The Clinton-Gore Administration: Sustaining America's Prosperity -- Highlights of the 2001 Economic Report of the President
January 12, 2001
Chapter 1: The Making of the New Economy
This year's Economic Report of the President examines the emergence of a New Economy, documenting the breadth of this change, and examining its implications. The Report defines the New Economy by the extraordinary gains in performance -- including rapid productivity growth, rising incomes, low unemployment, and moderate inflation -- that have resulted from a combination of mutually reinforcing advances in technologies, business practices, and economic policies.
- New economic trends. Since 1993, real GDP has grown at an annual rate 46 percent higher than in the 20 years before 1993. The combination of this faster growth, more than 22 million new jobs, widespread gains in real incomes, and moderate inflation has surprised most observers. In the second half of the 1990s, the U.S. economy grew faster than that of any other major industrial country.
- Widespread improvements in labor productivity. Annual labor productivity growth has accelerated by 1.6 percentage points since 1995. Increases in capital per worker explain 0.4 percentage point of this growth, and faster technological change in the computer sector accounts for 0.2 percentage point. The majority (1.0 percentage point), however, stems from technological improvements in the rest of the economy. These gains have been pervasive and are particularly apparent in services sectors, such as wholesale and retail trade and finance, which are major users of information technology (IT).
- The innovation system has been transformed. Between 1990 and 1997, the number of IT firms more than doubled. The supply of new technologies has been boosted by stronger competition, increased spending on R&D, and new organizational structures for innovation. Small firms linked in networks and clusters now play a larger role than before. Deregulation and international competition have stimulated the demand for new technologies. Financial innovations, such as venture capital and stock options, have become increasingly common.
- Organizational changes have complemented technological innovation. New production methods that take advantage of continuous performance evaluation have been introduced. Inventory and supply chain management have been revolutionized. Corporate boundaries have been radically transformed through mergers and acquisitions.
- Economic policies have played a crucial role. Fiscal discipline swung the annual budget balance by nearly $500 billion since 1993. Surpluses have led to debt reduction, keeping interest rates relatively low and encouraging investment. Public investments in people and technologies have helped supply skills and knowledge. Measures to expand markets at home and abroad have helped spur competition. Social policies have helped the disadvantaged while maintaining incentives for work and adaptation.
- The fundamental rules of economics have not been repealed in the New Economy. Policy remains crucial in ensuring non-inflationary growth, preserving fiscal discipline, nurturing a vibrant private sector, and creating an economy that works for all.
Chapter 2: Macroeconomic Policy and Performance
This chapter reviews macroeconomic developments during the past year and offers the Administration's economic forecast. It also examines the long-term fiscal outlook and the importance of preserving the fiscal discipline that has been so critical to the expansion.
- Another strong year. Economic growth moderated in the second half of 2000. Nevertheless, real GDP grew at a 4.2 percent annual rate over the first three quarters of 2000, following 4 consecutive years of growth in excess of 4 percent. The unemployment rate remained between 3.9 and 4.1 percent through the first 11 months of 2000 without generating excessive core inflation or inflationary expectations. Strong productivity growth kept employers' labor costs per unit of output from increasing, while real compensation per hour rose 1.6 percent between the third quarter of 1999 and the third quarter of 2000.
- Effects of the New Economy. Despite the cooling off of the stock market in 2000, evidence of the New Economy abounds. Reflecting past growth in stock market wealth, consumer expenditures continued to grow faster than disposable personal income, driving the personal saving rate into negative territory. In an investment environment that remained favorable even without further increases in stock prices, business investment was strong, especially in information processing equipment and software. U.S. exports grew robustly in 2000, but imports grew even more rapidly, reflecting the strong growth in consumption and imported capital equipment. The large trade and current account deficits can be attributed to low rates of private saving out of current income and a high rate of investment that is being financed partly by foreign saving attracted by the extraordinary New Economy investment opportunities in the United States.
- The Administration forecast. Potential output is expected to increase at a solid 3.8 percent annual rate in 2001 and 2002, about the same as its growth from 1995 to 2000. The projected real GDP growth rate of 3.2 percent per year during 2001 and 2002 is somewhat slower than the rise in potential output; as a result, the unemployment rate is projected to edge up 0.3 percentage point per year, unwinding any tightness in labor and product markets. The current situation of low core inflation, high productivity growth, and lean inventories points to a continuation of the expansion—though growth is definitely expected to moderate, and more sharply in the short term than anticipated when the forecast was made.
- The importance of fiscal discipline. Over the past 8 years, a combination of restrained growth in spending and increased revenues associated with strong economic growth have created a situation in which the Federal debt held by the public is on track to be eliminated around the end of the decade, if fiscal discipline is maintained. However, the course of the budget and the economy in the years ahead remains highly uncertain, and pressures on the budget will mount as the effects of an aging population on Social Security and Federal health care spending begin to kick in. Used wisely, today's surpluses can help prepare for this demographic challenge by encouraging national saving and investment that will keep the economy on a robust growth path.
Chapter 3: The Creation and Diffusion of the New Economy
This chapter looks at the sources of performance improvements in plants, firms, and industries. It traces these improvements to innovation in information technology (IT), complementary changes in organizational practices that enhance the productivity of firms using IT, and the emergence of a more competitive business environment.
- How much technology? The rapid growth of the IT sector was one of the most remarkable features of the 1990s. The last decade saw a rapid convergence of several key technologies—processing power, data storage and transmission, and software—that translated recent technological innovations into real performance gains. Domestic revenue in the IT sector grew by 120 percent during the last decade, while quality-adjusted prices for computers fell by over 80 percent. The Internet has recently spawned thousands of new companies and created billions of dollars in market value. Wireless telephone carriers alone now employ over 150,000 people in the United States and generate 10 times the annual revenue they posted a decade ago.
- Why is the U.S. awash in technology? Several factors in combination have created a uniquely favorable climate for innovation and entrepreneurship in the technology sector. Deregulation and open, competitive markets have created a strong demand for new technologies among firms. Entrepreneurial ventures have found ample funding. During the 1980s, venture capital investment grew on average by 17 percent per year. In the 1990s, the pace doubled. Total venture capital investment jumped from $14.3 billion in all of 1998 to $54.5 billion in the first three quarters of 2000. In addition, initial public offerings have raised over $300 billion since 1993, more than twice the amount raised in the previous 20 years, even after accounting for inflation. Research and development spending—which grew nearly 40 percent faster than the economy as a whole from 1995 to 1999—continues to expand the base of scientific and technical know-how, and strong legal protection for intellectual property has rewarded innovators for their R&D efforts.
- Why technology matters. The adoption of IT has led to performance gains in many sectors of the economy. Manufacturing plants and service firms are increasingly automated, while workers are given more flexible job assignments and stronger incentive pay, leading to improved performance. Supplier relationships are becoming more closely integrated through use of computer systems that coordinate the various aspects of production and warehousing, allowing firms to reduce inventories dramatically. Firm boundaries are also shifting, as firms outsource non-core activities and move toward flexible, collaborative relationships like strategic alliances with suppliers, customers, and even rivals.
- The challenges ahead. The end result is an economy that has been unusually vibrant, dynamic, and entrepreneurial, with high rates of business formation—and business failure. Innovation is by nature a risky endeavor: equity values will continue to fluctuate, and the economy as a whole will continue to experience the rise and fall of the business cycle, making underlying productivity trends difficult to discern. It is important that this dynamic, competitive framework be retained. While government action is often needed to lay out the "rules of the game," it is important that market participants be allowed to innovate and experiment.
Chapter 4: The New Economy in a Global Context
This chapter describes how U.S. participation in the global economy has been critical to the emergence of the New Economy. Improved technology leads to increased international trade and investment, while deeper integration into the world economy makes available larger markets and lower-priced imports that spur innovation and benefit both consumers and firms.
- Technology and globalization- . The effects of new technologies are apparent in U.S. international trade. Over 70 percent of U.S. export growth since 1996 has consisted of capital goods, including items such as computers, semiconductors, and telecommunications equipment. Exports of services that reflect the fruits of U.S. innovation, such as royalties and business and financial services, have likewise grown faster than other U.S. service exports. Meanwhile, imports—of which capital goods are the largest component—have supported the investment that underlies our superior economic performance. An example is in computers, where imports account for more than 60 percent of U.S. computer purchases, even while U.S. computer exports have grown rapidly, supported by the availability of low-cost imported components. This sort of globalization helps all Americans, as consumers gain from increased competition and lower prices, while firms benefit from global suppliers and larger export markets.
- The role of policy. The Administration's international economic policy has fostered globalization, thereby providing incentives for competition and innovation. Openness has been spurred by more than 300 trade agreements, including historic agreements such as the North America Free Trade Agreement, the Uruguay Round trade agreements, permanent normal trade relations with China, a moratorium on tariffs on e-commerce, and market-opening agreements in sectors central to the New Economy such as telecommunications, information technology equipment, and financial services. High-tech exports have boomed, with the value of computer and semiconductor exports growing more than 50 percent faster than overall exports since 1996. The opening of markets matters as well for non-technology U.S. exports: for example, shipments of U.S. oranges to China went from far less than 1 million kilograms in 1999 to more than 10 million kilograms in the first 9 months of 2000.
- Global challenges in the New Economy. Technology raises a number of issues in the international context, including effects on workers, the environment, and challenges such as money laundering and tax evasion. The widened U.S. current account deficit can be related in part to the effects of the New Economy in spurring U.S. productivity and thus raising our output growth ahead of our major trading partners. While annual U.S. labor productivity growth increased after 1995, productivity growth actually slowed in the six other largest world economies, including an average annual decline of more than 0.8 percentage point in Japan. Superior U.S. performance has been reflected in capital inflows, as foreigners have sought to invest in the United States. The current account deficit—the counterpart of capital inflows—has thus supported rising investment, which has grown by 4.6 percentage points as a share of GDP from 1992 to 2000. This contrasts with the experience of 1980-88, when the declining current account balance was associated with a nearly 1 percentage point decline in the share of investment in GDP.
Chapter 5: Living in the New Economy
This chapter describes how the New Economy and Administration policies combined to improve the quality of life for the vast majority of Americans. A key theme is the continuing need for government involvement to enable all to share in the benefits of the New Economy.
- Good news from the American economy. As a result of a strong expansion and innovative policies, real median household income reached a record high ($40,816 in 1999) and the unemployment rate is lower than it has been in 30 years. Some of the largest gains accrued to the least well-off groups. African-American and Hispanic households had record high income levels and record decreases in poverty. The African- American unemployment rate fell from 13.0 percent in 1993 to 7.6 percent in the first 11 months of 2000. The Hispanic unemployment rate fell from 10.7 percent to 5.7 percent.
- Helping families help themselves. Since 1993 the number of people on welfare has fallen by 8.3 million, or 59 percent, and many of those leaving welfare are now working. The transition from welfare to work has been made easier by policies that make work pay, such as the Earned Income Tax Credit. Nearly 19 million 1999 tax returns claimed the EITC, and the credit helped lift an estimated 4.1 million people out of poverty in 1999. Increases in child care subsidies and efforts to help custodial parents collect child support have also helped low-income families. Other programs, such as the Empowerment Zone/Enterprise Community initiative have targeted impoverished communities. Poverty rates in central cities fell from 21.5 percent in 1993 to 16.4 percent in 1999, and the unemployment rate fell from 8.2 percent to 5.3 percent.
- Education in the New Economy. In elementary and secondary education, the Federal government promotes new investments and innovation, especially for lower-income schools. Federal funds pay for one-fourth of all new computers in schools, and the Federal E-rate program provides $2.25 billion per year to subsidize telecommunications services in schools and libraries. These investments have contributed to the near-tripling of Internet access in public schools since 1994.
- Innovation and access in health care. Recent technological innovations have enabled better diagnosis and treatment of many diseases, but they contribute to increases in health expenditures. Innovations in the health care delivery system, particularly the growth of managed care, have helped slow the growth of expenditures, but the system remains imperfect. Rising costs are particularly burdensome to the 43 million Americans who lack health insurance coverage. Extending coverage was an Administration priority, as exemplified by the 1997 creation of the State Children's Health Insurance Program.
- Building livable communities. The strong economy has brought rapid growth on the outskirts of many metropolitan areas, with an average of 2.3 million acres of land being developed each year. The chapter describes efforts to discourage sprawl and encourage smart growth.