New technology fails to justify US bull market

Will US share prices continue to rise or will they plunge? We are all in two minds about such questions
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The Independent Online
DEBATE ABOUT whether or not there is a "new paradigm" of technology- boosted growth rages as fiercely as ever, especially in the US. Will Alan Greenspan opt for a rise in interest rates at the Fed meeting today, or will he decide that the trend in productivity has improved enough to head off any inflationary dangers? Will US share prices continue to rise - or will they plunge?

If we are honest, we are all in two minds about such questions. Ed Yardeni, Deutsche Bank's ultra-wired New York economist, notes that the latest poll of institutional investors shows an amazing 45 per cent of respondents saying the stock market is a bubble. Yet 43 per cent have the biggest share of their portfolios in the highly valued technology industry.

In his latest newsletter he notes: "Two of the most popular television game shows in the US today are Who wants to be a millionaire? and Greed. The stock market lottery game continues to make millionaires of those who bought the winning tickets, especially in the high-flying tech sector."

He adds: "To a certain extent, the euphoria is justified by big gains in productivity that are keeping a lid on inflation while boosting profits. But stock-led prosperity may be starting to outpace productivity-based prosperity. This is fine as long as nothing trips the charging bull. I've been spending too much time worrying about this possibility. Now, I just want to get wildly rich fast like everyone else!"

There is a solution to the puzzle, however. Of course there's a new economy, stupid. But its effects will be slow to manifest themselves, will take us by surprise and do not, alas, mean the millionaire-creating process that is the US stockmarket will continue for much longer.

Everybody knows Moore's Law that computer power doubles every 18 months or so. The price of computer power has already fallen 10,000-fold within a single generation. Growth of 35 per cent in computer power dwarfs the 5 per cent a year power growth delivered by steam engines and their successor electric engines between 1869 and 1939.

At the same time, the expansion of computer use has been extraordinary. Use of the Internet is growing literally exponentially. It took radio 37 years to reach a global audience of 50 million, and television 15 years. Yet it took the world wide web just three years after the development of the web browser in 1994.

The improvement and extension of technology on this scale has inevitably improved economic well-being. But almost as well-known as Moore's Law is the productivity paradox. Average productivity growth in the advanced industrial economies has slowed as computer use has become more widespread. The excitement about last week's US productivity figures was that they might provide the first conventional evidence that the technological revolution has boosted productivity and growth.

Part of the reason evidence for a new economy has been so scant is that there are long and variable lags between technical developments and any economic impact they might have, because businesses have to adopt the new technology and invest a lot in it. Twenty years is not long enough for business to have adopted a brand new technology widely. Even in the US, rapid investment in IT software and hardware dates back only to the start of the current recovery in 1992.

In a well-known paper the economic historian Paul David at Stanford described how it took 40 years for US industry to reorganise in order to exploit efficiently the electric dynamo. On top of the amount of investment, it demanded other social and legal pre-conditions, such as limited liability, development of the banking industry, free trade and a reliable framework of contract law and competition policy. But when all that was in place, the result was staggering: mass production and and mass consumption.

A second explanation of the productivity paradox is the possibility of mismeasurement. In his latest speech Alan Greenspan observed that the gap between US GDP measured by output and by income had widened dramatically. The latter is far higher. It is very hard for formal statistics to keep up with the economy at a time of great change.

What's more, conventional statistics never keep up with improvements in living standards over time. Brad DeLong, an economic historian at Berkeley, has looked at improvements in real living standards in the US since the end of the Civil War. The statistics say GDP per worker today is around $60,000. In the late 1860s it was $7,500 measured at 1998 prices. But, as he points out, in the 1860s, there was no TV, no antibiotics, no convenience food, no central heating so the average 19th-century worker would have been much worse off than even a disadvantaged citizen on a paltry $7,500 income in 1998. After all, Nathan Meyer Rothschild, the richest man in the world, at the time died of an abscess that could have been cured today with a $10 antibiotic.

So it is pretty safe, actually, to conclude that the economy is improving in ways that we can not yet get an accurate fix on. The catch is that even if you take the brightest possible outlook for economic growth it poses bullish investors on Wall Street a challenge. Share prices ought to rise relative to dividends if either the trend growth rate rises or the risk premium falls.

Professor Nick Crafts of the London School of Economics has calculated that either you must believe US growth has risen to an implausible 4.5 per cent - even the most ardent new-economy believers talk about trend growth of around 3 per cent - or you must believe in a negligible equity risk premium. Some analysts do, of course, but the average, risk-averse investor ought to be aware of that heroic assumption.

Besides, new technologies almost always end up benefiting consumers, not corporations, in the very long run. If the Internet and globalisation really are bearing down on prices, that suggests increases in profits, and hence dividend growth, might be a lot more limited than the rosiest views of the stockmarket imply.