Devil's Advocate: The new economy myth

In the first of a trilogy on new economy winners and losers, Martin Brampton exposes the 1990s as the decade when we got more of the same - slow growth dressed up as success...

Did the last decade of the twentieth century see a technological revolution that brought a step change in the economies of the IT using world? The claim was often made that we were finally seeing a dramatic payoff for years of technical ingenuity and its commercial deployment. I have expressed my doubts and now that reliable figures are becoming available it seems we cynics are vindicated.

The optimists, often led by Alan Greenspan at the US Federal Reserve, used to claim the new economy involved significant productivity gains. They in turn were expected to lead to a sharp increase in profits, leading markets to rise sharply against low inflation. Money poured into initial public offerings of new technology stocks, allowing venture capitalists to achieve extraordinary rates of profit.

Reality now looks rather different. Actual economic performance in the much-hyped five years from 1995 to the millennium struggled to match the average growth rates for the 25 years from 1948 to 1973. In fact, the growth of labour productivity was actually as much as 20 per cent lower. Taking an even longer look, the average growth rate of output for the hundred years from 1889 to 1989 was 2.2 per cent, a rather better figure than the measly 1.6 per cent achieved from 1990 to 2000.

Indeed, this is all part of a long-term trend where the entire world economy has slowed down significantly since 1973. Subsequent fallbacks have quickly wiped out the spectacular gains that attracted so much publicity. During this period there was a serious problem of excess capacity and over-production in the world’s manufacturing capability, resulting in falling prices and reduced profitability.

The US gave the impression of having defied the trend between 1985 and 1995 but this was achieved largely by a combination of sizeable reductions in the value of the US dollar combined with government magnanimity to business. The main losers were Japan and Germany, which suffered from correspondingly high currency values leading to poor sales and economic recession.

The scene was set for an extraordinary bonanza in the US stock markets, just at a time when corporate profits were poised to shrink steadily. Repeated easing of credit restrictions created a wash of money in the US that chased share prices ever higher. The main buyers of shares were companies themselves, as they found it effective to borrow money through the issue of huge bonds.

Buying their own shares drove prices to new heights, along the way creating ideal conditions for executives to benefit from stock option schemes. Cash reserves built from borrowings were also used to invest in the shares of other companies, and as share prices seemed on a constant upward path the owners of shares grew ever richer. Any crisis that looked likely to upset the golden scenario, such as the crash of Asian stock markets in 1997, was smoothed over by a further easing of credit.

But companies spread their borrowed money more widely than just buying shares. The cheapness and ease of borrowing encouraged a boom in the purchase of plant and equipment. Thus major suppliers such as Cisco and Nortel were able to sell massive volumes of product, apparently confirming a new economic paradigm. Indeed the telecoms sector became the most absurd anomaly of the boom. By 2000, US telecoms companies were capitalised at trillions of dollars, making up 15 per cent of the total for non-financial corporations. That contrasts with their contribution of a mere 3 per cent to the US gross domestic product.

At this point, companies were in a situation where their financial stability depended critically on high share prices. At the same time, the profitability that should underpin share prices was falling. Recently, we have been seeing how companies tried to square that particular circle. Next week I will look at that in more detail.

** Martin Brampton is a director and founder of Black Sheep Research (www.black-sheep-research.co.uk ), an independent consultancy providing research, writing and speaking services on a wide range of business and technology subjects. Martin was previously a director at Bloor Research, and has worked with IT as a user and analyst for over 20 years. He can be contacted at silicon@black-sheep-research.co.uk.

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