Reasons to hope for growth

Editor's note:

After a whipsaw summer – consider nearly 40 one-day swings of 200 points or more on the Dow – welcome to the bad old September slide.

This back-to-business month is notoriously downbeat for the stock market. For September 2002, add war worries over Iraq and more confidence-rocking ripples from corporate scandals – and stand back. What's next?

Economists keep working to reconcile offsetting indicators – a rise in gross domestic product brings cheers. An unemployment rise brings us back to earth. Wait! Unemployment is down.

And investors can be forgiven for rethinking the idea of tying their financial futures too closely to the performance of firms that – as became clear in the '90s – aren't always what they appear.

What to do? Look for context. Today's lead story looks past Wall Street's wildness to gauge the New Economy's real legacy as investors adjust to a post-boom era. Follow-up stories will look at its long-term implications for workers and consumers.

- By Clayton Collins

Rooting for the New Economy these days is like yelling in an empty stadium: The players have all gone home. The fans have vowed never to watch again. Even the season-ticket holders are cashing in their seats for pennies on the dollar.

So why cheer amid such deafening silence?

Because something is transforming America's economy. And it looks increasingly like one of those periods when new technology permanently bolsters living standards.

Of course, investors have heard all this before – from brokers peddling stock that's now nearly worthless. Oddly, that's a positive sign. Dramatic technological change has often spawned investment booms and busts. But each time, they've heralded the beginning – not the end – of an important leap forward.

That's why, more than ever, it's crucial for investors – particularly those just starting out – to think long term. Those who glimpse the shape and pace of things to come will be far better placed to profit than the dotcom-chasers of yesteryear.

"The crash is not the end of the technology revolution; it's really the beginning of its glory days," says W. Brian Arthur, economist at Santa Fe Institute in Santa Fe, N.M. "After the crash, the technology stops being glamorous. It loses its glitz, its cachet. And we settle into a period of hard work."

And that is precisely the era we're entering, he argues: sober, growth-oriented, and quietly setting the stage for new industries not yet conceived.

Unconvinced? Take a stroll down memory lane.

At the start of the Industrial Revolution, Britons began to get excited about using canals to ship bulk goods like coal. They poured in money with increasing abandon and, in 1793, the canal-building boom crashed.

In 1845, they piled in again, this time with railroads. Companies floated new plans for railway lines, sometimes a dozen or more a week, and eager investors temporarily ignored the growing overcapacity.

Then the bottom fell out, and by 1847, hundreds of companies had closed and railroad stocks had lost 85 percent of their value.

That's eerily similar to the recent telecom crash, where companies installed too many fiber-optic telephone lines for too few customers.

An Internet joke now making the rounds points out that people who bought $1,000 worth of beer a year ago and returned the empty cans for a 10-cent deposit would still have more money left ($214) than those who plunged $1,000 into Nortel stock (now worth about $165) or that of WorldCom ($9.23).

The point, however, is what happens after the crash. Historically, Mr. Arthur points out, canal and railroad companies continued to extend their networks and, slowly, traffic increased.

By 1910, Britain sported nearly 10 times the trackage that had stoked the investment frenzy 65 years earlier.

Now, fast-forward to today and answer three questions:

Do you know anyone using e-mail less frequently than two years ago?

Have any of your friends turned in a cell- phone because it's a dead-end technology?

Have you unplugged your computer because, after all, the digital revolution is over?

Most people will probably answer no. The crash of telecom and dotcom stocks didn't reveal a flaw in the technology. It simply overestimated – probably by a decade or two – the speed with which society would adopt it widely. And it probably underestimated the full impact such technology will have on society.

"To think that this revolution is about dotcom companies is to stand on a whale and fish for minnows," says Paul Saffo, director of Institute for the Future in Menlo Park, Calif. "It's not just about making new things. It's about creating new tools that allow us to make new things."

For example: Many of the genetic therapies now being developed stem directly from the mapping of the human genome, which could not have been accomplished without computers. And it's not limited to new industries.

"The information revolution has been affecting manufacturing, trucking, financial services, and all the things that people were doing before," says Alice Rivlin, former vice chairman of the Federal Reserve and now professor at New School University in New York City. "It's a very profound change in how economic activities are carried out and organized. And it doesn't have a lot to do with buying things over the Internet."

While economists and others disagree about how revolutionary this period will ultimately turn out to be, they have nevertheless formed a rough consensus around two points.

First, productivity looks to be growing faster today, even during the economic slump, than in the 1970s and '80s. Second, information technology is playing some role in accelerating that growth.

For instance, from 1973 to 1995, US nonfarm workers got only a little more efficient each year – an unspectacular average of 1.4 percent. But since then, their productivity growth has jumped to nearly 2.4 percent a year, points out Martin Baily, senior fellow at the Institute for International Economics in Washington. Why?

Certainly the boom of the late '90s played an important role – and that part of the growth equation has since disappeared. The surprise is that productivity continues to grow despite the slump.

Last year's 1.1 percent might look pretty shabby, but it's far better than the 0.6 percent decline averaged during the previous four recessions, Mr. Baily points out. When the economy revives, he expects the growth to snap back to a sustainable 2 to 2.5 percent per year.

Not everyone believes in the New Economy. "The new technologies do improve our standard of life, of course, but I don't see any reason to think that they give us a structural improvement in the rate of productivity growth over the period ahead," says James K. Galbraith, chair of government and business relations at the University of Texas in Austin. "The optimist in me says we'll have stagnation. The pessimist in me says it will loop into another recession."

Still, many skeptics seem to be warming to the idea of a tech-enhanced, more productive period that lies ahead. Its economic impact alone could be huge.

If the United States' economy grows half a percentage point faster than it did in the period 1975-95, it would allow workers' wages to rise faster without triggering inflation, says Dean Baker, co- director of the Center for Economic and Policy Research, a think tank in Washington.

And future financial claims on society – the extra burden from increased Social Security spending, for example – would be eased or erased by a sustained growth spurt, he points out.

What investors can learn from all this boils down to two things: patience and diversification. For starters, let go of those fanciful dreams of a '90s-style sharp rebound in the stock market. All those 20 to 40 percent annual investment gains really were part of an unsustainable bubble, economists say.

"We're looking at a very weak economy going forward," Mr. Baker says. "This is a cyclical phenomenon, but it could be a very long-lasting cyclical phenomenon."

Second, watch old-line companies – not just those in glitzy new industries – to see the innovative ways in which they implement technology. "Look for the companies that can reinvent the whole nature of their business," says Mr. Saffo of the Institute for the Future. "That's where the short-term opportunities are."

Long term, prepare for long, slow, consistent growth fostered by new industries we haven't even dreamed up yet.

History suggests there's a 40- to 50-year lag between an invention and its widespread use, says Arthur of the Santa Fe Institute.

Railroads were operating in the 1830s but didn't reach their golden age until the 1870s and '80s.

The electric motor, commercially available in the early 1880s, became common in the 1920s.

If history is any guide, it will take a similar period for business and society to fully adapt to today's collection of information technologies – the Internet (invented 1969), microprocessors (1971), and cheap lasers (the '80s).

"Nobody knows what the business organization of the future will look like," Arthur says. "And it's going to take two or three decades of experimentation until that will work itself out. But this revolution will be as big as the Industrial Revolution – and may even be bigger."