Emperors, Clothes and Mirrors: A Sceptical View of the New Economy
By Chris Leithner
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The novel nature of the cyber economy is often offered as an excuse for technology companiesÕ ÔtemporaryÕ lack of earnings, but the problem is more fundamental.

The dramatic fall worldwide in the market prices of many Internet, IT and dot com (ÔtechÕ) stocks in 2000 appears to have dented but by no means destroyed faith in the ability of the New Economy and tech stocks to enrich their owners.1

A typical Australian example of this unbroken faith, an article in The Weekend Australian (28-29 October 2000), began with the words: ÔCrash! A dotcom disaster. A sure time to buy if there ever was one. Any veteran market watcher will tell you that when you read those headlines it is time to go bargain hunting . . . ThereÕs a revolution in technology driving changes in communication and media and now is the time to jump on board, with the caveat of all investment activity: choose wisely.Õ Another article in the same issue stated that Ôthe basic story of Internet companies remains as true as ever. They can achieve much faster creation of value than is possible in more mature industries because of their global reach, and because of their ability to transform industries in which information is an important component.Õ

New Economy enthusiasts thus remain undaunted. Although they concede that many tech valuations are unreal and that the ride will be volatile, they assure us that the Internet, IT and dot com revolutions are genuine, all-encompassing and unstoppable. And because they are evolving so rapidly, those people, politicians and nations who ÔdonÕt get itÕ will be left stranded and impoverished.

A sceptical view

Tech sceptics, on the other hand, fret that the benefits of the Internet, IT and the like have been overstated and that the prices of tech stocks remain absurdly inflated. Surveying the historical record, these sceptics readily acknowledge the importance and benefits of technology, but hasten to add that wealth derives from the growth of capital (and not credit); that capital derives ultimately from savings (and not debt); and that the principles of economics have survived the technological ÔrevolutionsÕ of the past.

Sceptics also prefer hard figures to soft rhetoric, pointing out that very few techs have real earningsÑin the US less than five in 100. Even on the techsÕ own notoriously optimistic projections, fewer than one in ten will be profitable in three yearsÕ time, and three in four will not exist in five years.2

On one fundamental point, however, enthusiasts for and sceptics of the New Economy agree. As Tom Bethell states in The Noblest Triumph: Property and Prosperity Through the Ages:

if we are really moving into a world in which the economic significance of the material realm is reduced, and ever more transactions take place in the virtual realm of cyberspace, we will enter a world in which . . . the old property rules no longer apply. 3

Hence the question: are there principles that can render profitable the production and distribution of digitised information? The predicament of the New Economy is that it consists ultimately in bundles of goods and services over which property rights are neither easily established nor straightforwardly maintained (and which, accordingly, cannot be non-arbitrarily valued). Moreover, precisely because standardised knowledge and digitised data can be and are being copied and disseminated so easily, cheaply, widely and quickly, their subjectively perceived value has been and may be subject to further downward pressure.

The problematic economic status of knowledge, ideas and information

The market slide in tech stocks was, it seems to me, a consequence of this fundamental cause. Put bluntly, the inherently problematic economic status of digitised information provides no basis for the remaining exuberance about the New Economy and tech companies. Underlying the case for caution are two principles which provide (dis)incentives for buying and selling in the marketplaceÑand therefore the division of labour, gains from trade and the creation of wealth.4

One is the exclusion principle: if you cannot pay for a good or service, then its producer, supplier or owner can exclude you from its benefits. Perhaps you want a Big Mac, but if you cannot pay for one then McDonaldÕs can prevent you from having one. The second principle is rivalry: most goods and services either cannot (or can only to a very limited extent) be consumed jointly. Only one of us can consume a particular hamburger, and only a few of us can ride in the same car at the same time.

Goods and services can therefore be classified according to the degree to which they possess the properties of exclusion of supply and jointness of consumption.5 Private goods, for instance, are characterised by exclusion and individual consumption while non-exclusion and joint consumption are the hallmarks of collective goods.

Information, knowledge, technology, and the like bear the hallmarks of that rare ideal type: the collective good. First, it is not easy to exclude non-payers from the consumption and enjoyment of knowledge, information and ideas. The usual way to achieve exclusionÑand therefore the incentive for profitable private sector provisionÑis through technical devices (such as scramblers and passwords), legal contrivances (such as patents and copyrights) or ÔbundlingÕ (as occurs, for example, when a private good such as advertising is incorporated into a radio or television broadcast).

To cite one example, few large circulation publications have profitable online editions, and fewer still have been profitable from the inception of their online operations. Moreover, the difficulty of excluding online non-payers means that the phenomenal rise of the Internet has been accompanied by the prominence of and disputes over Ôintellectual propertyÕ.

Second, the consumption and transmission of expertise, information and ideasÑcomputer softwareÑis not ÔrivalÕ. Any number of consumers can jointly use a single copy of some types of software (indeed, they are designed for this very purpose), and one personÕs use does not decrease othersÕ use and enjoyment. The Internet also makes it possible for many people to copy and transmit vast amounts of information instantaneously, almost anywhere and at virtually zero cost. For producers of digitised information (as opposed to raw materials and manufactured goods), this is a potential disaster. Whether or not they are patented or copyrighted, goods and services that can be easily copied risk becoming low-value commodities.

If consumption is non-rival and exclusion is difficult to enforce, then the establishment and maintenance of clear rights of property and ownership over informationÑparticularly digitised informationÑwill neither be established easily nor straightforwardly maintained.

This point is hardly new. Two hundred years ago US President Thomas Jefferson noted that the exclusion principle is very difficult to apply to ideas, knowledge and information:

If nature has made any one thing less susceptible than all others of exclusive property, it is the action of the thinking power called an idea, which an individual may exclusively possess as long as he keeps it to himself; but the moment it is divulged, it forces itself into the possession of everyone, and the receiver cannot dispossess himself of it. [Knowledge, information and ideas], then, cannot in nature be a subject of propertyÕ [italics added].6

Two corollaries and three risks

Two corollaries accompany the implications derived from the principles of exclusion and rivalry. First, not only do these principles underlie the consumption of most goods and services, they also provide incentives for their production. Businesses have an incentive to produce because, thanks to the exclusion principle, they receive payment in exchange for their output. Second, given rivalry, market values can be established as the basis for exchange, the division of labour and the creation of wealth.

Exclusion and rivalry, then, provide incentives for producers and clear criteria for valuation by consumers. Absent exclusion and rivalry, however, incentives to produce profitably are weak and standards of asset valuation are arbitraryÑa perfect description of tech stocks if there ever was one. Although this presents many potential benefits for consumers, profound dangers exist for investors. Indeed, from an investorÕs point of view, the New Economy rests on surprisingly shaky foundations.

First, the economic fundamentals of e-commerce are not nearly as favourable as is commonly supposed. Because they lack unambiguous incentives to produce these non-rivalrous goods and services (as opposed to Ôbusiness plansÕ), few entrepreneurs have done so profitably. Barriers to entry and profit margins will usually be low and sometimes non-existent. Moreover, key attributes of technology, such as its rapid and unpredictable rate of advance, will exacerbate these difficulties. It is thus easy for a firm to steal a march on its competitors and then lose it soon thereafter.

Second, it is hardly surprising that there exists no established means to capitalise a software business or estimate the intrinsic value of an e-commerce stock: their non-rivalrous and non-exclusive nature makes such a thing inherently arbitrary. The difficulty is usually ascribed to the novelty and revolutionary character of the cyber economy, and thus to these companiesÕ ÔtemporaryÕ lack of earnings. The problem, however, is much more fundamental, as already discussed.

Third, under these circumstances greed and rampant speculation crowds out sober investment. Huge paper gains from IPOsÕ first day of trade in 1999 and early 2000, for example, created the impression that large returns could be obtained effortlessly and thus dulled participantsÕ appreciation of risk. The results of these floats also encouraged entrepreneurs to create superficial Ôbusiness plansÕ and rhetoric rather than viable businesses which possessed real capital and produced real profits and real wealth.7

Internet and tech mania has also created vast amounts of Ônear-moneyÕ (that is, pieces of paper that can be converted readily into cash). Shares in these companies constitute one type of near-money; options over shares are another. Both types of near-money depend upon an expanding base of shares and shareholders. Internet and technology outfits, and those that mimic them, thus risk meeting ignoble ends because eventually there will be few new participants to reward existing ones.

Conclusion

Despite the plunges in the prices of tech stocks, the marginal utility of digitised data and technical knowledge is still perceived to be vastly greater than that of wheat and motor cars. The inherently problematic economic status of digitised information, however,Ê provides little basis for this remaining exhuberance about the New Economy and technology companies.

Endnotes

1ÊÊ See J. Doherty, ÔReady To Roll: Managers See a Shining Future For StocksÕ, BarronÕs Online (30 October 2000). See also M. Veverka, ÔHot to Trot: TechnologyÕs Future Still Looks BrightÕ,Ê BarronÕs Online (11 September 2000).

2ÊÊÊ Doherty, ÔReady to RollÕ; see also J. Willoughby, ÔBurn, Baby Burn: Net Companies, Still Burning Cash, Try To Conserve Their TinderÕ, BarronÕs Online (2 October 2000).

3ÊÊ T. Bethell, The Noblest Triumph: Property and Prosperity Through the Ages (New York: St MartinÕs Press, 1998).

4 G. Hardin, ÔThe Tragedy of the CommonsÕ, Science No. 162 (1968), 1243-1248. Also R. Musgrave, The Theory of Public Finance (New York: McGraw-Hill, 1959). See also P. Samuelson, ÔA Diagrammatic Exposition of a Theory of Public ExpenditureÕ, Review of Economics and Statistics 37 (1954),Ê 350-356.

5E. Savas, Privatisation: The Key to Better Government (Chatham New Jersey: Chatham House, 1987).

6 T. Bethell, The Noblest Triumph.

7A. Shama, ÔFor Dot.Coms ItÕs the Vision Thing: Most New Internet Firms Lack Business SavvyÕ, BarronÕs Online (14 August 2000).

Author

Chris Leithner is Senior Lecturer at the Centre for Public Administration, University of Queensland Business School, and Director of Leithner & Co. Pty. Ltd.

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