BUSINESSWEEK ONLINE : DECEMBER 18, 2000 ISSUE
COVER STORY Commentary: Tech Leads--Both Up and Down Historically, if the tech of the era dives, so does the economy. But they always rebound Considered by size, the tech sector seems like the runt of the economy. Business and consumer spending on such items as computers, communications equipment, and home-telephone services totals only 7% of gross domestic product. Tech leaders such as Cisco Systems (CSCO) and Microsoft (MSFT), employing about 40,000 workers apiece, are dwarfed by industrial giants such as General Motors (GM) and General Electric (GE). Even those widely publicized dot-com layoffs are smaller than the statistical error in the monthly unemployment numbers from the Labor Dept. But size doesn't always matter. Today, more than ever before, the U.S. economy marches to the beat of the tech drummer. In the second half of the 1990s, tech spending accounted for a quarter to a third of growth--and with many nontech companies already slowing and seeing weak earnings, tech spending is even more important. Indeed, in the third quarter of 2000, consumer and business spending on technology was responsible for 40% of economic growth. Without tech, the rate of economic growth in the third quarter would have been a minuscule 1.5%--not recession level, but close. As a result, any further tech slowdown could cause outsized problems for the economy. And given the relatively fragile state of the economies of Asia and slowing growth in Europe, a downturn in the U.S. could spread to the rest of the world as well. Equally important, the tech boom has been the major driver of the productivity boom of the past five years that has made it possible for the U.S. to boast faster growth and lower unemployment without triggering an inflationary spiral. A sustained slowing of tech spending, if it happens, would undermine those gains. That could mean a return to the slow-growth, high-inflation days of the 1980s. How serious is the danger? The U.S. has seen tech slowdowns before, most recently in 1985-86 and 1989-91. But those fluctuations in the tech sector did not have much of a macro impact since the information-technology industry was much smaller relative to the U.S. economy as a whole. This time, things are different. A more revealing historical precedent requires looking back to the railroads in the late 1800s and the automobile industry in the 1920s. Like the tech sector today, these were technologically innovative industries that were so important in their heydays that their ups and downs produced booms and busts in the larger economy. To be sure, an interest-rate cut from the Federal Reserve now would go a long way toward blunting the impact of the current tech slowdown. Telecom and other companies trying to raise funds to continue capital spending would find the going much easier. At the same time, lower rates could put a floor under stocks and ease the capital squeeze on young tech companies. In a Dec. 5 speech--exactly four years to the day after he made his famous ''irrational exuberance'' speech--Fed Chairman Alan Greenspan made it clear that he is aware of the danger that ''weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending.'' The financial markets, which assumed this meant a likely rate cut in January, jumped in response to his words. Yet in the past, such market responses to Greenspan's jawboning have proved temporary. His ''irrational exuberance'' remark held the market down for only a couple of weeks before it started climbing again. Until Greenspan makes real moves to cut rates, it's likely that the economy will remain hostage to the specter of a tech downturn. Take manufacturing. Over the past year, factory output has expanded by a healthy 5.6%. But all of that has come from the increased output of high-tech equipment, while nontech manufacturing showed virtually no growth at all. Equally important, a sustained tech slowdown could erode the pace of productivity gains. In recent years, rising productivity has been fueled by a rapid expansion of the stock of productive gear and software, which has grown at an annual rate of 6.5% since 1995. Any trimming of tech spending would pare those hikes in capital stock, with negative effects on productivity. Forecasts of a 4% sustainable growth rate assume the continued high investment level of recent years. Moreover, any tech slowdown would likely have other indirect effects on the economy. One possible casualty: the consulting industry, which has piggybacked the tech boom by providing assistance to companies implementing the latest technology. After years of rapid growth, the market for consultants is showing signs of weakening. Web consulting firms such as Xpedior Inc. and Marchfirst Inc. are cutting jobs, and the damage could spread to the larger consultancies as well. Historical analogies to railroads and cars also suggest that a technology-led downturn could be quite bad. Consider railroads, which dominated the economy in the second half of the 1800s, much as tech does today. During this period, any time railroad expansion paused, the economy and the markets suffered. A slowdown in railroad construction helped trigger the panic of 1873 and an economic contraction that lasted until 1879. The failure of railroads, such as Philadelphia & Reading Railroad Co. in 1893 and the resulting financial panic, helped cause the near-depression and widespread layoffs of the 1890s. In a similar fashion, the expansion of the auto industry was the driving force of the 1920s boom. Car ownership tripled in that decade, creating an overpowering demand for steel, rubber, and petroleum for roads and new homes. But auto demand peaked in April, 1929, because the Fed lifted interest rates and because the car-buying needs of Americans were temporarily sated after a decade-long binge. At first, the rest of the economy seemed to get along just fine. But without impetus from the auto sector, the boom could not continue. The result: the October, 1929, crash and ensuing downturn, which hit the auto industry and its suppliers first and hardest. It wasn't until the Fed started easing monetary policy years later that the auto industry began to recover. Still, the past offers some good news for the present. Despite the viciousness of the railroad and auto-led downturns, the industry always came back stronger than ever. The 1890s slump was followed by a resumption of railroad expansion. From 1895 to 1915, the number of passenger miles traveled by rail nearly tripled as Americans took advantage of fast, cheap travel. Meanwhile, cheap shipping costs contributed to the rapid productivity growth of the early 20th century. Moreover, like today, the railroad and auto booms led to the creation of too many competitors, many of whom went under when the economy slowed. But these shakeouts did not affect the long-term health of the industry. The collapse of auto sales in the early 1930s brought massive consolidation as well-known carmakers such as Pierce-Arrow went under or were greatly weakened. But overall, the auto industry emerged from the Great Depression with its position at the core of the economy more solid than ever. Sales rebounded in 1936 and 1937, and big carmakers became the major powerhouses of the economy, a role they maintained well into the postwar era. The implication is clear: No matter how long the tech slowdown lasts, America will have an information-led economy. But the long-term trend won't stop a technology slowdown from doing great damage today. By Michael Mandel Economics Editor Mandel covers the New Economy. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS The Tech Slump COVER IMAGE: The Tech Slump CHART: Tech Spending Slowdown TABLE: Angst in the Air Who May Prosper Despite the Fall TABLE: Recession-Resistant Commentary: Tech Leads--Both Up and Down TABLE: Technology Booms and Busts Commentary: Greenspan: This Is Your Captain Speaking... More Bad News for the Naz CHART: Valuations Remain Sky-High Asian Electronics: Who Pulled the Plug? (int'l edition) CHART: Cooling Down INTERACT E-Mail to Business Week Online

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