Everyone wants a stake in the new economy, but has the race for the future gone too far?

If the dot.com bubble bursts, the old economy could pay the price for over-investment in hi-tech stocks
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Is it possible to have too much of a good thing? Economists have started to ask whether the technology boom on the stockmarket has led to over-investment in the fashionable new sectors and under-investment in "old economy" industries.

If so, there could be a depressing fall-out as the bubble - if it is one - bursts. For the penalty for the misallocation of funds could be too much new-economy capacity, and capital too costly for rapid investment growth in the old economy.

It has certainly been easy for dot.com and other hi-tech businesses to raise capital through the stockmarket so far this year, although last week's reversal in their share prices could indicate that this is starting to change.

As DeAnne Julius, a member of the Monetary Policy Committee, pointed out in a recent speech: "So-called new-economy firms, particularly internet-based start-ups, can attract investment at a very low cost of capital, while old-economy firms are having to pay high dividends on their much larger income streams to keep their investors."

Stephen Lewis, chief economist at Monument Derivatives, argues that much of the dot.com investment will prove unproductive. Just as public sector investment in the 1970s "crowded out" more productive private investment by soaking up funds and raising the cost of capital, so the dot.commery could be choking off some old-economy investment that would yield a higher financial return.

Stock exchange figures indicate the amount of equity issued overall has been on an upward trend. But Mr Lewis says: "A lot of capital is being channelled out of old-economy stocks into these new areas. It is only productive investment that is a good thing. There is a real possibility of over-investment and a collapse in profitability."

Pessimists draw a parallel with Japan in the late 1980s, where there was clearly - with hindsight at any rate - an artificially low cost of capital and excessive lending, especially in real estate.

"When we are talking about European companies buying into the US new economy, then I don't think that parallel holds," says George Magnus of Warburg Dillon Read. "There is no firm evidence it is money going into speculative investments."

He adds: "You could say money going into internet start-ups is speculative, but that is clearly a matter of opinion."

But the Japanese example does remind us that the broader economy will not be immune from whatever unfolds in the narrow, booming sectors of the stockmarket. For, as Mr Magnus admits, the growth and productivity enhancements are there but the corporate earnings are not.

"In the early phase, the stockmarket re-rating of technology companies was about a reassessment of growth and productivity prospects. This year it has been more about the blind faith that some of the glitter of the technology companies will be transferred to the old economy."

Mr Lewis predicts there will be a further effect if the dot.com boom turns to bust, through the damage it is likely to cause to business and consumer confidence. "The overall economic climate will be much bleaker," he says.

Other experts are more optimistic, however.

David Miles, Professor of Economics at Imperial College, argues that the internet bubble is unlike earlier episodes such as Japan in the late 1980s. For many online companies are actually not spending large amounts of the money they raise investing in physical assets. If it is creating over-capacity anywhere it appears to be in advertising, but the main resource being used is the time and attention of the managers and venture capitalists.

"What would the founders of these dot.com companies be doing otherwise? Probably nothing much. It is not going to be the same as having an overhang of half empty offices or factories after a conventional bubble bursts," he says.

Professor Nicholas Crafts, an economic historian at the London School of Economics, is yet more upbeat.

He draws a parallel between today's high-technology boom and the railway mania of the 1840s, a stockmarket bubble that did indeed burst dramatically.

"A lot of the schemes failed, but 7,000 miles of railway got built by 1852 and became the core of the mainline network," he says. Even after railway share prices collapsed, investment in laying railway tracks continued, expanding the network to 20,000 miles by 1870.

The excessive physical investment in rail came after 1870, Professor Crafts says. For example, Marylebone, the terminus of the Great Central Railway, was not opened until 1899, and the line's links were not completed until 1910. It never paid a dividend to its investors. But it has been well-used, nevertheless, and would perhaps have been a profitable investment half a century earlier.

If this analogy holds, then the real investment that is currently being undertaken will form a key part of the nation's long-term infrastructure, whatever the short-term financial excesses on the stockmarket.

A final consideration, in today's global capital market, is where the funds invested in hi-tech companies are ultimately coming from, for it could be the case that what is being squeezed out is not other productive investment at home, but less productive investments overseas.

Mr Magnus argues that this is exactly what has happened, with investors everywhere seeking the best new-economy opportunities on the planet.

Although there is no direct evidence, the size of capital flows into the United States from Japan and Europe, shown in the chart, is suggestive.

Within Europe, the same is probably true for the UK, with more inward investment from the Continent than British outward investment into continental companies.

For what investors everywhere want is a stake in the economy of the future. Declines in technology share prices suggest a recognition that the process had gone too far, however. There is still a future in old economy investment too.

d.coyle@independent.co.uk

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