Silicon Valley

And what should the leaders focus on when they decide to lead? The new economy. Don’t laugh. That by now old mix of hardware, software, e-commerce and new-media businesses, and emerging and established companies was the engine that drove the good-times economy. Unless someone gets serious about how to get that sector back on its feet, it’s going to be a long tortured haul before those good times roll again. And while the Democrats may have muffed their opportunity to articulate a plan in time for the midterm elections, it’s not as if any hopeful signs are emanating from the White House, either.

Let’s start with the all of the anecdotal stuff around us, particularly out West. First question: Will the last out-of-work person to leave the San Francisco Bay Area please turn off the lights? The figures say that the unemployment rate is 5.7 percent nationwide and 6.3 percent in California (and 7.9 percent in Silicon Valley). But we’re finding those numbers as hard to believe as Enron’s balance sheets. What about those throngs of working-age people in coffee houses every day? We suspect those places would be even more crowded save for the legions of the busted, long-term unemployed who can no longer afford a cuppa regular joe, let alone an overpriced one with steamed milk. A scan of the papers shows that things seem little better in the other big Western tech centers, from Seattle to Denver to Albuquerque to Phoenix to Austin. The scene isn’t as grim in diversified L.A. — never exactly a hotbed of the tech boom — but even from there come reports of more and more “For Rent” signs in tony shopping districts such as Melrose Avenue in West Hollywood.

Here’s the heart of the issue: America’s growth depends on innovation — much of which has traditionally come from the West. In the latter half of the 1990s, a disproportionate share of the U.S. economic and job growth came from new companies at the bleeding edge of innovation. The only bleeding edge these days is on the big ax that’s taken out so many of those companies. And, to circle back to the leadership problem, the most disturbing thing about this is that no one — politician, business leader, whatever — is talking about it, let alone leading us to a solution. How do we get the innovation machine going again and plant the seeds of the next boom?

Since the carnage began some two and a half years ago with the NASDAQ meltdown, we’ve all been told — and we’ve desperately wanted to believe — that the next wave of prosperity is just around the corner. Well, here’s a news flash: It’s clearly not. We keep turning corners only to find the same damn dark alleys.

Many analysts are now saying that the ongoing venture-capital smackdown could last as long as another two years. San Francisco-based VentureOne and Ernst & Young in late October issued survey results indicating that “with $3.9 billion invested in 464 financing rounds, investment in the third quarter of 2002 was at its lowest level in four years.”

The Washington Post — in a six-part profile of the tech bubble published this past week — cited statistics indicating that that venture capitalists at the peak of the boom in 2000 funded 6,500 companies to the tune of $107.5 billion. This year, about 1,500 companies will get a little bit over $10 billion — a funding level last seen in 1996. This all means that many early-stage companies that are still running on fumes will run out of funding. And if two years of pain are what’s in store for the start-up sector, an essential motor of job creation, that’s yet another 24 months before the seeds even get planted for the next crop of start-ups.

But what about the big hardware and software companies? Well, many of them are still busy laying people off (such as Sun Microsystems, which last month announced it will be cutting another 4,000 jobs). Judging by forecasts issued by the Washington-based Precursor Group, an institutional-investment research firm, things are starting to turn around, but very slowly. The firm reports that spending on information technology peaked in the third quarter of 2000 at an annualized $395 billion, bottoming out in the fourth quarter of last year at an annualized $327 billion. Spending started to tick up in the third quarter of this year and may rise between 3 and 6 percent in 2003 (with Microsoft emerging from the tech blow-out with its strongest position in five years, Precursor says). But that growth will be weak relative to what Precursor says is a historical trend of an 11 percent annual growth in IT spending.

Perhaps that’s just a sign of an industry that’s matured. OK. But even Greenspan says that the broader economy has only scratched the surface of the kinds of productivity-enhancing innovations that the tech industry has been producing. The prognosis is dire. We may be in the throes of a cycle where an underfunded entrepreneurial sector just isn’t capable of creating new innovations — the kind of that get commercialized by the big boys and adopted throughout the economy, thereby creating jobs, rising incomes and stock values, prosperity, and yes, happiness for all.

Which brings us back to the coffee houses, the preferred thumb-twiddling locales of the long-term unemployed. They provide us with a real human dimension behind all those numbers and trends and abstractions. There’s a piece in the Oct. 14 issue of Fortune called “Generation Wrecked.” In it, a term we haven’t heard in years makes a comeback — “slacker.” It seems that members of the so-called Generation X are once again whining about the economy, but this time around, it’s justified.

This is a group that has indeed come full circle. Generation X is now defined as classic baby busters, born between 1966 and 1975. The older part of this group graduated from college and ran smack into the recession of 1990-91 that felt as though it went on until 1993 or 1994. Many then rode the World Wide Web rocket to stratospheric salaries, only to crash back to earth and make a beeline back to living with mom and dad. To quote Dr. Evil of “Austin Powers” fame”: “Boo frickin’ hoo.”

But remember: This is the generation of Americans that should have its best years in front of it — marrying, having kids, buying houses and furnishing them, paying taxes, saving for college, saving for their retirement (because, as we all know, if they were to depend on Social Security, their benefits by the time they retire would barely cover a weekly supply of cat food). So boomers, you can laugh it up over this group’s plight. Still, just think about the broader social impact of having all of those bright, young, energetic and now experienced folks lying fallow and unproductive.

Something has to be done. But what? For an inkling, we could look back to early 2000, when Business Week ran a prescient cover story called “The Coming Internet Depression” (which later became a book).

What made the so-called new economy of the 1990s possible, wrote senior editor Michael Mandel, was a system of market mechanisms that made rapid innovation possible. Those mechanisms, he said, included venture-capital funds, stock exchanges that allow new companies to raise additional funds from public markets, a large pool of capital willing to take risks, and skilled workers willing to make bets on new companies in exchange for stock options.

“When a downturn starts, watch out,” Mandel wrote. “The powerful forces that have made the New Economy so dynamic will begin moving in reverse — first slowly, then faster and faster. Rather than being led by housing and autos, as in the past, the next recession will be driven by the innovative sectors of the economy. A falling stock market and a slowing economy will mean lower potential payoffs even from successful startups, which will diminish the willingness of venture capitalists and corporations to put resources into the risky business of developing new innovations. The number of startups will decline, the pace of innovation will slow, and prices for tech equipment will fall more slowly or even start to rise, reducing the willingness of companies to buy new technology.”

Sound familiar? Let’s not niggle about the points on which Mandel was wrong — such as an outbreak of inflation that he posited would happen when a tech-led expansion began a nosedive (if anything, one prevailing fear now, given the excess capacity and weakness of the American, Japanese and German economies, is that of deflation). Still, Mandel does assert in an excerpt of his book that “at some point the recovery may require stronger measures than simply cutting interest rates and boosting spending. Just as the New Deal involved government intervention in the financial and labor markets in order to stabilize them, so government may have to take a hand in the high-tech sector to stabilize the New Economy.”

This kind of thinking finally seems to be awakening in the tech sector, although executives are perhaps too wrapped up in a kind of dogmatic libertarianism to say it directly. Instead, they’re resorting to speaking in code, invoking quaint terms like “competitiveness” last heard in the hazy pre-history of the boom era. At a recent gathering of executives in Scottsdale, Ariz., they were muttering in the hallways about whether the sustained American tech slump will result in the U.S. ceding technological leadership to China and India. Says Bill Whyman, the Precursor Group’s president, “They’re grasping at every straw they can and wrapping themselves in the flag of competitiveness.”

Time to circle back yet again to the leadership problem and those politicians. It’s been said that the Bush administration doesn’t understand the importance of the new economy, let alone fathom what kind of help both the entrepreneurial and established high-tech sector might need. Bush’s government might be a collection of CEOs, but few of them came from high tech — the business experience of the two top dogs was in running distinctly old-economy companies such as Harken and Halliburton (in the case of the former, right into the ground).

The administration has made some recent moves such as drawing people from Silicon Valley into posts at the Commerce Department. Unfortunately, that agency could charitably be described as a bureaucratic backwater. One senior government official, who asked not to be named, says the administration does realize that the weakness in the new economy is a problem, but is reluctant to get involved for fear of veering into the land of “industrial policy” (yet another term we thought the boom had permanently banished). Hmm. And what would the administration’s protectionism of the steel industry, boosting of farm subsidies, and sops to the timber industry be called?

But it’s not as though the Democrats are picking up on any of this either. One irony is that San Francisco’s Nancy Pelosi has assumed the top party leadership spot in the House — but she’s always had more to say about abortion and gay rights than about the new economy. Never mind that her district’s economy has been laid to waste by the downturn. Al Gore, who arguably helped accelerate the tech boom in the 1990s by talking up the “information superhighway,” has shed any apparent claim to leadership on these issues in favor of being the tribune of the downtrodden common man. Seems he’s forgotten what will produce the rising tide that will lift all those boats.

Admittedly, getting the new economy back to level flight is tough. One thing that might help is Washington stepping in to settle the fight between Silicon Valley and Hollywood over copyright protection. This ugly, mostly behind-the-scenes battle has thrown a big roadblock in front of a renewed push for the penetration of broadband Internet connections that might help unstick everything from telecom to hardware to software to new media. The senior government official says the administration understands that getting the spat settled might help the economy, albeit with a bit of a lag. But the Bushies can’t overcome their reluctance to intervene in what amounts to a “food fight.”

Here’s another idea that might help start the motor humming. During the campaign, former Clintonistas Gene Sperling and Janet Yellen proposed a time-limited, targeted tax break for investments in plant and equipment, particularly information technology. But that idea got lost in the din and doesn’t seem to have resurfaced again. As a Republican Congress prepares to undergo a muted orgy of renewed tax cutting, why not throw that idea into the hopper as well?

Those are just a couple of ideas. Having folks in power start saying something, anything, that gets at what’s wrong might even have the salutary effect of raising confidence, just because people — investors, workers, laid-off Gen Xers, retirees — believe someone besides Greenspan is on the case and is pointing the way to a new and better future. As for more specifics on what could and should be done, that’s the kind of stuff that policymakers are paid to figure out. It’s just hard to see how they’re going to come up with solutions when they’re not even asking the right questions.