The Outlook
WASHINGTON
Interest rates are rising. The stock market is slumping. The expansion is well into its 10th year. It's a classic recipe for an economic slowdown.
Yet as Friday's jolting growth report shows, this millennial boom is now being driven by an unusually powerful engine: corporate America's insatiable appetite for high technology. Nearly a third of the increase in gross domestic product in the April-to-June period came from business spending on information-processing gear and software -- even though those products make up just a 20th of the economy's total output.
While the expansion itself is old, the Internet-driven phase still is in its infancy. Corporations are scrambling, for example, to reap the efficiency gains from business-to-business e-commerce networks that barely existed just six months ago. High-tech investment soared at a 31% annualized pace in the first half of this year. In contrast, total business investment has been increasing by a solid but more modest rate of 10% per year in recent years.
With the overall economy growing at a developing-country-like 5% annual rate so far this year, it's easy to overlook the fact that there really is a slowdown under way, at least in some key sectors. Thanks to six Federal Reserve interest-rate increases over the past year, new-home sales have slipped. Industrial production -- excluding computers, telecommunications equipment and semiconductors -- was flat through the first half of the year. The wealth gusher behind the great 1990s household spending spree has dried up, with the broad-based Wilshire 5000 stock index down 10% since the year began.
In other words, monetary policy is working precisely as it should: raising the cost of capital to the point where many consumers and investors are turning more frugal.
Nor has the tech sector been entirely insulated from the Fed, as worries of slumping demand and weak earnings have hammered the New Economy Nasdaq anew in recent days.
It's important, though, to make a distinction between the stock market and the real economy. Many tech companies' stocks are being punished because their growth isn't quite as stellar as investors had hoped, yet their expansion by conventional standards remains spectacular. Telecom giant Nokia Corp.'s stock suffered last week because a 62% second-quarter profit rise on a 55% revenue increase from the year earlier hadn't met expectations. Ford Motor Co., by contrast, won kudos for a 6% increase in sales.
Demand for tech products remains unusually strong, in part because the Fed's 1.75% rate increases to date still look puny compared with the huge returns that companies anticipate from Web-related investments. "Customers can save the equivalent of 5% of their revenues by putting supply chains on the Web," says Chris Stix, a technology analyst at Morgan Stanley Dean Witter. He's aware of one pharmaceutical company that's planning to increase sevenfold its purchases from Internet supplier Cisco Systems Inc., wiring up everybody from employees to physicians.
While the economy's zip over the past year has made Fed officials nervous about inflation, many analysts say high-tech investment-led growth at this speed is OK. Economists make a distinction between consumer-demand-led growth -- which can push up prices if too many people chase too few goods -- and supply-led growth. Computers expand the economy's capacity to produce, thus raising the speed limit. Indeed, despite the outsized second-quarter expansion, inflation actually moderated during the period.
That doesn't mean the central bank will calmly keep rates on hold as expectations of a slowdown fade. Rapid growth, whatever the source, can tax an economy's resources. In testimony before Congress earlier this month, Fed Chairman Alan Greenspan cited two early-warning signs of strains that, if aggravated, could prompt more rate increases. One was the swelling current account deficit. American households aren't saving enough of their paychecks to fund American business's high-tech investment binge, forcing a perilously high dependence on foreign capital.
The second concern cited by Mr. Greenspan was the ever-tightening labor market, which could touch off an inflationary wage-price spiral. True, the Web allows employers to squeeze more out of each worker. But companies are also hiring more and more workers to make and use new computers and software. If the Labor Department reports Friday that the jobless rate fell in July, the odds would jump for a further nudging-up of interest rates on Aug. 22.
That would further damp the nontech portions of the economy. Whether the tech sector would cool is an open question. "There's been a shift of capital out of the so-called Old Economy into the New Economy," Mr. Greenspan told Congress. He's helping accelerate this transformation.
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