Wall Street Journal - June 21, 1999
THE OUTLOOK
If Adam Smith were to visit the U.S. at the millennium's end, he would like what he saw. For most of this century, corporate concentration and government intervention inflicted arthritis on the "invisible hand" that Smith said guided selfish individuals in a market economy to achieve greater collective wealth. But today, the invisible hand is more limber and supple than ever.
In the past two decades, globalization has forced American companies to compete on a world-wide scale, and the collapse of communism has extended capitalist principles to every corner of that globe. Deregulation has injected market forces into areas long insulated from them, such as telecommunications, air travel and medicine. The Internet has helped better-informed buyers find legions of new sellers, and sellers find far-flung buyers. The principles of market economics, detailed by the Scottish philosopher in 1776, have infected U.S. life with an intensity unmatched in history -- thanks in part to remarkable technological advances.
But will the economy of the 21st century continue to fit the economic thinking of the late 18th century?
That question is the subject of a paper by economic historian J. Bradford De Long of the University of California at Berkeley and law professor A. Michael Froomkin of the University of Miami. They argue that some of the very characteristics that make information technology so economically potent may cause carpal-tunnel syndrome for the invisible hand.
In Smith's economy, if you consume a good, I cannot. Only one of us can eat the same cookie or ride the same bicycle at any given time. But in the new economy, information is the ultimate good, and information can be consumed by a vast number of people at once.
The cost to Microsoft of developing Windows software may be huge; but the marginal cost of putting it on one more computer is virtually zero. The same can be said for Amazon.com or America Online. If one person is using it, a thousand can; and if a thousand are, a million might as well. That's why today's hot Internet companies grow so rapidly.
Truth is, in the network economy, if more people are consuming a good, it becomes more valuable. Ten people sharing the same car have a problem. But tens of millions sharing the same e-mail system may have a distinct advantage over those who don't, because of the ease of communication.
In Smith's world, that leads to monopoly. The invisible hand, seeking to extract maximum value for society, encourages the successful network to grow until it becomes dominant. That's what happened in the case of Microsoft. And Mr. De Long and Mr. Froomkin suggest the Microsoft story might be repeated over and over again in the coming decades.
Technology enthusiasts say there's no need to worry. The new economy may lead to more monopoly-like concentrations of economic power, says Kevin Kelly, editor at large of Wired magazine and author of "New Rules for the New Economy." But "they will be temporary concentrations that are quickly overthrown by other concentrations." Just as Web-based portals may loosen Microsoft's hold on computer operating systems, so too will other shifts in technology keep others from feeling too secure about their market dominance.
"The industrial economy was populated with oligopolies: industries in which a few large firms dominated their markets," argue business economists Carl Shapiro and Hal Varian in their book "Information Rules." "In contrast, the information economy is populated by temporary monopolies. Hardware and software firms vie for dominance, knowing that today's leading technology or architecture will, more likely than not, be toppled in short order by an upstart with superior technology."
The danger comes, however, if the pace of innovation slows and temporary monopolies become more permanent, stifling innovation.
Another potential problem for the new economy is what Mr. De Long and Mr. Froomkin call the absence of "excludability." In order for Smith's economy to work, sellers must be able to force consumers to become buyers, and pay for what they use. But digital data are cheap and easy to copy. As a result, getting users to pay could become increasingly difficult.
The history of network television offers a case study in how businesses deal with such a problem. Unable to exclude viewers from the airwaves, broadcasters turned to advertisers to pay for their product. Many Web-based companies take a similar approach. But it's unclear just how much of the new economy can survive on advertising alone. And in any event, the invisible hand works best if the people using a product are also the ones paying for it.
Mr. De Long and Mr. Froomkin say television's economics make advertisers demand the lowest common denominator. They offer the example of "two programs, one of which will fascinate 500,000 people, and the other of which 30 million people will watch as slightly preferable to watching their ceiling." Advertisers will want the maximum audience, but the other show might do better if its half a million fascinated viewers were willing to pay for it.
All this suggests that Smith's ideas will need some rethinking in the years ahead. Just as the Gilded Age gave rise to antitrust law and labor unions, the information age may require new arrangements to ensure the greatest benefits to all.
--Alan Murray