Can our companies make the leap from the old to the new high-tech economy?

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The Independent Online

Were it not for hi-tech, the UK, with FTSE running at an all-time high, would actually be in a bear market

Were it not for hi-tech, the UK, with FTSE running at an all-time high, would actually be in a bear market

Disraeli wrote of two nations and there is more than a bit of that division to which he referred in our society today. But there is also a new divide in all the developed countries between the new economy and the old one. The new economy - telecommunications, software, information technology, electronic commerce and so on - is racing on. Meanwhile the old economy - everything from consumer durables to conventional retailing - is pretty stagnant.

This phenomenon is particularly evident in the US, though it would be astounding were the divergence not to be happening everywhere. You can catch a feeling for this by looking at the top graph, which breaks down GDP growth into the two different segments, and the bottom left-hand one, which shows investment spending in the different bits of the economy. Were it not for hi-tech, the US economy would be growing at less than 2 per cent a year, instead of the 4 per cent plus that it is currently achieving, and investment would be almost at a standstill.

Given this divergence it would be surprising if the US financial markets were not to reflect the much better growth prospects for hi-tech. But perhaps most astounding is the way in which this re-rating is still continuing. Look at the way the Nasdaq index (at the bottom) has spurted in the past month.

Here, we have no real equivalent of Nasdaq, a separate exchange for high-technology stocks, but the point has been made by many people that were it not for hi-tech companies the UK, with FTSE running at an all-time high, would actually be in a bear market. The market thinks the new economy is wonderful; but if you believe that share prices are rational, it also thinks the prospects for the old economy are pretty poor. It is almost as though the market believes that the next downturn could see continued strong growth in the new economy but a recession in the old one.

The analytical problem here is that the new communications technologies have three different effects. They are a set of products for which demand is booming: telecommunications, software and so on. They are a new distribution system: a way of selling books, airline tickets or banking services that is radically cheaper than the previous distribution lines. And they are a new production system - or at least they hold out the possibility of a radical streamlining of the present production systems.

The first two stories are already in the market. As noted the boom sectors are still being re-rated, while the pressure on the distribution mechanism is hammering the high-street stores. But the impact on the production system, in some ways the most interesting impact of the new technologies, is not really appreciated.

Suddenly companies making anything from a product, like a car, to a service, such as a package holiday, have the opportunity to cut their costs. The new technologies enable companies to link seamlessly with their suppliers up the production chain and the customers down the chain. So standard but expensive aspects of production, like making sure the components are ordered, arrive on time and are paid for, can now be done without human intervention. It is a change as radical as the introduction of just-in-time manufacturing, but with wider applications because it can be used by service industries as well as those making physical objects. Indeed it is ideal for service industries, which typically "manufacture" their service at the point of sale rather than at a large central factory. The new technologies give a way of controlling both quality and costs at multiple outlets.

This is of enormous importance. The hi-tech corner of the economy is between 3 and 6 per cent of the total, the range depending on what you consider hi-tech. It is growing very fast but that growth is leveraging only a small part of the whole. The application of hi-tech to the low-tech, on the other hand, affects just about the whole economy.

So clearly this is enormously important. Trouble is, it is quite hard to see what it does in the short-term for individual companies or even industries. We are not going to buy more washing machines because the firm making them has streamlined its production facilities: we will simply buy rather cheaper ones. Nor are we going to buy more restaurant meals, or have a our hair cut more often. I must admit I haven't quite figured out how information technology will affect hairdressers, but in general we will see yet more deflation: the greater efficiency that the new technologies make possible will be delivered to consumers in the form of lower prices. Competition will see to that.

What will this do to mainstream companies? In terms of output probably not a lot, but in terms of costs it will be of seismic importance. Companies everywhere will be under the cosh. If they don't race to cut costs by applying best-practice IT they will be wiped out. But the more they substitute technology for labour, the more they will need to downsize their present labour force. The new technologies will therefore give a further impetus to corporate restructuring. The game, therefore, will be how to restructure as swiftly and painlessly as possible.

What is new? Companies, you might say, have been in this situation for ever: they have always been faced with the challenge of trying to do more with less. That is true, but there are two new elements. The technology is moving faster than at any time since at least the 1950s; and this is already a period of global deflation, not global inflation.

The impact will probably be pretty negative for conventional companies, because managing cost-cutting in a period of deflation, while applying state-of-the-art new technology is a difficult management challenge. The only recent general experience we have of a prolonged period of deflation is Japan, which has not in general managed the downsizing of its industries at all well. That should not suggest that the Japanese disease will spread to the rest of the world, for there are special factors in Japan which do not apply elsewhere. But it does suggest that the lowly rating of the shares of companies in the old economy is justified. The two-nation division of the world economy still clearly has some distance to run.