New Economy: Is it real or a mirage?

The US economy has been enjoying a nine-year-long boom, puzzling many observers whether this unprecedented expansion is going to last longer or will soon fizzle out. This is an important question for us as well, because Korea's economy is now closely aligned to the US economy.


Optimists claim today's economy is fundamentally different from the industrial economy based on smokestack manufacturers. So, they say, there is no longer a "business cycle" that will regularly visit every five or so years, and that the current boom can continue without triggering inflation.


Under business cycles of the past, companies had to hire more workers, buy more raw materials and build bigger factories when the economy was humming along. This spurt in business expansion led to higher wages and prices which in turn caused inflation. Then as inflation rose, businesses had to cut back on investment in response to declining purchasing power and demand, which caused recession with high unemployment. For this reason, the rate of inflation and unemployment rate had an inverse relationship as indicated by the so-called Phillips Curve.


The optimists argue that the Information Revolution now sweeping through the world has changed all that. Today, companies wanting to increase their output do not have to hire more workers. Instead, they boost workers' productivity by investing heavily on technology and finding more efficient ways to work. Higher productivity enables employers to pay higher wages and still make decent profits. Productivity-led growth does not necessarily lead to higher prices; expansion can continue unchecked, unless the pool of prospective workers runs out which would bid up wages.


Globalization played a part in this fundamental change. Until now, domestic companies looking to expand had to procure their materials mainly from local suppliers and to recruit new hires from the local labor market. When demands were high, suppliers and workers alike could have more bargaining power, bidding up their prices. Higher input prices--including wages--would be passed on to consumer prices, thus fueling economy-wide inflation.


These days, however, thanks to the diffusion of Internet commerce and development of sophisticated inventory management tools, a domestic company can order parts and components from a foreign supplier at lower costs with reasonable delivery time. When a company needs more workers, it can outsource the entire project to a foreign contractor employing workers at a fraction of what the company pays domestically. So, according to the argument, there is no reason to believe continued expansion will put a strain on domestic resources and lead to inflation.


One implication of this argument is that the US Federal Reserve's concerns about the overheating economy and raising of interest rates to forestall inflationary threats are overblown. Higher interest rates, according to this optimistic view, would only dissipate the steam gathering for further growth.


This is what the 'New Economy' argument is all about. One proponent who writes frequently on the subject, Michael Mandel of Business Week, recently declared the New Economy's victory over conventional economics in an article entitled "How most economists missed the boat." Immediately after the publication, The Economist of Britain carried an article refuting Mandel's proclamation.


In its article, The Economist disputes the existence of the New Economy by citing a work by Robert Gordon, a macroeconomist specializing in productivity issues. The main point of this article is that only half the productivity increase since 1995 can be accounted for by higher productivity in computers and software; the rest came from cyclical factors and measurement errors. So, the Economist argues, there is no definitive evidence that the US economy is undergoing any structural change toward a totally new system which would be immune to business cycles.


What The Economist article missed in its attack, however, is the fact that info-tech industries have a high spillover effect, meaning that investment in these sectors can create more growth and jobs in other parts of the economy. In addition, information technology is not only affecting the industry that invented it, but permeates through every part of every industry that adopt the technology.


For example, many old-line manufacturing industries such as steel, chemical and machinery are spending heavily on software that seamlessly connects different offices within an organization, allowing quicker decisions based on better information. The demand for enterprise resource planning, one type of software doing just that, is on the rise among these otherwise traditional companies.


It is our view, as well as Business Week's, that the economy is going through a fundamental transformation that defies any conventional categorization of inflation-unemployment tradeoff. However, some caution may be in order. The business cycle is not going to disappear, but it will become milder and have longer intervals, giving extra maneuvering room for policymakers.


What does this New Economy debate have to do with Korea? It has significant relevance to the nation's economy in two respects.


For one thing, the Korean economy may be going through the same kind of change that the US economy has gone through, so we have to revise our thinking about the basic workings of the economy and policy prescriptions.


It is true that the share of Korea's info-tech industries--as defined by info-tech equipment, services and software--took 11.6 percent of GDP in 1998, surpassing the comparable figure in the US of 8.1 percent in the same year. It does not, however, necessarily mean the nation has matured into a New Economy. The figures only show the share of high-tech components, mostly memory semiconductors, is unusually high at 58 percent of the total info-tech revenues. Although a small pocket of the nation's economy is highly advanced, remaining sectors are still in a developing state. Under these circumstances, it is much too early to say that the Korean economy belongs to the New Economy and that economic policies should be changed accordingly.


Another aspect we must consider, while discussing the argument in the Korean context, is that this country's economy and its financial markets are increasingly moving in sync with their counterparts in the US. In that sense, the health of the US economy is of critical importance to us. Whether the current expansion will continue should be closely monitored by Korean observers. That is why we should watch the Fed chairman's every comment on the state of the economy and on interest rate trends.