[Economic Report of the President (2001)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]

 
Chapter 1

The Making of the New Economy



Over the last 8 years the American economy has transformed itself so
radically that many believe we have witnessed the creation of a New
Economy. This Report presents evidence of fundamental and unanticipated
changes in economic trends that justify this claim. In the 1990s, after
two decades of disappointing performance, the economy enjoyed one of
its most prosperous periods ever. Strong and rising growth in real
gross domestic product (GDP), declining and then very low unemployment,
and a low, stable core inflation rate characterize the long expansion.
Even though growth moderated in the second half of 2000, the achievements
of the past 8 years remain impressive.

From the first quarter of 1993 through the third quarter of 2000, real
GDP grew at an average annual rate of 4.0 percent--46 percent faster
than the average from 1973 to 1993. This exceptional growth reflects
both strong job creation and increased productivity growth. Americans
are working in record numbers: the number of payroll jobs has increased
by more than 22 million since January 1993, and in 2000 the share of
the population employed reached its highest level on record. Also in
2000 the unemployment rate dipped to 3.9 percent, the lowest level in
a generation. Unemployment rates for African Americans and Hispanic
Americans were the lowest since separate statistics for these groups
were first collected in the early 1970s.

Americans are not only working more; they are also working smarter. The
economy has rapidly become more productive. Since the beginning of 1993,
output per hour in the nonfarm business sector has grown at an average
rate of 2.3 percent per year, compared with an average of 1.4 percent
per year for the previous 20 years. Even more remarkably, since the
fourth quarter of 1995 productivity growth has averaged 3 percent per
year. This acceleration in productivity has produced higher incomes and
greater wealth. From 1993 to 1999, the real income of the median
household grew more than in any   period of similar length in the last
30 years. Meanwhile the value of corporate stocks has nearly trebled,
even after taking into account the downward adjustment in stock prices
during 2000.

These income gains have also been widely shared: even incomes at the
bottom of the distribution have risen rapidly (Chart 1-1). Disadvantaged
groups have seen their situation improve markedly. The overall poverty
rate declined to 11.8 percent in 1999 (the most recent year for which
data are available), its lowest level since 1979 and 3.3 percentage
points below the rate in 1993. The poverty rate for African Americans was
23.6 percent in 1999--still too high, but far below the 1993 level of
33.1 percent. The poverty rates for Hispanic Americans and elderly
Americans have also fallen sharply.



This chapter describes the remarkable achievements of the 1990s and the
factors that gave rise to the New Economy. The chapter identifies the
sources of the economy's faster growth and estimates the contribution of
each. The focus is on information technology and the factors that
reinforce its impact: organizational change and sound economic policy.
Updated, sector-specific data on productivity gains indicate that those
sectors that have invested the most in information technology--wholesale
trade and finance, among others--experienced some of the greatest
productivity gains during the 1990s. The chapter then highlights the
importance of innovation in business practices in firms throughout the
economy. It goes on to discuss the importance of sound fiscal policy,
competition-enhancing trade and technology policy, and effective social
policy--all working together to further the progress of the New Economy--
and the gains that have already been made. The chapter concludes by
looking ahead to the challenges we will face in the coming years to
sustain the virtuous cycle of growth and innovation--and to share fully
in its rewards.

The Economy from 1973 to 1993

The remarkable economic trends of the 1990s took many by surprise.
They represent a distinct change from the 1970s and 1980s, decades in
which the economy was plagued by persistent inflation, periodically high
unemployment, slow growth in productivity, rising inequality, and large
Federal budget deficits. Stagflation was an unwelcome phenomenon of the
1970s, as two major oil shocks were followed by simultaneous inflation
and recession. The massive and costly recession of the early 1980s and
the collapse of oil prices in 1986 broke the back of the very high
inflation rates that had emerged in the late 1970s. But as unemployment
fell below 6 percent in the late 1980s, core inflation started to climb
again. Between 1973 and 1993, GDP growth received a boost from the large
numbers of women and baby-boomers entering the work force. But at the
same time, persistently slow productivity growth (averaging less than half
of what it had been during the preceding 25 years) kept GDP growth in check.

These trends affected the incidence of poverty. In the 1960s and early
1970s, poverty had been declining as economic progress gradually raised
the incomes of those at the bottom. The nationwide poverty rate, which
had stood at 22.2 percent in 1960, fell to 11.1 percent in 1973. But the
combination of slow productivity growth and a relatively slack labor
market likely played a role in ending this improvement, dragging down
household incomes, especially for the poorest. The poverty rate continued
to fluctuate, falling during expansions in the business cycle and rising
during contractions. However, throughout the 1980s it never fell lower
than 12.8 percent, far above the low of the early 1970s. And by 1993
poverty had risen to 15.1 percent, almost matching the 1983 level of 15.2
percent, its worst since the 1960s.

Federal budget deficits had become commonplace in the 1970s, but they
increased rapidly in the 1980s in the presence of a fiscal policy based
on overly optimistic budget forecasts. Efforts to restore fiscal
discipline in 1990 failed because of a weakening economy, and deficits
grew worse rather than better, reaching almost $300 billion in fiscal
1992. By the end of fiscal 1981, publicly held Federal debt had fallen
to 25.8 percent of GDP. By the end of fiscal 1993 it had almost doubled,
to 49.5 percent.

Given these problems, few believed in 1993 that the U.S. economy could
achieve and sustain low unemployment rates, moderate inflation, or robust
productivity growth, let alone all three. The Federal Government seemed
incapable of balancing its budget, and there was little to suggest that
U.S. incomes could grow more rapidly than those in other major industrial
countries. Yet in the years that followed, all of these seemingly
improbable events occurred--and at the same time.

What Makes the Economy New?

The U.S. economy today displays several exceptional features. The
first is its strong rate of productivity growth. Since 1995 the trend
rate of productivity growth has been more than double that of the
1973-95 period. A second is its unusually low levels of both inflation
and unemployment. In the past, low levels of unemployment have usually
meant sharply rising inflation. Yet despite an unemployment rate that
has been close to (and at times below) 4 percent for 2 years, core
inflation has remained in the 2 to 3 percent range. A third is the
disappearance of Federal budget deficits. Federal fiscal policy often
becomes more expansionary as a period of economic growth is sustained,
yet in the past 8 years the structural budget balance has moved steadily
from a massive deficit to a large surplus. A fourth is the strength of
the U.S. economy's performance relative to other industrial economies.
As a world technological leader, the United States might have been
expected to grow more slowly than countries that can benefit from
imitating the leader's technological advances. Yet over the second
half of the 1990s, the United States continued to enjoy both the highest
income per capita and the fastest income growth of the major industrial
nations. These developments reveal profound changes in economic trends
that justify the term ``New Economy.''

Three interrelated factors lie behind these extraordinary economic
gains: technological innovation, organizational changes in businesses,
and public policy. Information technology has long been important to the
economy. But in the early 1990s a number of simultaneous advances in
information technology--computer hardware, software, and
telecommunications--allowed these new technologies to be combined in
ways that sharply increased their economic potential.

In part to realize this potential, entrepreneurs instituted widespread
changes in business organizations, reconfiguring their existing businesses
and starting new ones. These changes included new production methods and
human resource management practices, new types of relationships with
suppliers and customers, new business strategies (with some firms
expanding the scope of their enterprises through mergers and
acquisitions, and others streamlining them to best utilize core
competencies), and new forms of finance and compensation.

Public policy was the third driving force. This Administration
embraced policies and strategies based on fiscal discipline, investing
in people and technologies, opening new markets at home and abroad, and
developing an institutional framework that supported continued global
integration. Together these created an environment in which the new
technologies and organizational changes could flourish.

The interactions among these three factors have created a virtuous
cycle in which developments in one area reinforce and stimulate
developments in another. The result is an economic system in which
the whole is greater than the sum of its parts. New technologies have
created opportunities for organizational innovations, and these
innovations in turn have engendered demand for these technologies and
others still newer. The increased growth prompted by the new
technologies helped the Federal Government restrain its spending growth
and boosted its revenue; the resulting smaller budget deficits (and later
surpluses) have helped keep interest rates down, encouraging further
investment in new technologies. Economic policies directed toward
promoting competition have prodded firms to adopt the new technologies,
spurring other firms to innovate or be left behind. Policies aimed
at opening foreign markets have increased earnings in the U.S.
technology sector, leading to yet more innovation, including innovation
in information technologies, which have lowered barriers to trade and
investment still further. These market-opening policies have also
allowed U.S. producers to become more productive, by expanding the
variety of key inputs available to them.

This 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 this
combination of mutually reinforcing advances in technologies, business
practices, and economic policies.

Sustaining the Virtuous Cycle

Americans can be gratified by the achievements of the last 8 years,
but we must not become complacent. The economy has been performing well
for so long now that there is a danger of taking growth for granted.
There are good reasons to believe that the long-term trend rate of
productivity growth has increased relative to the post-1973 trend, and
many new technologies do not yet appear to have exhausted their
potential for further improvements. On the other hand, more moderate
economic growth is projected for 2001 and beyond. Hence the economic
forecast described in Chapter 2 is optimistic, but also cautious about
the future.

In addition, it would be a grave error to assume that the economy has
been so transformed that the basic rules of economics no longer apply.
The potential for faster growth exists, but demand cannot run ahead of
supply without the danger of rising inflation. The economy also remains
susceptible to cyclical fluctuations. Indeed, the rewards of the New
Economy are associated with increased risk, since the economy depends
more heavily than before on financial markets, which remain volatile.

Abandoning the public policies that have helped transform the economy
would also be a mistake. The current prosperity certainly reflects, above
all, the efforts of the private sector, but it would be wrong--and
dangerous--to ignore the contribution of policy. In particular, it would
be risky to put aside the policies that have helped us move from huge
budget deficits to large surpluses and have laid the groundwork for the
capital formation that has been so important in stimulating growth. It
would be just as dangerous to undermine the policies that have supported
the investments in people and technologies that are the keys to advancing
productivity. It would be folly to abandon the efforts to increase
competition in markets at home and abroad, because it is this competition
that helped create a domestic business environment in which entrepreneurs
can flourish and a global economy from which all Americans can benefit.
Finally, the government should continue its efforts to ensure that
prosperity is more widely shared, because this is something the private
sector will not automatically accomplish on its own.

A strong economy, even the extraordinary economy of the last 8 years,
cannot solve all America's problems or guarantee that every American
will be better off. Important steps have been taken to spread the
benefits of economic growth to disadvantaged regions and families.
But much remains to be done. The resources are available to tackle
the problems of insufficient access to health insurance, of aging
educational facilities, and of a Social Security system that lacks
adequate long-term reserves, to name a few. The challenge is how
best to use these resources to improve the well-being of all Americans.

Information Technology and the New Economy

Spending on information technology has clearly played a leading role
in the recent acceleration of economic growth. Although this sector
remains a fairly small part of the economy--its share of GDP was an
estimated 8.3 percent in 2000--it accounted for almost one-third of
all output growth between 1995 and 1999 (Chart 1-2). Even more
remarkable, in 1999 business spending on information technology
equipment and software was responsible for more than 11 percentage
points of the 14 percent real growth in total equipment and software
spending by business. The information technology sector is also one
that has seen a surge in innovation. To be sure, the computer, the
cell phone, optical fibers, lasers, and the Internet had all been
invented before the mid-1990s. But over the course of that decade, a
series of innovations in computer hardware and software and in
telecommunications took place that has allowed for new and complementary
interactions among these technologies on an unprecedented scale--a dramatic
example of which is the emergence and increasing commercial use of the
World Wide Web.

There is a broad consensus that information technology has been
important in the recent surge in economic performance. But the role of
developments beyond this sector remains more controversial. One view of
the recent economic transformation identifies the New Economy narrowly
with the production and use of information technology. Some proponents
of



this view argue that performance in the rest of the economy has
simply followed previous trends, or that the recent strong economic
growth has boosted it only temporarily.

Although the innovation and diffusion of information technology have
clearly been important, the broader definition of the New Economy
adopted in this Report more accurately conveys the pervasiveness of
the recent economic changes. A growing body of evidence now shows
that the widespread application of information technologies has
stimulated remarkable improvements in production processes and
other business practices outside the information technology sector.
But innovations in information technology and its use have not been
the only source of such change. Indeed, there has been a surge in
innovation in other technologies as well. Together with supportive
public policies, these changes have fundamentally transformed the
economy. An examination of recent productivity growth supports this view.

The New Trend in Productivity Growth

Productivity is now growing considerably faster than it did over the
20 years after 1973 (Chart 1-3). What can be said about the sources of
this acceleration? Two simple analyses help to answer this question. The
first estimates the contributions to growth in aggregate private nonfarm
business productivity from each of the different sources of that growth,
such as increases in the amount of capital per worker. The second uses
data on output and employment by industry to pinpoint the areas of
economic activity where the acceleration has taken place.

Sources of Growth: Capital, Labor Quality,
and Total Factor Productivity

A standard model of economic growth allows us to estimate how various
sources have contributed to the recent acceleration of productivity.
Table 1-1 shows that productivity, measured as output per hour in the
private nonfarm business sector, accelerated in the late 1990s. Its
growth rate rose from an annual average of 1.4 percent before 1995 to
an annual average of 3.0 percent from 1995 through 2000. The total
acceleration from the first period to the second is thus slightly
more than 1.6 percentage points. (The results reported in Chart 1-3
and Table 1-1 are based on real output increases that are averages
of growth in production and growth in income, each of which is a valid
measure of private nonfarm output. The chart and the table differ
slightly in that the latter covers the private nonfarm sector and
therefore excludes government enterprises.) The first question to
ask about this



total acceleration is how much, if any, of it is the
result of business cycle effects and how much is structural.

Productivity Growth and the Business Cycle

Productivity growth varies over the course of the business cycle,
typically speeding up in the early stages of booms and slowing or even
turning negative in slumps. But changes in productivity also have an
underlying structural, or trend, component. There is no foolproof way
to tease apart these cyclical and structural components in the
productivity changes one actually observes. The increase in productivity
growth after 1995, however, is noteworthy in that it occurred at a time
when the economy already was enjoying a high rate of resource utilization.
Sharp increases in productivity have usually occurred in economies
recovering from recession (Chart 1-3). By contrast, since 1995 the U.S.
economy has followed a steeper productivity trend, which started well
after the 1990-91 recession was over.

Statistical estimates suggest that almost none of the acceleration in
productivity after 1995 has been cyclical. An econometric model in which
hours worked adjust gradually to changes in output indicates that, by
1995, strong demand had already pushed actual productivity about 2
percentage points above where it would have been otherwise. From 1995
through 2000, the cyclical component of productivity edged up only
slightly relative to its trend, so that actual productivity grew only
slightly faster (by 0.04 percentage point) than structural productivity
(Table 1-1). As of the third quarter of 2000, the cyclical component of
productivity was still above trend, suggesting that actual productivity
growth is likely to fall below trend growth over the next year or so, as
GDP growth moderates. But the estimates indicate that there has been a
structural acceleration in productivity since 1995 of slightly less than
1.6 percentage points.

Even though economists differ as to the correct way to adjust for
responses to the business cycle, the finding that a structural
acceleration has taken place is robust. For instance, even if the
cyclical adjustment used here proved to be in error, and in fact
productivity growth after 1995 received a boost of as much as 0.5
percentage point a year from shifts due to the business cycle, one
would still conclude that a structural acceleration of productivity
of greater than 1 percentage point has taken place.

The fact of a shift in the trend of structural productivity growth
does not tell us how permanent that shift will turn out to be. All
one can say is that the post-1995 acceleration does not appear to be
associated with the normal business cycle variation of productivity.
Whether the structural trend that emerged in 1995-2000 will continue
for many more years, or whether structural productivity growth will
moderate sooner, remains uncertain. We could be observing not a long-term
shift to a faster productivity growth rate but simply a shift to a higher
level of productivity, with faster growth for a while followed by a
return to the pre-1995 trend. Or we may be witnessing the opportunity
for faster trend growth over a longer time span. Chapter 2 revisits this
issue in the discussion of the forecast.

Contributors to the Structural Productivity Acceleration

In general, a structural acceleration in productivity can come from
an increase in any of the following four sources of growth or their
combination:

 growth in the amount of capital per worker-hour throughout the
economy (capital deepening)

 improvements in the measurable skills of the work force, or labor
quality

 total factor productivity (TFP) growth in computer-producing
industries, and

 TFP growth in other industries.

TFP growth is the increase in aggregate output over and above that due
to increases in the quantities of capital or labor inputs. For example,
TFP growth may result when a firm redesigns its production line in a way
that increases output while keeping the same number of machines, materials,
and workers as before.

Capital investment has been extremely strong during the current
expansion. Particularly after 1995, investment in computers and software
responded markedly to robust economic growth, low real interest rates, a
strong stock market, and rapidly falling computer prices. As Table 1-1
shows, investment in information technologies added slightly more than
0.6 percentage point to the increase in structural productivity growth
after 1995. Because the rate of investment in capital goods other than
computer hardware and software slowed during that period, the contribution
of overall capital deepening to increased productivity growth was only
about 0.4 percentage point, or roughly 24 percent of the post-1995
acceleration of structural productivity.

The Bureau of Labor Statistics measures labor quality in terms of the
education, gender, and experience of the work force. Using statistical
methods, the Bureau determines differences in earnings paid to workers
with different characteristics and infers that these relative wage
differences reflect relative productivity differences. Measured in this
way, labor quality has risen as the education and skills of the work
force have increased. Because that increase occurred at about the same
rate before and after 1995, however, the contribution of labor quality
to the recent acceleration in productivity has been negligible.

The rate of growth in TFP in computer-producing industries has been
rising. Computer prices have been falling as technological improvements
are adopted and made available commercially. The decline in prices was
particularly marked from 1997 to 1999 (Chart 1-4). Calculations based on



these price changes indicate that computer manufacturing accounts for
about 0.2 percentage point, or about 11 percent, of the acceleration in
structural productivity.

The final contribution comes from accelerating TFP in the economy
outside the computer-producing industries. The contribution of this ``non-
computer sector TFP'' category is calculated as a residual; it captures
the extent to which technological change and other business and workplace
improvements outside the computer sector have boosted productivity growth
since 1995. This factor accounts for about 1.0 percentage point of the
acceleration in productivity, or about 63 percent of the total. (The
percentages do not sum to 100 because of rounding.) This implies that
improvements in the ways capital and labor are used throughout the
economy are central to the recent acceleration in productivity. Some
of these gains have likely resulted as firms learn to apply innovative
information technology to their particular business and production
methods.

Productivity Increases by Sector and Industry

The figures reported above indicate that both the more widespread use
of information technology and improvements in business practices have
boosted productivity growth. Data on productivity growth by industry
provide a further means of exploring this idea. If the story is correct,
these data should show, for example, an acceleration in productivity in
wholesale and retail trade as a result of improvements in distribution
and supply chain management. Improvements would also be expected in
financial and business services, both of which are heavy users of
information technology.

Table 1-2 shows growth in value added per full-time equivalent employee
by industry in 1989-95 and 1995-99. With some important qualifications,
the evidence does show that productivity growth increased after 1995 in
industries that are heavy users of information technology. A further
analysis sorted industries into two groups according to the intensity
with which they use information technology (as indicated by the ratio of
their spending on information technology to their value added in 1996).
The dividing line between the two groups was determined such that each
group accounted for roughly half of the value added in the economy in
1996. The analysis found that growth in value added per employee was
considerably more rapid in the more information technology-intensive group
of industries between 1989 and 1999. In addition, the acceleration of
value added per employee in this group was more than 50 percent greater
than the acceleration in the less information technology-intensive group
(Table 1-2).

Striking evidence of improvements in distribution and in the management
of the supply chain comes from wholesale and retail trade, both of which
experienced much faster productivity growth after 1995. In 1999 these
industries accounted for 25 percent of full-time equivalent employees in
private industry. Output in these industries increased significantly
without corresponding increases in employment.

Data for financial institutions as a group also show an acceleration
in productivity after 1995, supporting the view that these heavy users
of information technology have performed well. Within financial
institutions, however, this observation holds true only for nondepository
institutions and brokers. Banks and other depository institutions
experienced a reduction in productivity growth after 1995. The insurance
industry also experienced an acceleration in productivity, reversing
what had previously been negative productivity growth.

The services sector showed an acceleration in productivity, but this
sector still experienced negative productivity growth after 1995.
Business services shifted from negative to positive productivity growth,
as did personal services. Health services, the largest industry in this
sector, reduced its rate of productivity decline.

On balance, the pattern of productivity growth by industry is consistent
with (although it does not prove) the view that improved business
practices and more-productive use of information technology have played
an important role in the acceleration of productivity. In addition, some
of the gain in productivity is presumably associated with capital
deepening.

Some difficulties in the data, however, both help explain certain
puzzles or anomalies in Table 1-2 and suggest that these results should
not be taken as definitive. First, consistent data on output and labor
input by industry are available only for 1987-99. The cyclical peak year
of 1989 is taken as the starting point here, further shortening the span
of the data. The brevity of the time periods before and after 1995 mean
that observed growth rates may not reflect actual industry trends.
Second, output in the private sector (or in nonfarm business) is computed
initially at the aggregate level and then broken down by industry.
Because this process is inexact, productivity growth can be overestimated
in one industry and underestimated in another. Third, difficulties in
constructing price deflators for industries such as business services,
insurance, and health care add errors and uncertainties to estimates of
productivity in these industries and in every industry that purchases
inputs from these hard-to-measure industries. The negative productivity
growth reported for health care, for example, seems inconsistent with
the rapid pace of technological innovation in that industry (see
Chapter 5).

Despite these data problems, the industry results are important. Some
prior analyses based on earlier data appeared to conflict with the view
that productivity growth was increasing in computer-using industries.
This new evidence, however, broadly supports the view that the new
technologies are yielding economic benefits.

Learning from the New Productivity Trends

The breakdown of the sources of accelerated productivity and the
analysis of industry data suggest three important lessons:

 The information technology sector itself has provided a direct
boost to productivity growth. Part of the recent surge in productivity
is the direct result of productivity growth within this sector.

 The spread of information technology throughout the economy has
been a major factor in the acceleration of productivity through capital
deepening. Increasingly, companies have been eager and able to buy
powerful computers at relatively low prices. The rapid advances in
computer technology, together with favorable economic conditions, have
fueled a computer and software investment boom.

 Outside the information technology sector, organizational
innovations and better ways of applying information technology are
boosting the productivity of skilled workers. A variety of changes that
go beyond the direct application of new computer technology, including
structural changes in private businesses and more effective use of worker
skills, have further boosted productivity.

What accounts for the changes revealed in this productivity analysis?
Answering this question requires moving behind the aggregate and industry
numbers to consider three sets of complementary developments: changes
within the information technology sector, changes in other sectors, and
changes in economic policy.

Innovations in the
Information Technology Sector

Dramatic developments occurred within the information technology sector
in the 1990s, particularly in the second half of the decade, when the pace
of innovation accelerated. The top left panel of Chart 1-5 shows the surge
in private research and development (R&D) spending on information
technology, and the top right panel shows the increase in the pace of
innovation (as measured by the number of information technology patents
granted annually). The bottom left panel depicts the surge in the
production of computers, semiconductors, and communications equipment:
between 1992 and 2000, real output in this sector increased more than
13-fold. The bottom right panel shows the rapid increase in employment in
the industries providing computer, data processing, and communications
services.

The process by which new information technologies are created in the
United States has undergone a number of major changes that have
transformed the ways in which such innovation occurs. In much of the
postwar period, defense spending was a major driver of innovation, and
the Federal budget was a more important source of R&D funding than it is
today. Innovation, however, was undertaken predominantly by large
manufacturers, and the U.S. economy was less integrated with the
international economy than it is today. That situation has changed
considerably, as Chapter 3 describes in detail. Four developments in
particular deserve mention: changes in the competitive environment,
changes in organizational structures, changes in compensation and finance,
and innovations in complementary technologies.

Growing Competition

The information technology sector is being driven by heightened
competition in an increasingly deregulated economy in which
international trade plays an ever-growing role. These pressures foster
the creation and adoption of new technologies, especially in the private
sector, which has begun to play a greater role in innovation since the
end of the Cold War. When businesses bring innovations to market, their
rivals are given strong incentives to innovate as well. In the area of
information technology, the firm that is the first to gain market
acceptance for a new type of product often gets to set the standard for
that product, and therefore is most likely to capture the lion's share
of the market. The innovating firm can then exploit its early success,
to develop the next generation of technology and products. The prospect
of second-generation success thus raises the premium on rapid innovation.



For firms to have strong financial incentives to innovate, there must
be strong demand for such innovation from other firms in other industries.
Almost 70 percent of all information technology products are purchased
by the wholesale and retail trade, finance, and telecommunications
industries. Competition in these industries (often on a global level)
encourages them to seek out new technologies to improve their own
productivity. Unlike in some other countries, in which barriers to entry,
pricing restrictions, and other business restrictions restrain competition,
in the United States competitive pressures are generally strong.
Deregulation in finance and telecommunications has helped create an
increasingly competitive environment.

The number of new firms in the information technology sector is a
measure of the incentives and opportunity to innovate--and the figures
paint a dramatic picture. Between 1990 and 1997 the number of information
technology firms more than doubled (Chart 1-6). Many innovations have
come from talented individuals in small startup companies that are willing
to take risks.

Organizational Changes

Competitive pressures have increased the importance of introducing new
products and processes quickly. Yet the know-how required to create these
products has become more complex and more dispersed. Today it is rarely



cost-effective for a single firm to control an entire innovation process.
As a result, businesses have altered the organizational structures within
which innovation takes place.

A smaller fraction of R&D now takes place within large, integrated
companies. Small firms are responsible for an increasing share of the
Nation's industrial research. Collaboration between innovating firms has
become commonplace, as the dramatic growth in interfirm technology
alliances in the 1990s demonstrates. Furthermore, today's innovations
increasingly draw upon scientific knowledge, much of which is developed
by universities and national laboratories. To take advantage of this
science base, private firms are now performing more basic research than
ever before. And because proximity to these universities and national
laboratories matters--by improving a firm's chances of capturing
spillovers and of hiring high-quality researchers--innovation today is
often characterized by geographic concentration into high-technology
clusters such as Silicon Valley, California. In these clusters and
elsewhere, many new firms, free of the constraints often imposed in
large, established corporations, continually enter the market with new
technologies and innovative business ideas.

Innovations in Compensation and Finance

New methods of financing have evolved to address the needs of new
entrants and of R&D in the information technology sector. Traditionally,
firms have used their physical plant and equipment as collateral for
financing. But the unique challenges of promoting innovation in sectors
where much of the know-how is based on intangible capital, plus the
considerable risks involved in financing high-technology companies,
have generated new institutional arrangements. Venture capital, in
particular, has played a crucial role, supplying funds and providing
management know-how and connections for entrepreneurs. Initial public
offerings (IPOs) have also been instrumental. The information technology
sector has made extensive use of new compensation mechanisms that provide
incentives to talented workers and managers. For example, stock options
enable firms to attract and retain talent while passing some risk on to
workers. The vibrant stock market has also been important, allowing
venture capitalists to cash out more easily through IPOs and enabling
workers holding stock options to boost their earnings. In an important
sense, success has generated success, as venture capitalists score big
and then use their augmented capital to seek out new profit opportunities.

The excitement over the technology revolution drove technology stocks
to extraordinary heights in the spring of 2000, although they have
retreated since then. The volatility in technology equity markets can be
disruptive to companies seeking new funding, but investors' willingness
to take risks and the availability of financial resources for successful
entrepreneurs continue to make U.S. financial markets important
contributors to the New Economy. Even after the recent decline in the
technology sector, price-earnings ratios remain high. This indicates
that investors are still willing to take a chance on companies with low
current earnings but the potential for rapid future growth.

New Complementarities

The changes in the information technology sector have been both
cumulative and complementary. Innovations in one area have created
demands in another. Breakthroughs in communications and data compression
techniques, for instance, generate demand for improved software and for
more powerful computers. Complementarities operate on both the supply and
the demand sides. In particular, the falling costs associated with the
use of computers have made certain types of research feasible for the
first time--the mapping of the human genome, for instance, was made
feasible by computers. Information technology is becoming increasingly
important in the development of new treatment options, and the Food and
Drug Administration uses computers to streamline the analysis and approval
of new drugs. Demand is particularly powerful when it generates positive
feedback through network effects. E-mail, for example, becomes
increasingly useful as more people use it.

The evidence suggests, then, that a number of factors have combined to
create a uniquely favorable climate for entrepreneurs. These factors
include a growing demand for new and improved technologies (spurred by
intense domestic and global competition and technological
complementarities), the improved capacity of reorganized firms and
networks to supply the new technologies, and innovations in thriving
financial markets.

Innovation Throughout the Economy

Simply buying and installing new technology does not automatically
increase productivity, profitability, or job creation. Yet some views of
the New Economy reveal a kind of naï¿½ve technological determinism that
ignores the vital role of complementary changes in production and
business practices. Companies throughout the U.S. economy have been
radically transformed by new technologies that enable entire product
networks to become more efficient, effective, and integrated. These
transformations are detailed in Chapter 3, but a few of the most
important changes are noted here, including changes in production,
inventory and supply management, customer relations, and corporate
structure.

New Production Methods

Innovations in information technology have generated many changes in
manufacturing processes. New technologies permit workers to analyze data
and make detailed adjustments to production lines on the plant floor,
boosting productivity, improving quality, and lowering costs. The
availability of data, often on a real-time basis, allows for continuous
performance evaluation that can improve efficiency. Workers who have
access to information technology can be empowered with more decisionmaking
responsibility. In addition, the new technology allows organizations to
disseminate information and coordinate their activities more easily,
resulting in less hierarchical organizational structures. In turn, these
new structures may reduce costs and further increase efficiency. Finally,
as in the information technology sector itself, innovations in the way
workers are compensated can help firms achieve greater productivity
gains from new technology, spurring further innovation in compensation
and finance. Studies suggest that worker performance improves when
incentives are tied more closely to performance. Stock options have
become more common as a method of attracting, retaining, and rewarding
employees.

Changes in Inventory and Supply Chain Management

Firms typically hold inventories as a cushion against uncertainties.
Producers keep excess raw materials and other inputs on hand to prevent
shortages on the production line, for example, and stores maintain
inventories to meet fluctuations in demand. The need for inventories
springs in part from incomplete information about demand. For this
reason, technologies that improve the dissemination of information
enable companies to react more promptly to market signals and to
economize on inventories (by sharing point-of-sale data, for example).
Indeed, aggregate inventory-to-sales ratios have fallen significantly
since the early 1990s (Chart 1-7).

The new information technologies have also changed the nature of
relationships between firms and their suppliers. Procurement practices
have changed radically, as firms become linked to suppliers through
Internet-based business-to-business marketplaces. This capability allows
businesses to streamline procurement activities, lower transactions costs,
improve the management of supplier relationships, and even engage in
collaborative product design. ``Just-in-time'' delivery, facilitated by
a more efficient transportation network including both surface and
aviation infrastructure, has been instrumental in allowing firms to
reduce inventories and lower costs while continuing to provide essential
services to producers and consumers.



New Relationships with Customers

Information technologies give firms the ability to develop richer, more
targeted relationships with their customers. Firms are able to tailor
marketing and product design more precisely to customer needs. Customers,
in turn, are able to find and compare the products that most closely
match their preferences. Scanner data from retail stores allow companies
to monitor which items are selling and which are not. This information
can be transmitted back to manufacturers, who can then adjust their
production schedules. This avoids stockouts and surplus inventory. The
information from scanners can also be used for marketing. Customers
who have purchased outdoor adventure products, for example, can be sent
information on related gear or travel opportunities that they may wish
to purchase.

Shifting Corporate Boundaries

Markets allocate resources efficiently by setting prices, expanding
choices, and encouraging competition. But in situations where pricing
and writing contracts is costly and difficult, where uncertainty is
high, and where information is difficult to come by, some activities
may be more efficiently undertaken within the firm than in the
marketplace. Transactions costs thus affect the make-or-buy decision,
which determines where the firm's boundaries end and the market begins.
Information technologies can radically change where these boundaries
should be drawn, and this sets in motion both centrifugal and
centripetal forces. An example of the latter is the large number of
recent mergers, some motivated by the belief on the part of some firms
that new technology allows the span of organization to be extended. As
Chart 1-8 shows, both the number and the value of mergers and
acquisitions have moved to new heights as firms seek to capitalize
on both efficiency gains and increased market power. On the other hand,
many small firms may be able to benefit by specializing in a few core
activities. This can lead companies to spin off parts of their
operations--an example of centrifugal forces at work.



Behind the New Trends: The Role of Policy

The Administration's policy strategy has complemented and fostered the
private sector initiatives that generated these new trends. The approach
has rested on three major pillars: fiscal discipline, investing in people
and technologies, and opening markets at home and abroad. Each of these
policy emphases has contributed to the economic environment in which the
New Economy has thrived. They have promoted the emergence of an economy in
which innovative new businesses are stimulated by relatively low interest
rates, an abundant supply of risk capital, world-class educational and
research institutions, a well-educated and well-trained work force,
competitive product and labor markets, and the development and diffusion
of the Internet. In addition, the Administration has pursued new social
policies to ensure that the American people have the opportunities to
share in the gains of the New Economy.

Fiscal Discipline

The Omnibus Budget and Reconciliation Act of 1993 was the right policy
package at the right time. The Federal funds rate had been moved to a low
3 percent in 1992 in an attempt to stimulate the economy and create jobs.
But long-term interest rates remained stubbornly high. The 10-year
Treasury bond rate averaged 7.0 percent in 1992--unusually high for a
weak economy. Bond yields were being predictably affected by the forces
of supply and demand: the Federal Government was set to run a deficit of
almost $300 billion, adding a massive new increment to the already
swollen stock of outstanding debt. With an oversupply of government bonds
and the prospect of even more to come, bond and stock prices were
depressed, and yields were correspondingly high.

In 1992 the new Administration was elected on a promise to turn the
deficits around. After a tough political battle in 1993, the
Administration was able to deliver on that promise. The 1981 reductions
in tax rates for those in the upper income brackets were partly rolled
back, and Federal spending was restrained. The markets responded quickly
to this serious effort to address the deficit by lowering expectations
of future inflation, and long-term interest rates accordingly fell. The
10-year Treasury rate hit a low of 5.3 percent in October 1993. Over the
next year or so, the combination of a stronger economy and the Federal
Reserve's decision to boost short-term rates pushed long-term rates
slightly upward again, but they remained lower than they would have been
without deficit reduction.

As economic growth and further restraints on spending (including the
bipartisan 1997 budget agreement) turned the huge deficits into surpluses,
a new fiscal environment emerged. The 10-year Treasury rate fell below 6
percent in 1998 and 1999. And despite the extraordinarily strong economy
and associated upward movement in short-term rates, that rate stood at
only 5.7 percent in November 2000. With a swing in the budget balance of
an impressive $492 billion over the last 7 years, the budget surplus for
fiscal 2000 came in at $236 billion, or 2.4 percent of GDP.

Chart 1-9 shows budget deficits and surpluses in each fiscal year from
1970 to 2000. The ups and downs caused by the business cycle are clearly
visible. But even clearer are the trend prior to 1993 and the subsequent
sharp turnaround. The 1993 deficit reduction act and subsequent restraints
on spending both fueled and capitalized on the private sector's potential
for rapid growth. (See Chapter 2 for more discussion of fiscal policy and
the deficit.)



The most direct link between improved fiscal discipline and growth is
that through low interest rates, which encourage investment. As interest
rates fall, financing of all kinds of activities becomes less costly. In
addition, low interest rates help keep the stock market strong, allowing
companies both old and new to lower their cost of capital. Ultimately,
the combination of falling prices for investment goods and reduced
interest costs stimulated dramatic growth in investment. Led by equipment
and software purchases, investment grew 13 percent per year between the
first quarter of 1993 and the third quarter of 2000. Investment is not
the only engine of growth, but new technologies cannot be acquired without
it. Strong investment is essential to rapid growth, and by reducing the
amount of saving that must go to finance the public debt, fiscal
discipline has made room for strong investment.

The result has been a virtuous cycle, in which the right policies in
1993 kicked off a chain reaction of smaller deficits, lower costs of
capital, higher investment, increased technology in the workplace, and
faster economic growth. As the deficit became a surplus, the virtuous
cycle kept turning.

Investing in People and Technology

If fiscal discipline had been achieved through cutbacks in education,
training, and technological development, it probably would have failed.
At the least it would have undermined the potential for long-term growth.
But the Administration did not make this mistake; instead its budget
proposals consistently pushed for increased spending for growth-oriented
programs while reducing total outlays. And although not all the requests
were approved in the final budgets, substantial funding increases did
occur in these areas.

Investments in people have come along several fronts. The Administration
has invested in children through support of kindergarten through 12th
grade (K-12) education, it has helped Americans attend college, and it
has worked hard to improve the training opportunities available to
American workers.

Our public schools play a crucial role in determining the future
productivity of American workers. The Federal Government has been an
important contributor to K-12 education by helping to ensure a more
equitable distribution of opportunities. Federal funds offset a good
deal of the difference in educational spending between rich and poor
districts. Through the E-rate program, the Administration has helped
schools invest in new technologies for the classroom. The Administration
has also provided leadership on initiatives to reduce class size,
raise standards, and improve accountability. Programs such as the 21st
Century Community Learning Centers Program help communities utilize
their school buildings after school hours to provide enriching programs
for children.

The New Economy has provided increasing rewards for higher education.
Responding to this fundamental change in the labor market, the
Administration has helped students prepare for college through the GEAR
UP (Gaining Early Awareness and Readiness for Undergraduate Programs) and
TRIO programs. These programs help students in high-poverty schools and
from low-income families through academic enrichment programs and
mentoring. For students who are admitted to college, Administration
programs such as the HOPE Scholarship tax credit and the Lifetime Learning
tax credit help students and their families afford the tuition. The
Administration has also substantially increased the funds available
through the Pell grant program.

Because learning continues throughout a lifetime, and skills often need
to be updated, the Administration has strongly supported training programs
for those already in the work force or seeking to rejoin it. The Workforce
Investment Act provides job training and job search assistance, with
priority given to low-income and displaced workers. In conjunction with
the programs of the Workforce Investment Act, Youth Opportunity Grants
help at-risk youths develop job skills. The Administration has also
supported the NAFTA Transitional Adjustment Assistance program to address
the needs of workers affected by economic dislocations resulting from
the North American Free Trade Agreement.

During the past 8 years, research funding at the National Science
Foundation has been increased by more than 60 percent, and that for the
National Institutes of Health by more than 80 percent. Information
technology has also been targeted for increased research. For fiscal
2001 the President requested more than $2 billion in Federal support for
information technology research, which will substantially increase the
Federal commitment to R&D in this area. He also called for a new
initiative in nanotechnology, which could someday lead to the ability
to store the information equivalent of the Library of Congress in a device
the size of a sugar cube, and the development of materials that are 10
times stronger than steel but a fraction of the weight.

Of equal importance has been the Administration's commitment to fostering
innovation in the private sector. The Research and Experimentation tax
credit has been extended through 2004. The Administration supported the
Internet Tax Freedom Act, which imposed a moratorium on Internet taxes,
enhancing the ability of entrepreneurs to explore new commercial
applications of this medium. The White House's Framework for Global
Electronic Commerce called for private sector leadership and limited
government involvement: government should intervene only to support a
predictable, consistent, and simple legal environment for e-commerce.
The Administration has also supported reform through the
Telecommunications Act of 1996, which encouraged competition in the
telecommunications industry and has led to lower prices, more customer
choice, and faster deployment of broadband networks to homes and businesses.

Setting the Rules for Fair and Open Competition

The United States has long had a bipartisan agenda aimed at expanding
world trade and investment, and a succession of Administrations have
negotiated trade agreements in various forums. Over the past 8 years,
this Administration has sustained the Nation's agenda for international
trade, signing and achieving ratification of a series of important
international agreements. These include the North American Free Trade
Agreement establishing a free-trade area throughout Canada, Mexico, and
the United States; the Uruguay Round agreement of the General Agreement
on Tariffs and Trade, which set up the World Trade Organization (WTO), a
rules-based, member-driven organization that regulates tariffs and
trade worldwide; multilateral agreements within the WTO on trade in
financial services, basic telecommunications, and information technology;
a moratorium on tariffs on digitally delivered goods; and an agreement
with China that has paved the way for its entry into the WTO. This
extraordinary record of achievement has already paid off in improved
economic performance and will contribute to continued growth ahead.

Globalization, spurred in part by these and other agreements, has been
particularly important in promoting the competitive pressures that have
made the U.S. economy so innovative. Foreign competition encourages U.S.
firms to improve and innovate, as firms that compete against the best
companies in the world are likely to adopt best practices themselves.
U.S. companies have also had the opportunity to take their own best
technologies and practices overseas through exports and foreign direct
investment. Globalization has also increased price competition, helping
to keep inflation down.

Globalization has also played a key role in enhancing domestic
production and adoption of information technologies. By exporting to
global markets, U.S. innovators have achieved scale economies that can
increase the returns to R&D in information technology. U.S.-based
producers also use components that can be produced more cheaply abroad
than at home to make products that are internationally competitive. The
importance of such global linkages for the computer industry is vividly
indicated in Chart 1-10, which shows that, in 1999, imports accounted
for fully 60 percent of U.S. domestic spending on computers, while about
50 percent of domestically produced computers were exported.

International competition has reinforced competition at home. The vast
U.S. market provides a competitive environment for most industries, even
without foreign trade. This large national market has been one of the
great strengths of the U.S. economy over the years. But competition can
be threat-



ened if a single company abuses its dominance in a market. Under
this Administration, this threat has been met by the active enforcement
of U.S. antitrust laws. These laws do not discourage successful companies
from growing and gaining market share by creating competitive products
and services. Rather, they prevent companies from seeking to gain a
market position that would threaten competition in an industry. Antitrust
laws limit corporate conduct that undermines competition and consequently
harms consumers. Indeed, the ultimate goal of antitrust legislation is to
protect consumers' interests.

Regulatory policies have also promoted competition. The regulatory
reform movement has been bipartisan ever since its beginnings in the
1970s, and the 1990s have been no exception. The 1996 Telecommunications
Act and auctions of portions of the electromagnetic spectrum to
telecommunications providers have allowed new companies to compete
against existing ones and dramatically expand the availability of
wireless service. This industry has exploded with new investment and
new services, and with a third generation of wireless service on the
horizon, it is vital that progress not be slowed.

In financial services, the Glass-Steagall provisions instituted in the
1930s prevented banks from joining with stockbrokers and insurance
companies to create financial monopolies. Restrictions on interstate
banking prevented bankers from straying too far from the geographic areas
they knew well. Given the massive financial instability of the 1930s,
narrowing the range of banks' activities was arguably important for
that day and age. But those rules are not needed today, and the easing
of interstate banking rules, along with the passage of the Financial
Services Modernization Act of 1999, have removed them, while maintaining
appropriate safeguards. These steps allow consolidation in the financial
sector that will result in efficiency gains and provide new services for
consumers.

Social Policies

As shown earlier, the stunning economic performance over the past 8
years has generated sharp reductions in poverty and across-the-board
improvements in income. The expansion has created a high-employment
economy that has provided economic opportunities for disadvantaged workers
and those who have not yet acquired marketable skills. Faster growth in
labor hours made an important contribution to the acceleration in output
that occurred in the second half of the 1990s. In a tight labor market,
employers hire and train workers they might previously have passed over.
During the 1990s employers hired and trained young people and older
workers, who typically comprise an untapped pool of potential. But
specific policies have also expanded opportunities.

The Earned Income Tax Credit increases the payoff from work for
low-income families, especially those with children. Since 1993 the
benefits and coverage of this credit have been expanded. In 1999
beneficiaries received a total of nearly $31 billion (compared with
$15.5 billion in 1993), and the number of families receiving
assistance increased by one-third, from 15 million to nearly 20 million.
The minimum wage operates in tandem with the Earned Income Tax Credit
to raise the incomes of working families. The Administration proposed
an additional $1 increase in the minimum wage in 2000. Even without
this change, when combined with the maximum 40 percent subsidy from
the Earned Income Tax Credit, the effective minimum wage is $7.21 per
hour of work. The cost to employers, however, is much lower. Meanwhile
welfare reform has encouraged families to become self-sufficient and
has supported them as they make the transition to work. The
Administration is reaching out to communities left behind by
economic growth with its New Markets Initiative, passed with bipartisan
support.

Some have suggested that all government programs designed to help the
disadvantaged reduce incentives and discourage economic growth. This
argument maintains that only a laissez-faire policy is compatible with
the labor market flexibility necessary to achieve strong economic
performance. But the Earned Income Tax Credit, welfare reform, assistance
with the transition from welfare to work, and support for lifelong
learning all indicate that government intervention can both improve
incentives to work and reduce economic inequality.

Challenges for the Future

Economic performance in the last 8 years has been so strong and so
qualitatively different from that of the previous two decades that it
may seem obvious that a New Economy has emerged. When productivity growth
and GDP growth both accelerate sharply, when unemployment and inflation
fall to their lowest levels in 30 years, when poverty starts to fall
again after years of worsening, and when incomes accelerate across the
board, clearly a significant change has occurred.

In addition, the economic transformations described in this Report point
to a truly New Economy. Information technology has become a pervasive
part of economic life, changing the way nearly all Americans work--from
farmers using the Internet to check a satellite report on soil moisture,
to software designers using the latest technology to create a new
learning program. Computers have been facilitating change in business
systems for some time, but the explosive growth in the production and
use of information technology that has taken place in recent years has
gone much further. The American economy has been profoundly altered. The
innovations that have taken place both within the information technology
sector and throughout the rest of the economy have included complementary
developments in organization, business practices, and public policies.

But the New Economy label is easy to misuse. The New Economy cannot be
invoked as the solution to all of America's problems. Its emergence does
not mean that the lessons of economic history can be discarded or that
concern for the disadvantaged and elderly can be forgotten. As we
describe in the rest of the Report, there remain many challenges ahead.
This chapter concludes with a brief summary of each of the remaining
chapters and the principal challenges that they identify for policy.

Preserving Fiscal Discipline

Chapter 2 describes how changes associated with the New Economy
continued to be reflected in macroeconomic performance during 2000.
Although growth began to moderate in the third quarter, it was still
on track to be about 4 percent over the course of the year. The
remarkable combination of very low unemployment and tame inflation
remained evident even as the economy proceeded through its 10th year
of expansion. Investment in equipment and software remained robust,
and productivity growth was very strong.

The chapter goes on to describe the challenges faced in 2000 as the
economy negotiated some speed bumps, such as the cooling off of the
stock market and rising oil prices. Although risks can never be
eliminated, the virtuous cycle of sound budget policies and strong
economic performance has left future policymakers with an economy
that is well positioned to weather possible storms. The chapter also
presents the Administration's forecast for the next 11 years.

For the longer term, the chapter examines the historic turnaround in
the budget outlook since 1993 and the challenge of preserving the fiscal
discipline that has been achieved. The aging of the population will put
increased pressure on budget resources for such programs as Social
Security and Medicare as the new century progresses. The chapter
describes how, by taking appropriate actions now to preserve the budget
surplus and make sound investments, the resources can be made available
to deal with these pressures when they arise. And although the New
Economy will not stop the population from aging, its continued
manifestation in strong productivity growth can be a further help in
dealing with this challenge.

Nurturing a Vibrant Private Sector

Chapter 3 looks at the sources of performance improvements in plants,
firms, and industries. It traces these improvements to technological
innovation, particularly in information technology, along with
complementary organizational practices that enhance the productivity
of this technology and the emergence of a more competitive business
environment. The analysis attributes the recent surge of technological
innovation to strong demand for new technologies, financial market
innovations such as venture capital and initial public offerings,
organizational changes, increases in private sector R&D (including
funding for basic research), and strong legal protection for intellectual
property.

Technological innovation has been particularly important for two
reasons. First, the information technology-producing sector itself is
highly productive, and the growth of this sector has led to increased
performance for the economy as a whole. Second, the adoption of
information technology has led to performance gains in other sectors
of the economy, making other inputs more productive by changing the way
firms do business. Manufacturing plants are increasingly automated, and
workers are being given more flexible job assignments and stronger
incentives through new compensation arrangements. Supplier relationships
are becoming more closely integrated through the use of computer systems
that coordinate the various aspects of production and warehousing,
allowing firms to reduce inventories dramatically. Firm boundaries are
also shifting rapidly, as firms outsource their noncore businesses and
move toward flexible, collaborative relationships such as strategic
alliances with suppliers, customers, and even rivals.

The end result is an economy that is unusually vibrant, dynamic, and
entrepreneurial, with a high rate of business formation--and of business
failure. It is important that this dynamic, competitive framework be
retained. Although government action is often needed to lay out the rules
of the competitive game, it is essential that market participants be
allowed to innovate and experiment. For example, the Administration took
important steps in September 2000 to ensure that adequate electromagnetic
spectrum will be available for new commercial communications technologies
such as third-generation wireless technology. At the same time, however,
U.S. wireless carriers will be free to work with their customers and
suppliers to determine exactly how these technologies should be delivered.

Ensuring That Globalization
Enhances the New Economy

Chapter 4 examines two interrelated phenomena: how advances in
communications and technology allow for expanded international trade
and financial flows, and how increased globalization is spurring
competition and innovation. Indeed, it is no coincidence that the New
Economy has emerged in the United States at the same time that U.S.
participation in the global economy has reached new heights, because
globalization and the recent advances in information technology are
inextricably linked. On the one hand, globalization has played a crucial
role in promoting the technological innovation and facilitating the
organizational restructuring that has yielded a New Economy. On the
other hand, improvements in information technology have spurred deeper
integration between the United States and the world economy.

The economic policy of this Administration has played a vital role in
fostering globalization, and thus in raising the incentives for
competition and innovation. Among the accomplishments of the
Administration are the historic agreements listed earlier in this chapter.
At the same time, a focus of U.S. trade policy has been to ensure that
these and other agreements safeguard global natural resources and respect
our Nation's values, including our commitment to core labor standards.

The effects of globalization and improved communications and technology
are evident in U.S. international transactions. Trade in capital goods
has soared since 1996, with particularly strong growth in items central
to the New Economy, such as computers, semiconductors, and
telecommunications equipment. There has also been strong export growth
in intellectual properties and in services that reflect the value of U.S.
innovation, such as business and technical services and financial services.

Although increased globalization and technological improvements have
raised U.S. economic performance and contributed to our prosperity, they
have also brought new challenges. Chapter 4 focuses on several of these,
including the widened U.S. current account deficit, ways to increase
growth in our major trading partners, and the implication of globalization
and technology for developing countries. Along with the gains,
globalization and technology have required adjustments as change affects
workers, industries, and communities in the United States. The chapter
therefore discusses the Administration's efforts to ensure that those
who have not shared in the gains are helped to acquire the tools that
will allow them to do so. Finally, the chapter examines the ways in which
U.S. economic policy seeks to preserve the environment and support labor
standards, and discusses the challenges that technology poses for
countries' legal institutions, for example through its misuse for tax
evasion.

Creating an Economy That Works for All

The New Economy has brought a great many good things to our Nation. But
it cannot solve all our problems. Left unassisted, it will not guarantee
an equitable distribution of opportunities or an optimal use of all
resources. Chapter 5 analyzes the programs and policies designed to help
those who might otherwise be left behind and to improve the quality of
life for all Americans. The chapter focuses on four important topics that
have a direct impact on the well-being of Americans. It examines the
Nation's welfare, education, and health care programs and the best ways
to manage the growing pains of our most rapidly growing communities.

Each of these areas has been characterized by important innovations
during the last 8 years. Our system of providing for the least well off
Americans has changed substantially. Public assistance programs now
reward work, making it easier for families to leave welfare and share
in the New Economy. Policies such as the Earned Income Tax Credit, child
care subsidies, and extensions of health insurance coverage provide
assistance to low-income working families. Innovations in health care
are directly improving the quality of life for many, and new programs
are bringing computers and the Internet to the classroom, helping
improve teacher effectiveness, reducing class size, and narrowing the
digital divide. Finally, policies that aim to reduce sprawl and encourage
smart growth are being implemented by forward-looking communities nationwide.

Despite the vast improvements in the quality of life experienced by
many Americans, several challenges remain. Welfare rolls have fallen
sharply: the number of people receiving welfare benefits is down by 59
percent since January 1993. However, some who have left welfare are in
jobs that leave them with less income than they had while on welfare,
and these individuals are likely to be among the first to lose their
jobs should the economy slow. There is also the challenge of what to do
for those who remain on welfare. Current law sets a lifetime limit of 5
years on receipt of welfare benefits. It is not clear what will happen
to those who exhaust these benefits and are unable to find jobs. More
broadly, substantial disparities in economic well-being remain across
racial groups and across regions; minorities and residents of the
Nation's central cities and rural areas suffer disproportionately high
rates of poverty and unemployment. Educational opportunities are also
unevenly distributed. Wealthy school districts spend more per pupil than
poor ones, and white children continue to score substantially higher
on national examinations than African-American or Hispanic children.
They are also more likely to go on to college. Our health care system
presents numerous challenges as well. It is important to continue to
control health expenditures to ensure that care is affordable to all.
Issues related to managed care must be resolved in a way that
appropriately aligns incentives so that health care is not overly
restricted or overly prescribed. Even with these issues under control,
many Americans will continue to lack health insurance coverage and will
therefore be unable to take advantage of the quality of care available
to the majority.  Finally, the New Economy has allowed certain
geographical regions to experience enormous growth in jobs and
population. This growth, where left unchecked, has led to suburban sprawl
and serious environmental consequences.

The final chapter of the Report recaps the story of the New Economy:
where it came from, how it is affecting our lives, and the challenges it
poses for the future.