Thank you, Tom Campbell, for that overly generous introduction. I was sort of wondering how you invited someone with Stanford ties to give the annual Haas School Business Forecast speech, but then I realized you had embedded as dean someone with Stanford ties – Tom Campbell. He has been an excellent congressman, state senator, law professor and now dean. Let me say at the outset that I have been a long-time admirer of Tom’s. The Haas School’s gain is Sacramento's and Washington's loss. He has been a fine, creative and committed public servant. And I know he is and will be a great dean and leader for the school.

Actually because of the Stanford connection, I was fully expecting a more hostile reaction. Let me assure you I am used to it, because, as Tom mentioned, I used to work at the OMB, the black hearts of the US government, where an introduction was never greeted, as it was now, with actual applause. In fact, at one point, I was called upon to give a speech at the pentagon, in the middle of cutting their budget and trying to secure the so-called “peace dividend” (remember that?). I walked into a cool reception as I entered the auditorium, made cooler when I saw, and contemplated for a moment, the following sign: “Please do not photograph the speakers on the platform, shoot them as they approach the podium.”

Let me say a word about the Haas School: I have spoken on a number of panels at Haas, given guest talks in MBA classes, even served earlier this year as a final judge of business plan presentations. It is a jewel of a facility, and a true asset to the Bay Area and the country. So it is probably not inappropriate to recognize in this setting the manifold contributions of the Haas family to our beautiful Bay Area – from this great school to the marvelously restored path along the bay at Crissy Field to the world’s best blue jeans! They are the giants on whose shoulders future generations of leaders can stand.

I have titled my talk, “California's technology economy: Dead or just resting? Where do we grow from here?” -- named, of course, for the scene in the old Monty Python and the Holy Grail film, when after the man’s arms are sliced off, his ally says “he’s not dead, he’s just resting.” But are we fighting in California with our arms and legs cut off, ready to bleed to death, or can we look forward to a better day? These are interesting questions.

Today, the attention of the nation and indeed the world are, of course, transfixed on the war in Iraq. The conventional wisdom is that our economy and the stock market have been simply waiting for a quick resolution – and we have certainly seen pretty significant moves – several percent a day, an overall move up of 8 to 10 percent since March 12th (exactly four weeks ago) – with each day’s news from the embedded reporters and TV cameras.

There is much to say, and much to analyze, about the situation in Iraq, but I would like to suggest to you that a quick end to hostilities, and a clear path to successful reconstruction in the aftermath, are necessary but not sufficient conditions for America's -- or California's -- return to growth. So I would like to spend my time today talking about how California's technology economy can grow regardless of the war outcome – which as of this morning, thank God, looks favorable -- with jubilant crowds literally throwing a noose around the neck of Saddam Hussein.

The fall off of the technology economy has of course been well chronicled: $8 trillion in wealth lost from three consecutive down years in the equity markets, the burst of the dot- com bubble, and so on.

What has been less well chronicled has been the response to that collapse. On the one hand, consumers (perhaps now a bit jittery because of the war and travel and terrorism fears) did not fundamentally lose their faith in either the economy or the markets. They have, of course, kept buying homes, kept buying cars, even – to a very large extent – left their money in the stock market. And well they should, because by any standard, despite the crash, they are materially better off than they were a decade ago.

The second response has been that innovation has continued. Entrepreneurs continue to flood our offices every day in the venture business with faster chips, better software, more advanced security, more reliable connectivity. Last year, we logged over 4,000 business plans in Carlyle Venture Partners on our deal log.

It turns out that the availability of financing has risen – substantially – on a trend line, but the amplitude of the wave pattern on that trend line has been large. Innovation has been more constant, rising in a wave pattern with a much smaller degree of variability.

So today we find ourselves in one of the troughs in terms of availability of financing: less money available to chase a relatively constant stream of innovation – as an investor, this is good news. The result, of course, is that asset prices are low. It is a good time, in my view, to make money.

To give you one metric, the US venture capital industry raised $100 billion in the year 2000. In 2002, it raised $6.9 billion – and returned to investors in the form of fund shrinkages $5 billion. So, last year, a net of $1.9 billion of new money came into the industry: one-fiftieth of the amount made available two years ago.

Of course it is a stock picker’s market – in both the private and public equity markets. Of those 4,000 business plans that came into Carlyle last year, we funded two new projects. Both are doing well, I am happy to say, and we funded several follow-on deals, but for now it is a buyer’s market.

Why? Again, some metrics. Ted Dintersmith of Charles River Partners pointed out in a speech at Harvard Business School last year that, from 1995 to 2000, the venture capital industry funded about 15,000 companies. Since then, about 1,500 have gone public. Another 1,100 have been acquired, and another 1,200 have gone out of business. This was a year ago, so perhaps those last two numbers have grown, but the point remains: some 10,000 venture-backed companies funded during the bubble have to be resolved. In a good market, maybe 200 or 300 companies a year can come public. So many will not make it.

Ernst & Young came out with a study yesterday with slightly different numbers but the same conclusion – of the 6,100 companies funded since 1996, only 1,500 (about one-fourth) have received any follow-on funding.

These companies will need to be resolved, and some will not make it. I would suggest that there is a great M&A advisory opportunity out there for some emerging boutiques serving the venture business and for some enterprising Haas graduates.

On the public side, some numbers are equally as daunting. As Michael Moe, CEO of one of those boutiques -- think equity research -- likes to point out, 61% of all publicly traded companies today have no research coverage at all.

Some investors and some underwriters, it seems, have given up. Again, as an investor, I see this as a great opportunity. Given the increased difficulty of being a public company, the immense and growing burdens on executives, audit committees, and the pariah status of research analysts in today’s world – some New York bankers were recently explaining to me that they are installing separate elevators for research and banking – I suspect there will be a new wave of going-private transactions. In addition, the industry leaders sitting on piles of cash: Microsoft has $ 6.6 billion, EMC, beaten down as it is, has $6.5 billion of cash – will be acquiring companies to extend their product lines and make their products better.

Part of the loss of faith and interest in companies spawned during the tech boom, mostly, I believe, outside of Silicon Valley and the Bay Area, is attributable to an undereducated media and public sector. This is perhaps best summed up by a comment from my friend and college classmate Jon Alter, who, last year in Newsweek wrote, “It turns out that much of the new economy was actually something very old – ripping off shareholders.”

I am here to say that I disagree emphatically. Nothing could be more wrong.

It is one thing to say that, for a time, returns were so outsized that asset prices were bid up unrealistically. That is the basic law of supply-and-demand the students learn well before they get to the Haas School. It is altogether another to say that no benefits were derived from the new economy. The benefits were and are monstrous – and they continue today.

Look around you. As the Wall Street Journal pointed out recently, five years ago, a DVD player cost $500. This Christmas, you could have bought one for $75. Five years ago, Dell was selling 15-inch flat panel monitors for $2,000. You can buy one this afternoon for $275.

The clearest evidence is this: For twenty years, US productivity growth averaged not much over one percent (1.4, to be exact). In the second half of the 1990s, it averaged almost 3% (ok, 2.6 to be exact) -- and increased by over 4% last year, in a recession. Everyone from Alan Greenspan on down has recognized that technology played the principal role in making this growth possible.

The situation might be compared to that surrounding the railroads just over a century ago. Then, as now, the excitement around the building of lines across the country attracted all manner of investors. Prices were bid up. Many lost their money. But the benefits to the economy were lasting. In fact, as Wired Magazine pointed out in its excellent recent 10th anniversary edition, the existence of a national transportation network made the next wave of companies (and their investors) successful -- starting with the merchant Sears, Roebuck, & Co. – and made the country better off.

So what do we see today? We see a constant pace of innovation. We see Moore's Law continuing apace – Intel's microprocessors could send 100,000 instructions a second thirty years ago; today they can send 3 billion. And we see a whole new wave of technologies on the horizon that will improve our communications, our health, our security – our very lives. For venture capitalists, for Californians, for Haas graduates –this is, and should be, exciting.

Let me talk about a few trends that we see at Carlyle:

• First, component and hardware prices will continue to come down. We are seeing the commoditization of hardware across the full spectrum of IT. The bad news is that this puts pressure on hardware vendors to keep cutting costs. The good news is that these lower prices, with the increased functionality I mentioned earlier, make all manner of new applications and new markets possible. Hence, the next leg of growth of technology.
• That brings me to me second trend. The early and rapid adopters of technology were other technology companies. It is obvious that, by 2000, they were wildly over provisioned with both equipment and software to meet their needs. The current adoption path is slower but bigger. The manufacturing floor. The warehouse. The medical industry. The financial services industry. The retail environment. The consumer marketplace. As prices fall, deployments become economic in markets where the old purchase price was too high.
• Third, as hardware commoditizes, key software inputs become more important: clustering, for example, which allows racks of commodity PCs to do the work of a big computer. Look at Google, now with 2/3 of the search market. Google’s speed and reliability is powered by hundreds and hundreds of low priced PCs arrayed in clusters. At any given moment, several hundred may be down or malfunctioning. But Google’s speed has earned it a loyal following.
• Fourth, the convenience of wireless. WiFi is here to stay. 802.11b networks may have been quickly overfunded by eager venture capitalists, but consumers and businesses want it. To my earlier point, a network card that was $75 a year ago can be had for about half that price today, going to $25 in a year or so. And demand is soaring: business purchases of WiFi networking equipment was up 62% this year, and consumer purchases were up 160%.
• That gives rise, of course, to a whole new market, a fifth thing on my list: security. Security going forward is critical. Not just WiFi security, but web services security, identity management, intrusion and what I call extrusion detection, instant messaging security.
• WiFi is the offspring of a sixth trend on my list: the unmistakable trend toward open standards, or at least the creation of stable platforms of standards in technology upon which great heaps of innovation can be developed and built.
• Seventh, handheld devices. Once people get hooked on wireless email – as we say in our office, they don’t call it “crackberry” for nothing -- they won’t want to go back. Phone-based instant messaging. Photo sharing. Gaming. Consumers in the US, and especially around the world, like the convenience of their devices being untethered.
• Eighth, utility computing, and other outsourcing and “pay as you go” models. I personally think that the death of the ASP was declared prematurely. For some enterprises, especially smaller or medium sized ones, this is the right way to price and sell software. For others it may not be. But beyond that, companies will look for a way to lower upfront costs, speed payback, and improve their own economics. This in turn will lead to the continued internationalization of software development through business process outsourcing.
• Ninth, the merger of information and computing technology and the health care industry. This will take many forms. Cheaper devices and sensors in the home and in the body for everything from stopping fibrillation events to monitoring the blood of diabetes patients. Faster drug discovery using chip-based technology. Better information and fewer mistakes on the hospital floor from the simple use of bar code and RFID tags, labels, and readers.

I could go on and on, but the point is this. That Wired Magazine issue I mentioned asked the question: what were you doing ten years ago? What you were not doing is this:

• Checking your email from the road;
• Buying a car online;
• Getting directions by GPS;
• E-mailing pictures to family and friends;
• And playing a video game against someone halfway around the world.

At Carlyle, not surprisingly, we are trying to play these trends. We have invested in a company with a new blade-based distributed storage architecture called Panasas. Commodity hardware, proprietary software. The result: three times the performance of incumbents at half the price.

We have invested in a clustering company called Rainfinity, which allows companies to replicate data without taking servers off line.

We are riding the handheld device wave with a company called Canesta that tries to solve the clumsy input problem with a sensor-based “virtual optical keyboard” – a keyboard projected in light on any flat surface on which the user can type in real time.

And lower-priced, faster sensors have made possible the success of an infrared sensor company called Indigo Systems. Indigo makes chips and components and infrared cameras that are the size of my knuckle – whereas the prior generation of cameras is as big as a TV camera. That miniature size and lower price makes possible all types of applications – they can be mounted on the helmet of a fireman to see through smoke. They can be and are being inserted on the front of an automobile to allow it to see objects or people through fog or darkness. They can be put on commercial aircraft to protect them from incoming shoulder-launched missiles – a chilling reminder of what we have to look forward to in this post-9/11 world.

And let me say something here about that. You may have read in the papers that Carlyle has been criticized and indeed on one day targeted by protesters, supposedly because we are a defense contractor. First of all, of course, we are typical venture capital and private equity investors, and we don’t make anything. Second, exactly 7% of our firm-wide investments are related to defense, so just as defense is one of many sectors of our economy, it is one of Carlyle's many sectors of investment focus. And third, we don’t apologize at all for helping to fund companies which make things like Indigo’s life-saving infrared sensors. Our goal as investors is to find companies that make things that make people’s lives better – and if they have security applications as well, that is the nature of advancement and growth. The world is better off with these devices than without them, and we are proud to back these companies.

All of the companies I just mentioned are in California, in Fremont, Santa Clara, San Jose, and Santa Barbara. We have always here in the Golden State been a hotbed of innovation, because our schools and universities – including and especially the University of California – are strong. Risk capital has been available. Innovators want to live here.

But it does not have to be that way. Consider the following: A cell phone you can buy at that storefront over on California Street may be designed by an engineer in France. The design is based on chip communication protocols developed in San Diego, by Qualcomm. The phone is manufactured in China. It is assembled in southeast Asia, and shipped to the United States to be marketed and sold.

We live in a truly global world of technology sourcing, innovation, production, and use. My point is this: California's ability to return to an era of growth – indeed America's ability to do that -- is not independent of the policies we choose and the environment we create.

So let me turn to five pillars of growth that I would suggest, from a policy perspective, are necessary to both return our economy to health and ensure its continued success.

First, an embrace of free trade. The example I just gave is instructive, perhaps especially in California. California, more than any other state in the union, is massively dependent on trade. Our volume of trade in 2002, $341 billion, was of course more than that of most nations. It was ten times the level of trade just 25 years ago -- $31 billion in 1978. When trade promotion authority (so-called “fast track”) came up for a vote in the last congress, it passed the house by just one vote. How is it possible – and I love them both – that our two local representatives, Nancy Pelosi and Anna Eshoo, could vote against free trade, which they did? California depends on it. It is demonstrable that our economy will be better off under an open trading system.

Second, an embrace of globalization. Again, from an economic perspective, the debate is over. Globalization has made the majority of people’s lives better around the world. In this regard, President Bush has some cleaning up to do.

Obviously, the diplomatic run up to the Iraq war was not smooth. Obviously, this has affected the perception of America around the world – and could, if not addressed, affect our economic opportunities as well. I submit to you that, as soon as the conflict has concluded, President Bush needs to take clear and decisive steps to demonstrate America's internationalist outlook and embrace of, to borrow his phrase, a “compassionate” form of globalization.

The President took one such step in the State of the Union Address with his bold initiative to devote $15 billion to combating AIDS in the developing world. Let me suggest two others:

I think the President could soothe many nerves abroad, and solve a problem that a majority of the world’s scientists say is a top drawer priority, by offering a compromise on the international effort to address global warming.

A second idea, speaking of both the environment and economic advancement and development is this: The single biggest addressable environmental problem in the world today is dirty water. Three million babies a year – three million – die prematurely from diarrhea-induced malnutrition from drinking dirty water. We could solve this problem today with existing sewage treatment technology and a manageable number of billions of dollars. Frankly, I think US environmental groups – and as Tom noted I am affiliated with several – are misguided in insisting that we spend those billions on US ozone measurement standards or wood preserving chemical rules that save one life for every six billion dollars spent. How about an initiative to save millions of lives by working for clean water in the developing world?

This sounds disconnected from California but it is not. Take my global warming example. When the Russians ratify the Kyoto agreement this year, which they will, a sufficient group of the so-called Annex One countries will have signed the accord such that it will enter into force. In the future, the fact that other countries are meeting this standard could allow them to prevent certain types of exports from non-complying countries, denying Americans the benefits of trade I mentioned earlier.

A third pillar: an embrace of growth-oriented, technology-friendly policies. I believe it is also demonstrable that tax cuts foster economic growth – and given where we are in the cycle, such fostering is needed. So I support the President’s proposed tax cut. I might have crafted it differently, but I support it. In California, we must watch how we handle the tax situation if we want to be the home to growth. Obviously, one proposal is to raise our already high top income tax rates by another two percent. It is obvious that this will, at the margin, merely encourage the best entrepreneurs and the best companies to consider other homes.

But my concern about growth-oriented policies goes beyond taxes. I will predict today that the venture-capital model will be attacked in the United States over the next few years. The reason is simple, vintage 1999 and 2000 venture funds will for sure lose money. Not all of that is understood yet. When it becomes obvious, people will ask why. The reason is, of course, that investing in early stage technology companies is risky – hence their 20% annualized returns for the prior 20 years!

But I am concerned about the sophistication of the remedies our public policy makers may adopt. Some proposals are sensible: we agree, for example, with proposals to require pension fund investors such as CALPERS to disclose fund returns. But others clearly are not: for example, the proposal to expense stock options – which are clearly shares and not cash claims on the operation of the business.

I hope our policy makers will not forget the enormous contribution of the venture capital model, the availability of risk capital for entrepreneurs and of outsourced innovation to big companies, to the success of the US economy.

I sit on the board of the NVCA, and we recently commissioned a study by Wharton Econometrics/DRI. The results were staggering: in 2000, venture-backed companies employed 12 million Americans directly, and 27 million when indirect employers were added. These companies accounted for $1.1 trillion output – 11% of US GDP, on less than one percent of capital invested. The leverage of this investment – and the benefits to the US economy – have been substantial, and I hope we don’t lose sight of that.

A fourth pillar, and this is especially critical here in California, is that we must pay attention to and invest in our basic infrastructure. It is inexcusable that with our high tax rates our schools are among the worst performing in the nation, our roads are clogged, our electricity is unreliable, and our water is a giant question mark hanging over our future.

Here, some creative responses are necessary. With respect to our roads, for example, we should eliminate the tolls at the Bay Bridge and to the Golden Gate Bridge. The congestion they cause constitutes one of the biggest point sources of air pollution in the entire region. According to environmental defense, the average urban commuter sits in traffic nearly four times as often as a commuter 20 years ago. This is absurd. We have the technology to swipe cars using RFID readers and transmitters. Let’s use it. For that matter, is it really necessary that the Golden Gate Bridge Authority to service a bridge completed well over a half-century ago, needs over 500 employees? Including four publicists? To ease congestion, environmentalists should consider dropping their objection to more lanes along existing rights-of-way. The roads are there now, and it is better than despoiling new lands with new roads or all of the air with more pollution.

On water, we should allow water trading so that economics can determine the highest and best use of our water resources. It is crazy for growers to have an eternal right to water at $20 an acre-foot and face a use-it-or-lose-it policy when municipal and industrial users in the cities are paying $400 and are starved for water in drought conditions.

Here, it seems our policy makers are stuck in a series of ruts. We need some creative solutions or California will fall behind.

Finally, the most important pillar of all – significant investment in our knowledge base – specifically, in our schools and in the federal R&D enterprise which has spawned so much of our basic science.

It is now hackneyed and self-evident that we are moving to a knowledge-based economy. But that means we cannot live with proposals such as that in the current budget – which would confiscate the resources of those California communities that are willing to face higher property taxes for better schools and send them to the state. It is not only unconstitutional; it amounts to “enforced mediocrity” which would spell the death of California.

On the federal side, R&D investment has the unfortunate characteristic of having a long-term and relatively silent constituency. Various presidents of both parties have done a good job fighting to the NIH, the NSF, and the rest of the research establishment that has generated advances from high-performance computing to mapping the human genome. But if we do not address other long-term federal budget problems with much more vocal constituencies, starting with Medicare and Social Security, this investment will be crowded out. Again, the result would be disaster.

So where are we, dead, or just resting?

Well, the bubble taught us – no reminded us, because we already knew it, that our economy is cyclical.

The trick is to judge where we are in the cycle. In venture capital, I submit that this is an attractive time in the cycle to be investing, because prices are low and there is less money chasing a relatively constant stream of deals.

More broadly in technology, we are in one phase of the ebb and flow. Hardware innovation made tremendous advances, and now software must catch up – in the form of new applications to be able to make use of the more powerful hardware in a business context.

The economy is positioned for growth, but it will be more modest that the go-go times we enjoyed in the late nineties. I see no reason to quibble with the consensus forecasts of 2.5% growth for this year, and perhaps I am a bit more conservative than the consensus forecast of 3.5% for 2004.

But we have only had four consecutive years of market declines once before in our history (during the Great Depression). And I do not believe we will have a fourth consecutive down year in 2003.

We have low inflation that remains under control. We have inventories in key sectors such as semiconductors worked off down to very modest levels. And most importantly, we have the benefit of continuing innovation.

Just 48 years ago this week, in April of 1955, the polio vaccine developed by Dr. Jonas Salk was declared safe and effective. Look at the progress we have made in that time. In only 40 years, according to World Bank data, we have doubled the life expectancy of human beings around the world. That is greater in four decades than had occurred in all of human history cumulatively before that.

My point is simple: we live in a time of worry. Many are pessimistic. But I submit to you this: this is the greatest time in human history, by any measure, to be alive.

More people have more access to freedom, to information, to computers, to faxes, to potable water; you name it, than at any time in human history.

I mentioned life expectancy, but here are some others. In the last 30 years, adult illiteracy around the world has been cut in half – from 47% to under 25%. The number of people living on under a dollar a day, under $365 of per capital annual income, has shrunk in the last two decades by 200 million. It had risen for the prior two hundred years.

Best of all, in America and here in California, we live in the most meritocratic society on the face of the earth. The most meritocratic society ever invented.

For those Haas students here today, Haas MBAs are at the top of the meritocratic heap. With enough work and perseverance, you can get any job you want with a top-tier MBA. And for those employers in the room, when you look at it in this context, I think you should “hire Haas.”

But more broadly, one of the things that has made this the best possible time to be alive is the innovation that has come from right here in the Bay Area. Yes, our policymakers need to be a bit more creative, and I hope they will be. I have offered some ideas today that are not that difficult to do – from cleaning up the world’s water in the name of globalization, to decongesting our roads in the name of efficiency to funding our schools in the name of knowledge.

At the end of the day, the purpose of technology of course, is not to develop it for technology’s sake, but to make people’s lives better. That is exactly what our California technology economy is doing – the entrepreneurs who drive it, the venture capitalists who fund it, the Haas MBAs who populate it. And I, for one, am proud to be a part of it.

Thank you very much.

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