Technology and the Stock Market.

• Author: Jovanovic, Boyan

Boyan Jovanovic [*]

This article reviews my work on the relationship between technological change and the stock market. My co-authors in this area are Jeremy Greenwood, Bart Hobijn, and Peter L. Rousseau. The papers that we have written so far are listed at the end of this article.

Creative Destruction in the Stock Market

Figure 1 shows that U.S. stock market capitalization has risen relative to GNP by a factor of about 12 over a 113-year period. On the other hand, business debt -- bank loans and corporate bonds -- begins and ends the period at about 40 percent of GNP, which implies that the debt-equity ratio has fallen by a factor of 12.

Although the long-run shift is out of debt and into equity, in the medium run equity and debt move together, which means that the waves in the stock market are not the result of shifts between the two modes of finance. Figure 1 also shows the official NBER recession dates, which are about as likely to appear when the stock market is low as when the stock market is high relative to GNP.

Can technological progress explain some of the medium-run swings in the stock market? I would argue that a "stock market wave" forms when major invention triggers a process of Schumpeterian creative destruction in technologies, in products, and (most relevant here) in firms. Briefly, what happens is: a new technology signals the end of an era, and the signal is bad news for the stock market incumbents. Large firms -- the companies that account for the lion's share of the stock market capitalization -- are good at routine innovation and good at improving methods they use and products they sell, but in small ways, a step at a time. The corporation thrives under "business as usual" conditions; in times of change, it is held down by ignorance, outdated training, and the vested interests of its employees. Its stock price then will fall if investors fear that the equipment and techniques it uses soon will be obsolete and that it will resist the new technology. The corporation's very survival may require a major ov erhaul, and current management may not be up to the task. The market drops until a wave of new entrants causes it to rise again. Inventions such as computers tend to be developed in small, privately held companies. These inventions do not add any value to the stock market until the small companies go public or are acquired. Thus, technological progress destroys values of old firms, and only later leads to stock-market entry and to a boost in productivity and earnings.

The Post-1973 Wave

Greenwood and I argue that the J-shaped post-1973 wave is an example of just such a process. By late 1972, Intel had developed its second computer chip. Within two years there existed affordable personal computers that, in...