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How Fast Can This Baby Go?

Pity the poor economic forecasters. After four years of systematically underestimating the growth potential of the U. S. economy, most finally gave in at the end of 1999 and hiked their forecasts of growth for 2000 to around 3%.

But even that wasn’t enough. The economy looks poised to turn in first-quarter rowth of nearly 5%, on top of a second half of 1999, in which growth topped 6%. Even measured over a full year — a more accurate yardstick — growth is running at a strong 4.5% and rising. And outside of energy prices, inflation shows no sign of budging. Consumer prices, minus food and energy, are rising at a 2% rate — slower than a year ago.

Profits, too, seem to be headed up. An early harbinger: On Mar. 28, Minneapolis-based retailer Best Buy Co. announced an earnings increase of 51% for the quarter ended Feb. 26, citing strong growth and better inventory management. Standard & Poor’s DRI, which predicted last June that after-tax corporate profits would rise only 1% in the first quarter of 2000, now expects them to soar by almost 14%.

What’s going on here? More and more, the productivity gains from information technology are permeating every corner of the economy. One example: Output per hour in nondurable manufacturing — including such industries as food and clothing — rose by 4.2% in 1999, the biggest single-year rise since 1992. And the stream of innovations coming out of the high-tech sector doesn’t seem to have peaked yet. “We’re only in the second inning of the Internet revolution,” says Bob Kagle, a general partner at Benchmark Capital, a leading tech. venture-capital fund. “Now we see a project a week that can fundamentally change an industry.”

Perhaps most important, the U. S. has developed a set of financial institutions, focused on venture-capital and the market for initial public offerings (IPO), that can systematically find and fund innovative businesses. This pool of mobile, risk-taking capital — a breakthrough in the history of financial markets — has the potential of boosting long-term growth. “The fact that you have credit available to these new types of ventures allows more new ideas to come in,” says Raghuram Rajan, a finance expert at the University of Chicago’s business school. “If the markets remain vibrant, it’s possible this could continue for quite some time.”

There is still plenty that could go wrong. High oil prices or some other shock could trigger an inflationary spiral. Private-sector debt, which is growing by about 10% a year, could drag down spending. Or a Fed-induced slowdown could get out of control and send the stock market plunging.

Moreover, no one knows how the productivity gains will hold up through the next recession. Nevertheless, it appears possible that the economy’s speed limit — the highest long-term growth rate that does not trigger inflation — may have moved up to around 4% rather than the 2% to 2.5% that conventional wisdom pegged it at not too long ago.

B2B BOOST. Even skeptical economists are uping their estimates of sustainable growth. Last June, Goldman Sachs & Co. predicted that productivity would rise by only 1.5% in 2000. Now they have hiked their estimate of underlying productivity gains to 2.5% to 3% a year. Combined with 1% labor force growth, that implies sustainable noninflatinary growth of 3.5% to 4%.

Yet for some in the trenches of the Internet revolution, even that appears timid. Grady Means, managing partner for strategy consulting at Pricewaterhouse Coopers, argues that the U.S. can sustain 6% to 8% annual growth as business-to-business (B2B) applications of the Internet start to take off. “People are just starting to apply B2B in creative ways,” says Means. “It suggests an engine that is just revving up, not getting tired.”

Means’ optimism may be extreme, but there’s no question that technology is creating new opportunities to boost productivity as companies use it to fundamentally change the way they organize their businesses. Auto makers, for example, are employing math-based technology to generate computer images of new cars and their components rather than mocking up every part of sculpting clay models during the design process. At General Motors Corp. (GM), that means new vehicles go from the drawing board to showrooms in two years instead of the traditional three or four. That’s letting GM slash $1 billion in product-development costs over the next two year. “It has potential to get better yet,” says Richard Wagoner Jr., GM’s president and CEO-elect, “because math-based tools aren’t fully integrated. “

Gains from using the Net help explain why companies can keep prices down even when costs rise. For example, with fuel prices soaring, Southwest Airlines Co. is getting big savings by using the Net for ticket distribution. In January, tickets sold through its web site accounted for about 27% of passenger revenue, vs. about 30% from travel agencies. “We think we can produced a booking on the Web for well under $ 1,” says Chief Financial Officer Gary Kelly, compared with roughly $ 10 for one made through a travel agent.

About the Author

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