment

– Use of ICT Investment

• For 1995-2001, ICT Investment Explains Entire Revival, continued revival in 2002 unexplained

But Here’s the Paradox

• ICT Investment Boom Has Died, at least in 2000-2003, should be “Bad News” for Productivity Growth

• But Productivity Growth Continues, as rapid 2000-early 2003 as 1995-2000

• Bad News vs. Good News, how can we make sense of this?

– ICT Investment is the bad news

– Continuing strong productivity the good news

• Has the role of ICT Investment Been Exaggerated?

  Table 4      

         

Contributions to Growth in Labor Productivity by Source  

1973-95 vs. 1995-2001 and post-1995 Growth Acceleration  

         

  1973- 1995- Post-1995  

  1995 2001 Change  

         

Labor Productivity 1.40 2.25 0.85  

   

Contributions from:    

     

Capital Deepening 0.71 1.17 0.46  

Information Technology Capital 0.42 0.97 0.55  

Other Capital 0.30 0.20 -0.10  

   

Labor Quality 0.27 0.25 -0.02  

     

Multifactor Productivity 0.42 0.83 0.41  

Information Technology Capital 0.30 0.73 0.43  

Other Sectors 0.12 0.10 -0.02  

     

Memo: Total IT Contribution 0.72 1.70 0.98  

Productivity Growth in the NFPB Economy: Actual and Trend

NFPB C6 Actual productivity growth and HP 6400 growth

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The Winter 2001-02 Productivity Bubble

• Bubble Growth, next 8 qtrs AAGR– 2001:Q3-2002:Q3 5.70 ???? (1.7 first 3)

– 1991:Q1-1992:Q1 4.01 1.15

– 1982:Q3-1983:Q3 5.19 1.58

– 1975:Q1-1976:Q1 4.63 0.99

• Are Forecasters Treating the Bubble as Normal or Incorporating a Historical Interpretation into their Analysis?

Reasons for Skepticism about the Standard Decomposition

• Delay (analogy with electricity in the 1920s)

• Retailing in the 1990s: all the big boxes

• Europe: retail is where the gap is

• U. S. States: no role for ICT use

    Table 5        

             

Labor Productivity by Industry Group, U. S. vs. Europe,  

1990-95 vs. 1995-2000, Annual Growth Rates in Percent  

             

  United States   European Union  

  1990- 1995-   1990- 1995-  

  1995 2000   1995 2000  

             

Total Economy 1.1 2.2   2.4 1.5  

       

ICT Producing Industries 6.1 6.5   6.0 8.5  

         

ICT Using Industries 1.4 4.2   1.9 1.3  

     

Non-ICT Industries 0.4 0.4   2.4 1.0  

       

     

             

Source: van Ark et. Al. (2002, Table 5).          

Why Won’t ICT Investment Come Back?

• This is the Bad News– For Productivity Growth (but ICT role

exaggerated)

– For the Economic Recovery

• Two Reasons– Macro (total economy)

– Micro (special aspects of ICT Boom)

Historical Analogies to the end of the late 90s IT Investment Boom

• Sir Edward Grey, August 3, 1914

• “The lamps are going out all over Europe; we shall not see them lit again in our lifetime.”

• Will the Late 90s ICT Investment boom Occur Again in our Lifetime?

Falling Prices Doesn’t Mean that Real Investment will Rise

Ratio of Computer Investment to Nominal GDP1960-2002

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The Micro Side: Does Supply Create its Own Demand?

• Moore’s Law Cycle Time is About Supply, but Economics is About Supply and Demand

• Demand Fundamentals of the late 1990’s: One-time-only sources of ICT Demand

The Micro Reasons why the ICT Investment Boom Won’t Come Back

• Least Controversial: Telecom Equipment

• The WWW Could Only be Invented Once

• Legacy of the Failed Dot-Coms

• Most Controversial: Software Falling Behind Hardware

What Dragged Down the Economy?

• End of Hi-Tech Investment Boom

• Stock Market Crash

• “Multiplier” Effects

After the Boom, a Sharp Slowdown in Real GDP Growth

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This Chart Corresponds to NBER’s Recession Announcement Last Thursday

• Previously announced that the peak occurred in March 2001

• New announcement (July 17) that the trough occurred in November 2001

• It took our committee 20 months to declare the end of the recession!

The Collapse of ICT Investment was the Driver of the Recession

Real Computer Investment and Real Computer Deflator Growth, 1987- 2002

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Real computer investment

Real computer deflator

Macro + Micro Implications

• We won’t have another five consecutive years with ~40% annual growth in computer investment

• Even if ICT investment goes back to 1995 rates, productivity growth will not

• That leaves the last topic: diagnosing the recovery

Can we be Confident that the Recovery will be Sustained?

• Last November (2002), the consensus was too optimistic– 3+ percent growth forever starting next quarter

• Fixed Investment Starts Growing at Double Digits– CBO late 2003 Equip Investment +17

• Classroom: – GDP = Multiplier times a+I+G+NX

Why was the Optimistic Consensus of November 2002 Wrong?

• Consumption– Auto Sale Payback

– Overextended Consumer debt

• Government Spending– Today’s NYT Op-Ed: “Watching the S&L

Finances Implode is like watching a multiple-car auto wreck happen in slow motion”

And the Rest?

• Net Exports?

– Residual effect of strong dollar

– No matter how slowly U. S. economy grows, forecast for foreign growth is slower

• That leaves Investment

– Fixed investment 1992<1989

Investment Pessimism?

• We’ve Already Seen: One-time-only aspects of late 1990s

• Capacity Utilization Rate: Historically Low

• Tight Credit Despite Alan Greenspan

If Everything is So Dire, How Come the Recovery Continued? The Bond Market Gyroscope!

• Signs of Weakness? Bond Market yields tank

• A Housing Refinance Boom follows, money flows to consumer pockets, the economy is not weak after all

• So far, so good

I’m a “former skeptic” converted to the case for rapid growth

• First, a rebound effect from slow growth in the first half of 2003

• Let’s look back at that chart of monthly GDP, change from 12 months ago

• The first reason for optimism is that the temporary slowdown in spring 2003 will be reversed

After the Boom, a Sharp Slowdown in Real GDP Growth

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Second Reason: Monetary Policy

• Short-term interest rates: down from 6.5% in late 2000 to 1.0% now

• Long-term (10-year) interest rate: down from 6.7 percent in January 2000 to 3.9 percent now

• As low as 3.1 percent in May-June 2003

• Fed will hold short-term rate low “as long as it takes” and buy long-term bonds if necessary

Fiscal Policy

• Federal Government Deficit:

– Surplus of $220 billion in 2000

– Projected Deficit of $450 billion in 2003

– Turnaround = $ -670 billion!

• Unprecedented shift from fiscal restraint to stimulus

Components of Budget Turnaround

• Loss of Revenue

– Weaker Economy

– Big loss of Capital Gains Revenue

• Bush Tax Cuts

• Higher Spending

Fourth Source of Stimulus: the Falling Dollar

• Dollar Appreciated 1995-2002

• Dollar has Weakened 2002-2003

• Assymetric Effects, why?– Fixed Exchange Rate with China and Hong

Kong

• Nevertheless a source of stimulus

Summary of Reasons for Optimism

• #1: Bounceback from weak spring 2003

• #2: Unprecedented Monetary Stimulus

• #3: Unprecedented Fiscal Stimulus

• #4: Weakness of Dollar

Remaining Weakness

• State and Local Government cutbacks: offset 1/3 to ½ of Federal Stimulus

• Consumers have Bought Too Many Cars

• Housing Finance Boom Depends on Falling Interest Rates

• Continued Impact of Excess ICT Investment in Late 1990s

On Balance, the signs are there for a vigorous expansion

• Need steady real GDP growth of 3.25 percent to keep unemployment constant

• Projected 3.75-4.25 growth from now for two years will bring unemployment back below 6 percent.

• Maybe not back to 5.3-5.5 percent until late 2005, early 2006

Implications for Korea

• Big export markets: U. S. and China

• Continuing strong growth in China, now a turnaround to strong growth in U. S.

• What about Japan?

• To quote Winston Churchill (who said this about Russia in 1939)

• Japan is “a riddle inside a mystery wrapped up in an enigma”