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USA: The Dot-com Obsession Warping the Economy

by David FriedmanLos Angeles Times
February 6th, 2000

It was inevitable that America's dot-com economy would gobble up Super Bowl advertising. Adoring media have wildly overblown both of them. Each somehow induces political leaders and ordinary citizens to shower vast sums of wealth on the fabulously wealthy for elusive promises of "community development" or "new," perpetually profitable industries.

Yet, while football-focused development is a relatively harmless diversion, cyberfantasies are warping U.S. society in far more fundamental ways. Spurred by unprecedented stock-market wealth, land-use, tax and development policies are skewing economic incentives almost exclusively toward a postindustrial, dot-com society. Alternatives that might better distribute technology and capital among the population and diversify the economy are being sacrificed.

Today's dot-com fortunes owe as much, if not more, to broad political and demographic factors as they do to novel technological discoveries. The biggest "new thing" in America over the last decade wasn't the Internet, but the unexpectedly huge flow of foreign and retirement capital into once-sleepy equity markets.

After the Cold War, security-conscious overseas investors pumped money into the United States. Aging baby boomers demanded, and got, highly favorable tax treatment for retirement investments, including expanded 401(k) and individual retirement accounts funded with pretax income, and lower capital gains when they cashed in their shares. In response, a torrent of money flowed into stocks. Annual mutual-fund and foreign U.S. stock purchases alone rose from about $4 billion in 1990 to more than $200 billion in 1999, by far the greatest increase in U.S. history.

All this profoundly changed the logic behind the stock market's performance. Cash-flush fund managers, for instance, invested heavily in giant corporations with millions of outstanding shares so they could move large blocks of money in and out of the market. By the late 1990s, defying years of retrenchment by large firms and the rise of small and mid-size enterprises, giant-company stocks outperformed the rest of the market.

Investors kept demanding returns much higher than even the big-cap run-up could possibly justify. They began searching for places to put money that were not constrained by traditional accounting and business principles. Information-age electronics and telecommunications companies claiming to have discovered a "new," limitless kind of industry fit these requirements.

By 1998, prices of "technology" firms--many, in fact, were retail or marketing operations possessing pedestrian skills, few technical employees and no earnings or likely prospects for generating them--were rising at astronomical rates. During 1999, they accounted for nearly 80% of the $5.2-trillion increase in the total value of U.S. corporate equities. Despite solid profits, high productivity and robust consumer spending, the combined value of America's bedrock, high-employment industrial stocks--aerospace, utilities, insurance, banking, autos, travel, real estate, food and health--did not grow at all. About 70% of all U.S. stocks were negative for the year.

Whether these trends presage a market meltdown is anyone's guess. More certain is the influence the dot-com economy exerts over the public imagination. Enticed by visions of staggering wealth accumulated by white-collar whiz kids toiling in campus-like buildings, public officials are gambling as never before on a postindustrial future.

Throughout the country, urban land-use policies are increasingly and exclusively oriented toward high-end activities believed essential for entering the information age. Factory or warehouse projects proposing "old" economic elements or, even worse, fostering traditional working- and middle-class jobs, are opposed on a variety of environmental, zoning and similar grounds. Reflecting such sentiments, information-age companies receive billions of dollars in relocation incentives, tax breaks, training grants and expedited permitting.

Dot-com CEOs are proving as adept at corporate welfare as sports-team owners who lobby for publicly financed facilities. Internet retailers exploit mail-order state-tax exemptions to offer products at prices local stores, which must pay such levies, can't match. Efforts to close such potentially devastating loopholes are ineffective against the dot-com juggernaut. Few even noticed when Congress immunized software firms from Y2K programming negligence liability, though the same protections have never been extended to other critical, but lawsuit-plagued industries like aerospace and pharmaceuticals.

Even the hyperbole is similar. When accounting groups proposed to end the chronically unfair advantage that stock-option compensation (which isn't charged against business revenues) enjoys over wages (which are), dot-com advocates went ballistic. "If we have to record a reduction in income [to offer options]" one said in a widely circulated report, "we won't be able to keep employees. It would destroy all American business and Western civilization!"

Behind all this is the conviction that disfavored industries are naturally fading away. Service-led growth, and the dramatic inequality increasingly evident in media-favored cities like New York, San Francisco and Washington, may be troubling but under such circumstances, unavoidable. Thankfully, dot-com opulence is more than adequately replacing the sectors of the past.

But it isn't. U.S. job growth in the 1990s was the slowest since the 1950s. Employment grew just 1.8 times faster than the population expanded, compared with more than 2.6 times as fast during the previous three decades. For the first time, retail and service occupations, the lowest paid of all major industry groups, now comprise nearly half of U.S. employment, up from just 37% in 1980. The dot-com boom did nothing to halt America's manufacturing decline. Production employment fell to just 14% of the total economy, an all-time low.

More troubling still, U.S. job growth was least impressive in precisely those regions that most fully realized the dot-com model of service and retail-sector expansion. Communities with the greatest average service-employment growth and manufacturing-job losses, including most of the politically influential Northeast, grew at just half the national rate. While many spun showcase "high-tech" projects as evidence of an urban comeback, U.S. core cities grew much less rapidly, relative to the nation, than in previous decades.

At the same time, regions that fostered full-spectrum economic growth in lieu of service-sector expansion--Riverside-San Bernardino, Las Vegas, Phoenix and Dallas, for example--grew far more rapidly, and in more balanced ways, than the national norm. Manufacturing, distribution and high-tech enterprises jointly expanded as they absorbed middle- and working-class families displaced from deindustrializing urban centers. Yet, few were hailed as "miracles"; rather, they were condemned as lowbrow sprawl.

Therein lies the deepening paradoxes of the dot-com era. Why do we celebrate regions that promote unbalanced inequality but revile those that foster more economic opportunities for everyone? Why do we burden wage income and savings with regressive taxes but exempt stocks from similar treatment? Why is it so much harder to open a factory in most urban areas than to build high-end, exclusive development projects? Why do we act as if a postindustrial future is so certain when the "old" and "new" economies flourish together when given the chance?

America's peace dividend--the tremendous capital surge throughout the 1990s--is being squandered on a strikingly limited, elitist myth. Rather than wait for a catastrophic "correction" to fix the problem, incentives presently skewed against more equitable alternatives should be redressed. Most critical is to end the politically based distortions that artificially inflate dot-com and related sectors. Working wages and savings should be afforded the same tax treatment as stock and equity investments. Local subsidies and permitting procedures that discriminate against working- and middle-class development should be constrained by industry-neutral, readily understood standards and rules.

It's possible that Internet entrepreneurs and coffee shops will still define America's destiny even with a level economic playing field. Forcing such a result seems an unnecessary risk. Point-and-click mail order has made a few wealthy and influential, but it's time to assure comparable opportunities for those pursuing other, equally promising game plans. *

David Friedman is a Markle Senior Fellow at the New America Foundation.

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