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New e-conomy: don't blow IT

Despite all the hype about IT and e-commerce, says Phil Mullan, a shortage of investment and ambition risks wasting the real opportunities provided by new technology

Almost every end-of-the-century review made the point that we live in a world of rapid technological change. Unfortunately, for many, this is not seen as a cause for optimism. The hopes of a better life raised by new technology are overshadowed by concerns about change being too rapid and the world spinning out of control. Genetic engineering, for example, offers the promise of eradicating many diseases and disabilities, yet for many it seems to be all about new Dr Frankensteins playing God. Similarly, information technology (IT) has the potential to transform global communications and bring immense economic, social and cultural benefits. Yet most people still equate the internet with pornography. In a Which? online poll, 58 percent claimed that the internet is a threat to the nation's morality.

Two things stand out about this ambivalent attitude to new technology. The fear of change in society today means that there is a tendency to exaggerate the pace of technological development. And that same sentiment of uncertainty means that the dominant impulse is often to hold development back and slow the apparently breakneck pace of change. As a result, we are in danger of wasting a great opportunity to move forward as fast and as far as we could.

While the public sense of rapid technological change is indisputable, the roots of this perception are social and cultural rather than economic. Although there is great potential in the technologies developed over the past half century, the actual changes seen in the past 10 to 20 years pale somewhat in comparison to some earlier phases of technical progress. Compare the arrival of steam power or telegraphy or electricity with the ability to buy Christmas presents over the internet today.

Today's sense of revolutionary change is not justified by material developments. Instead it is the product of the disorientation many feel as we move into different social and political conditions. In the course of the past quarter of a century a lot that we had become used to has disappeared - the left-right divide in politics, respect for institutions from the church to parliament, a sense of solidarity at work and in the community. This shift into an uncharted era has easily helped to conjure up an exaggerated sense of change and of things being out of control.

The irony is that, in a period when the rate of change is pretty unexceptional, and much could be done to speed things up, the general mood is for more restraint. Even people working in the new technology industries are influenced by a defensive mindset of caution. Their general strategy for using new technologies is constrained by narrow short-term considerations and the desire to avoid too much disruption. As a result, genuine possibilities for progress are being wasted. The danger of society missing technological opportunities is well illustrated by today's big economic debate - the arrival of a New Economy.

In the USA in particular, the talk of the nation is about this New Economy. From business to government, from Wall Street to Main Street, the growing consensus is of a major change for the better in the American economic condition. The benefits of this New Economy are attributed to the combined effect of globalisation and the take-off of information technology. The explosion of the .com society over the past five years has given the thesis popular credibility, as the electronic revolution is said to be changing everything.

This discussion is now rubbing off on to Britain, too, where every newspaper has its internet sections while net entrepreneurs are hailed as the rising stars of the business world. What is the substance to the notion that we are in the throes of a US-led economic transformation that can dwarf the impact of the agricultural and industrial revolutions?

In the USA, the continuation of low inflation and steady growth has many observers believing that the good times are here to stay. America ended the 1990s still riding its longest-ever economic boom. The US Department of Commerce recently revised the statistics in a way which suggests that economic expansion has been even faster than previously thought. The revisions are themselves products of New Economy thinking. By treating software spending for the first time as an investment instead of a company expense, they automatically flatter gross domestic product (GDP) and investment figures. As a result, the US economy officially roared ahead at an annual rate of 4.8 percent in the third quarter of 1999.

Behind these national statistics, US businesses appear in good health, too. Corporate quarterly earnings continue to surge. Spending on computers and communications, never mind software, dominates investment figures. Last year US companies are estimated to have spent $35 billion on getting into e-business. And it seems that the promises of a renaissance in productivity growth could finally be realised. Since 1996 productivity growth has doubled, to average two percent a year.

As the Americans celebrate, many believe that Britain is in the earlier phases of a similar transformation. Boasting an increasingly American-style flexible economy, Britain too has experienced a record period of expansion. What the economists call 'weightlessness' is on the rise, with services provision in Britain growing to three times the size of manufacturing production. The high-profile flotations of Freeserve and other British internet companies have introduced a form of the US internet share frenzy, while on the ground one in five of the British adult population is an internet user.

The prosperity of a brave new economic world appears to await us all in the twenty-first century. There is, however, one teeny problem with this thesis. The numbers don't yet add up, on either side of the Atlantic. You can speculate all you like about the unique impact of e-business and the new rules of a New Economy, but one economic law remains constant throughout history: if you do not invest the surplus you produced in the past, it will constrain the growth of surplus in the future. Without such capital investment productivity growth will remain below the historical trends, and capitalism will not realise its potential for accumulating wealth. And where is the level of investment today?

Contrary to the frequent talk in America of surging investment, business investment has been slower over the past decade than at any time since the Second World War. From the end of recession in 1982 until the next economic peak in 1990, business investment as a percentage of GDP averaged 12 percent. In comparison, in the period since the last economic trough in 1991 to the middle of 1999, business investment, including software, fell to an 11 percent average. This represents a reduction of about one tenth in US business investment year in, year out over the 1990s compared to the 1980s. The US investment boom is a myth.

Hardly surprising, then, that the acclaimed US productivity renaissance is difficult to substantiate. As Stephen Roach, chief economist from Morgan Stanley Dean Witter, wrote in the Harvard Business Review over a year ago: 'It must be stressed that there is not one shred of official evidence that the US economy has broken out of the productivity slowdown that it has been mired in since the 1970s.' (September/October 1998) For the 1990s cycle as a whole productivity growth averaged 1.5 percent a year compared to 1.1 percent in the 1980s and 1.3 percent in the 1970s - a small improvement but still short of the average of two percent a year since the US Civil War and three percent since the Second World War. Advocates of the New Economy thesis often point to two percent growth in productivity since 1996 as the best evidence of a new era. Yet productivity grew just as fast for the five years 1982 to 1987. With these figures in mind a four-year productivity spurt is sparse indication of a New Economy.

Investment rates in Britain have contracted even more sharply. Over the 1990s business cycle, investment rose one fifth slower than the corresponding period of the 1980s. As in the USA, business investment as a share of GDP fell in the 1990s compared with the 1980s. In Britain there was not even a late 1990s spurt in productivity to give credibility to the New Economy thesis. As the Bank of England noted in its Inflation Report in summer 1999: 'Since 1995 productivity growth has been below its long-run trend. There is no strong evidence that the trend growth rate has shifted.' Over the 1990s cycle as a whole productivity growth was over one tenth weaker than during the (already unimpressive) 1980s cycle.

Given these economic facts, how has the notion of economic renewal, never mind revolution, taken hold? A look at the American case reveals what has really happened with the new technologies - and how these developments are likely to shape what happens in Britain over the next two to five years.

One factor (albeit not the most important one) in the misguided view of the new technologies is the impact of hype. When they boast of the $35 billion spent by US companies on the internet last year (compared to about $7 billion across Britain and the rest of Europe) it sounds like a lot of money, but it is only three percent of total business investment and less than 0.5 percent of GDP. To devote less than one two-hundredth of America's annual wealth production to investing in the internet economy is scant evidence for proclaiming a revolution. For all the efforts of the net entrepreneurs in 1999, British business is committing even less of its resources - representing less than 0.25 percent of GDP - to internet operations.

Internet technology, even in America, is still in its infancy. Retail sales over the internet are about one percent of the total, and the potentially more important business-to-business deployment of internet communication remains rudimentary. This, of course, will develop. But it is important that immediate impressions do not destroy an historical perspective. The potential of the internet needs to be compared with the innovations of earlier phases of capitalism which had enormously beneficial impacts both for wealth creation and human wellbeing: water power, textiles, steam power, steel, railways, chemicals, telephony, electricity, the internal combustion engine, aviation. How the internet matches up in hindsight will depend on human ingenuity and creativity over at least the next 15 years, both in applying the internet across society and in developing it further.

Yet judging by the record of IT in general, the internet's pace of expansion and its wider structural impact will be less than it could be. This highlights the more problematic aspects of recent US investment patterns. One cannot judge what is happening in the US economy as a whole by focusing on IT alone. The key issue is how new technologies are applied across the rest of the economy. In the past this rule applied to the steam engine and electricity as much as it does to IT today. It is possible to have a boom in a specific sector, as in the IT hotspots of California and a few other US states, but its feed-through effects for national productivity will be minimal. If the new technology is not properly integrated into the economy as a whole, not only will the rest of industry fail to reap the benefits, but the feedback effects which propel the further development of the new technology itself will be limited, too. This is the stage we are still at with IT. The striking feature is not how quickly IT is revolutionising the economy, but how slow this process remains, 50 years after the development of the computer, 40 years since the satellite, 30 years since the semi-conductor, and 20 years since the PC.

Glowing statistics about investment in information technology can distort the fuller picture, because these investments alone do not show any full-blown reorganisation of industry to incorporate the benefits of IT. Yet it is the rapid growth of spending on computers and other IT equipment that sustains the belief in a wider investment boom. True, over the past 20 years IT spending has risen from one seventh to one quarter of all US business investment. But it is easy to draw wrong conclusions from this fact. It does not follow that total investment in the economy is also growing. Nor is the reallocation of investment towards IT always a good thing.

We have already seen that total investment across the US economy is weaker now than at any time since the post-1973 slowdown. IT spending represents a bigger share of a smaller total investment fund. The larger investments in IT products are offset by bigger falls in other crucial investments in new plant and machinery, and often in longer-term projects. Investment in business structures, for example, has fallen from four percent of GDP during the expansionary periods of the 1970s and 1980s, to three percent in the 'renaissance' 1990s. This fall off in non-high tech investment is just as, if not more, important for future prosperity.

And there is nothing magical about the productivity benefits of IT investment that can compensate. The assumption that IT investment is bound to be more productive than 'traditional' capital goods is a blind one. Many of the IT investments taking place today are of limited long- term benefit. A high preponderance of IT spending is on office-type technology - the ubiquitous PC and accessories. This has a dubious effect on productivity. After a one-off boost to office productivity from a reduction in clerical workers, nobody has been able to substantiate ongoing gains from giving people the new capability to play around with spreadsheets and produce fancier looking reports from their own desks. As MIT economist Paul Krugman has observed, the productivity gains from an old-fashioned, non-electronic development such as the deployment of transport containers was much bigger.

Another question mark over the quality of IT spending is that much of it is fast depreciating. Think again of the desktop PC and the number you see thrown out on to office pavements or into skips. In general, IT investment becomes obsolete more rapidly than most other productive investments. Dollar for dollar it contributes to wealth creation for a shorter time. This brings about a fall in the average lifetimes of capital assets, representing real decay in economic potential. One statistical quirk illustrates the negative long-term consequence of weighting investment in favour of IT. In the 1990s, gross flows of capital investment increased, yet the net capital stock of the USA has averaged just two percent a year, the slowest rate since the 1930s. The explanation is that, since the IT investments which make up more of the gross flows do not last that long, they make a relatively smaller contribution to the net stock.

The languid growth in net capital stock is crucial for future prosperity, because it represents the amount of technology each worker has to hand. And nobody has yet discovered a durable way to raise productivity without more technology. The irony of being in the midst of the 'third technological revolution' is that in reality the stock of technology we have to work with is growing so sluggishly.

The reported surge in US investment and innovation turns out to be not just unexceptional, but below par. Yet it is more than the distortion by statistics that sustains the belief in the revival of prosperity. When so much importance is being vested in so little productive development, it is clear that those promulgating a New Economy are as much in the sway of the climate of diminished expectations as everybody else. In an era of general caution and restraint, small steps forward can appear as gigantic leaps. This stultifying approach permeates the whole of society, including the business class. More than anything else, the belief in the arrival of a New Economy reflects the low horizons and aspirations of modern capitalism.

Jeffrey Garten, dean of Yale School of Management, argues that everybody in the industrialised world seems to have caught the anti-growth bug, so that an 'over-cautious mindset' prevails. Governments have made a virtue of austerity with policies which restrain growth. Much of business has accepted the environmental case against too-rapid economic development. The Prince of Wales' new year message well expressed this sentiment, with his encouragement of 'a world that recognises the idea of limits'.

Investment these days, from Japan and East Asia to America and Britain, is seen as more of a problem than a solution. Too much investment is blamed for the over-capacity that sent Japan into slump in the late 1980s, for the overheating and financial turmoil in East Asia, and for the boom-busts of the traditional business cycle in the West. Investors Chronicle now goes so far as to welcome 'the benefits of low investment. The weakness of capital spending may not be the problem it is alleged to be. Not only has it boosted returns to shareholders, it also means companies are well placed to cope with higher interest rates' (27 February 1998). This short-termist sentiment continues to spread inexorably, effectively dampening economic activity.

Rewriting a decade of mediocre expansion as an economic miracle is one thing. Of much greater concern is that the genuine possibilities now offered by new technology will be significantly delayed, if not lost altogether. Society is being held back by the stultifying effects of a culture of restraint, where 'unrestrained growth' is seen as a dangerous thing, experimentation is derided, and innovation is regarded as too risky. The loss of confidence within the biotech industries is a visible and dramatic example, as they publicly abandon promising areas of genetic technology in which they have invested billions.

The same mood of restraint and short-term expediency also afflicts many of the prophets of the electronic economy. It means that the potential of IT and the internet could just as easily go to waste. If the same laggardly approach is shown to the internet as has been shown to new technology in general over the past 15 years, we can anticipate that the benefits of the New Economy will be more mirage than miracle. Society will miss out in the early years of the twenty-first century on the genuine possibilities posed by the past quarter of a century of technological breakthroughs. Whatever the technological opportunities, if society is not prepared to invest its capital and its confidence in them, then slow growth will become a self-fulfilling prejudice.

Phil Mullan is the author of The Imaginary Time Bomb: Why An Ageing Population Is Not A Social Problem, available to Friends of LM at a reduced price. Phone (020) 7269 9224 for details

To discuss the ideas and issues raised in this article, go to: http://www.informinc.co.uk/interaction$forum/economy

Reproduced from LM issue 127, February 2000

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