Politics Adds to Wall Street’s Economic Worries

Whoever finally wins the U.S. presidency will inherit a booby prize of a slowing economy, possibly tipping over into a recession. That’s why stock prices dropped sharply last week.

Politics plays a role in the outlook. The post-election chaos is creating uncertainty around the world. Stock markets from Tokyo to Frankfurt to Mexico City fell Friday because investors feared that when the election is ultimately decided, the result will be a climate of bitterness that could paralyze government for years.

But economic forces more than political ones drive financial markets. And there the news is bad. Right now, Wall Street sees ominous signs of a slowdown in business investment in technology--the corporate spending on computers, software and Internet connections that has been the backbone of the U.S. economic boom of the last eight years.

More than 60% of the $1 trillion that U.S. business invested in plants and equipment last year went into information technology. Such spending accounted directly for nearly one-fifth--18.5%--of U.S. economic growth, reckons economist Edward McKelvey of Goldman Sachs.

Mounting evidence that tech investment is slowing accounted for steep declines Friday in the stock prices of Intel, Sun Microsystems, IBM, Dell Computer, Hewlett-Packard, Texas Instruments and other leading tech firms.

Bad news for such elite companies is not an isolated matter, but an ominous sign for the whole economy. The real importance of technology investment is that it has led in recent years to extraordinary gains in productivity--the phenomenon of getting more from the same input of labor or capital. Productivity rises, for example, when improved software enables a few workers to safely and efficiently run a factory from a single control panel. And it occurs when Internet communications allows faster delivery of mail and packages.

Productivity gains of the ‘90s allowed higher-than-usual economic growth without inflation. Pay raises were possible without risk of inflationary pressures. Productivity gains have been the real force behind rising stock prices.

But that prosperous pattern is already changing. With a slowing economy, companies everywhere complain that they can’t raise prices to offset rising costs. Next year will see companies “turn to cost cutting--layoffs of workers and cutbacks of expenditures--as a way to increase profits,� predicts economist William Rhodes of Williams Capital Group, a New York-based investment firm.

The next president, in short, will inherit a less happy economic environment than the Clinton administration enjoyed in the ‘90s.

Most experts see the U.S. economy continuing to advance next year--but perhaps by only 3% compared with 5.6% in 1999 and 4.4% in the first three quarters of 2000.

Such reduced growth in economic activity and corporate profits will probably take the stock market down a peg. But that could be simply a pause for consolidation in a healthy economy, unless foreign investors lose confidence and cause the dollar to fall.

Foreign investment in U.S. stocks, bonds and businesses has been a major factor in U.S. prosperity in recent years. In the first half of 2000, foreign investors poured a net $190 billion into U.S. investments.

Foreign companies have built U.S. plants and acquired U.S. companies. Deutsche Telekom is offering $46 billion for VoiceStream Wireless, a small U.S. telecommunications firm. Vivendi of France is paying $24 billion for Seagram and its Universal Studios entertainment assets. Nissan has just announced that it will build a truck plant at a still undetermined location in the Southern states.

All such investment supports the value of the dollar and enables the U.S. to buy lots of imported goods and services and still have low interest rates and low inflation.

But a slowdown in the U.S. economy, coupled with uncertainty about U.S. political stability, could make such investment go elsewhere. The U.S. is not the only investment game in town as the new century begins.

Germany’s big economy is reforming its industries and building up its financial markets. German businesses and consumers are getting the benefit of tax reductions. Even the laggard Japanese economy seems finally to be on track for improvement.

Economist David Malpass of Bear Stearns notes that the European currency, the euro, has risen slightly in recent days.

Foreign investors worry about a lengthy, fractious process of arguing the U.S. election’s results through courts and further recounts.

It’s not that sophisticated investors here and abroad deny the necessity of assuring an accurate vote count and redress of errors. It’s the aftermath of the argument that concerns them: Will the next president be accorded the mantle of legitimacy or will he be thwarted at every turn?

Financial markets welcomed gridlock in the early stages after last week’s election. The prospect of the two parties evenly divided in the upcoming Congress and a president elected with a paper-thin mandate promised that no large tax cuts or spending programs were likely. Budget surpluses would pile up.

But as the week went on, a more disturbing prospect loomed of a government so divided and bitter that it won’t agree even on spending or tax measures needed to spur a lagging economy. Such political paralysis can erode confidence--and markets and economies depend most of all on confidence.

Yes, worries about slowing business investment mainly caused stocks to fall last week. But the declines were intensified by concerns about politics. A slowdown could become a recession if men and women of goodwill can’t settle vote recounts and disputes intelligently and get on with the nation’s business.

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James Flanigan can be reached at [email protected]. An archive of his past columns can be found online at http://ukobiw.net/flanigan.