New Economy

Created: 1999-07-02
Last Modified: 1999-07-30
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DRAFT: A Framework for Understanding Our New Economy

part of a joint project with Stephenen Cohen and John Zysman


Politicians come to Silicon Valley these days much as their predecessors came to Manchester, England to ooh and ahh over the industrial revolution a century and a half ago, or to Detroit before the Great Depression to ooh and ahh over the mass-production assembly-line. Yet when they leave do they understand the nature and significance of the technological and economic transformation through which we are living? Do they understand the extent to which policies to nurture and support the high-tech information-based computer-and-communications sectors of the American economy are in all of our interest--and not just the redistribution from weak claimants to powerful special interests that is the meat and fish of American politics?

By and large they do not. And this is too bad. For we all believe that this is a genuine moment of transformation--one in which getting the foundations, the rules and resources to support a new kind of economic growth, right will pay enormous dividends. And getting the foundations wrong, failing to properly set the rules and provide the resources, will recoil badly. For in such transformative moments change comes so rapidly that politicians and their advisors trying to shape the future face an almost impossible task. How are they to understand the choices they have and the opportunities available before it is too late to make the right decisions?

Few in Manchester during the industrial revolution, for example, noticed that the British government was not building schools for children of workers migrating in from the countryside to the jobs in the new factories. Yet it was clear to keen-eyed observers that industrial technology was rapidly becoming both closely linked with science and increasingly sophisticated. By the end of the nineteenth century the lack of a well-schooled workforce meant that the post-steam-engine technologies of electricity, metallurgy, and chemistry found themselves much more at home in late nineteenth century Germany--where investments in schools had been made. Thus Britain entered the twentieth century and its half-century death struggle with anti-democratic German regimes having squandered a large initial edge in technology and productivity, because its political leaders hadn't even realized that nurturing the next generation of industrial development required upgrading the literacy and technical skills of the workforce.

But perhaps politicians and their staffs--elite journalists and those who rely on them for their opinions--policy-planners and think-tank experts who rarely venture beyond the Beltway--would have a chance of grasping the nature and significance of this age if we can communicate to them a framework for understanding our "new economy," a consistent thread on which the can hang anecdotes and experiences, and to which they can refer when they need to form opinions on issues of policy.

Framework: The New Economy

That is what we are here to do--to try to lay out a framework for understanding our "new economy" in which we all believe. Ideally the framework should be simple enough to be easily incorporated as a five-minute motivating section in larger briefings, clear enough that a wet-behind-the-ears congressional staffer can gain enough from reading a thirty-five page document to sound sophisticated and knowledgeable, and bullet-proof enough that its hundred-page version can withstand serious critiques without suffering serious damage.

So let's begin. First of all, it is important to note that all kinds of people have been using the phrase "new economy" in all kinds of ways to mean all kinds of things with which we would not agree. For example, the "new economy" is not going to give us permanently low unemployment without inflation. It is not going to give us a world without bear markets. It is not going to eliminate the business cycle.

So it is important to reclaim the phrase "new economy" for what we do believe. The new economy is about a new source--with the potential to become the dominant source--of economic growth. Economic development has become less and less about accumulating more and more physical capital, and more and more about the creation and deployment of intellectual capital. It is science based. But it also includes innovations in business models--many of these innovations made possible by technology. It is about a new style of business entrepreneurship and risk taking that is exploding many of the organizational tactics of business--again a style made possible by new technologies.

Now as this new source of economic growth expands throughout the economy, it is going to need foundations: rules of the marketplace that are consistent with its needs, and resources to fuel its development. Thus the right government policies become important--or at least the wrong government policies become significant obstacles--to the economic transformation. Recall that a little more than a century ago the railroad and the refrigerated boxcar made the Chicago stockyards possible: mass-slaughter the beef in Chicago, ship it dressed to Boston, and undercut local small-scale Boston-area slaughterhouses by a third at the butchershop. Or you could do so unless the Massachusetts legislature required--for "health" and "safety"--that all meat sold in Massachusetts be inspected live and on the hoof by a Massachusetts meat inspector in Massachusetts immediately before slaughter.

Without the right rules--in this case federal preemption of state health and safety regulation affecting interstate commerce--you don't have America's highly efficient Chicago meatpacking industry. Without limited liability you don't get corporations with enough capital to take advantage of the economies of scale available in late nineteenth-century America. As it was then, so it is now. But what, exactly, is the nature of this techno-economic transformation? And what foundations--what rules and resources--are needed to support its full growth and development?

This Transformation

You all have your favorite pieces of evidence of the speed and breadth of this transformation. Take your pick. Some are most impressed with the rapid take-up of the web. Others with the new forms of employment, new approaches to compensation, and new ways of launching enterprises many of which were developed right here. Others are impressed with Moore's Law and Metcalfe's Law--how this time it seems not to be the case that the highest-value uses of new technology are adopted first, or rather this time it seems that the continous explosion in the amount of processing power and the size of the network is constantly bringing new and even higher-value applications of technology within our reach. Still others focus on analogies--to the modern computer network as the equivalent of telephones, telegraphs, radios, televisions, and books all rolled into one, and even more.

The emergence of an "information" economy, the successive clusters of innovation--semiconductors and computers, microprocessors, the net--the reconfiguration of existing economic activities from package delivery to customer support--it is clear that what we have here is not a garden-variety leading sector that greatly amplifies productivity in making some small slice of commodities, but instead a wave of innovation that is going to greatly amplify productivity practically everywhere. Think of Sam Walton as the first network billionaire: Walmart's cost advantage is supposed to have come from purchasing power and economies of distribution, but previous attempts with less sophisticated information technology to take advantage of such economies--think of Federated Department Stores--did not fare well. For me the most impressive statistics is the 20 percent fall in the manufacturing and trade inventory-to-sales ratio since this stage of the last business cycle: better information technology--and pressure from competitors with better information technology--seems to be making a difference everywhere.

Let me highlight that for a moment. It is a commonplace that workers who use computers are more productive, that sites that computerize and network see boosts in productivity, that firms are eager to computerize and network--and yet that aggregate economy-wide productivity shows next to no sign of productivity gains from computerization and networking. And it is rapidly becoming a commonplace that the resolution to this "productivity paradox" lies in our inability to measure changes in the quality of shopping or in the degree of fit between the good bought and the consumer who bought it. Because of the automatic teller machine, people don't have to take sick time to make it to the bank. But that change the Bureau of Labor Statistics's statistical system does not catch. Thus it seems likely that the productivity benefits from computerization and networking are already being distributed extremely widely--that even people who wouldn't know an object method if it bit them are already the substantial beneficiaries of computers-and-networks through lower costs, better quality of service,and more choice.

Let me also highlight that this techno-economic revolution has--so far--proven to be overwhelmingly an American one. The entrepreneurial, risk-loving, independence-rewarding culture of the Americas has proven vastly more effective at sparking innovation and driving through to success than the cultures--loyalty-rewarding, consensus-loving, organization-building--that a decade and a half ago many of us saw as mounting a serious and significant challenge to the United States's role as the leading edge of world technological development.

But it will not stay all-American forever. Consider the success of Finnish wireless innovation. And consider how the European wireless standard offers potential competiive advantages to firms focused on that standard. We have to expect new and unexpected nodes of innovation to emerge from diverse locations--and we have to fear that foreign government decisions about rules and resources will play to foreign competitors' strengths and not to the strengths of America's entrepreneurial, free-wheeling, risk-loving pattern.

So how can we as a nation sustain this transformation, and assure that broad national advantage flows from it? How can companies for which it is genuinely true that what is good for them is good for America educate our political masters to what is at stake?

Through a policy debate. But what should it be about?

Resources and Rules

Fifteen years ago the policy debate had to have a large "macro" component: high deficits that drained the pool of savings and led to high domestic interest rates and a high cost of capital; a high exchange rate generated by high domestic real interest rates that priced U.S. producers out of world markets and foreign producers into U.S. markets. Now--thanks to shrewd changes in congressional operating procedures pushed by George Bush and his team that changed the dynamics of congress, thanks to Bill Clinton's and Alan Greenspan's trade of deficit reduction for more expansionary monetary policy, and thanks to a good deal of luck--we don't have to worry about the macro picture. We don't have an extraordinarily high cost of capital and an extraordinarily overvalued real exchange rate.

So, instead, the debate should be about resources and rules. Resources to sustain innovation and use of these revolutionary technologies. Rules to make sure that competition happens and that competition is constructive.

Resources come in four overlapping categories--human, physical, financial, and intellectual.

Human resources fall into three categories. Elite workers--how to make sure that the U.S. educational system produces the elite scientists and engineers that high-technology industries need (rather than producing hordes of lawyers and MBAs only), and how to make sure that U.S. businesses get the chance to draw on the elite scientists and engineers that our--very good--universities train. Skilled workers--how to reshape our educational systems so that a good chunk of young adults are able to use computers and their technologies as familiar tools. Mass--how to make sure that the skills and orientations necessary to make effective use of computer-driven systems are part of the basic stratum of literacy that everyone acquires. It would be extremely cruel if we developed technologies capable of greatly amplifying human powers of recall, association, calculation, and thought--and then created a large divide which many people could not cross by failing to give them basic experience with how computer systems work.

Physical resources--who is going to build and maintain the network? AT&T has one view of the incentives it needs to provide high-speed service to the last mile. (And they did just install an extra repeater 2/10 of a mile up my private road to--as best as I can see--boost cable signal strength to acceptable levels for a cable modem for one house: mine.) So far this isn't a problem. May it not become one.

Financial resources--cost of capital is not a problem now. Availability of financing for entreprenurial ventures is not a problem now. Financial institutions to properly support Silicon Valley systems of options-based compensation may become a problem.

Intellectual resources--knowledge--investment in research and development--where will the next generation of advances in fundamental knowledge come from? These are very serious questions that are by and large not debated enough in Washington.

In addition to resources there are rules: taxes, management of the network backbone, access to the "last mile," privacy, legal reform--modernizing adjudication--making sure that separate sets of rules made by nations jealous of their sovereignty do not hinder a globally interoperable network--making sure that rules abroad do not disadvantage American competitors.

Last, but surely not least, every transformation has winners and losers. There are people whose lives are disrupted--whose economic niches disappear. Many times the winners do not realize that they are the winners from change. But the losers always realize that they are the losers. Government policies to create the right kind of resources and rules will be stable and sustainable only if politicians believe that they are genuinely acting in the public interest--rather than doing favors for a particular sector that is making life difficult for numbers of their constituents. So the debate must make sure that the winners know that they are winners--that their ATM cards would not work without fast routers--and must make sure that the losers are cushioned by what must be an inclusionary economy.


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Comment on this page...

Do you have a perspective to offer? Please contribute it. If the web does change the world, it will do so only by increasing the bandwidth of communication--by automatically combining the intelligent thoughts of many people. Eric Raymond has claimed that as far as writing software is concerned, "with enough eyeballs, all bugs are shallow." It may well be true for the rest of the fields of human endeavor as well...

Articles are very informative and invigorative. I'm interested in impact of information technology on economy. How economic forces are going to interact and what new economic forces will emerge.

I'm a student at Indian Institute of Management,Ahmedabad,India.

Contributed by Sunil Kumar Rajak ( on January 27, 2001.

I am very impressed. I have never seen such kind of online education before on the webpage of a Professor. I saw this site by coincidence.I will apply to Phd program in economics, and according to the application materials, I need to provide the names of some professors who I am interested. Therefore, I was looking for your articles to understand your main area of interest. But your home page attracted my attention. Hence, I wanted to make a comment about it. Since internet is widely used, online education can be an effective way of teaching. I believe there is a high correletion between the development of economics and technology and this correlation is increasing at an increasing rate. I hope you continue this methodology.

Contributed by Bilgehan Karabay ( on November 25, 1999.

An important piece of the infrastructure of this new economy is not finished: the Internet. As the Elite, or even just Skilled, workers of the academic world are drawn into commercial enterprises, who will be left to contribute the science--algorithms, protocols, & architectures--to move the Internet to the next level? Will the global E-commerce infrastructure be designed and sold by Microsoft, Cisco and IBM? Should or can government focus investments to realize a digital infrastructure supporting an open market for goods and services?

I think there is a role for governments and academia to play, like they did in the creation of the original DARPA-funded Internet. I'm just not sure what it is. Your framework and associated debate might help.

Contributed by G Mahoney ( on April 23, 2000.

There has to be an important role for governments and academia--and private-sector open-source--to play. I'm trying to think about what it is...

Contributed by Brad DeLong ( on April 23, 2000.

Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
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