Maybe the New Economy Isn't So New

This chapter is from the book

Ride the Wave: Taking Control in a Turbulent Financial Age

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This chapter is from the book

This chapter is from the book 

Ride the Wave: Taking Control in a Turbulent Financial Age

Learn More Buy

Even with the dramatic slowdown in economic activity in late 2000–2001, you can't help but be excited about the future and amazed about the past. The decade of the 1990s was one of extraordinary expansion and growth, particularly over the last five years. And much, much more is yet to come. As we discussed earlier, the IT revolution, for all its glory, is still in its infancy. The world of infinite bandwidth—communication power—is now imaginable. This will mean ubiquitous, always-on computing and Internet access. The day will come soon when computers will be imbedded in virtually everything. And IT is not the only thing to look forward to.

We are on the precipice of major breakthroughs in medical science that will dramatically alter all of our lives. I would argue that the breakthroughs we will see in the next decade will dwarf all developments in medicine to date. These have tremendous implications, not just for the quality and quantity of our years on Earth, but also for our retirement planning, investment horizon, career planning, and general economic behavior.

Some have suggested that the development and broad use of the fuel cell to replace the internal combustion engine should also be seen as one of the seminal and important developments of the next ten or twenty years. And major discoveries in nanotechnology will, as we saw in Chapter 4, revolutionize manufacturing and so much more. Increasing returns to knowledge assure that the speed of change will be rapid in this, the Acceleration Age, and that the developments will be profound.

This is not new. Although the speed of acceptance of new technologies has certainly accelerated, an innovation cycle has been evident for more than two hundred years. Ever since the beginning of the first Industrial Revolution in the late 1700s, we have seen wave after wave of innovation roughly every fifty to sixty years. Once or twice a century, as Alan Greenspan has pointed out in many of his speeches, a new technological advance meaningfully alters the way the economy works, boosting growth, enhancing productivity, and often literally changing society. We saw it in the mid-1800s with the introduction of the railway and at the turn of the last century with the automobile, electricity, and the radio. The economic impact of these technologies is well known, but their social impact is equally as important. The electric lightbulb extended the working day and allowed for a new scope of evening activities—night baseball, for one. Prior to electricity, most of the population went to bed a lot earlier than they do today, not too long after sundown. The railroad allowed for the transport of people, not just goods, across great expanses. Remote towns could prosper as long as they had a railway station and regular train stops. Heaven help the town if the railroad decided to discontinue service. The car was the impetus for the development of the suburbs after World War II—the relative isolation of the housewife, the commuting dad, strip malls, fast food, drive-in movies, and the trucking industry.

These were not easy or instantaneous transitions. Often the pace of progress was halting at first, then overly euphoric, and then overly pessimistic, as the pendulum of human behavior and market psychology swung from one extreme to the other. The fact remained, however, that these technological breakthroughs had a profound effect on many aspects of life: the costs of production, transportation, and communication; productivity growth; the location of the population; the mass culture; and the political scene.

I believe that today we are in the early days of another upwave in the innovation cycle. This time, the breakthrough technologies are the Internet and the application of digital technology to the life sciences. We might also include fuel-cell technology and nanotechnology as secondary, but still significant, scientific developments. This period, as before, is fraught with risk and disappointment. Change is always difficult as many leaders in business and politics attempt to protect the status quo, fearful of change and innovation. Imagine how the stagecoach operators felt when the railroad came or how the kerosene and coal manufacturers reacted to the advent of electricity.

The dot-com crash should not be seen as the end of the upwave. Quite the contrary. While it was wrong to expect too much of the dot-coms, it is equally wrong to expect too little. We are in the early days of an upwave in the "Long Cycle." This is a once-in-a-lifetime cycle. It occurs every fifty or sixty years. In upwaves, expansions are long and strong and recessions are short and mild. Gyrations can be great, but the trend is up. This upwave, I believe, will last at least another ten to fifteen years, and maybe longer.

The Long Cycle

Living in a world of tremendous volatility and change, we inevitably get caught up in the day-to-day orbit of our lives, our businesses, our careers, and our investments. But I believe it is important to look at the economy from a longer-term perspective, as well. Too much of my time is spent focusing on the very short-term movements in financial markets and economic indicators. And while monitoring the business cycle is what I get paid to do, it is useful and appropriate to put this cycle in an historical framework. I find it quite enlightening to think of the world in the context of the long wave—a decades-long cycle around which the shorter-term business expansions and contractions revolve.

The long wave was first spotted by Russian economist Nikolai Kondratieff in the 1920s and is sometimes called the Kondratieff wave. It is a controversial concept; many quibble endlessly about how it should be measured. It is very difficult (virtually impossible) to pinpoint the exact dates of peaks and troughs in the long-term economic cycle. I don't think this really matters. The fundamental usefulness of the construct—the model—remains. The concept of a long wave has moved more into mainstream thinking in recent years with the endorsement of Alan Greenspan.

Greenspan and I have both accepted the concept of the long wave without necessarily attempting to map the precise dates of the cycle. There are significant statistical problems in doing so. Data are needed back to the end of the eighteenth century, well before government statistics agencies were set up to collect it. But nevertheless, those who have attempted to do the analysis conclude that a discernible long cycle in economic activity can be mapped out (Figure 8.1).

Figure 8.1 The Long Wave

Kondratieff caused such an uproar with his cycle research in post-Revolution Russia that he was arrested and sent to Siberia. His work angered the Bolsheviks because it showed that downturns in capitalist economies were self-correcting. Kondratieff's work fell on a far more receptive audience in the United States. Joseph Schumpeter, with his now-famous theories of creative destruction, followed in the Russian's footsteps. Schumpeter is seen as the first New Economy thinker because of his interest in technological advance and its implications for economic growth. Continuing the research today is, among others, Stanford economist Paul Romer. As I discussed in Chapter 1, Romer analyzes the importance of knowledge and ideas in the growth process, seeing these as intrinsic to growth, rather than as exogenous forces.2

Breakthrough Technology

It was not the computer, per se, that triggered the current upwave. We have had computers on our desks for twenty years. It was the networking of computers in a global information highway that spurred the forces of change, reducing the costs of communication to nearly zero and triggering a flurry of productivity-enhancing activities. The biotech revolution has barely begun. As I discussed in Chapter 4, we are on the precipice of major breakthroughs in medical science, and this combined with the developments in the nanotech world and fuel-cell research will continue to contribute to head-spinning change for the next decade or more.

In all upwaves, the new inventions or discoveries trigger an enormous disinflationary process (Figure 8.2). Businesses reorganize, costs decline, efficiency rises. The quality and variety of products increase. These factors combine to raise real wages and the standard of living. Family living standards rise even more than the economic numbers can capture, because the improved quality, service, and selection often cannot be readily measured. Prices fall, particularly for the new products and services that are introduced. The economic pie gets bigger, and though there continue to be disparities, for the most part, everyone is better off. Today there is the so-called digital divide—determined more by "know and know-nots" rather than "have and have-nots"—but the jobless rate fell throughout the 1990s across the knowledge spectrum. As we have seen, the biggest improvements were for the unskilled and untrained—the hard-core unemployed—who were finally lured into the job market by the booming economy and the desperate need for workers.

Figure 8.2 Mitigating Inflation ... Technological Breakthroughs (year-over-year percent change: ten-year moving average)

Upwaves are periods of considerable dislocation, often accompanied by intermittent periods of excessive optimism and pessimism. While jubilation may run hot and cold, the constant churning that innovation causes can be very painful. New must replace old, and new-new replaces new. The product life cycle can be very short. Many of the winning tech companies in the early 1980s are long gone—Commodore, Wang, Control Data. IBM was quick enough to move from the mainframe to PC and then on to network and Internet servicing. A less-nimble company would have long ago joined the ranks of Wang. Those people or regions that cannot or choose not to adapt are left embittered and often disadvantaged. It is not easy to ride an upwave, but it can be very rewarding.

Wars Also Play a Role in the Long Cycle

Military engagements have been instrumental in the timing of the long wave cycles. Defense establishments—in the U.S., Europe, Israel, and elsewhere—have led much of the advanced tech research in the world. Wars themselves are distracting, expensive, destructive, and inflationary. However, they also trigger substantial innovation. There is nothing like an armed conflict or a rabid enemy to get the scientific juices flowing, even if for the purpose of mass destruction. What we find is that once the war ends, the military innovations often can be put to lucrative and beneficial peacetime use. We saw this with the computer, radar, the airplane, anesthesia, the Internet—just to name a few. Even atomic research has found its civilian uses.

Turning points in the long cycle have often been associated with major military encounters. Some long-wave theorists attach importance to the popularity of the military engagement: the end of a popular war triggers an upwave, while the end of an unpopular war marks the beginning of a downwave. While this is highly controversial and may be putting too fine a point on the theory, for the United States, something like it can be seen in the long-cycle pattern (Figure 8.3).

Figure 8.3 Military Encounters and the Long Wave

Consider the coincidence of cycles with wars in American history. The end of the Revolutionary War—certainly a popular war in the Colonies—ushered in the era of the cotton gin, the threshing machine, and iron working. Transportation routes such as canals and roadways were the big infrastructure projects. The upwave ended with the relatively unpopular War of 1812.

The next upwave began around the time of the Mexican War and lasted for roughly twenty years, eclipsed by the devastation of the Civil War. This was the period of the railroad, the steam engine, the telegraph, and the first telephones. The building of the American railroad infrastructure led to booming labor markets. Transportation costs plunged as the railway and steam ships allowed for the transport of goods across former regional boundaries. Cities and towns flourished along the routes. The prices of goods, most notably food, fell sharply as agricultural products were whisked from the Midwest farms to the East Coast cities. The prices of all household goods declined as wage rates rose. Real family purchasing power increased sharply. Productivity growth surged and communication capability rose dramatically with the telegraph.

This communication breakthrough, invented in the 1830s, increased the flow of information through the economy. Tom Standage, a journalist with the Economist magazine, has called the telegraph "the Victorian Internet."3 However, the telegraph remained too expensive for the average consumer, so the transformation of communication on a broadly based scale awaited the telephone and later the Internet. The steam age moved production from the household to the factory; the railroad allowed for the development of mass markets and all of the economies of scale that they entailed.

The next major upwave followed the end of the Spanish-American War in 1898 and lasted until well after World War I. This was the age of electricity, the radio, and the automobile—a spectacular period of economic transformation. With electricity, the assembly line became possible. It took years for the full effect of the productivity gains to be measured, as businesses needed to literally rebuild their operations to take full advantage of the new technology, a phenomenon that has been well documented in the computer age as well. New technologies often initially create more problems and inefficiencies than they solve. This is what economist Robert Solow (cited earlier) was referring to when he said that the computer boom was evident everywhere but the productivity statistics.

Electricity markedly enhanced living standards in countless ways, reducing communication costs, transforming the production process, and removing the constraints of the rising and setting of the sun. Automobiles, radio, the first aircraft, the first office machines, photography, and the development of plastics all contributed to the improvement in living standards during this period. Automobile sales doubled in the 1920s, bringing with them similar gains in the demand for steel, glass, rubber, and highways.

But the population's move to the suburbs awaited the next upwave at the end of World War II. A swell of soldiers returned home to marry and start families. The Baby Boom began. The pent-up appetite for consumer products was ravenous. The technologies of the earlier upwave were adopted on a mass-market scale. Electricity touched off a spectacular wave of innovation in the home, from washing machines to vacuum cleaners. The liberation from the tedium of repetitive household chores had a lasting effect on the role of women and society at large. Adding to these innovations were the first computers, transistors, jets, rockets, lasers, and television. The leading industries were consumer durable good manufacturers, such as the automakers and electronics companies, as well as the producers of synthetic materials and petrochemicals. This was the Industrial Age—the age of chemistry. There was an enormous build-up of infrastructure: highways, airports, schools, libraries, television networks, and airlines.

The era ended with the end of the very unpopular Vietnam War in 1975, not long after the first OPEC energy crisis and the resultant recession. What followed was a period of stock market decline, economic stagnation, and inflation—the downwave. While the stock market finally began to recover in 1982, with the end of the period of dramatic monetary tightening, I do not date the next upwave—the current one—until well after the end of the Cold War in 1989. The Gulf War in 1990-91 touched off a moderate recession. The rebound was initially halting, as we have seen. I date the beginning of the current upwave at 1995. By then, the Internet was a force on the American scene; within two years a critical mass of households—roughly one-third—had adopted the new technology for home use.