Innovation and the Financial Crisis

By Michael Mandel, PhDChief Economist, BusinessWeek

Mass Technology Leadership CouncilFebruary 25, 2009

The financial crisis is the symptom, not the cause

Looking back, the Internet Decade (1997-2007) was much weaker than we

realized.

Real wage gains were nonexistent• Median earnings (2007 dollars)

– College graduate, BA only » 1997: $51779» 2007: $53437» 3.2% increase over ten years

– Young college graduate (25-34), BA only» 1997: $44657» 2007: $45358» 1.6% increase over ten years

Real stock market gains were nonexistent

S&P 500, adjusted for inflation

00.20.40.60.8

11.21.41.6

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec-

97=1

This period compares unfavorably to the Great

Depression

S&P 500, adjusted for inflation

0

0.5

1

1.5

2

Dec

-97

Dec

-98

Dec

-99

Dec

-00

Dec

-01

Dec

-02

Dec

-03

Dec

-04

Dec

-05

Dec

-06

Dec

-07

Dec

-08

Dec-

97=1

1997-2009 1927-39

We kept spending and borrowing, and the rest of the world kept lending us money.

Accumulated Trade Deficit Since 1980 (as % of GDP)

0%

10%

20%

30%

40%

50%

60%

1980 1984 1988 1992 1996 2000 2004 2008

perc

ent

Why?• The U.S. was supposed to be the most

innovative economy (Google! Apple! Biotech! Google!)

• It was okay to move production overseas, because we would invent new stuff.

• It was okay to borrow, because we would invent new stuff

• It was okay to lend us money, because we would invent new stuff.

But leading tech sectors have struggled.• Weak performance of infotech stocks• Weak performance of pharma stocks• Mediocre performance of biotech stocks

Since 1997, infotech and pharma stocks are flat,

after adjusting for inflation

Infotech and pharmaceutical stocks, adjusted for inflation

0

0.5

1

1.5

2

2.5

3

3.5

Sep

-97

Mar

-98

Sep

-98

Mar

-99

Sep

-99

Mar

-00

Sep

-00

Mar

-01

Sep

-01

Mar

-02

Sep

-02

Mar

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-05

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-06

Mar

-07

Sep

-07

Mar

-08

Sep

-08

sept

-07=

1

drug companies info tech companies

Technology shortfall!

• The Internet alone is not enough.• Our existing technology and business-

know flowed to the developing world. • We did not create sufficient new products

and services to pay for imports. • Dependence on financial innovation

instead of real innovation.

• We’ve seen the consequences• There’s only so long you can wait for the

next big thing. • In my 2004 book Rational Exuberance, I

argued that if the pace of innovation slows, “it will become a lot harder to service all the debt that companies and people took on during the 1990s. Housing prices will slump and perhaps even plummet.”

• Financial crisis = Adjusting to a world with

slower expected innovation• $4 trillion in excess debt goes bad and

needs to be written down• Nationalization of banks, repudiation of

debt.• Collapse of trade bubble.

How Long Will It Last?

• Without innovation, it’s a slow slog. • It takes a long time to dig ourselves out of

a $4 trillion hole just through savings.• Consumer demand will stay soft for years.• That’s why economists are increasingly

gloomy.

But innovation is the wild card.• It can surprise on the upside, as well as

the downside.• New products and services boost both

demand and supply. • Innovation creates jobs, spurs growth• The essential missing ingredient.

What are the odds?• Innovation is fundamentally unpredictable,

but some areas are more mature.• Infotech: Ripe; communications, social

media, cloud computing, news/entertainment?

• Biotech—Ripe; more than 25 years since the first biotech drug

• Energy—still lagging.

Does the financial crisis impede innovation?• Hard to say. Funding is more difficult, but

resources are cheaper. • During the so-called ‘boom,’ housing

sucked up all the financing because it was supposed to be so low-risk. Hah.

The outlook: My best guess

• I’m going to go with medium-term optimism.

• Over the next year, the economy will be sustained by education, healthcare, and other government programs.

• Over 3-5 years we will see innovation-driven growth.

• I would not be surprised to see another boom.

Faith in the future

ResourcesMy bloghttp://www.businessweek.com/the_thread/economicsunbound/

My intro textbook (just released!):Economics: The Basics

My weekly video podcasts:http://www.businessweek.com/mediacenter/podcasts/

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