No Quick Fix

0 Comments | Insight on the News, April 16, 2001 | by Rex Roberts

A noted economist has good news and bad news for a New Economy with old problems.

As Nasdaq and the Dow plummet, economists argue whether the long, steep slide reflects a speculative bubble, an irrational faith in tech-driven markets or merely a momentary setback. The debate is far from academic: investors and entrepreneurs have lost $3 trillion during the past year, with formerly high-flying companies such as eToys and Price-line losing 99 percent of their stock value.

In the coming months, political and business leaders face crucial decisions regarding the economy, writes Michael J. Mandel in The Coming Internet Depression (Basic Books, $24, 181 pp). Mandel, an editor with Business Week renowned for his prescience, predicted the market bust, but he remains a believer in the so-called New Economy.

"The U.S. has a New Economy in which the business cycle has been replaced by the tech cycle, fueled by risk capital and intense devotion to innovation," he writes. The problem is, many leaders in Washington and on Wall Street talk about the Information Age, but secretly believe it's all a mirage. "In their hearts, many do not accept that anything really significant has changed."

This is a grave mistake, argues Mandel. As the market falls and economy slows, venture capitalists are less willing to take risks and businesses retrench. But because technology start-ups work on the principle of "increasing returns to scale" -- high research and development costs are offset as markets expand-- they thrive best in hothouse conditions. "A growing economy is even more essential for dot-coms," writes Mandel. "Their task is far easier if they can take a slice of a growing market, rather than having to take sales away from existing brick-and-mortar retailers in a stagnant market."

Likewise, policymakers can't allow an economic slowdown to drag on too long. Congress can cut taxes and increase spending -- pleasing Republicans and Democrats alike -- and the Federal Reserve can lower interest rates, but nobody knows what it will take to jump-start the stalled economy.

"If the Old Economy was an automobile, the New Economy is an airplane," writes Mandel. "In an automobile, if anything unexpected happens, the natural and correct response is to put on the brakes. But just as an airplane needs a certain airspeed in order to stay aloft, so the New Economy needs fast growth in order for high-risk investment in innovation to be worthwhile."

Mandel's prognosis and prescriptions for an ailing economy are persuasive, if frightening. In the worst-case scenario, the current slump turns into a recession that turns into a depression that goes global. Besides domestic worries such as soaring unemployment, inflation and defaults, the United States could experience a run on its currency. If this happens, all bets are off, although Mandel supports beefing up the International Monetary Fund and other global financial institutions.

Mandel doesn't offer much specific advice, but he does outline useful trends and alternatives. Worried investors driven to rethink the whole notion of capitalism will find Thomas Sowell's Basic Economics: A Citizen's Guide to the Economy (Basic Books, $30, 366 pp) helpful. It attempts to describe how societies create prosperity or poverty. That is, those investors who can still afford the book.