U.S. Department of the Treasury

(Archived Content)

FROM THE OFFICE OF PUBLIC AFFAIRS

I'm glad to have this chance to talk with you again. As Treasury Secretary I usually discuss the current state of the business cycle, financial markets and the government's budget. Today I want to reflect for a few moments on the longer term challenges facing our new economy.

I am taking this approach because I am convinced that in the next five years we are going to make a more consequential set of choices for our country than in any five year period since World War II:

• About how we manage trillions of dollars of budget surpluses now in prospect, at a time when the return to private investment is higher than it has been in many years and the baby boom generation is nearing retirement.
• About how we manage a global economy in an era that is still defined by what it follows - as in the post Cold War era - rather than what it is, and an era in which the industrial and the developing world are coming together at an unprecedented rate.
• About how we define the institutions of a market economy for the information revolution - just as we defined the institutions of a market economy for the industrial revolution more than a century ago.

To respond to these challenges in the right way we need to start with two fundamental questions:

• First, what is it that is new about the new economy?
• Second, what should be the broad elements of a national economic strategy for taking advantage of the opportunities that a new economy presents?

1. What is New About the New Economy

   The new economy is both palpable and amorphous - more often declared than defined. But if there is one fundamental change at its heart it must be the move from an economy based on the production of physical goods to an economy based on the production and application of knowledge.

   Of course, the switch from old to new is one that is taking place gradually over time. But there can be little question that the role of knowledge goods is increasing relative to traditional industrial goods. In this sense, our new economy becomes ever newer - both because of progress in new industries and because of the replacement of old industrial output with new.

   This has implications for the nature of economic value, and for the structure and dynamics of markets and what it means to say that a market is efficient. Let me say a little about these two inter-related changes before considering the implications for our nation's economic policy.

   A new source of value

   It used to be that value resided in the mass of what was produced - as with an ingot of iron or a barrel of oil or a bushel of wheat. But increasingly today the canonical product is a gene sequence, a line of computer code or a logo. As Chairman Greenspan has so often emphasized, in such a world, goods are increasingly valued for the knowledge that is embodied in them rather than for their physical weight. And as we all know from our own experiences, the amount we can contribute to our economy, and the amount our economy is prepared to compensate us for our efforts, now have more to do with how much we know than with how much we can lift.

   Nearly 200 years ago, Thomas Jefferson famously captured some of the uniqueness of information as an economic good: He who receives an idea from me, receives instruction himself without lessening mine; as he who lights his taper at mine, receives light without darkening me. That insight must carry even greater salience today. Except that for many of today's innovations, often the very brightness of the candle will depend on how many are there to enjoy it.

   An information-based world is one in which more of the goods that are produced will have the character of pharmaceuticals or books or records, in that they involve very large fixed costs and much smaller marginal costs. And it is one in which networks effects will be much more pervasive. Think about a lonely fax machine; it is a hunk of metal that is best used as a door stop. Now think about 100,000 fax machines; that is 10 billion possible connections.

   A new market dynamic

   The greater salience of these characteristics has crucial implications for business and for the functioning of the economy as a whole.

   For one thing, it means that the only incentive to produce anything is the possession of temporary monopoly power - because without that power the price will be bid down to marginal cost and the high initial fixed costs cannot be recouped. So the constant pursuit of that monopoly power becomes the central driving thrust of the new economy. And the creative destruction that results from all that striving becomes the essential spur of economic growth. In that sense, if the agricultural and industrial economies were Smithian - the new economy is Schumpeterian

   The same characteristics also mean that what engineers call positive feedback, philosophers call self-fulfilling prophesies, and what others call rolling snowball effects are increasingly important.

   The old economy is a negative feedback economy. Consider the classic Smithian model of wheat: when prices rise, farmers produce more, consumers buy less, and equilibrium is restored at a lower level of demand. By contrast, the information economy will increasingly be a positive feedback economy: one in which rising demand drives higher efficiency and higher returns, drives lower prices and yet higher demand. In such a world, the avalanche, rather than the thermostat, becomes the more attractive metaphor for economic policy.

   Another way to capture the distinction would be that the traditional industrial economy was a Newtonian system checks and balances, in which disequilibria of demand and supply arose, only to be equilibrated by adjusting prices. While the right metaphors for the new economy are more Darwinian, with the fittest surviving, the winner frequently taking all, and, as modern Darwinians have come to understand, accidents of history casting long and consequential shadows.

2. Keeping it Going: the Right Strategy for a New Economy

Clearly the United States has benefited enormously from these developments - or what Vice-President Gore has called the information technology supply shock. Consider:

• With the oil shock of the 1970s web saw a sharp price increase in a sector that was important to many other parts of the economy - and everything bad happened. Inflation went up, productivity growth slowed, unemployment rose sharply and the economy went into decline. The result was a new term of art - stagflation - and a long period of diminished expectations.
• Information technology in the 1990s is the mirror image of what oil was in the 1970's. The relative price has not gone up, it has gone down. And the consequence has been accelerated productivity growth, lower unemployment, lower inflation and enormous benefits to our country.

This shock has had a great deal to do with our current economic success. But it would be a grave mistake to assume that it all goes forward automatically. There have been other moments in our history when new technologies were doing great things to our economy; when our economy was more successful than it had ever been; and when new wealth was being created at unprecedented rates. One of those times was the 1920s.

In that sense the new economy will need constantly to be renewed. And that will only happen on the basis of old values.

Let me highlight five core elements of the strategy that that we have followed and that we propose for the future and how they relate to the needs of the new economy.

The advent of a new economy fundamentally changes the stakes involved in the choice of our nation's fiscal policy. When there was less that was profitable to invest in, budget deficits that crowded out private investments were a smaller problem. When financial markets were less sophisticated less able to move forward and compute the consequences of future fiscal actions for today's long-term interest rates, prospective deficits were less bad and prospective surpluses less good. In a world that is rich with investment opportunities, and where investors are all able instantly to compute the implications of changes of policies five and ten years out - the importance of running a surplus and pursuing prudent policies becomes much, much greater.

That is why we believe there is a compelling argument for setting, as a medium term goal, the elimination of the net debt held by the public. Like tax cuts, reducing publicly held debt also delivers substantial direct benefits to the pocket books of American families: both by reducing the burden of future payments on interest and principal, and by helping mortgage holders by putting downward pressure on long-term interest rates.

The crucial point is that debt reduction can provide these kinds of benefits to American families in a way that will also support the long-term strength of our economy at a time when the return on investment is probably greater than it has been in a very long time. The bottom line is that the more we save through debt reduction, the more that America's businesses will be able to invest in the technologies that will shape our future.

The most robust empirical finding about the new economy is that the return on investment in human capital has risen faster than the return on investment in physical capital. If investments in factories were the most important investments in the industrial age - the most important investments in an information age are surely investments in the human brain.

We have an enormous opportunity now to perpetuate our prosperity in a knowledge-based economy by increasing our investments in the users and producers of information - and the most important contribution we can make is in education. The digital divide is a very important problem in America. And the greatest source of the digital divide is the inability to read.

• My children are fortunate enough to attend public schools with good teachers and good facilities. All kids should have those same opportunities. They should not be in schools where the classrooms are converted closets; where lunch begins at 9:45 because facilities are inadequate to serve all kids; and when the average elementary school is now 60 years old. That is why school construction is so high on the Administration's agenda.
• One million teachers will retire in the next decade. To replace these teachers with the kinds of teachers we want, we need to make teaching a valued and honored profession and to pay our teachers well.

These investments will be absolutely critical to our nation's future in a post-industrial age. They are especially important at a time when jobs are looking for people as much as people are looking for jobs. A strong economy is a good thing - unless, that is, you are trying to hire skilled teachers or staff a well-functioning military.

Just as orphan drugs cost much more than drugs with a larger market, and bestsellers cost much less than academic monographs - when a market is driven by a positive feedback, its efficiency will be directly related to its size. Success will breed success, because it increases efficiency and reduces costs by involving larger networks and by achieving larger production lines over which to amortize the high initial fixed cost. And getting the good lines going and maintaining a high yield of growth will generate cascading benefits.

The crucial implication for those of us in government is that policies that help to expand the size of markets in any way become that much more important:

• Deregulation becomes that much more important, to ensure that government is not preventing or distorting the development of fast-growing markets. That is why passing the Telecommunications Act was important. And it is why we worked so hard to pass the right kind of Financial Modernization legislation last year.
• Support for international trade becomes that much more important - because it enables us to take better advantage of the new economies of scale; it allows networks to be larger; and it allows more value to reside in those networks. In that sense it is perhaps only a slight exaggeration to say that the importance of comparative advantage is yesterday's economics - while today's economics is the importance of global scale.

We know that markets and the spur of competition are the best producers of applied knowledge. That is why our country has benefited enormously and will continue to benefit enormously from the group represented here today - and from a national financial system that makes America the only place in the world where you can raise your first $100 million before you buy your first tie.

At the same time, the most important innovations that we see today are built on progress in basic science, everything from group theory to quantum theory. If one asked what research had made the most important contribution to the navigation of ships since the 1600s, a good case could be made that it was the pure mathematics involved in the development of imaginary numbers - such as the square root of negative one - which in turn helped to produce Maxwell's equations, which in turn helped pave the way for the invention of the radio.

This kind of basic science is best diffused broadly, so production must be supported from the outside. That is why a crucial component of public policy at this time must be strong support for basic research. And it is why the President's budget for FY 2001 calls for largest public investments in basic science in our country's history.

Finally, we need to work to make sure that new technologies and the new markets they create work well for all of our people.

This is partly a matter of keeping our economy strong, because a strong economy is the best social policy ever invented. In today's high-pressure economy, jobs look for people more than people look for jobs. This benefits most the people who would otherwise be trapped on the sidelines. For example, there are three million more African-Americans in the labor market than there would have been in 1993.

It is partly a matter of bringing more people into the networks upon which this new economy depends. Notably, if the challenge of universalization a half a century ago was to ensure that all had access to electricity and running water, the task today is to ensure that all have access to telecommunications, to information technology and to basic financial services. Within America and globally, we face a challenge in that new technologies can create centers of strength that pull away - or they can make possible faster and broader diffusion of opportunities around the economy. Public policy will have a great deal to do with whether our new economy follows the more inclusive path.

And it is also and importantly a matter of meeting the challenges and concerns that new technologies present - from consumer privacy to genetic discrimination - so that people have confidence that innovations will be used appropriately. That is why, for example, we at Treasury are focused on devising the right kind of regulatory approaches to internet banking, and on developing digital signature legislation to ensure that consumer protections in the electronic world are equivalent to those in the paper world.

America is the most fortunate country in the world. This is as fortunate time to be an American as any in our history. And those involved in the high technology sector stand out in their good fortune relative to other Americans. But it is not a time to rest on any laurels. Parameters such as normal rates of unemployment and potential growth have surely changed. But the basic laws of supply and demand and the verities of human psychology have not.

That is why we must all focus on ensure that the new economy is built on old virtues and investments that are attentive to the needs of the new economy and can help markets be as large and efficient as they can be. If we can work together to achieve these things as we have so successfully worked together as a nation in recent years, I believe they offer great potential for our county's future. Thank you.