Is This a Mid-1990s Moment for the Economy? Three Reasons for Optimism

A painful recession was fading into memory, yet the expansion felt unsatisfying to many. There was evidence of huge technological leaps everywhere except in the data on worker productivity. And the unemployment rate was falling to levels that forecasting models predicted would trigger a burst of inflation.

That was the economic situation in the mid-1990s, and it also describes 2018. An intriguing — and optimistic — possibility for the years ahead is that the parallels with the 1990s won’t end there.

Back then, technological advances that had been building for years finally started to translate into higher rates of productivity growth economywide. Some feared inflation, but Alan Greenspan, the Federal Reserve chairman, decided not to move pre-emptively to choke off the expansion. Instead, he advocated patience to see just how hot the economy could get without setting off a spiral of rising prices.

The result was the strongest period of growth and prosperity in recent decades.

History, of course, may not repeat itself. The mix of technological advances and sound economic policy that generated the 1990s boom simply may not materialize this time. Plenty of threats could send this expansion hurtling toward recession instead.

A trade war or emerging markets crisis or economic policy mistake could prove more powerful than economic fundamentals. And some of the technological advances that seem on the verge of fueling a productivity boom may take longer to develop than their enthusiasts assert.

But it’s clear that some senior economic policymakers are at least open to the possibility of a boom. In a speech last month, the Federal Reserve chairman, Jerome Powell, discussed the 1990s experience in detail, suggesting that Mr. Greenspan’s strategy at that time was one to emulate.

In 1996, many Fed policymakers wanted to raise interest rates to head off the risk of inflation. “But Chairman Greenspan had a hunch that the United States was experiencing the wonders of a ‘new economy’ in which improved productivity growth would allow faster output growth and lower unemployment, without serious inflation risks,” Mr. Powell said.

“Meeting after meeting,” he added, the Fed’s policy committee “held off on rate increases while believing that signs of rising inflation would soon appear. And meeting after meeting, inflation gradually declined.”

Mr. Powell wasn’t forecasting that the same would happen in coming years; rather, he was preaching the virtues of Mr. Greenspan’s strategy of risk management that allowed the boom to emerge.

The expansion of the last nine years has been steady and successful at putting millions of people to work, but it has fallen short in overall growth or in generating substantial boosts to incomes.

The culprit: productivity. The amount of output per hour of labor has been growing slowly. In the last five years, it has risen about 1 percent annually, compared with 2.1 percent on average since 1947.

If that changes, and businesses find ways to get more production of goods and services out of each hour of work, it should set the stage for higher wages and faster growth. That’s what happened in the 1990s: Annual productivity rose an average of 1.8 percent from 1991 to 1995, then leapt to a 3 percent annual rate from 1996 to 2000.

What are the chances of a similar jump in the coming years, with similar beneficial results? Economists don’t have a great understanding of what drives productivity advances, but there are three realistic possibilities of where gains might come from — and they aren’t mutually exclusive.

Solow’s Paradox and Technological Diffusion

In 1987, the economist Robert Solow joked that “you can see the computer age everywhere but in the productivity statistics.” That is, even as there were remarkable advances in semiconductors, software and desktop computing, it wasn’t evident in any efficiency improvements in the overall economy.

The surge didn’t arrive until well into the 1990s, and that pattern — a long lag between a technological innovation and its full economic impact — makes sense when you think about it.

For example, fewer corporate executives have a full-time secretary now than they did in the 1980s, in part because of innovations like voice mail, email and desktop word processors. But it’s not as if companies suddenly fired a bunch of secretaries on the day they got a voice-mail system. It was a gradual process as more people became accustomed to answering their own phones and typing their own memos.

Just because some high-performing companies have started using a productivity-enhancing technology doesn’t mean it has spread throughout the business world. By the early 1990s, Walmart became efficient in using computers to manage its supply chain — at a time many retailers were still using old-school cash registers. It would be years before the bulk of the industry caught up. The Walmart catch-up effect was a major part of the late 1990s overall productivity surge, according to research from the McKinsey Global Institute.

Moreover, sometimes big innovations can actually make the economy less productive while they are being introduced. An automobile factory that’s installing a robotic assembly line might employ many robotics engineers, but also autoworkers still making cars the old way. Even if the innovation eventually results in higher productivity, the company might need more person-hours of work per car produced in the short run.

What are the potential parallels in 2018?

Technological optimists have argued for years that artificial intelligence, machine learning, advanced robotics, augmented reality and other areas offer huge potential efficiency gains. As in Solow’s Paradox from an earlier era, there’s no evidence yet in the economic data, but perhaps that will change, as it did with an earlier generation of advances.

That’s exactly what McKinsey consultants found in research published in June.

One day driverless cars may be a boon for productivity — but right now they are a drag on it as thousands of skilled engineers work to develop the technology without generating a dime of economic output.

Similarly, farms may eventually increase their yield with artificial intelligence that allows them to automate the pulling of weeds and the application of fertilizer. Electrical utilities may be able to become more efficient using smart grids. Hospitals may be able to deliver better care for less money when computers help diagnose patients.

Will technologies like those be ready for prime time soon, or ever? That’s the part we don’t know for sure.

But there are other forces that will more clearly affect the productivity outlook in the next few years.

Tax Cuts and a Capital Spending Surge

At the root of conservative economic philosophy is that low taxes on capital, along with light regulation, will encourage businesses to invest more heavily, resulting in a more productive economy in the long run.

The next few years will be a test of that proposition.

The corporate income tax rate was cut to 21 percent at the start of the year, from 35 percent. The Trump administration’s deregulation-minded appointees have had a year and a half to go about their work.

Oh, and the stock market is booming, and interest rates remain low by historical standards, implying companies should have plenty of access to capital on favorable terms if they want to make those investments.

In short, this should be a conducive environment for businesses to increase their “capital stock” — the accumulated facilities, equipment, software and other intangible investments — to enable workers to be more productive.

Is this investment actually happening? The evidence isn’t definitive at this point. Business investment rose at an 11.5 percent rate in the first quarter of 2018 and 8.5 percent in the second quarter, both substantially faster than the economy as a whole. But that was fueled in part by a boom in energy exploration that was probably more tied to the rise in oil prices in 2017 than tax policy.

The nascent trade war may create a layer of uncertainty for businesses that have major customer bases overseas as they weigh big-ticket investments, working at cross-purposes with the stated goal of the tax legislation.

But the verdict on whether pro-business policy out of Washington will drive a surge in investment spending, with big benefits for productivity, will depend on more than a couple of quarters, and remains a real possibility.

The Tight Labor Market

Finally, the tight labor market could force businesses to find more efficient ways to deploy workers.

With the unemployment rate at 3.9 percent, near a several-decade low, companies in a range of industries have been complaining about the difficulty of finding qualified labor.

This shows up in headlines about trucker shortages, construction worker shortages and oil field worker shortages. It may eventually show up in faster growth in wages, no matter what happens to technological advances or business investment.

But one distinct possibility is that it will force businesses to act more creatively and aggressively about squeezing more economic output from each hour of labor.

Companies could invest more heavily in new capital — think of automated checkout kiosks at retail stores or restaurants. Or companies could provide extra training so that each worker can get more done.

It could also happen through experimentation with new management techniques or other business practices; these would show up in what economists call “total factor productivity.”

This isn’t the traditional way economists think about productivity, but we see it in other contexts. When the minimum wage is raised, companies sometimes try to replace human labor with machines or focus on making their workers more productive.

The ultralow unemployment may have the same effect in the years ahead.

There is, for good reason, a tendency to focus on the risks of what can go wrong in the economy. The current expansion could become the longest on record next year, which makes the recession risk talk all the more relevant.

But the 1990s are a reminder that there can be good economic surprises as well as bad ones. Predicting the future is hard. And the parallels aren’t perfect. But there’s reason to wonder if economic history just might repeat itself.