Two Sobering Corollaries

Two corollaries accompany the ‘Paradox of Information and the Information Economy’ set out in Part III. First, not only do exclusion and rivalry influence incentives for the consumption of particular goods and services: they also provide incentives for their production. Most generally, businesses have an incentive to produce private and toll goods because, thanks to the exclusion principle, they can demand 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 for valuation are arbitrary – a perfect description of tech stocks if there ever was one.

Three Chickens Come Home to Roost

These corollaries provide the basis of my longstanding and deepening scepticism about the ‘New Economy’ and ‘tech stocks.’ The New Economy cheer squad takes a macro stance and proclaims that the enormous economies of scale (‘leverage’) inherent in the production of digitised knowledge, intellectual property and IT are pushing us towards a winner-take-all economy in which a select few companies will become ‘the next Microsoft.’ In sharp contrast, taking a micro view I see many potential benefits for consumers but three profound dangers for investors. 

First, the economic fundamentals of the production of software and e-commerce are not nearly as favourable as is commonly supposed. Because they lack unambiguous incentives to produce non-rivalrous goods and services (as opposed to ‘business plans’), few entrepreneurs will do so profitably. Absent exclusion, barriers to entry and profit margins will usually be low and sometimes non-existent; moreover, key attributes of modern technology, most notably its generally-rapid but individually-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 exist 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 to these companies’ temporary lack of earnings. From this analysis, however, the problem is much more fundamental – and, I believe, intractable. Finally, under these circumstances greed and rampant speculation crowd out sober investment. Huge paper gains from IPOs’ first day of trade in 1999 and early 2000, for example, created the impression that large returns can be obtained effortlessly, and thus dulled participants’ appreciation of risk. The results of these floats also encouraged entrepreneurs to produce superficial ‘business plans’ and rhetoric rather than create viable businesses, real capital, real profits and real wealth. 

More generally and perhaps most disturbingly, the Internet and tech mania has created vast amounts of ‘near-money’ (i.e., pieces of paper which can be converted readily into cash). Shares in these companies constitute one type of near-money; and options over shares are another. Both types of near-money depend upon an expanding base of shareholders. Internet and technology sectors, and those which mimic them, have in some instances resembled giant Ponzi schemes which meet ignoble ends because eventually there are too few new participants to reward existing ones.