In the late 1990s, everything was going to be different. After decades of trial and error, business organizations had finally worked out how to benefit from information and communication technology (ICT), and that technology itself was (and still is) improving to the tune of Moore's Law.
All this was going to result in the end of the business cycle, lower inflation, increasing productivity growth and greater economic spoils for just about everyone, heralding a new era of prosperity. Instead, we got the dot-com crisis and then the financial crisis, so was this talk about a 'new economy' nonsense? Actually a lot of troubles arrived exactly because much of these predictions actually materialized.
Higher economic growth
Organizations finally figured out how to benefit from ICT, by using practices such as business process re-engineering (BPR), installing enterprise resource software (ERM), creating flatter hierarchies, devolving power to the front line, empowering employees with information (coming out of systems like customer relation management software and the like). There was indeed a significant uptick in productivity figures from the mid 1990s onward.
If labor is more productive, it can also earn higher wages without creating inflation and this is indeed what happened (albeit for a relatively brief period), turning around the trend of stagnating median wages.
The end of the business cycle
A more productive economy can grow faster without unleashing inflation. This reduces the need for the central bank slamming on the breaks to stop inflation in its track. Not many people might believe it, but prior to 2000, most recessions were actually deliberately caused by the Fed in order to cool the economy and combat inflation.
Also, better inventory management with the help of smart information management tools (like supply chain management software systems) and practices (like just-in-time inventory management systems), reduced the incidence of recessions further. Large swings in inventories and the ripple effect they cause down the supply chain used to be another important factor besides the Fed that caused recessions.
The prospect was not only that the economy could grow significantly faster without causing inflation, but also that much of the traditional business cycle was tamed.
What went wrong?
Well, with hindsight, much of this actually happened, but this unleashed other, more destructive forces. Rises in productivity started the Fed to worry about deflation, rather than inflation. The low interest rates that were a result of that contributed to a huge asset price bubble (the dot.com bubble) that was driving on hopes that 'this time would be different.'
So instead of the traditional business cycle, we got the familiar 19th century debt deflationary cycle. But this cycle was made significantly worse because the belief in markets, financial markets especially, had reached rather unrealistic levels. People mistakenly thought that financial markets could do away with a lot of regulation. This enabled big parties to devise all kinds of extremely complex products, which traded on hardly regulated markets. Shifting stuff off their balance sheets into these synthetic products allowed them to rinse and repeat.
Most wage earners experienced stagnating wages that fell increasingly behind rising productivity and borrowed against rising asset prices to join in the increased prosperity.
For a while, all those complex products made for a highly profitable business (for the originators), but this couldn't last when the underlying assets started to fall and the whole thing blew up in our faces.
Now, there isn't much of a direct connection between the 'new' economy and the 2008 financial crisis, but one direct line is to the low interest rates the Fed, worrying more about deflation, brought about by the 'new' economy.
But the low Fed interest rates were as much a result of the dot.com crisis and the need to reflate the financial system after that, as the financial system held the economy hostage. Implosion of big financial institutions would create such dramatic negative consequences for the economy that the alternative was better.
What a wasted opportunity this is..
The 'new' economy was real. It still is. The advances in ICT are real and the manifold ways in which business organizations have taken advantage of these are also real. We could have had an excellent economy had we not deregulated the financial markets and let the financial sector hold the economy hostage. The really curious thing is, we still don't seem to have learned that lesson. Or perhaps the financial sector simply has way too much clout.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
