SUSAN GRANT

Observing changes in the performance of the US economy, economists have recently begun to discuss the possibility that structural changes, particularly advances in information technology, are altering economies, making them more dynamic and efficient. Supporters of this 'new model' or paradigm argue that the conventional relationships between economic growth, unemployment and inflation are breaking down and that it is becoming possible for economies to enjoy both high growth rates and falling unemployment without rising inflation. This is very promising, as it holds out the prospect of prosperity continuing to rise without interruption, business cycles becoming a thing of the past, and economic policy being freed up to concentrate on problems other than inflation. However, some economists take a more cautious view of the effects of advances in information challenging the interpretation of some of the empirical evidence, and explaining the recent performance of the UK and US economies by an unusual combination of factors. Some of these factors, they argue, are temporary and are likely to be reversed soon thereby restoring the conventional relationships.

It has been traditionally thought that high levels of economic growth and the accompanying low levels of unemployment will be accompanied by inflation. Keynesians argue that as employment approaches the full employment level (usually defined as 2-3 per cent unemployment), demand-pull and cost-push pressures will start to rise. High levels of employment will raise income and aggregate demand. It may also result in a rise in wage costs as workers feel more confident in asking for wage rises and as firms compete with each other for increasingly scarce labour.

New classical economists have also traditionally argued that if unemployment falls below the non-accelerating inflation rate of unemployment (NAIRU), inflation will rise. NAIRU is, by definition, the rate of unemployment consistent with a stable rate of inflation and occurs when the aggregate demand for labour equals the aggregate supply of labour. In the late 1990s it was estimated that the UK's NAIRU was 7 per cent unemployment and the USA's NAIRU was 6 per cent. If unemployment falls below NAIRU, aggregate demand for labour exceeds the aggregate supply of labour and the nominal wage rate is bid up, raising costs and prices. Inflation will continue to rise until unemployment is returned to the NAIRU level.

Therefore, both groups of economists have conventionally argued that once unemployment falls below a certain level, inflation will start to rise. They have also seen growth being constrained, in the long run, by the rate of increase in the quality and quantity of resources. For instance, the UK's trend growth rate is estimated to be 2.25 per cent. This increase in productive potential comes mainly from advances in technology and educational performance.

This suggests that the conventional relationship between low levels of unemployment and inflation and the extent of supply constraints on economic growth have changed. It is claimed that advances in information technology and their application are causing a significant, positive shift in productivity. This is causing the productive potential of economies to rise at a greater rate than in the past. It is also reducing costs of production and allowing employment and wages to rise without causing inflation.

In recent years the UK has experienced low inflation, falling unemployment and positive growth. However, the most noticeable change has been witnessed in the USA, where not only are inflation and unemployment low but output and productivity are experiencing significantly above-average growth rates.

Supporters of the new economic paradigm argue that it is not surprising that these changes are most noticeable in the USA. This is because advances in information technology have occurred most rapidly and extensively in the USA. For example, more than 75 per cent of the world's connections to the Internet are taking place in the USA.

There are three main views on the new economic paradigm.

1. The zealots. These claim that the world is on the verge of a third industrial revolution in which the application of IT, including the growth of high technology industries, the spread of the Internet and the expansion of electronic business, is creating a new economy in which growth can increase with minimal inflationary pressure. They argue that the advances in IT will have a greater impact than past inventions, such as the invention of the internal combustion engine and electricity.
2. The cautious supporters. This group is also sometimes referred as new paradigm optimists. It includes Gordon Brown, the Chancellor of the Exchequer, and Alan Greenspan, the Head of the US Federal Reserve. They believe that advances in IT coupled with supply-side improvements are enabling companies to increase efficiency and provide the opportunity for higher growth rates with less risk of inflation.
   In 1999 Gordon Brown told a Treasury Select Committee that the UK could be on the verge of a sustained period of low inflation and strong growth, similar to that being experienced in the USA. Alan Greenspan has also argued that high rates of investment, especially in capital which embodies high technology, has increased productivity and raised corporate efficiency.
3. The sceptics. This group claims that the productivity figures are not as impressive as they first appear, that there are a variety of reasons for the more recent performance of the US and UK economies, and that the performance may only be temporary. Among the factors they identify as putting downward pressure on inflation in both the UK and USA are the high values of their currencies; supply-side improvements resulting from previous direct tax cuts and deregulation; and low expectations of inflation and increased global competition. They also claim that inflation is not dead but merely sleeping. If, for example, the value of the dollar falls, inflationary pressures could again build up. They claim that growth is high in the US as a result of an upswing in the business cycle rather than any change in the structure of the economy. As a result, they argue that a new model is not needed to explain the current economic behaviour.

A variety of empirical evidence is put forward in support of the new economic performance, including:

1. High levels of investment in information technology. In the US, whilst other investment has been rising relatively slowly, investment in computers has increased fourteen fold in the 1990s and Internet connections are more than doubling each year.
2. Growth of employment in IT. A significant proportion of the new jobs created in the UK and USA are in industries that are either producers or intensive users of IT. It has been estimated that by 2006 nearly half of the US workforce will be employed in these industries.
3. Contribution of IT to economic growth. Between 1995 and 1998 the IT sector, which accounted for only 8 per cent of total output, contributed an average 35 per cent of the country's economic growth.
4. Productivity. The USA's productivity figures have been showing a marked improvement. Before the late 1990s productivity rose at an average rate of 1.1 per cent but in the late 1990s it accelerated to more than 2 per cent per annum. This rise has been attributed to the increase in the level of fixed investment, much of which has embodied new technology. The productivity performance has been less impressive in the UK, where productivity growth has been lower in the late 1990s than in the early 1990s. This may reflect the fact that the recent slowdown in economic growth has not been associated with a reduction in employment.
5. Growth rates. Since 1996 the UK's growth rate has risen significantly. In 1998 and in 1999 (to date) the economy grew at an average of 4 per cent per annum in comparison with its 30-year average of 2.8 per cent. Supporters also claim that the effects of the IT advances are just beginning to be felt, and that the full effects in terms of productivity and growth may not be evident until some time into the twenty-first century.
6. Unemployment and inflation. In recent years both the UK and USA have been experiencing low inflation and low unemployment. In the UK the decline in unemployment experienced from 1993 has been combined with the lowest Ievels of inflation for decades. Indeed, in 1999 unemployment fell to an 18-year low while inflation was below the government's target rate. In the USA unemployment fell below 6 per cent in 1995 and continued to fall (it was 4.3 per cent in June 1999) and has again been combined with low inflation. 
7. Boom on Wall Street. Share prices have risen to record levels. Some have interpreted this as indicating that financial investors believe the economy has changed, and high growth and profits will continue.

Sceptics challenge some of the evidence and interpretation of the data put forward by the supporters.

1. Boom on Wall Street. The sceptics argue there are other causes of the rise in share prices, including a reduction in the attractiveness of government bonds.
2. Low inflation. As mentioned earlier, other causes are advanced for the low levels of inflation. It is also pointed out that countries have often had periods of low inflation, which were then followed by a rise in inflation. The sceptics are already seeing signs of increasing inflationary pressure. They mention, for example, that at present, the growth of demand (5 per cent) in the USA is outstripping the growth in output (4 per cent).
3. Significance of the advances in IT. The sceptics claim that past technological advances are likely to prove more significant than the recent developments in IT. Robert J. Gordon of Northwestern University in the USA, has argued in a paper published in May 1999 that the main productivity gains from the application of IT have already occurred and that the IT revolution may never come close to matching the impact that the internal combustion engine and electrical power had on productivity and growth.
4. Productivity figures. The reliability of the productivity figures has been questioned. It is difficult to measure productivity, particularly in the service sector and in the United States there have recently been changes in the method of measuring productivity. Even taking the figures at face value, the sceptics point out that this improvement in productivity has been largely concentrated in computer manufacturing, which is currently a relatively small sector of the economy. According to Robert J. Gordon, productivity growth in computer manufacturing increased by 42 per cent between 1995 and 1999 which, despite its small size, was enough to increase overall productivity figures. However, advances in IT do not appear to have raised productivity levels in other industries. Indeed, productivity in some other sectors, e.g. non-durable manufactures, has slowed.

2 Apart from increases in the quantity and quality of capital investment, what are the key causes of economic growth?