The speed with which US growth decelerated from the 5 per cent pace of the first half of 2000 to close to zero at the moment, has given cause for thought both in the US and here in Ireland, which has a rapidly expanding new technology sector.
In the US, concerns have been aired by the Federal Reserve that some of the attributes of the new economy may heighten the risks that slowdown, when it starts, could be rapid and pronounced. Rising productivity played a major part in the ability of the US to sustain a faster pace of growth in the 1990s with little rise in inflation.
About two-thirds of the rise in productivity since 1995 is estimated to have been derived from the consolidated effects of high technology investments. Capital investment began to rise beyond the normal cyclical experience in 1993 and accelerated until a few months ago.
This investment boom was driven by companies' need to invest in cost-reducing capital as increasingly competitive markets reduced their pricing power. Even when demand in the US was growing very strongly companies reported that their pricing power was weak.
The question now being addressed in the US is whether this is the end of a normal investment boom or are there characteristics of the new economy investment process which may see a very sharp setback followed by a quick recovery?
Three attributes of the recent capital investment boom appear to form the germs of the Fed's concern over heightened risks in the new economy, as compared to the old. The first is the rapid pace of depreciation of high-tech equipment which is put conservatively at 30 per cent per annum compared to 15 per cent for other equipment.
Therefore, the replacement cycle is three years rather than seven for other equipment. This means heavy investment is needed just to maintain the capital stock which supports demand for investment goods in the upswing. The second feature which is different, in contrast to old economy capital, is the greater degree to which investment in new technology equipment is sensitive to fluctuations in its cost. The price declines of the last decade partly fuelled the boom in high-tech equipment. However, higher interest rates, declining stock prices and the rising cost of issuing corporate debt in the past year have raised the overall cost of capital.
Thirdly, this capital carries with it large spillover effects which tend to generate explosive growth in the upswing. For example if one company invests in a network of computers then a range of their suppliers may find benefit in also doing so or may even be forced to invest to continue the business link. This accelerates demand for high-tech equipment and speeds the dispersion of new technologies. However, a pause in the process would have a dramatic effect on demand for computers since the knock-on effect of one decision not to invest implies a whole sequence of investment decisions are not triggered.
These aspects of investment in high-tech capital suggest a sharp investment-led slowdown is possible. This in turn may lead to "the possibility that greater caution and weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending" as has been noted by Alan Greenspan.
From speeches in earlier years it is clear that Mr Greenspan has a concern that loss of confidence is difficult to restore if policy inaction allows it to get badly damaged. If, what he has called "the fabric of confidence" is protected, recovery can also be swift in the new economy model. We have seen a sharp fall in US consumer confidence and aggressive Fed action in January. On this analysis the Fed is likely to be ready to make more cuts in the months ahead.
In Ireland the woes of the US technology sector have reawakened forecasts of a bust in the economy here. While it is highly likely that growth this year will be slower than previously, the threat to domestic prosperity from an international economic slowdown is a good deal less than much recent commentary, would lead one to believe.
Irish exporting is dominated by the activity of foreign-owned companies in the chemicals and machinery and equipment (mainly electronics) sectors. These two sectors have accounted for 80 per cent of the total growth in exports over the last 10 years and they have contributed an average annual 3 percentage points of real GDP growth, i.e. nearly half the total. However, we need to distinguish between the likely impact on GDP growth and that on employment and prosperity. By way of illustration, during the 1980s real GDP grew at an annual average rate of 3.5 per cent - only 0.5 per cent below what was then the long-term average.
However, that decade is remembered as one of lengthy recession and not surprisingly given that employment was in almost continual decline, falling 60,000 over the 10 years, and there was net emigration of almost 200,000. The 1980s were years of external boom that saw export volumes rise by 9 per cent annually. Domestic demand, however, grew at little more than 1 per cent annually.
The reason strong export growth did not compensate for weakness in the domestic economy lies in the limited extent to which foreign-owned manufacturing companies are linked to the rest of the economy. This is evident from the fact that employment in the chemicals and machinery and equipment sectors that dominate our exporting activity is quite small relative to total employment and that growth in employment in these sectors has been a small part of the total increase in jobs in the last 10 years. Even if one assumed that one job was created elsewhere in the economy for every job created in the multinational companies, it would explain less than a quarter of the annual increase in employment over the last 10 years.)
Apart from having less reason to fear the impact of the international slowdown, there is every reason for optimism about continued strength in domestic economic activity. The structural effects of demographic change are still a positive source of expansion. The fiscal and monetary environment in which the economy is operating remains supportive with interest rates still at relatively low levels and more likely to fall than rise further, while the tax reductions and real spending increases in the 2001 Budget will soon be coming on stream.
Eunan King is senior economist at NCB Stockbrokers
