1. Enron 2nd & 3rd May 2000 Technology, the Internet and the “New” Global Economy Goldman Sachs Gavyn Davies Chief International Economist

2. 1 The New Economy - I Stability of GDP The New Economy - I Stability of GDP GDP Level Time New Economy is more stable, but level and growth of GDP is unchanged in the long run Old Economy New Economy

3. 2 Variability of the Macro Economy Standard Deviations of 5-year percentage changes 1 Variability of Real GDP Growth Variability of Consumer Price Inflation 19991989Change 19991989 UK France Germany Japan US 1 Five year moving average of trailing five year standard deviations. 1.0 2.0 1.1 0.9 1.3 2.2 0.9 1.2 1.3 +1.2 -1.1 +0.1 +0.3 0.0 1.0 1.5 2.6 1.5 0.9 0.4 1.1 0.5 0.7 -0.1 -1.1 -0.4 -2.1 -0.8

4. 3 The New Economy - II Reduced NAIRU The New Economy - II Reduced NAIRU GDP Level Time Old Economy New Economy Adjustment Phase - Higher GDP Growth Long Run Steady State - Higher GDP level, Unchanged Growth

5. 4 Estimates of the NAIRU in Major Economies Estimates of the NAIRU in Major Economies % of Labour Force 1997 2 1980s 1 1970s 1 1960s 1 UK France Germany Japan USA 1 Source: “Unemployment”, Richard Layard, Stephen Nickell, Richard Jackman, Oxford University Press, 1994. 2 Source: IMF World Economic Outlook, May 1999 1.6 0.5 1.8 2.6 5.0 1.8 1.9 3.9 5.2 6.0 2.1 4.0 7.8 7.9 6.4 3.5 8.9 9.7 7.0 5.0

6. 5 Impact of Labour Market Improvements on GDP Growth Impact of Labour Market Improvements on GDP Growth UK France Germany Japan USA ‘Structural’ Unemployment 1 20001995 2.5 8.4 11.1 9.1 6.6 4.1 10.8 11.5 5.1 4.6 Change +1.6 +2.4 +0.4 -4.0 -2.0 Impact on -0.3 -0.5 -0.1 +0.8 +0.4 % of labour force (% pa, 1995-00) GDP Growth Rate 1 Trailing 5-year average of unemployment rate.

7. 42 43 44 45 46 47 48 49 50 51 52 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 1.1 1.2 16801700172017401760178018001820184018601880 Share of top 10 percent in income Inequality Labour Productivity Growth % 6 The Industrial Revolution Source: Greenwood

8. US Productivity 7 98 100 102 104 106 108 110 112 114 116 118 120 122 135791113151719212325272931333537 (CYCLICAL TROUGH=100) QUARTERS INTO US ECONOMIC UPSWING 90Q4-99Q3 82Q1-90Q2 74Q3-82Q4

9. 8 Relationship between Output & Productivity Growth Relationship between Output & Productivity Growth Country Direction of Productivity Probability of Break in Relationship in Sector USA UK France Germany Japan USA UK France Germany Japan Nonfarm Whole Economy Manufacturing 1995 77% 78% 21% 95% 47% 95% 47% 89% 61% 89% 1997 81% 67% 28% 72% 40% 92% 69% 85% 27% 64% Up Down Up Down Break

10. 9 The New Global Economy - The Story So Far The New Global Economy - The Story So Far Long Run GDP Growth (1977 - 95) ‘New Economy’ GDP Growth (1995 - 2000) Change in GDP Growth in ‘New Economy’ Period Caused by Change in: % 3. Cyclical change in economic ‘slack’ 2. Labour force growth 1. Productivity growth USA 3 1 4 ½ -½ ¾ ¼ Japan 3½ -2¼ 1¼ -½ -¾ -¼ Germany 2¼ -½ 1¾ ¼ -¼ 0 -½ France 2¼ ¼ 2½ ½ 0 0 -¼ UK 2¼ 0 0 -½ ½ 2¾ 1 Change in NAIRU OECD 3 ¼ -½ ¼ 0 3 0

11. 10 B2B Commerce in the US 0 500 1,000 1,500 2,000 98990001020304 $ bns Source: Goldman Sachs.

12. 11 B2B and the Internet The dominant impact of the internet on the macro- economy is likely to come via B2B (business-to- business) commerce conducted online, which is set to grow rapidly over the next five years. B2B growth is expected to spread to Europe and Asia with a lag of 1-2 years. The growth of B2B commerce online represents a supply-side shock analogous to the oil price shocks of the 1970s, though in reverse.

13. 12 Conventional View of B2B Supply Shock Only Conventional View of B2B Supply Shock Only Q P S1 D1 S1 D1 P1 A Q1 P2 B S2 Q2

14. 13 Actual Impact of B2B Supply & Demand Shock Actual Impact of B2B Supply & Demand Shock Q P Q1 S1 D1 A P1 S2 B P2 Q2 D D2 C Q3

15. 14 Initial B2B Cost Savings by Industries Source: GS B2B report Industry Cost Savings Aerospace Machinings 11% Chemicals10% Coal2% Communications/ Bandwidth 5-15% Computing11-20% Electronic Components 29-39% Food Ingredients 3-5% Forest Products 15-25% Freight Transport 15-20% Healthcare5% Life Science 12-19% Machinings (Metals) 22% Media & Advertising 10-15% MRO10% Oil & Gas 5-15% Paper10% Steel11%Autos 5%

16. 15 Potential Impact of B2B Commerce on Inflation Potential Impact of B2B Commerce on Inflation Average On GDP Deflator Total impact of B2B Germany USA France Japan UK 3.7% 3.4% 4.0% 3.5% 4.0% 3.6% No of Industries Affected by Narrow 23 36 20 14 in Economy 58 93 36 32 12345 Shock Cost Savings Average Initial Cost 5.0%15.2% 5.1%21% 5.4%13% 5.0%14% 4.3%17% 4.2%15% by Industries Narrow Shock Broad Shock Narrow Shock Broad Shock 14% 8% 10% 15% 12% 11%

17. 16 B2B and Industrialised Economies * Percentage points deviation. ** Long-term value refer to deviations from the baseline of the CPI level. % deviation from baseline Long-term G5 Weighted Average GDP 4.9 Short-term interest rate* -0.1 CPI Inflation** 2000 0.6 0.2 0.3 2001 0.6 0.4 0.4 2004 1.2 0.1 0.0 2009 2.5 Potential GDP 4.90.00.11.23.4 -1.7 0.0-0.9

18. 17 Industrialised Countries - GDP and Potential GDP Following B2B Shock Industrialised Countries - GDP and Potential GDP Following B2B Shock 0.0 1.0 2.0 3.0 4.0 5.0 2000010203040506070809 Potential GDP GDP % Deviation from Baseline * Long-run Level

19. The New Global Economy - The Impact of B2B The New Global Economy - The Impact of B2B 18 Will boost real GDP by 5% in the long-run Growth at least 0.25% per annum higher for 10 years Inflation unchanged, bond yields unaffected Equity markets benefit despite profits being squeezed in intermediate sectors Some risk of higher short rates, especially in US

20. 19 Productivity and Labour Force Growth Productivity and Labour Force Growth (% per annum) 1977-1995 (actual) 2000-2005 (Expected) 1995-2000 (Estimated) Labour Productivity Growth Labour Force Growth Japan US Germany France UK OECD (average of above 5) Japan US Germany France UK OECD (average of above 5) 1.4 1.8 1.9 1.6 1.9 2.6 1.7 1.1 0.5 0.2 1.2 2.2 2.0 1.5 1.8 2.0 1.2 0.3 -0.3 0.6 0.2 0.7 2.7 2.5 2.3 2.6 2.8 2.6 0.7 -0.3 0.5 0.2 0.4

21. The New Global Economy - The Next Five Years The New Global Economy - The Next Five Years 20 Long Run GDP Growth (1977 - 95) Resulting GDP Growth in Next 5 Years Caused by Change in: USA 3 Japan 3½ Germany 2¼ France 2¼ UK 2¼ OECD 3 3¼ 2¾3¼3½2¾3 Change in GDP Growth in Next 5 Years (compared to 1977-95 averages) 0-¾11¼½0 3. Cyclical change in economic ‘slack’ 2. Labour force growth 1. Productivity growth -¼ 1¼ ¼ ½ -1½ 0 ¼ ¼ -¾ 1 ½ 0 0 ¾ ½ 0 0 ¼ ¼ Change in NAIRU 0 ¾ ¼ Note: These figures assume no “hard landing” shock in the US, continuing supply-side reforms and a “technology catch-up” in Europe and Japan, and significant global effects from the spread of B2B commerce.

22. The New Global Economy - The Next Five Years The New Global Economy - The Next Five Years 21 Global growth has potential to reach 3% p.a., assuming enlightened policy shifts. US slows from 4% growth to 3%, partly due to labour force deceleration. Japan rebounds to 2¾% as productivity returns to normal and slack is absorbed. Continental Europe jumps to 3¼% owing to productivity catch-up and lower NAIRU. UK slightly higher.

23. US 22 1 2 3 4 5 6 7 86878889909192939495969798990001 % Plus 1 Std Dev. Average Minus 1 Std Dev. REAL 10 YEAR BOND YIELD

24. 23 The New Economy - IV Market Wrongly Extrapolates Growth The New Economy - IV Market Wrongly Extrapolates Growth GDP Level Time Old Economy New Economy Adjustment Phase - Higher GDP Growth Long Run Steady State - Higher GDP level, Unchanged Growth Equity Market Wrongly Extrapolates Higher Growth Rate

25. 24 New Economy Effect on Current Equity Valuations (% point contributions) New Economy Effect on Current Equity Valuations (% point contributions) Index New Economy Effects Re-based, 1994 Earnings Component Productivity NAIRU Labour Force 100 164 +6 +2 -8 Combined Earnings and Valuations Actual Value 235 253 Source: Goldman Sachs Higher Earnings: Lower Equity Risk Premium Lower Real Interest Rate 0 12 28

26. 25 Required Real Earnings Growth Rates (% pa) Required Real Earnings Growth Rates (% pa) 1. USTemporary Non-TMT TMT Market Permanent0 to 15After 15Historic 2. Europe Non-TMT TMT Market Temporary Permanent0 to 15After 15Historic 3. WorldTemporary Permanent0 to 15After 15Historic 2.8 8.3 3.5 3.0 2.75 10.5 3.0 4.4 4.6 3.5 7.0 2.1 3.0 2.75 15.0 5.4 4.9 2.9 Non-TMT2.93.02.753.3 TMT7.53.011.14.4 Market3.7 3.35.52.8 3.76.92.8 3.35.42.8

27. 26 Global: Required Real Earnings to Generate a 2% Risk Premium Global: Required Real Earnings to Generate a 2% Risk Premium 0 2 4 6 8 10 12 14 Required Cash Flow Growth, caagr (%) Market TMTNon-TMT Historic Temporary Permanent 7.5 3.3 5.4 3.7 4.4 11.1 2.9 3.3 3.0

28. 27 Required Real Earnings Growth Rates to Produce 2% pa Equity Risk Premium Required Real Earnings Growth Rates to Produce 2% pa Equity Risk Premium Note: Since March 27, the day that Nasdaq peaked, Global TMT has fallen 17%, but non-TMT is unchanged. We have assumed no change in bond yields since March 27 in order to isolate the impact of changes in equity prices on required cash flow growth rates (n.b US 10 year bond yields are 7bp lower since March 27). 1. Global TMT 2. Global Market Temporary Permanent Temporary Permanent Now March 27* 4.4 11.1 4.6 12.9 3.25 4.9 3.3 5.4

29. 28 Sectoral Shares in Equity Market Capitalisation Sectoral Shares in Equity Market Capitalisation Financial Growth ex TMT Other Old Economy Other Old Economy Other Old Economy Other Old Economy Other Old Economy Technology Media Technology Media Telecom Media Telecom WorldUSEUUKJapan Technology 100% 80% 60% 40% 20% 0% Note: Market indices are FTSE World Large Capitalisation Indices.

30. 29 US Software Profits and Economic Activity US Software Profits and Economic Activity 0 1 2 3 4 5 -30 -20 -10 0 10 20 30 40 50 7880828486889092949698 % OECD Consumer Growth Software & Profit Relative to Trend % Spending Services

31. 30 US Hardware Profits and Economic Activity US Hardware Profits and Economic Activity 0 1 2 3 4 5 -40 -30 -20 -10 0 10 20 30 40 7880828486889092949698 % Hardware Profit Relative to Trend OECD GDP Growth %

32. 31 Actual and Implied US Profit Share (% GDP) Actual and Implied US Profit Share (% GDP) 2 3 4 5 6 7 8 9 10 6570758085909500051015 % of GDP