Outlook: Productivity miracle doesn't spell a bull market

Barclays resurgent; Hot air review
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The Independent Online

The Dow Jones Industrial Average struggled back through the 10,000 barrier yesterday, and although it has already done this twice before since the atrocities of 11 September, there's a stronger belief among many investors that this time the rally will prove sustained. The US economy seems to be on the mend and, if that's the case, what's to stop equity markets returning to past glories as well?

The long-term bull case for equities rests largely on the idea that there will continue to be above average rates of productivity growth in the US and European economies. Once economic growth resumes, continuing productivity gains ought to be reflected in resurgent corporate earnings, the theory goes. And since valuations depend ultimately on how quickly a company can repay its capital, this in turn ought to result in a resumption of the bull market.

How realistic are these assumptions? Productivity first. Measuring productivity gain is a notoriously inexact science, especially across the broad sweep of economic activity, and there are still plenty of experts around who believe the latest phase of the information technology revolution has so far failed to deliver anything out of the ordinary at all. The really big gains in productivity over the past ten to twenty years have been in distribution and retailing, where innovations like bar coding and just in time stock control have resulted in some very dramatic gains indeed.

The interesting thing, however, is that both these developments are now comparatively old, and it is a moot point as to how much exceptional productivity gain has so far been driven by the IT innovations of the past ten years - the desk top PC and the internet.

OK, so maybe there's been a bit of it in the US, but in Europe there may not have been much at all. In any case, there are strong reasons for believing that the best, as John Chambers, chairman of Cisco, puts it, is yet to come. Mr Chambers' forecasting record has been somewhat discredited over the last two years, but it is a view also held by Bill Gates, chairman of Microsoft, and he's got a record of being more considered and realistic on these matters all round.

The pace of technological development, he pointed out during a session on the fringes of the World Economic Forum annual general meeting in New York last week, has continued unabated right through the bursting of the technology bubble. Indeed, the technology and telecoms bust may perversely have given technology take-up a real boost by causing a collapse in the price of bandwidth, which in turn makes the use of centralised servers for corporate purposes that much more economic. The potential for cost and productivity gain from this development alone, which is still in its infancy, is huge. For Mr Gates, the really dramatic productivity gains are not going to start kicking in until the second half of the decade.

So big leaps in productivity equals higher profits and higher share prices, right? Not necessarily. Again it is a favourite saying of Mr Gates that profit is not a natural state for companies, unless of course you happen, like him, to have a monopoly. We live in an ever more transparent and competitive world, where even substantial market positions are harder to defend than ever. The strong likelihood, therefore, is that the value of all these wonderful productivity gains which supposedly await just around the corner, will simply get gobbled up by the workforce and the consumer. Sustained earnings growth for all but the most powerful companies may prove a good deal more illusive than many investors think.

Barclays resurgent

It is usually at this stage in the business cycle that banks report their worst. In the last recession, Barclays was virtually wiped out by its bad debt experience and it was hardly surprising that banks in general came to be seen as an integral part of the boom to bust cycle of the wider economy. In the good times they lent like topsy only to call it all in again in the inevitable credit crunch that followed.

Well, all that seems to have changed and although Barclays' bad debts are on the rise again, they are as yet hardly enough to frighten the horses. For Barclays to be reporting record profits at this stage of the cycle, as it did yesterday, is by the standards of the past an astonishing achievement.

Nor is it just the vicissitudes of the economic cycle that make this such a surprise. Two years ago, the imminent demise of the big banks was being widely predicted. With their cumbersome branch networks and burgeoning cost bases, they couldn't possibly hope to compete with the internet new entrants and other low cost operators. Two years on, and most internet banks are history while those that have survived have failed to make much of a dent in the current account hegemony of the traditional players, or their dominance of Britain's cash deposits.

All of this makes Matt Barrett, Barclays' chief executive, rather smug. He shouldn't be. The chief reason the present downturn has not been as vicious as some others, either for businesses or banks, is that interest rates are so low. What's more, the consumer bit of the economy for the time being continues to boom, but with household debt at an all time high, how much longer can that continue for?

With consolidation ruled out in the UK, retail banking may no longer be the breeze it once was.

Hot air review

Sometimes it seems that the whole of Whitehall is powered by hot air alone, but no more is this the case than with the Cabinet Office's Performance and Innovation Unit. The PIU yesterday produced the fourth and final draft of its much-leaked energy review and what a colossal waste of heat and light it proved to be.

Chaired by the Department of Trade and Industry's atomic kitten, Brian Wilson, but with input from the nuclear-hating Environment Minister Michael Meacher, the review has predictably turned out to be a classic piece of Westminster fudge. Early drafts of the report cast doubt on whether there was any future at all for nuclear in the energy mix so Mr Wilson sent back the review until it came up with more palatable answers.

The result is a report which provides succour to just about everyone in the energy chain. Britain, says the PIU, has no need to start worrying yet about being held to ransom by imported gas but we should push for a big increase in renewable energy whilst keeping open the nuclear and coal options. That just about covers everything.

The truth, as the PIU tacitly admits, is that any policy designed to maintain security and diversity of supply while also enabling the UK to deliver on its environmental obligations is going to mean a sharp rise in household energy bills. That is why in his introduction Tony Blair is careful to describe the review as "a report to government, not a statement of government policy". An administration as risk averse as this one, is not about to stick its neck out when it does not have to, especially when Parliament works on five-year terms but the PIU is looking out 50 years.

The PIU's final recommendation is that the Government create a Sustainable Energy Policy Unit and start a public debate. More hot air in place of hard decisions then.

j.warner@independent.co.uk

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