From today's Wall Street Journal:
The Internet Boom Took Up Slack
My analysis of the birth and death of the recent boom ("False Hopes for the Economy -- and False Fears," editorial page, June 3) is criticized by a proponent of Austrian cycle theory, Robert Batemarco ("The Credit Expansions that Fool Entrepreneurs," Letters, June 13).
My thesis was that the investment boom had non-monetary origins in CEOs' emerging expectations of outsized productivity gains lying ahead and, in a surprise-free unfolding, would have unwound naturally as the gains materialized, though speculative excesses obviously occurred -- a thesis with roots in the German School of Spiethoff and Cassel (1904-1924).
The hard issue was why post-boom unemployment, now more than 6%, has overshot its pre-boom level of 5%. The interwar Austrian School of Mises and Hayek (1928-1939) held that a boom's excesses cause such overshooting: a slump is the cure. I noted weaknesses in their overinvestment argument. Austrians counter with a revised "malinvestment" argument. Because useless investments drove out good ones, the boom yielded underinvestment, so "the capital stock is unable to support the higher employment levels of the boom," as Dr. Batemarco says.
But that model does not fit. If there were now a capital shortage, long-term real interest rates would now exceed their pre-boom level, which they do not. If solid old-economy investments were being crowded out in the late 1990s, corporate interest rates net of inflation would have been elevated, which they were not. It appears that the Internet boom found enough slack in the labor market to make its investments, raising total investment from 11% to 13% of GDP, without having to cut into other investing. And in fact the world capital market went on financing us at the old terms. The crowding out is not evident.
Still, we must honor the Austrian theorists as the first to see capitalist ventures as voyages to the unknown, driven by visions of entrepreneurs and hunches of lenders and investors and fraught with unanticipated consequences.
Edmund S. Phelps
Professor of Political Economy
Columbia University
New York
Updated July 1, 2003
