Did the Roaring 90’s Really Roar?
The basic story is fairly straightforward -- the nineties look good compared to the eighties -- but that is because the eighties were so dismal. By almost any measure they were far worse than the fifties and sixties, the post-war golden age. In fact, the nineties do not even stack up well against the oil-shock ridden decade of the seventies. If the nineties were the best of times, as some politicians were fond of saying, then there is serious trouble down the road.
The most basic measure of economic performance is GDP growth. The U.S. averaged 3.1 percent annual GDP growth in the nineties. This beats the 2.9 percent rate of the eighties, but doesn't come close to the 3.7 percent rate of the fifties or the 4.4 percent rate of the sixties. In fact, it even trails the 3.3 percent rate for the seventies business cycle.
As many people rightly note, GDP growth isn't everything. Let's take a look at the wages of a typical worker. Unfortunately, the story is not much different here. The real (inflation adjusted) median wage grew at a rate of 0.6 percent annually in the nineties. This is better than the eighties, when real wages fell at the rate of 0.5 percent a year, but it isn't close to the growth rate of the sixties, when wages rose at a 1.9 percent annual rate. By this measure the nineties performance also lags the seventies, when real wage growth averaged 0.8 percent annually.
At this point, the anxious nineties boosters are now yelling that the"new economy" began at the end of 1995, and that by including the early nineties in these calculations, we are just confusing the issue. While it is normal to treat business cycles as a whole, it is the Christmas season, so we can indulge the believers in the fabulous nineties.
The second half of the nineties clearly is markedly better than the first half. But don't go placing your money on the new economy just yet. The average rate of GDP growth from 1995 to 2001 was 3.8 percent -- this still isn't quite up to the fifties and sixties growth rates, but it is almost a full percentage point above the growth rate of the eighties. According to the fabulous nineties crew, this growth was driven by a new economy productivity surge, which was in turn driven by an investment boom in computers and other high tech equipment. In addition, the late nineties saw unemployment fall to a thirty year low, without any significant increase in the inflation rate.
While the low unemployment rates of the late nineties are certainly good news, it is not clear that we need a fabulous nineties story to explain them. The Federal Reserve Board allowed the unemployment rate to fall to 4.0 percent (actually, the unemployment rate bottomed out at 3.9 percent during three months of 2000), without any noticeable impact in the core (excluding food and energy) rate of inflation.
But, this can as easily be explained by a change in the Fed's policy as by any grand claims about a new economy. Prior to the mid nineties, the Federal Reserve Board accepted the NAIRU theory, which said that inflation would accelerate if the unemployment rate fell below 6.0 percent. Although the theory and evidence for this view were never terribly compelling, the Federal Reserve Board had apparently accepted the NAIRU, and would start raising interest rates if the unemployment rate threatened to sink below 6.0 percent, thereby slowing the economy and pushing the unemployment rate higher. In 1995, with the unemployment rate already slightly below 6.0 percent, the Federal Reserve Board decided to experiment, and lowered interest rates. Rates were cut further in response to the East Asian financial crisis. In other words, the 4.0 percent unemployment rate of the late nineties -- with low inflation-- is indeed worth celebrating, but it's not clear that we need the"new economy" to fill out the picture.
The other measures for the late nineties don't make a very compelling new economy case either. Productivity growth averaged 2.5 percent. This is more than a full percentage point above the eighties' 1.3 percent rate, although still somewhat below the 2.8 percent rate of the fifties and sixties. But here also, there is less than first meets the eye. Computers and software become obsolete more quickly than buildings. In the late nineties, a large and growing share of output had to be devoted simply to replace these items as they became obsolete, leaving less a smaller share for consumption and new investment.
The Commerce Department publishes a measure of"net domestic product (NDP)" which measures output without counting the investment that must take place simply to replace worn out and obsolete equipment. The new economy's productivity score by this measure is 2.0 percent average annual growth, well below the 2.8 percent rate of the fifties of sixties. This 2.0 percent rate of productivity growth is slightly better than the 1.8 percent rate of the seventies, but even this small difference may not stand up. There have been changes in the measurement of output -- and therefore productivity -- which lead to a higher measured rate of growth. The improvement in the rate of productivity growth of the late nineties compared to the seventies may be entirely attributably to changes these changes in measurement, not an actual improvement in economic performance.
What about the investment boom that got so much attention? Remember this boom was sparked by lower interest rates, which were in turn caused by the shift from the large budget deficits of the early nineties to the huge surpluses at the end of the decade. Here also, there is less than meets the eye.
While the nominal interest on long-term government bonds did fall by almost three percentage points, it is the real interest rate (the nominal rate minus the inflation rate) that matters for investment. Also, while interest rates do generally move together, they don't follow the exact same pattern --corporate investment decisions depend on the interest rates they pay, not the interest rate the government pays. While the real rate on government bonds fell by 1.3 percentage points from the late eighties to the late nineties, the real rate on corporate bonds fell by just 0.8 percentage points. This is good news, but mot enough to spark an investment boom.
And, we don't find an investment boom in the data. In 2000, the peak year of the nineties cycle, the investment share of GDP reached 13.1 percent. This was considerable better than the 11.2 percent share at the last business cycle peak in 1989, but only slightly higher than the 12.9 percent share at the 1979 peak. But, this investment share was accompanied by an extraordinary run-up in the United States trade deficit, which implies foreign borrowing or negative net international investment. While investment in the domestic economy will make us wealthier in the future, paying the interest on foreign borrowing will make us poorer. If we net out these two effects, the net share of the investment components of output (investment minus net exports) was 9.4 percent in 2000. This compares to 12.0 percent at the business cycle peak in 1979, and 9.7 percent at the 1989 business cycle peak.
The real story of the new economy was a consumption boom, as the consumption share of GDP hit record levels. This consumption boom was in turn supported by the next big actor in this drama, the stock market boom. At its peak in early 2000, the total value of stock in the United States was close to $18 trillion, approximately 1.8 times total output. This was due to the fact that the ratio of stock prices to corporate earnings was at more than twice its historic average. If you think this is good news, remember the United States also had a booming stock market in 1929, as did Japan in 1989. Only someone with a bad sense of humor -- or a smart speculator -- would like to see the stock market rise to levels that can't be justified by economic fundamentals.
This is important to remember as we wallow in the new economy bust. Even with its recent declines, the stock market remains over-valued. The full adjustment process will prove painful for many investors, who will lose much of their retirement income, and the economy as a whole. Also, the country cannot continue its extraordinary rate of foreign borrowing indefinitely. At some point the dollar will decline, which will lead to higher prices and lower living standards. In short, we are experiencing bad economic times, with trouble on the horizon. Before long, the"new economy" will be just a bad memory.