News Analysis: US data suggests New Paradigm is here to stay

Easing employment costs suggest that high growth is being achieved without stoking inflation in the labour market
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The Independent Online
POLICYMAKERS AND economists and were sent scurrying back to their textbooks last week after the United States delivered a boost for believers in the "New Paradigm" school of thought. The American economy roared way ahead of forecasts in the third quarter, growing at an annual rate of 4.8 per cent. Yet employment costs eased, indicating high growth can be achieved without putting pressure on the labour market or triggering inflation.

Not only that, but it emerged the pace of the current expansion was even faster than previously thought. The economy has now grown in every quarter since 1991 at an average rate of 3.5 per cent rather than the more modest - but still impressive - 3.1 per cent.

The department said that last year GDP rose 4.3 per cent, 4.5 per cent in 1997 and 3.7 per cent in the previous year - a revision from the previous figures of 3.9 per cent, 3.9 per cent and 3.4 per cent respectively.

More importantly, the thinking for the revisions went straight to the heart of the debate about New Paradigm. Its disciples believe the economy is in a phase of structural - rather than simply cyclical - improvement. New technology has enabled companies to achieve higher productivity, meaning that more output can be achieved without having to raise employment costs.

The Commerce Department said efficiency gains from innovations in the financial services industry, such as automatic telling machines, had not been fully recognised.

This means historic inflation appears more benign as price rises have reflected improvements in quality of service rather than simply inflationary hikes. It also decided to treat software spending as an investment on a par with new machinery and equipment, rather than as an expense.

The advance of information technology has allowed a substantial revision of growth over the 36 months to the end of 1998 - a period when the stock market almost doubled in value.

Thus on Friday, the day after the figures were published, the technology- rich Nasdaq stock market broke all records, smashing first its intraday high before closing at an all-time peak. The Dow Jones added another 100 rise on top of a 227 surge on Thursday to close at 10,731 - some 400 short of reclaiming the all-time high.

Such is the dominance of the US economy and its financial markets that almost every equity index across the globe rose sharply on the news. In London the FTSE 100 added 210 points over the two days while Paris, Stockholm and Helsinki hit all-time highs.

The spike in shares called time on the long period of concern on the bond and stock markets over the summer that saw a marked fall-off in values.

Looking forward, the question is simple - do the latest figures confirm that the way the US economy works has changed markedly or do they simply put off the dread day when orthodoxy returns and the markets come back to Earth with a bump?

The New Paradigm advocates received cautious support from the US Treasury Secretary Larry Summers and chairman of the Federal Reserve, Alan Greenspan. Mr Summers said improvements in productivity had made possible increases in living standards "without inappropriate inflationary pressures". Mr Greenspan said the recent economic performance was "not ephemeral", although he went on to say that at some point the growth in productivity would have to "plateau".

In a research note published before Thursday's figures, economist Stephen Slifer of Lehman Brothers in New York said productivity growth was set to accelerate. With labour costs rising 5 per cent but the cost of capital falling 4 per cent, he said companies would seek to replace employees with technological investment.

He said the growing amount of investment in technologywould restrain inflation and drive interest rates down.

"With 4 per cent GDP growth, 1 per cent inflation and interest rates as low as they are today, the stock market should soar," he added. "It is hard to imagine a more positive environment for equities."

The key, again, is technology. The Internet is in its infancy with e- commerce making up just 1 per cent of sales. Yet a recent survey showed prices were some 15 per cent cheaper then in-store - and free of sales tax.

Orthodox economists believe that this analysis ignores economic fundamentals. Commodity prices are rising and this will eventually feed into the shop floor, out of the factory gate and on to Main Street America. The market for available - and employable - people is shrinking and as more people are sucked into the workforce, productivity will eventually plateau, as Mr Greenspan contends.

On top of that is the ballooning current account deficit. As long as foreign investors continue to put enough money into the American economy, the situation is sustainable. But if investors believe the US stock market is overvalued and as the recovery in the Far East and in Europe continues to draw in money, the Wall Street will seem less attractive. As investors sell dollar assets then the US currency will decline and the Dow will tumble.

Which brings us back to the US stock market. Concern about the unsustainable rise on the Dow has been with us since Mr Greenspan warned of "irrational exuberance" in December 1996.

Since then it has added another 4,000 points and shows no signs of slowing. Yet many believe the party must end, especially if American consumers stop running down their savings to fund their spending, which is now rising at more than 5 per cent.

This fear makes the stock market volatile. Every major piece of data sends the Dow on a fast and furious roller-coaster ride. In this atmosphere the slightest shock could provide the trigger. If the Dow slumps, the fall-out would be severe.

As Paul Volker, the ex-chairman of the Fed said, the world's economy depends on the US economy, which depends on consumers spending, which depends on the stock market, which depends on some 30 hi-tech companies that have never made a penny profit.

Against this background Alan Greenspan must guide the economy gently down to Earth. Many economists believe there will be another 0.25 per cent rate rise on 16 November.