U.S. Department of the Treasury

(Archived Content)

FROM THE OFFICE OF PUBLIC AFFAIRS

Today I want to talk about what is new about the new economy; and what the new economy means for economic policy.

The new economy is often declared; seldom 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.

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 forms of industrial output with new.

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

It used to be that value depended importantly on resided in the mass of what was produced - as with an ingot of iron 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 the amount we can contribute to our economy, and the amount it is prepared to compensate us for our efforts, depend increasingly now have more to do with on how much we know rather than with how much we can lift.

It is a main characteristic of the new economy that my consumption of a good does not necessarily detract from your consumption of themit. If I am wearing a shoe, you cannot be wearing my shoe. But if I am informed, if have access to software, you can also have access to that software. Thomas Jefferson put it less prosaically when he said: 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.

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 network 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. The number of connections that are possible rises not proportionately with the number that are connected, but by the square of that number.

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

This dynamic is highlighted by the growth of the Internet, where it does not take a change in the rate of growth to produce an ever-larger absolute effect. Moving from one million Internet users to two million Internet users has one kind of impact; moving from 2 million to 4 million has a somewhat greater impact; and going from 4 million to 8 million, a still larger impact. An increase in the installed base has a larger absolute economic impact than any deceleration in the rate of innovation at the cutting edge.

An economy of very high fixed costs and very low marginal costs will also be characterized by positive feedback economy. The old economy is driven by negative feedback: rising demand leads to higher prices, which leads producerswhen prices rise, to produce more and, consumers to buy less, which restores and equilibrium at a lower level of demand. By contrast, in an information economy, rising demand will often produce higher efficiency and higher returns, drives and lower prices, leading to yet higher demand. In that sense, if the agricultural and industrial economies were Smithian - the new economy is Schumpeterian.

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 of opposing forceschecks and balances, in which disequilibria of demand and supply arose, only to be equilibrated by adjusting prices. While In contrast, the right metaphors for the new economy are more Darwinian, with the fittest surviving, and, as modern Darwinians have come to understand, accidents of history casting long and consequential shadows.

It is fair to say that the emergence of a new economy has been kind to the United States economy, with a wide-ranging impact that Vice-President Gore has called the information technology supply shock.

Consider:

• In the 1970s we saw dramatic increases in the price of oil, and what followed was a quite dramatic deterioration in the economic performance of the United States and many other nations - along a number of dimensions.
• Today, we have again seen a sharp rise in the price of oil. But we have also seen, particularly in the US, the IT supply shock: another dramatic and continuing change in the price of a key input to the economy, only this time, the direction in prices is down. And in place of stagflation, we are seeing a combination of rapid growth and relative price stability for which we have yet to find a name.

Some say that the spread of new technology is a wave. Others - living further west of here, perhaps - say it is a river. What we can safely affirm is that it would be unwise to take these good times for granted. Our own experience in the late 1920s and 1930s, and Japan's in the 1990s, remind us that positive supply shocks and stable prices are no armor against economic downturns. 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 a successful economic strategy and how they relate to the needs of the new economy.

Ten years ago we had an economy where we were caught in a kind of vicious cycle - high deficits led to high interest rates, led to low levels of investment, led to slow levels of economic growth, led to reduced revenues, led to larger deficits -- and around and around again. Through the policies that we as a country have pursued during the 1990s, we have crossed a threshold.

And so today we enjoy a virtuous circle -- a virtuous circle of budget surpluses, lower interest rates, more investment, more growth, more revenues, larger budget surpluses, more investment, and around and around again. And that switch from vicious cycle to virtuous circle has unlocked the energy in this economy that has helped to make this expansion the longest in our country's history.

This shift in policy has made and will continue to make an important contribution to the continued development of a new economy. Because a new economy fundamentally changes the stakes involved in the choice of our nation's fiscal policy. In a world that is rich with investment opportunities, and where investors can quickly understand 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. The more that is saved through debt reduction, the more that America's private sector will be able to invest in the technologies of our future.

We hear often, and rightly, these days about the great importance of education. In an era where the return on investment in human capital is so high, it is doubly important to ensure that our children receive the best education possiblerising much 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:

• 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 major new public investment in 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. That is why we are working hard on a bipartisan basis to support putting more teachers in classrooms, allowing better teachers to go into education, and reduce class sizes.

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.

That means that deregulation becomes that much more important, to ensure that government is not preventing or distorting the development of fast-growing markets. That is we worked so hard to pass the right kind of Financial Modernization legislation last year. I do not think it is an accident that the country that has so far realized the greatest benefits from the IT revolution is also, at least until recently, the only country where you could raise your first $100 million before you have bought your first suit.

And it means that a strong and stable global economy becomes that much more important: because the greater the potential scale, the more quickly those economies of scale can set in, the further that prices can fall, and the faster that demand and efficiency can rise. So the economic and broader benefits to the US of successful international integration are greater today than they have ever been. Globally:

• We must work to support global economic growth, by keeping our own economy strong, and make the case for imports, in all countries, as well exports.
• We must work to build a stronger, more stable system for the flow of global capital, so that crises such as those we saw in Asia are less frequent and more effectively contained, and capital can flow to where it will have the greatest impact on growth.
• We must work to support strong international financial institutions to promote poverty reduction and successful economic development in the poorest countries.

And, as recent events in Prague have once again underlined, we must recognize that in an integrated world, economic and financial issues cannot be divorced from other concerns. As the President has said: a legal framework of mutual responsibility and social safety is not destructive to the market; it is essential to its success. And a crucial part of global integration must be common agreements to make a global system work for people.

We know that markets and the spur of competition are the best producers of applied knowledge. 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.

We know from the experience here in Cambridge that 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 - an imperative that this Administration has sought to meet in successive Presidential budgets.

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 a moral imperative, in an economy as prosperous as ours. But in an economy where jobs are looking for people more than people look for jobs, and where bottlenecks make it hard to attract and retain workers, it is also an economic imperative.

One way to achieve this goal is to keep our economy strong, because a strong economy is the best social policy ever invented. It says something about the U.S. labor market today that companies are actually hiring planes to advertise jobs fairs in the skies over Baltimore Orioles games. It is a different world, indeed, from the one of a decade ago, when we debated the sources and causes of what was then referred to as the jobless recovery.

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.

• That is why it is so important that this Administration is providing the right kind of training programs to move people from school to work, and from welfare to work. Welfare rolls have dropped 56 percent - by nearly 8 million people - since 1993. Under the Welfare to Work Partnership, private businesses have hired more than 1 million former recipients.
• It is also why we have worked hard, on a variety of fronts, to provide capital to areas of our country and groups within our country who traditionally have not had such access: most recently, through the President's New Markets Initiative.

This is as fortunate a 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. For all that has changed in this more information-based economy, the basic laws of supply and demand have not changed

That is why we must all focus on ensuringe 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. Thank you.