You've all heard it before. Name your productdog food, cars, detergent,
light bulbssooner or later, advertisers are pushing it as "new and
So it is, after a historic economic expansion in the United
States with no end in nearby sight, that many want to slap that
label on the good ol' U.S. economythe "new economy," they
With higher productivity, low inflation, low unemployment and
long-term growth, advocates argue, today's new economy is the
updated and improved version of the old and average economy.
Well, is it?
That was the question posed during a special meeting of the
board of directors of the Federal Reserve Bank of Minneapolis
late last fall. Arthur Rolnick, senior vice president and director
of research for the Minneapolis Fed, told board members at the
start of the retreat, "We have evidence that maybe something is
going on that's quite a bit different from the last decade or
Over the course of two days, board members listened to experts,
looked at facts, heard a little history and added their own anecdotes
about whether this was truly a new (and improved) economy.
Like any good discussion among a roomful of people, the answer
was clear: yes and no. "Is this a new economy?" asked Gary Stern,
Minneapolis Fed president, during his presentation to directors.
"I don't think we have a definitive answer on that."
That's not to say there weren't strong opinions on both sides
of the issue. New economy advocates point out that unemployment
and inflation have been at low levels most experts previously
believed were not coincidentally possible. Combined with high
productivity growthand in a tight labor market, no lessthese
three elements are the triumvirate for long-term growth and prosperity,
new economy advocates argue.
But naysayers point out that, in fact, some of this has been
seen before. While it might be a different economy, it is not
a new economy.
"The facts support both sides," said Warren Weber, a senior
research officer with the Minneapolis Fed, in his statistical
overview of the issue.
The big picture
While unemployment and inflation trends still grab their share
of headlines, productivity growth has been the showstopper. After
languishing for better than two decades, productivity has posted
strong gains since 1995, and is the real driver behind the new
The key to recent productivity gains, to many at least, is the
increased prevalence of knowledge in our society. To help the
bank's directors put recent productivity growth into historical
context, they were asked to take a couple of big steps backall
the way to the Middle Ages. Gregory Clark, professor of economic
history at the University of California-Davis, said that in the
grand scheme of human history, living standards saw no marked
improvement for hundreds of years until about 1820, and then "growth
Productivity, for all practical purposes, was in the tank for
centuries, Clark said. In fact, it took hundreds of years for
the real living standard to exceed that of the 14th century. Before
the 20th century, output was largely agricultural and driven by
capital, land and labor, Clark said. Knowledge had little role
in any country's economy. By its nature, the value of knowledge
is hard to capture, and has what Clark called an "incentive problem."
In the classical world, he said, there were "no institutions to
provide the incentive that would allow people to reap rewards
from knowledge." For example, the absence of property rights meant
that one person's good idea soon became everyone's good idea.
Because of this, in part, growth was rarely in evidence and, when
so, fairly predictable.
The Industrial Revolution brought significant growth that was
attributable to more traditional sourceseconomies of scale,
increased efficiencies and so onbut by the 20th century
growth became more difficult to categorize. It was "like manna
from heaven," Clark said. Productivity increased through some
unexplained source whereby the same inputs created more outputs,
Clark said. Something had changed. Ultimately, increased productivity
must come from one of two sources, Clark said: capital investment
or increased efficiencies, or a synergy of the two. Clark theorized
that growth in efficiency was driven by investments in people.
IQ tests slowly drifted upward as the modern economy invested
more in people's education and other knowledge enhancers.
Broader productivity gains came "as a result of the spillover
effect of many of these private efficiencies and investments"
in knowledge, Clark said, because only a small portion of the
full spillover benefit is captured by those making the investment.
Society harvests the rest.
Fast forward to today's economy, where knowledge has become
king. John Rollwagen, a partner in St. Paul Venture Capital and
former chief executive officer of Cray Research, told the board
that today's economy values knowledge over everything else, and
has changed the very nature of exchanges and transactions.
"I'll trade you what you know for what I know. That's happening
around us all the time," Rollwagen said. He added that knowledge
was a perishable good because its value decreased over time, and
could only be shared (not exchanged) because the original holder
retains ownership after the transaction. As such, the value of
a knowledge exchange has even replaced that of a monetary exchange.
In today's knowledge economy, Rollwagen said, "(Having) your knowledge
and my knowledge wins out vs. my knowledge and your money."
Knowledge as competitive advantage was not invented in the last
five years, to be sure. However, knowledge today is increasingly
well captured by advancements in computers and information technology,
Rollwagen said. He passed a new digital camera among the directors,
noting that the $1,200 camera had twice the computing power of
the most powerful Cray computer he ever sold, which at the time
was worth $30 million.
As the value of knowledge has increased, so too has the value
of communications. At the same time, however, advancements in
information technology have drastically decreased the transaction
costs of communications, as computers, software and telecommunications
are now "inexpensive commodities," Rollwagen said.
The impact of these technology advances has reached some industries
faster than others. Philip Heasley, vice chairman of US Bancorp,
told the board that banking is one of the few industries that
is digital by naturephysical only in traditional currency
of cash and checks, which are being replaced by credit and debit
cards and e-banking.
Out with the old (economy), in with the new (economy)
Productivity comparisons of the last five years with the previous
two decades show some striking differences. Labor productivity
growth in the private sector was more than 2 percent from 1995
to 1999almost double the rate from 1972 to 1995, according
Big productivity jumps have come in manufacturing. Although
a modest part of gross domestic product (GDP), manufacturing productivity
grew 4.4 percent annually from 1995 to 1999, and durables manufacturing
saw impressive growth of 6.5 percent during this time, Weber said,
most of it fueled by 40 percent annual productivity growth in
the computer industry.
Weber acknowledged that the current productivity growth spurt
spans only a short period. But he said that it occurred a few
years into the economic expansion of the 1990s rather than early
on (which is more common), and in the face of low unemployment.
Proponents of the new economy also point out that productivity
is likely higher than the data suggest. Some have argued that
current growth is riding on the back of the computer industry.
But Weber said that economic growth has been very broad-based,
and strong income and profit figures suggest that overall productivity
might indeed be higher than current calculations indicate.
Plenty of anecdotes surfaced during the course of the retreat
to support the idea that productivity growth was broad-based,
though maybe triggered by computers and other technology-based
Jean Kinsey, professor of applied economics and head of the
Food Retail Industry Center at the University of Minnesota, said
productivity has increased significantly in food retailing through
such innovations as the bar code and other technology investments
that have made the industry more consumer-focused and efficient.
These productivity gains have led to falling real food prices,
lower distribution costs and a proliferation of new products and
David Koch, chairman of Graco Inc. and chairman of the Minneapolis
Fed board at the time of the retreat, said his company's productivity
has skyrocketed in recent years. From 1992 to 1998, company productivity
improved 35 percent. Return on sales rose from less than 5 percent
in 1980 to more than 13 percent in 1999, Koch said, and sales
per person more than tripled from $66,000 in 1980 to $209,000
in 1999, with net earnings per employee seeing even greater growth,
In years past, "the question every year was not if we were going
to raise prices, but how much," Koch said. That's not so today,
he added, because there is constant pressure on prices from global
competitors and industry consolidation.
Director Kathryn Ogren said her Montana car dealership has seen
significant labor improvement through the deployment of information
technology. Director Rob Wheeler said his South Dakota jewelry
business recently installed new technology in a manufacturing
line, which cut the line's labor from nine to three people.
Been there, done that
Not everyone is ready to jump on the new economy bandwagon, however.
Critics, for example, point out that average productivity growth
from 1950 to 1972 was slightly higher than the growth achieved
over just the last five years.
Much of the productivity growth is the result of gains in computer
manufacturing, with annual productivity growth of better than
40 percent. "This has a dramatic effect even though it's only
1 percent of GDP," Weber said. After factoring out the effect
of computer manufacturing, productivity growth in manufacturing
was roughly 1.75 percent from 1995 to 1999.
"What I have an issue with is 'new' economy," said Dan Laufenberg,
a senior economist with American Express. "Growth in productivity
of 3 percent is not new." He said that there were several short
periods in the 1970s and 1980s that saw productivity growth over
3 percent, despite the fact that the overall trend rate was much
lower. He added that the current productivity push is merely "a
catch-up" period to make up for slow growth earlier in the decade.
Laufenberg said the current expansion was "different, due specifically
to capital deepening in computers," which in turn has been responsible
for the productivity increases. "We're not seeing dramatic productivity
gains in other areas right nowthe kind of 'general growth'
that you would expect to see."
Capital deepeningusing capital to replace laborusually
happens late in an economic expansion, Laufenberg said. The current
expansion is no different, as capital deepening in computers has
occurred in the last five years, much of it tied to large increases
in the number of computer users and dealing with Y2K.
What is new, Laufenberg said, is the net effect of changes to
price measurement. A reformulated consumer price index, for example,
added 0.35 percentage points to productivity in 1998. "But we
don't go back and revise history" with regards to past productivity
growth, Laufenberg pointed out to board members.
The reclassification of GDP means that the United States is
looking at 3 percent to 4 percent growth going forward, Laufenberg
said, but much of that "new" growth is merely through recalculating
the measuring sticksimilar to changing the number of feet
in a yard, or creating a 14-inch foot. People wouldn't suddenly
become shorter or taller just because the measuring standard had
"It doesn't change reality," Laufenberg said.
Laufenberg also is skeptical that the application of technology
is generating the productivity gains. "There is no statistically
significant evidence that the overall economy is showing productivity
gains from technology," Laufenberg said, because virtually all
of it is captured or realized by the individual.
Laufenberg said his colleagues considered him a "raving lunatic"
for being too optimistic in 1990, when he predicted productivity
growth of 1.8 percent for that year (which ended up 1.7 percent).
In a similar vein, "you have to be careful to not be too exuberant"
about recent productivity gains, he said. "We won't know what
the answer to this is for some time."
That uncertainty was shared by others at the retreat.
"It's clear economists don't know what's driving this," said
Tom Melzer, former president of the Federal Reserve Bank of St.
Louis, who is now an investment banker.
What effect on Fed monetary policy?
Regardless of any agreement over whether this is truly a "new"
economy, the Federal Reserve is faced with the responsibility
of making some sense of the current economic order, and determining
a proper direction for monetary policy in the, er, not-yet-officially-agreed-upon-economy.
Uncertainty over some fundamentals in the U.S. economy can make
this a tricky task. Forecasting models can give policymakers a
good idea of what to expect economically, but it "doesn't give
us the story of why it happened," said Minneapolis Fed President
Stern. "We don't know as much as we would like about productivity
and why it accelerates," nor does the Fed "have a good explanation
for why the slowdown happened" from 1972 to 1995, he added.
Given that uncertainty, Melzer said it is important for monetary
policy to remain focused, and that is precisely the Fed's goal.
Essentially, forecasting future growth expectations is a simple
formula with three basic pieces: labor pool growth, labor productivity
growth and inflation, according to Melzer. Of these pieces, labor
pool growth is very predictable, and the Fed typically targets
an inflation rate, which means that "productivity is the only
moving part," Melzer said. In the last few years, monetary policymakers
have had the good fortune to see higher-than-expected productivity
gains and lower inflation.
"I'd much rather be surprised on the positive side than the
negative side [regarding demand growth projections]," Melzer said.
This ultimately leads to conservative productivity estimates.
If demand projections are overestimated, higher inflation is likely
to occur, "which takes a lot of political and economic capital
to rein in," Melzer said.
For this reason, Melzer said, monetary policy "shouldn't get
enthusiastically on board on the high end" of growth projections.
He reminded the directors that price stabilitynot general
economic growthwas the Fed's main objective. Monetary policy
has little or no direct effect on the size of the labor force
or productivity growth, which meant that inflation was the only
piece of the economic growth equation that the Fed could control,
"Many people believe that the FOMC (Federal Open Market Committee)
is targeting real growth," Melzer said. To the contrary, the Fed
does not and should not set expectations for real growth"the
economy will determine that," Melzer said.
In keeping its sights on inflation and price stability, Melzer
said the Fed should establish clearer objectives. "We should tell
people that's what we're trying to do," he said, such as publicize
a targeted range for the annual inflation rate.
But there is no agreement on what the inflation target should
be, both within the Fed and among private sector forecasters,
Melzer said. Although there is loose agreement on a 2 percent
inflation rate, an opportunity is missed to create more certainty
with regard to growth expectations.
"We're compounding uncertainty about productivity with lack
of agreement on what we want to achieve with regard to inflation,"
Melzer said. "We need more consensus on what that inflation number
Stern said the FOMC has been grappling with inflation targets
"for some time," but ultimately the uncertainty and lack of agreement
on inflation targets require the Fed to move very slowly and cautiously.
Maybe a new approach by the FOMC was necessary, one that was less
anticipatorya common FOMC dispositionbecause no one
knows exactly what's happening, much less why. Or maybe the FOMC
"should react more quickly to indicators of inflation rather than
indicators of a slowing economy," Stern said, to keep the focus
on inflation rather than on influencing the economy directly.
"You have to be cautious given the uncertainty about what's going on,"
Stern said, adding that societies often do not recognize or understand
major economic shifts when they occur. As a result, Stern said, "as you
change policy, do it incrementally and infrequently, because we just don't
know enough about the animal with which we're dealing."