Innovation and the Financial

Crisis
By Michael Mandel, PhD
Chief Economist, BusinessWeek
Mass Technology Leadership Council
February 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

1.6
1.4
1.2
Dec-97=1

1
0.8
0.6
0.4
0.2
0
Dec-97

Dec-01

Dec-02

Dec-03

Dec-04

Dec-06

Dec-07

Dec-08
Dec-98

Dec-99

Dec-00

Dec-05
This period compares unfavorably to the Great
Depression

S&P 500, adjusted for inflation

2

1.5
Dec-97=1

0.5

0
Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-05

Dec-07

Dec-08
Dec-03

Dec-04

Dec-06
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)

60%

50%

40%
percent

30%

20%

10%

0%
1980 1984 1988 1992 1996 2000 2004 2008
 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

3.5
3
2.5
sept-07=1

2
1.5
1
0.5
0
Sep-99
Mar-00
Sep-00
Mar-01
Sep-01

Sep-04
Mar-05
Sep-05
Mar-06
Sep-06
Sep-97
Mar-98
Sep-98
Mar-99

Mar-02
Sep-02
Mar-03
Sep-03
Mar-04

Mar-07
Sep-07
Mar-08
Sep-08
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
 Resources
My blog
http://www.businessweek.com/the_thread/economicsunbound/

My intro textbook (just released!):

Economics: The Basics

My weekly video podcasts:

http://www.businessweek.com/mediacenter/podcasts/mandel_on_econ
omics/current.html