Using Information Indicators to Recognize an Economic Recovery

Money and
Economics

(January 2002)

Summary: By looking at the economic activity in three specific areas of the information technology sector — the so-called information indicators — we may be able to make an early prediction as to when an economic recovery has started.

On January 11, 2002, Federal Reserve Chairman Alan Greenspan, in a speech to the San Francisco Bay Area Council Conference, expressed guarded optimism that a recovery may be just around the economic corner.

As is his custom, Greenspan refrained from unnecessary irrational exuberance, refusing to predict a time frame in which the ailing economy would finally stagger to its feet. Indeed, Greenspan specifically warned that the economy still faces "significant risks", such as increasing unemployment, a rise in long-term interest rates, and the ongoing uncertainty regarding terrorism.

Most financial pundits agree with Greenspan, that the economy is basically sound and a recovery is inevitable. What we are all wondering, of course, is when will the recovery make its appearance? Are there early warning signs for which we can look?

Conventional wisdom says no, that major events within an economic cycle do not cast shadows into the future. For example, we know that, one day, we will notice a rise in inventory levels. Soon thereafter, we will see increased industrial production, which will lead to growth in household income and spending. This, in turn, will create a sustained increase in what economists call "final demand", a dependable sign that the recovery has arrived.

However, these type of economic signals do not come into focus until well after the economic cycle has changed course. Thus, we are not able to recognize the start of a recession or a recovery until months after it has occurred.

Like everyone else, I do not have a crystal ball, and I cannot tell you when the economic recovery will begin. However, I maintain that we will be able to recognize the very beginnings of the recovery by looking at three particular aspects of the information technology industry.

Over the last decade and a half, the economy has undergone a permanent change. Today, all sectors of the economy are dependent upon the flow of information, just as, traditionally, they have been dependent upon capital, labor, raw materials and transportation. As CEOs around the country begin to feel confident about near-term prospects, one of the first things they will do is take steps to ensure that their company's information infrastructure is ready for increased production and sales.

When this happens, we will begin to see a significant and sustained increase in information-related expenditures, creating a change in what I call the information indicators.

These expenditures will fall into three categories.

1. The use of outside expertise, both in consulting and services.

2. The consumption of critical Internet- related services.

3. The purchase of computer hardware.

To begin, companies will need to examine their current IT (information technology) organization, and prepare it to be more productive. Some companies will do the analysis in-house, but many firms, especially the larger ones, will call upon outside consulting services to help with strategic evaluation and planning. Ultimately, these firms will need to expand their information services, either through internal growth or through outsourcing.

Thus, if we are searching for clues of a nascent economic recovery, the first information indicator we can look for is an increase in money spent on IT consulting and outsourcing.

Second, we will also see increased consumption of certain critical Internet-related services, the most important of which is bandwidth (the capability of moving data from one location to another).

Compared to other primary resources, bandwidth has unique characteristics. The more growth a company achieves, the more bandwidth it requires. However, since bandwidth is not storable, significant increases are purchased only as they are needed. Thus, an increase in the amount of new bandwidth means that more information is moving, a sure sign of economic health.

Once enough companies become optimistic about the future, the amount of bandwidth purchased in the U.S. — the second information indicator — will rise quickly in order to feed the information-intensive activities associated with economic expansion.

Finally, at the same time as strategic planning is set into motion and demand for bandwidth begins to increase, a great many companies will need to purchase computing equipment. The first sign that this is happening will be a sustained increase in the third information indicator: the production of the many components used to manufacture computers, such as processors, memory chips and disks. This increase will be followed by growth in sales of computer equipment, such as routers, servers, point-of-sale systems, and personal workstations.

(Such sales, by the way, can act as a bellwether when the economy moves in either direction. For example, by the middle of 2000, more than a year before the beginning of the recession, new orders for computer equipment and software had already stalled.)

In the late 1990s, many commentators announced that we had a New Economy based on an information-supported paradigm in which many of the old rules of business were obsolete and irrelevant. Today, as we clean up the last sticky pieces of the Internet bubble, it is obvious that such thinking was short-sighted and foolish.

Nevertheless, what we need to realize is that, since the mid-1980s, information technology and the Internet *has* permanently changed the underlying dynamics of the economy. Today, the rapid flow of information is as important to the health of a company as is capital, labor, raw materials and transportation. Moreover, as I explain in my book Harley Hahn's Internet Insecurity, the Internet increases what economists call the "velocity" of money, which in turn affects the GDP (gross domestic product) of the economy.

Since the flow of information is critical to all business sectors, monitoring the information indicators may give us an unprecedented early warning window into the machinations of our economic system. Once we develop the tools to measure these indicators effectively, we may be able to predict incipient recessions and recoveries well in advance.