David R. Henderson, Ph.D. Economics

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Is There A New Digital Economy of Ideas

Red Herring Magazine, February 1, 1997

Advances in computer technology will eturn out to be as important as the invention of electricity. In fact, today's digital technology has already revolutionized communications. In the early 1960s, when my father received a long-distance phone call from Peoria, everyone in the family grew silent, knowing that only something serious could warrant a long-distance call. (In fact, my great-aunt had died.) Today, when I get long-distance phone calls in the evening, I often hang up because the caller is trying to sell me something. The difference between the two eras is that phone calls today are much cheaper. Between 1950 and 1990, according to Gary Hufbauer of the Institute for International Economics in Washington, D.C., the inflation-adjusted price of a three-minute phone call from New York to London fell by more than 93 percent. Miraculously, quality improved.

Computers can't take credit for all this, of course--the introduction of satellites and fiber-optics had a lot to do with it--but they have eliminated much of the need for high-cost manpower. Similarly, computers have revolutionized transportation and production, and will continue to do so. The result could well be an economic renaissance. While we're used to considering a 2.5 percent growth rate respectable, the computer revolution could raise that rate for the real gross domestic product to 3.5 or even 4 percent. And as goods become cheaper, even very low-income workers will benefit.

But to say that computer technology will create unprecedented wealth is not to suggest that the so-called old economics will suddenly become meaningless. Ten or even 100 years from now, a few important economic facts will remain unchanged. People will still need money to buy things, which means they will have to continue working, lending capital, or feeding at the government trough to get that money. (In other words, scarcity--people wanting more than they have and being willing to pay for it--will still exist.) People will still want things--man does not live by ideas alone; bread comes in awfully handy too. And finally, the government will still be able to mess things up by regulating and taxing heavily or help things out by reducing regulation and cutting taxes and spending.

The reality is the opposite. Everything that has happened in the last 15 years is consistent with the old laws of economics. Remember all the people who were so excited about personal computers that they went out and--without a business plan or even a sense of business--started their own computer retail stores? They apparently didn't calculate that when lots of other people started similar stores, each store would have to cut prices. Most of the stores went bankrupt fairly quickly. Profit margins were squeezed as the supply of retail outlets increased. A little dose of Econ. 101--increased supply brings down prices--would have saved these folks a lot of money.

Programmers' errors

In fact, that one simple idea--that when something is abundant, it's also cheap--could serve as an important lesson for young people who think the way to get rich is to become really good at computer programming. The problem for them is that lots of people are becoming computer programmers, and not just here but also in India, where $14,000 a year is a great salary for a programmer (see "Bottlenecked in Bangalore"). This is the competition. So if you move to Silicon Valley to make your fortune in programming, you will quickly find that you'd better build or tap some other skill--a reality no more surprising than the fact that the last 100 years' incredible increase in agricultural productivity brought real food prices down and shrank the agricultural workforce from more than 37 percent of the labor force in 1900 to less than 3 percent today.

The people in the Silicon Valleys of the world who will make lots of money are those who can figure out how to use computer technology in areas where it has previously not been used (or not used well) and who can get their product to market relatively early. Bill Gates didn't make his first billion by simply programming; he made it by using programming to market a product--in his case, an operating system.

Again, this is the old economics: to make a fortune, find a niche that no one is supplying and do that well. These niches will increase considerably as people find ways to use computers to replace manpower, which is a very expensive resource.

Crude calculations
What else can "old" economics say about the future? MIT economist Paul Krugman recently wrote that the price of minerals and oil will rise as an expanding population pushes against finite resources. I disagree. Technological innovation, brought about by the digital revolution and other technological improvements, will substantially increase the available supply of mineral resources and oil--a process that's already occurred in this century. In 1931, Harold Hotelling, the best resource economist of the time, predicted that the real price of oil and of other fixed resources would rise as the amount left on the earth decreased. Given his assumptions, his conclusion had to be true. But one of his key assumptions was that the inflation-adjusted cost of discovering and extracting resources would not fall. It has. Which is why the known reserves of oil have increased even as we use more and more of it. In 1920, the director of the US Geological Survey said that peak annual production of crude oil had almost been reached. But by 1948, annual US production was four times the 1920 level. In 1939, the US Interior Department stated that US oil supplies would run out in 13 years. Fifty-seven years later, of course, the United States is still producing a lot of oil. Or take iron: in 1950, world reserves of iron stood at 19 billion metric tons of metal content. Between 1950 and 1980, 11 billion tons of iron were produced. That ought to have left 8 billion tons of reserves, right? Wrong. Reserves of iron in 1980 stood at 93 billion tons, almost five times their level 30 years earlier.

This isn't new math. It's not even new economics. It's consistent with what economists such as the University of Maryland's Julian Simon and Princeton University's William J. Baumol have been saying for years, that the natural resources known and available to us have continually expanded and may never come close to being exhausted. 

In 1980, Mr. Simon put his money where his mouth was by betting gloomster Paul Ehrlich that the prices of five minerals--chrome, copper, nickel, tin, and tungsten--would fall by 1990. Mr. Simon won. During those ten years, the prices of all five minerals fell--chrome by 40 percent, copper by 18 percent, nickel by 3 percent, tin by 72 percent, and tungsten by 57 percent. Mr. Ehrlich, whose word of honor is more reliable than his forecast of increasing scarcity, paid up. I'd like to offer Mr. Krugman the same challenge: I'll bet him $1,000 that the price of minerals and oil will have dropped by the year 2000.

Banned in Australia
But high growth, though desirable and plausible, is not inevitable, and the factor most likely to stunt growth is heavy-handed government intervention, which will ultimately slow progress. My favorite example of this is the Australian government's decades-long prohibition of cable television. Government officials stated explicitly (and evidently with no idea how foolish they sounded) that they were delaying approval of cable TV until they could determine the best cable technology. As if the answer to that would be the same in 1964 as it would be in 1996. 

Other examples can be found closer to home. Court decisions have made firms with deep pockets liable for almost anything that can go wrong with their products (even if they are being misused), almost destroying the US production of general aircraft and immunization drugs. Only 964 general-aviation aircraft were produced in the United States in 1993, a 94 percent decline from its peak in 1977. And the increasing risk of liability suits for DPT (diphtheria, pertussis, and tetanus) shots caused the wholesale price of the vaccine to rise 4,000 percent between 1980 and 1990, while the price in Japan over that same time period rose by only 31 percent. No doubt many other firms and industries were stillborn because of the liability laws. 

Optimists believe that government's power to mess things up is itself limited by the technological revolution. Because communication and transportation are so much cheaper these days, they say, capital is increasingly "footloose," moving to where it will be well treated. Governments, therefore, must now worry more about how their policies will affect investment incentives. The optimists have a point. But it is, alas, exaggerated. The judge, legislator, or president who makes a bad decision that destroys a country's wealth does not necessarily destroy his own. Capital mobility alone, therefore, isn't enough to restrain governments. The price of liberty, today just as 200 years ago, is eternal vigilance.

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