Politics
Just wait for the gold rush to end
Published 21 February 2000
A new economy? Some people want us to believe that the Internet will give us an endless boom. But Paul Wallacehears worrying echoes of an old economy
You may think that whoever coined the name Oxygen for the latest soaraway Internet company must have had a sense of humour. The financial bubble in dot com stocks is hardly short of air. But it is just as likely that Oxygen Holdings' twentysomething venture capitalists - whose ritzy media backers include Matthew Freud and Elisabeth Murdoch - don't see the joke at all. After all, they're incubating (nothing so mundane as investing in) start-ups in the new e-economy of virtual value and endless boom. Financial bubbles are a fuddy-duddy discredited old economy idea.
Yet we are not so much charting new territory as warping back to the globalised economy of the 19th century. The Victorian era holds up a mirror to the present day that is far more revealing - and sobering - than the crystal ball of our Panglossian futurologists.
To listen to new economy hypesters - let's call them the neweconomistas - you would imagine that global communication and delivery had been invented yesterday. No doubt they are too busy boning up on e-jargon and brainstorming hip domain-names to recall J M Keynes's description of the world around 1900: "The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages."
One-click ordering may now have jazzy shopping trolley icons, but it's still home delivery. That's old, not new. E-mail may be a hundred times superior to snail-mail, but Amazon still delivers your books by post or courier. Ordering your groceries from the local Tesco's doesn't sound so far removed from ringing up the village store and getting them sent round in the van.
Even so, let us accept that e-commerce is opening up a new electronic frontier, one that slashes distribution costs and empowers consumers. Does this amount to an unprecedented economic revolution? Only to those who never watch Westerns.
In 1850, the US had less than 10,000 miles of railroads; by 1910, this had risen to 250,000. Steam replaced sail. Transportation costs nosedived, making it possible to buy foodstuffs and commodities on the world market. The consequence: a dramatic international price convergence, argue Kevin O'Rourke and Jeffrey Williamson in Globalisation and History. In 1870, wheat in Liverpool was three-fifths more expensive than in Chicago; 25 years later, the margin had fallen to less than a fifth. An even bigger price gap for meat in 1895 collapsed in the next 15 years, as refrigeration made the British market accessible to far-away foreign imports.
So today's electronic revolution gives us a welcome advance, but hardly an unprecedented change. Time for the neweconomistas to shift ground - to the claim that the Internet economy is wholly new in its potential to make information instantly available to all. In financial markets, for example, day-traders, glued to computers in their back-bedrooms, are taking over from old-style professional dealers.
But all advances are relative. Before the first transatlantic cable was laid in 1866, information in the City of London about prices on Wall Street was three weeks out of date. The cable gave traders current prices within the day. Price differences between London and New York fell by over two-thirds. Moving from weeks to a day is a bigger advance than moving from telephone to Internet trading.
There are further striking parallels between today's "new" economy and the old economy of the 19th century. Over the past two decades, capital has broken free from national boundaries. Last year, companies' foreign direct investment reached a record $800 billion. Yet before the first world war, capital was also on the move, and on an even more astounding scale in relation to the size of economies. At its peak, Britain's foreign investment accounted for almost a tenth of output or a half of total savings. The big difference between today and the 19th century is that, though capital can now move freely, it's not so easy for people. It's true that there is more migration now than in most of the rest of the 20th century; but, generally, you are better off as a can of beans if you want to move to another country.
The new economy combines low inflation and low unemployment - not the sort of mix you're supposed to have in the dismal trade-offs of the dismal science. Neweconomistas frequently attribute the death of inflation to the high-tech revolution. But inflation has been in retreat since the mid 1970s. It fell substantially in the 1990s before the Internet flourished.
Again the parallel with the late 19th century is instructive. Then, prices fell as domestic markets opened up to international competition. British farmers were hammered by cheap producers in the new world. Today, vast new industrial capacity has come on stream in Asia. Firms are losing the pricing power they could once exert in national economies; this in turn keeps wage pressures at bay.
But what makes the e-economy year zero for its over-excited cheerleaders is the impact of IT and the Internet on productivity. Inspired by a recent surge in American productivity figures, the neweconomistas envisage a permanent improvement in the growth of output per worker. Recent productivity gains are certainly impressive compared with America's recent past. They are comparable, however, to those in Japan or the UK in the late 1980s and, as economists at HSBC observe: "We all know what happened to those two 'new paradigm' models as they entered the 1990s." Indeed, productivity growth has recently been falling in both the UK and the euro zone.
The point about America is that when economies operate beyond full capacity, as in the US today, productivity figures flatter to deceive. More output is squeezed out of the labour force than is sustainable in the long run. The truth is revealed when the economy slows down or goes into decline in the downleg of the business cycle.
The business cycle? But my dear, that's so old economy. With the US celebrating its longest expansion in history, the business cycle has been written out of the script.
This is a triumph of wishful thinking over experience. The business cycles of the 19th century were driven, like the current upswing, by investment rather than by consumer or government spending. In principle, investment is a good thing. But you can have too much of a good thing, especially when investment is spurred by soaring stock markets. As Keynes wrote: "There is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the stock exchange at an immediate profit." Only when the financial climate turns sour is the new project revealed as a waste of money. That's when the music ends and the debts (in hard cash) are no longer dwarfed by soaring valuations of paper assets.
The characteristic rhythm of the 19th- century business cycle was a long investment-driven upswing that often topped out in a speculative mania. A sharp recession followed. So far, we have not encountered a similar downside, but it is surely waiting in the wings. As Walter Bagehot wrote more than a century ago: "At particular times a great deal of stupid people have a great deal of stupid money." Ring a bell? Today's stupid people may no longer be Bagehot's "quiet ladies, rural clergymen and country misers", but their money is just as stupid, their capital just as blind. An old rule of thumb was to move out of stocks when the cab driver bent your ear with his latest stockpicking prowess. By this token, when the Mirror's tipster column stops delivering the news and becomes the news, it's time to take cover.
Whenever shares rise - or fall - there is never any shortage of storytellers to explain why. The agreed storyline on Internet stocks is that the new virtual economy is rapidly displacing the old industrial economy. Buy that (and the shares) if you like - but don't forget that capitalism has always been about creative destruction. A more plausible interpretation is that this is an old-fashioned gold rush - another disconcerting echo of the 19th century. And what happened at these Klondikes? A few prospectors hit gold, while the rest panned for fool's gold. It's the same with Internet companies. A very few genuinely innovative players like Yahoo! have broken into the rich seam of eyeball count that makes for potentially big profits. The rest - the imitative stragglers - are already falling by the wayside.
Does it matter if investors waste their money in speculative blow-outs on companies with wacky names? Unfortunately, yes. When the bubble bursts, there is credit revulsion - to use the evocative Victorian phrase - which affects sound companies as well as back-of-the-envelope ones. Debts that seemed manageable when financial assets were rising become onerous for both consumers and companies. These bad debts have to be purged from the economic system - something that it has taken the Japanese a decade to deal with after their bubble of the 1980s.
Let Keynes - no ivory tower economist but a highly practised investor - have the last word. "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." Oxygen or no oxygen, the Internet bubble will burst and with it more than the naive hopes for a new economy.
Post this article to
We want to encourage people to comment on our content and to exchange views with other readers and hope this will be done on a courteous basis. However, if you encounter posts which are offensive please let us know by emailing comments@newstatesman.co.uk and we will take swift action where necessary.
