Forgotten, But Not Gone Remember Y2K? Three years ago at this time, there was a virtual frenzy in corporate America and the halls of government over the fear that a “millennium bug” in our computer systems would wreak all sorts of havoc on civilization as we knew it. It was the leading topic of conversation in boardrooms and at cocktail parties for months on end. It was, for a time, our grand obsession.
On a somewhat more serious note, literally trillions of dollars were spent around the world; long-retired Fortran and Cobol programmers were pressed into service and every little gadget you bought had a “Y2K Compliant” sticker on it (I wore one on my shirt for a few days just so there would be no doubt). Major industries and agencies were required to certify that they had fixed any potential problems (essentially an impossible task). I was a member of some sort of governmental Y2K Task Force and prepared a major economic impact study on the subject.
It’s hard to believe that all of the hoopla was such a short while ago. So much has happened since then that none of us give it a second thought. But, alas, we should.
Believe it or not, it appears to me that Y2K is playing a not inconsequential role in the sluggishness of our national economic recovery. My logic is quite simple. One of the impacts that Y2K had was to markedly accelerate capital expenditures in 1999. We knew at the time that in many instances this spurt in investment was going to be at the expense of future years. A similar and understandable inventory buildup also occurred as the curtain closed on the twentieth century.
While there were no great catastrophes to mar our celebrations of a new millennium (I know, in the wrong year), there are at least three phenomena from the Y2K hysteria which still linger. First, the burst in investment served to convince the Federal Reserve (and almost no one else) that the economy was overheating. The response was aggressive increases in interest rates far beyond what was necessary to keep inflation in check (we won’t mention the fact that there hadn’t been any significant inflation in the economy for years before that). That policy stance backfired as business activity slowed a year or so later and not even eleven straight rate cuts would get things moving.
Second, the huge amount of 1999 investment (buying everything now instead of later just in case Y2K craters your old stuff) left the corporate sector with limited flexibility. Capital budgets were cut for 2000 and 2001, and the short-term productivity benefits were not commensurate with the enormity of the outlays (somewhat comparable to the current spending for heightened security, but at a much greater magnitude). As the economy slowed in 2001, the capital mix was not suited to the needs of major firms. Add September 11 and the recent stock scandals to the equation, and you create a difficult environment for stimulating meaningful growth.
Third, many of the purchases associated with Y2K were computers, telecommunications equipment, and other microchip-laden products. Capacity was expanded in these sectors, with the expectation that exploding global demand would keep orders flowing. Weakness around the world has delayed this digital deluge, and manufacturers are dealing with too much plant (and debt).
Fortunately for all of us, the Y2K scare proved to be much ado about nothing. The hype was way overblown. Nonetheless, amid all of that smoke there were at least a few embers of fire which are only now beginning to flame. The current economic slowdown is being complicated, lengthened, and intensified by that silly little bug that nobody even thinks about any more. It may be forgotten, but it is definitely not gone.
War -- Again Over the past few months, I have written about the economic prospects associated with various potential disruptions in the Middle East and elsewhere. The topic of the moment is, of course, a war with Iraq. As is my custom, I will avoid the temptation to express any views one way or the other on the merits of such a conflict. I decided a long time ago to restrict my public comments on policy issues to things economic (unless it somehow relates to baseball).
There are obviously multiple outcomes that are possible, but a few conclusions are apparent. Whenever there is uncertainty or instability in the world, there is a flight to safety among investors. Treasury bonds will be popular, thus impacting interest rates to a modest extent. The Federal Reserve will work to continue its pattern of monetary ease, which coupled with a sluggish private market should keep interest rates low.
Oil prices already have a “risk premium” built into them. In all likelihood, any invasion of Iraq will not significantly impact world oil supplies. There are several mechanisms to make up for any lost quantities that might reasonably be expected, and current production capacity has a considerable surplus. (There is, of course, a doomsday scenario in which all of the Middle East removes petroleum from the market in protest of any invasion. The cost of such a move to the countries involved would be astronomical in many cases, so I doubt that is a real threat. The other one is the destruction of significant production capacity, again not impossible, but the chances are remote.) I suspect that the real impact on oil prices will be minimal, at the most a (very) temporary spike followed by a return to prices in the mid-$20s per barrel range. Such a pattern is similar to that observed following the invasion in the early 1990s and will not make a huge difference in inflation.
Another issue is the growing budget deficit of the US government. A sluggish economy, a big tax cut, and new spending on terrorism and security have rapidly transformed the fiscal situation from one of substantial surplus to one of substantial deficit. It appears that a war with Iraq would not take too long, as it is akin to a battle between the New York Yankees and a decent high school team. Nonetheless, it will be expensive, and the need for an ongoing presence will persist for quite some time. While the impact on the budget will hardly be devastating, a war with Iraq will likely cost $100-$200 billion over time, will further limit the ability to achieve balance, and will crimp private sector borrowing and investment capacity as the economic recovery begins (not a good thing). It will also reduce the potential to meet other pressing needs in such areas as healthcare, transportation, and security.
In short, on the issues that people usually discuss, the effects are notable but not dramatic. Interest rates, oil prices, and inflation will likely see only minor impacts; the federal budget will be affected a bit more, but not beyond the bounds of reason. The bigger issue is the aftermath of the war itself. If a stable government emerges and overall Middle East tensions are lessened, significant benefits can occur. The world petroleum situation will settle down to some extent, and the US could probably add new and stronger trading partners for our massive output capacity. An accelerated domestic energy policy could also generate substantial gains while preserving environmental integrity. On the other hand, if a war leaves the region more uncertain than it is now, ongoing economic dislocations will limit expansion potential throughout the world for decades to come.
The biggest wild card is, as is becoming all too common in economics these days, psychological. How will consumers and investors react? There is no doubt that we have been a bit skittish of late; terrorism and corporate scandals have taken their toll. The smart money is on a temporary (but potentially sharp) adverse reaction that is quickly reversed as the reality of American military superiority surfaces.
To sum up, on purely economic grounds, a war with Iraq will likely have measurable but modest consequences for business activity. Its implications in other areas may well be far more extensive. From my perspective, the most important factor for the economy is that we work toward a more favorable environment in the region after it is behind us, whatever “it” is.
A Prescription for Employment Expansion I often hear concerns about the fact that our recent seeming onset of modest growth is not being accompanied by increases in employment. In other words, we’re experiencing a “jobless recovery.”
Why is that occurring? First of all, we enjoyed such a significant economic expansion in the 1990s that some of our inefficiencies were masked by strong revenue growth and a general trend of increasing profits and output per worker. Now that the frenetic pace of the last decade has slowed, firms are beginning to tidy up their operations. The result is layoffs and staff reductions.
A second factor at play in the job situation is the ongoing impact of globalization on several low-tech, low-wage sectors. As trade becomes more open, production will and should gravitate to areas with comparative advantages. Few would regard it as a bad thing that our domestic business complex doesn’t sustain jobs for which the world market wage is less than $1.00 per hour.
A third factor in this mix derives from the sheer strength and endurance of the last expansion. Many sectors, buoyed by low interest rates and Wall Street creativity, as well as by expectations that new capital would be plentiful and good times would last forever, increased their capacity substantially. Some even enhanced their production capabilities at rates well beyond what will be needed in the near future. Thus, when the economy became sluggish, the debt burdens became oppressive.
The tragic events of September 11 also caused additional declines in demand, making the problem even worse and fueling a comparable retrenchment in the retail sector.
So what’s the prescription for expanding job opportunities?
Let’s face it. We are a high-tech, high-wage economy, and we are dependent on global demand for our growth and prosperity. Our ability to perpetually sustain prosperity requires that we constantly discover and implement original ideas.
We must adequately fund and reward the basic research that leads to innovation. The key breakthroughs responsible for much of the economic prosperity of the post-War era originally grew out of government-supported basic research. It is a public good and is essential to our ability to create jobs on an ongoing basis.
Continuing access to the capital resources needed to implement technology, build large plants, and spur a steady stream of investment is vital. And we must have policies to spur investment—investment tax credits, accelerated depreciation, research and development incentives.
In addition, it is imperative that the corporate accountability issue be resolved. It is highly unlikely that corporations will be willing to undertake major investment initiatives in the current environment of market uncertainty. Reliable information is one of the requirements for a market to function effectively. When investors lack confidence in the numbers, they’re not going to put their hard-earned money into the game; at that point, the whole structure breaks down.
Rigorously enforcing existing safeguards is important, of course. Over-regulation, however, is not. Recent reforms and the markets own capacity to discipline companies through the performance of their stock will go a long way toward resolving this issue. It is critical to reassure the investing public that the recent debacle was an aberration and not endemic to the entire market. They must also feel confident that a lot of folks are really trying to get it right.
The final prescription for promoting our high-tech, high-wage economy is adequate education and job training opportunities. While there will continue to be jobs at the low end of the skills spectrum (primarily in the services sector), employment requirements in virtually all industries will increase in the future. In fact, emerging sectors such as biotechnology, nanotechnology, moletronics, genomics, smart materials, alternative energy, and others we haven’t even thought of yet, can only be sustained by highly trained scientists, engineers, and sophisticated technical workers. Federal, state, and local initiatives in this regard must be flexible to meet ever-changing needs.
The methods I’ve suggested are not overnight panaceas, but they do suggest a rational way to have meaningful employment growth and opportunity as our economic engine revs up and moves forward.
September 11 -- An Economic Retrospective Like most of you, I was stunned, horrified, and deeply saddened by the events this past September 11. There haven’t been many times in the past quarter-century when my thoughts didn’t at least partially drift toward things economic, but such matters were far from my mind that fateful day as I sat riveted to the tube the remainder of the morning as one shocking event after another unfolded. I was frankly amazed that before the first building fell, my phone rang with a reporter wanting to know what impact these events would have on the economy. I soon discovered that I had better get used to it—that even in the midst of the horrific tragedy, questions about the economic fallout needed to be asked and answered. I fielded several hundred such calls over the next few days.
Looking back about a year later, it is safe to say that no corner of the world went unscathed. The short-term effects were without a doubt negative, though I believe some of the ultimate economic impacts will be positive (there is, of course, nothing positive about the tragic human effects).
What have we learned thus far? Perhaps the most encouraging thing we know is that our fundamental institutions are strong. Despite close proximity and massive damage, the markets opened the next week without a hitch. To be sure, stock prices fell sharply in the wake of the unprecedented uncertainty and the obvious negative impacts on some sectors (such as airlines). The important thing, however, was not the value of the Dow; it was the simple fact that the markets opened and functioned as they should have, accurately reflecting equity values as they were perceived by investors at the time. That is as it should be. Within a few weeks, the overall market had indeed surpassed its September 10 levels with only those sectors with genuine damage to their long-range prospects being left behind. (The subsequent drops in the major stock indices to levels below those immediately following the attacks are clearly attributable to largely unrelated factors, most notably the corporate scandals and their effects on the perceived integrity of market information.)
Another remarkable feat was the emergence of positive economic growth in the fourth quarter of 2001, just weeks after the attacks. I, not uncharacteristically, was an optimist relative to many of my colleagues and predicted increases in the first quarter. But no one believed it could happen as soon as it did. In fact, subsequent data revisions have shown us that overall business activity has actually been much better since September 11 then it was in the prior three quarters.
That is certainly not to say that these events and their aftermath haven’t taken their toll on economic conditions. In their absence, current momentum would have been much stronger. Costs have increased due to security concerns, both in the public and private sectors and the resulting war effort has adversely impacted the federal budget. The extra security has reduced efficiency and productivity in measurable ways. Our analysis indicates that the rate of expansion in gross domestic product is 0.3-0.5% less than it would have been, therefore dampening the momentum and resiliency of the recovery. Viewed more formally, September 11 has added a subtle risk premium to many aspects of our lives (economic and otherwise).
Over a more extended time period, accelerated cooperation among nations, refocusing priorities, new incentives for research and development to solve security problems, and a greater emphasis on our culture are but a few of the many reasons to expect net economic gains from our national tragedy. In the interim, deal realistically with the challenges, recognize the opportunities, and revel in the underlying strength of our national economy and its institutions.