Nova Economia Commoditizacao

8/13/2019 Nova Economia Commoditizacao

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Technology, Economic Growth, and the New Economy

William D. NordhausYale University June 13, 2000

DRAFT: Do not quote without permission

I. What is the new economy?

A. Definition

We hear a great deal about the new economy. What exactly do we mean by this term?The new economy is a vague name for that part of the economy that is involved withinformation technology. Most of the action is in computers and software, but these areclosely linked to communications and communications equipment. For this purpose, we

should omit radio, TV, and most of telecommunications services, some of which datefrom the 19 th century and remain very much old economy.

A working definition of the new economy is as follows:

The new economy involves acquisition, processing and transformation, and distribution of information. The three major components are the hardware (primarily computers) that processes the information, the communications systems that acquire and distribute theinformation, and the software which, with human help, manages the entire system.

Sometimes, people have in mind what I would call the brand-new economy, which isthat sector which produces or uses the Internet. While electronic communication datesfrom the 1960s, the qualitative change in the usage and power of the Internet came withthe introduction of the World Wide Web in 1989. So far, however, the Internet doesntamount to much in the real economy.

B. Old Wine in New Bottles?

When asked about a new technological development in the aircraft industry, Fred

Kahn, who was charged with deregulation of this industry in the 1970s, responded, Anairplane is just marginal cost with wings. Similarly, in viewing the new economy weshould ask whether, when stripped of the rhetorical flourishes, the new economy issimply old wine in new bottles.

In one important sense, the new economy is definitely old wine. After all, peoplehave been adding up 1s and 0s for centuries and sending messages for millennia. But thenew economy is qualitatively and quantitatively different from both old economy and


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the former number-crunching-and-commmunicating sectors. A number of featuresdistinguish new from old economy. First, the new economy involves software, which forthe first time begins to substitute for and replace human intelligence. Earlier industrialrevolutions replaced other human attributes, such as when the power revolutionsubstituted for human power, but for the first time software is able to substitute for thatunique human feature, intelligence.

The second feature of the new economy is the extraordinary rate of productivityimprovement. It is not just that computers and software are getting better or thatcommunications are becoming more rapid. They are improving at sustained rates thathave never been seen in the recorded economic statistics.

Third, a substantial part of the new economy particularly software is characterizedby a cost structure that is peculiar to information: it is expensive to produce butinexpensive to reproduce. Combined with the communications power of the Internet, thismeans that any digitized information can be reproduced and transmitted around to

world in virtually limitless numbers at virtually the speed of light. These are the mostpowerful economies of scale known to date.

Fourth, much of the new economy has strong network characteristics. Networks canhave powerful economic impacts in several dimensions, each of which is seen in differentparts of the new economy. Networks have strong adoption (or demand-side)externalities; they tend to have tippy equilibria, seen in such features as a strongtendency toward market dominance or even monopoly; standards and history have animportant impact on market evolution in networks; and networks stimulate very unusualand evil-looking market strategies, some of which surfaced in the Microsoft antitrustcase.

We can almost say that the new information technology is like a new factor ofproduction, perhaps we should call it artificial intelligence, that may over the next fewdecades reshape the economic landscape. It is at this stage too early to say whether in factthe information revolution is changing the economy in a fundamental way; my task hereis to give you an update on where we are at the present time.

II. Major Features of the New EconomyIn this section, I will describe some of the dimensions of the new economy, focusing

on its size and growth along with the price and productivity performance and itscontribution to the overall economy. Most of this discussion concentrates on the UnitedStates.


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Growth in Communications Speed

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Growth rate of 4 percentper year (doubling in19 years)

Growth rate of 70 percentper year (doubling every

year)

Figure 3 .

As Figure 2 shows, the actual rate of improvement over the last quarter-century through June 2000 is a compound 27 percent per year in clock speeds, starting with a speed of 108KHz with the 4004 chip in 1971 and progressing through the 1,000,000 KHz or gigachipintroduced in March 2000. (Data are from Intel at www.intel.com/intel/museum.)

2. Technological improvements in communications

I know of no comparable estimates of the progress in software and communications. Forillustrative purposes, I constructed a graph for communications similar to that for computers.This looks at the speed of communications devices from the telegraph of 1844 to the high-speed connections available today. For this, I measured the speeds available in relativelysmall establishments, such as a rural railroad station in the 19 th century of a residence today.(Figure 3 is based on estimates by author.)

What is apparent in this figure is the inflection point in the last quarter century, when therate of improvement rose from around 4 percent annually to a rate of about 70 percentannually, or doubling of speeds each year.


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Information TechnologyInvestments

Computers

Software

Comm.Equip

Instruments

Photocopy

Office

Figure 6

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Growth in Nominal Value Added, 1996-99

Figure 7 .

Figure 6 shows thebreakdown in informationtechnology investment by type.Clearly, computers and software arethe dominant force.

D. Which are the growingsectors in the new economy?

Which sectors are growingmost rapidly? Figure 7 shows thegrowth in nominal value added bymajor industry over the last threeyears. There is nothing particularlynotable about manufacturing in thenominal output data, althoughcommunications is growing mostrobustly.


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E. The significance of the Internet

Today, most people think of the Internet as the new economy, and I have labeledthis the brand new economy. In fact, the Internet is genuinely new and different. Whileelectronic communications dates from the 1960s, the qualitative change here came withthe introduction of the World Wide Web in 1989. As we all know, it has grownexplosively since that time in many dimensions.

The significance of the Internet in my mind comes primarily as an informationdistribution channel. And in this respect, it is awe-inspiring. The Internet has resulted in aphenomenal decrease in the time needed to access information. For example, if you areinterested in searching for documents in English on Sweden and the New Economy,you can find 1,410 items using the search engine Google in approximately 1 second. Or togive another example, if I wanted to obtain data on retail sales or the unemployment ratethat was not on my book shelf, it would take at least a few minutes or perhaps a few daysto obtain the information. Using the Internet, these data can be retrieved in a few seconds.It seems accurate to say that nothing so revolutionary to information distribution hasoccurred since the invention of the printing press. Figure 9 shows an illustration of thechanging nature of search due to the Internet.


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Decline in Search Time

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Search time declines at 90percent per year (halves in0.6 years)

Search time declines 2.2per year (halves every 34years)

Figure 9 . Search time for document deposited at Library of Congress.

F. How important is e-commerce?

While the Internet offers untold possibilities as a device for the distribution ofinformation, lets focus for the moment on the narrower issue of how the Internet hasaffected the economy. Enthusiastic estimates of the impact of the Internet are legion. Forexample, Jupiter Communications recently announced, Web-impacted spending, whichincludes both online purchases and Webinfluenced off-line purchases, will exceed $235billion this year [i.e., 2000] and reach more than $831 billion in 2005.(http://www.jup.com/ company/pressrelease.jsp?doc =pr000518)

One of the surprises that comes from a careful look at the data is that the consumercomponent of the new economy (B2C) is still relatively small in its penetration ofeconomic activity. The only reliable estimates to date are a special Census survey of thefraction of retail sales that was transacted electronically in the fourth quarter of 1999. (Thisnumber excludes travel services, financial brokers and transactions, and ticket sales.)Retail sales were $21.2 billion at an annual rate. As Figure 10 shows, only 0.6 percent of


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It is natural that sellers resist commoditization. The following colloquy describesthe efforts to resist commoditization by the worlds most famous monopolist. MicrosoftsBill Gates wrote an e-mail which stated,

Our competitors are still hard at work trying to obsolete Windows. More peoplethan ever now believe they will. Netscape and Sun endeavor to commoditize the[Windows operating system].

The following colloquy extracted a definition from Gates:

Q. (Boies) When people used the word with you "commoditize" as in the statementthat Netscape was threatening or endeavoring to commoditize the operatingsystem, what did you understand commoditize to mean?

A. (Gates) That they were creating a product that would either reduce the value oreliminate demand for the Windows operating system if they continued to improveit and we didn't keep improving our product.

The new economy encourages commoditization because of the gains fromstandardization and from broadening markets. Just as grains and other old-economyproducts became standardized and sold on exchanges in the 19 th century as transportationexpenses fell, or as securitization in financial markets led to broadening of the market inthe 20 th century, just as creation of environmental property is leading to trade in emissionsrights, the same tendency will continue in the 21 st century as market participants attemptto get the cost reduction that comes from standardization of all kinds of goods and

services. Commoditization along with good information about prices will tend to reducethe dispersion in prices among markets and among market participants. This will directlyimprove the well-being of consumers, particularly uninformed consumers, and it willindirectly tend to chip away at the margins and eventually the existence of high-cost andhigh-price producers.

III. Economic Performance in the New Economy

A. Price trends

Historians remind us that a new economy a new industrial revolution is bornevery few years. Railroads, electricity, telephony, radio, antibiotics, highway networks,air travel, and television were important historical examples. Our new economy, the ITrevolution, is the latest and a most dramatic industrial revolution.


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It is interesting to speculate on how the current new economy stacks up againstnew economies of the past. Modern economic and statistical techniques allow us tomeasure output and prices on a standardized basis in ways that were not possible in anearlier era. We therefore have begun to measure the price of standardized goods likecomputers, software, and automobiles and in some cases to include these improvedmeasures in our consumer price indexes and national income and product accounts.

The most dramatic case in point is computer prices, for which the U. S. governmentcalculates a hedonic price back for almost 30 years. Figure 11 shows the price andoutput calculation that come out of that calculation. The fall in computer prices is nothingshort of phenomenal. We know of nothing like it in recorded economic history.

Figure 12 shows the relative price trends of computers along with anotherrevolutionary product, electricity. For comparison purposes, it is useful to deflate them bywages so as to show the relative prices of computers or electricity to labor. Electricity pricesbegin in 1883, shortly after the first marketing of electricity, while computers begin with theearliest introduction of computer price hedonics into the U.S. national accounts.


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0.1

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( 1 9 9 6 =

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0.01 0.10 1.00 10.00 100.00 1000Computer output (billions of 1996 $)

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1990

1999

Figure 11 . Computer prices and output in the U.S. economy, 1972-99

The sustained rate of decline in relative prices of computers was 3 to 4 times largerthan that of electricity. Given the tremendous decline, along with its versatility as a factor ofproduction, it is little wonder that the output of computers and other IT products have grownso rapidly.

B. Productivity

1. Measurement Issues


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The major economic question about the new economy is the extent to which it hasraised, or will in the future raise, the economys productivity. The new economy has twoimportant impacts on productivity: it improves access to existing information, and it speedsthe transmission speed and bandwidth of information. The question is, how much has or willthe improved access to information increased productivity?

In answering this question, we must make four preliminary points. First, we mustdistinguish between the contribution of the new economy to final output (consumer goodsand services) and the contribution as an input. To the extent that the new economycontributes directly to consumer welfare (say, through the joy of e-mailing the family), that isunlikely to be accurately reflected in economic measures of productivity.

Second, measuring the contribution of the new economy to productivity as an input toconventional output is likely to be accurately captured. For example, if better computerprograms improve managing oil refineries and thereby lower the cost of producing variouspetroleum products, this will show up in output and price measures for petroleum products.

Third, it may be difficult to know how much of the improved productivity (say inpetroleum products) was due to the new economy, however, if we do not have accuratemeasures of the output of the new economy. The decomposition of output growth betweenthe contribution of new-economy inputs and other (labor, other capital, etc.) inputs andtechnological change cannot be properly made without accurate measures of the output ofnew-economy inputs.

Fourth, an important route by which the new economy will show up in measured

productivity is through the final output of new-economy services and products. These wouldbe investment and consumption of computers, software, telecommunications equipment, andtelecommunications services. If these are not accurately measured, a large part of theeconomic contribution of the new economy will simply be missed. This raises a majordifficulty for economic statisticians because the measurement of real output in these areasrequires use of complicated and sophisticated hedonic techniques to capture the very rapidquality change in the equipment and services that are produced.

In this area, most countries are probably underestimating the contribution of theinformation economy to their economies. Few countries accurately capture the price trends of

computers, and no countries to my knowledge measure accurately the prices of software,communications, or communications equipment. This means we are underestimating,perhaps significantly, the growth of our economies.


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Relative Price Change: Electricity and Computers

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Figure 12 . Relative Price Decline for Electricity and Computers in Years After EarlyIntroduction


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Share of item in total production: Item:

Cons- Private Total prod-

umption Investment GDP uction (billions)

Computer and office equipment 11.2% 62.2% 55.9% $93.7 Audio, video, and communications equipment 34.3% 52.4% 78.8% 78.0

Electronic components and accessories 0.1% 0.0% -5.7% 129.4Scientific instruments 5.3% 42.5% 72.1% 118.8Communiciations except radio and TV 42.9% 2.2% 52.2% 287.5

Figure 13 .. Share of different components in new economy, 1996

2. B2B or B2C?

Most of us look to the consumer side of the new economy with the excitingopportunities at browsing the Internet, shopping, playing games, and a myriad of otheractivities. What is the relative importance of the consumer sector compared to the businesssector?

The best way to get at this is to look at the destination for the output in differentsectors. Figure 13 shows the U.S. data for 1996, which is the latest year for which we havecomplete input-output data. Communications and audio/video/communications equipmenthave a large share going to personal consumption one-third and two-fifths respectively. Forcomputers, instruments, and electronic components, the share is between nil and extremelysmall. While the consumer share (B2C) has probably grown rapidly in recent years, it is likelythat the major impact of the new economy is currently in the business-to-business (B2B)sector.

The point here is to suggest that most of the impact of the new economy is likely to beseen either as output (investment) or as inputs to production rather than as new consumerproducts and services. This suggests that we have a good shot at capturing the impacts on theeconomy.

3. Trends in Measured Productivity

Economists have been waiting for an upturn in productivity growth, hoping that therevolution in information technology would spur rapid growth through the economy.Indeed, innovations in information technology (computer hardware, software, and

communications) have produced astonishing improvements in every corner of the economy.


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Labor Productivity Growthin U.S. Business Sector

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Figure 14 . Labor Productivity in U.S. Business Sector

[Source: Bureau of Labor Statistics]

The prices of computers have fallen more than a thousand-fold in the last three decades.Electronic mail and the Internet are changing the face of retailing. Computers are the nervesystem of business running airline pricing and reservation systems, scanning price andquantity data in stores, dispatching electricity, clearing checks, dunning taxpayers, andsending students their tuition bills. Some economists think that computers are like a newfactor of production.

Until recently, experts were puzzled, in the words of Robert Solow, thatComputers can be found everywhere except in the productivity statistics. Even ascomputers invaded every aspect of economic life, productivity growth showed littleresponse. But this changed in starting about 1995, when productivity began growing rapidlyand regained a substantial part of the ground lost after 1973. Having grown at 3.2 percent peryear from 1948 to 1973, productivity growth slowed to 1.4 percent in the 1973-1995 period;productivity then surged ahead at 2.9 percent per year from 1995 to 1999 (see Figure 14).


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Enthusiasts spoke of a new era and a brave new world of American capitalism.Even Fed Chairman Alan Greenspan, known primarily for his understatement, joinedtechnological enthusiasts, stating:

A perceptible quickening in the pace at which technological innovations are appliedargues for the hypothesis that the recent acceleration in labor productivity is not just a

cyclical phenomenon or a statistical aberration, but reflects, at least in part, a moredeep-seated, still developing, shift in our economic landscape.

Economists who have looked at the numbers under a microscope uncovered someinteresting facts about productivity in the late 1990s. Among the important factors in theproductivity acceleration were the following:

Productivity explosion in computers. The productivity explosion (and consequent pricedecline) in computers is extraordinary. Measuring productivity as the dual using pricedecreases, from 1972 to 1995, the relative price of computers fell at about 18 percentper year, and in the 1995-99 period the decline amounted to 29 percent per year.Computer productivity alone added 0.23 percent per year to the productivityacceleration after 1995 according to the Council of Economic Advisers.

Capital deepening because of investment in computers. Companies have invested heavilyin computers and software over the 1990s. According to the Council of EconomicAdvisers, this investment has added almost 0.5 percent per year to labor productivity.

Putting all these factors together, the Council of Economic Advisers estimated that

one-half of the upturn in labor productivity in the late 1990s about 0.70 percent per year was due to production and use of computers. The balance was a combination of cyclicalproductivity and productivity increases in other sectors.

4. The Gordon Hypothesis

Some economists believe that outside of computers and measurement, there has beenlittle or no improvement in productivity growth. This view has been particularly associatedwith Robert Gordon of Northwestern. According to the Gordon hypothesis, the entire upturnin manufacturing productivity growth is due to computers while the improvement in

nonmanufacturing is due to the business cycle and to measurement improvements.

Because of data gaps, it is difficult to assess the Gordon hypothesis. To test it, I haveexamined the growth in labor productivity by industry. Unfortunately, the data by industrycurrently go only through 1997 and do not yet incorporate the major data revisions ofOctober 1999. Nonetheless, the results are extremely provocative.


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The methodology used to construct these indexes are as follows. I have gathered datafor real output (generally, double-deflated value added) and hours worked for 10 majorindustry groups in the private economy. I then construct three different measures:

Private total productivity growth is the growth in private GDP per hour worked. Thisis the usual measure examined.

Private weighted productivity growth is the weighted average productivity growth ofthe 10 major sectors. This measure corrects for the composition of output andproductivity by sector, which can lead to extraneous changes to productivity.

Private weighted productivity growth less computersremoves the new economy sectorsfrom the calculation. For this calculation, I have excluded the output in the two sectorsElectric and electronic equipment and Machinery, except electrical. These twoindustries constitute about 4 percent of total hours worked in the private sector.

Figure 15 shows the results of this calculation. Labor productivity in the private sector(weighted) accelerated from slightly 0.96 percent per year in 1978-89 to 1.93 percent per year1996-97.


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5. Skeptics

Many are skeptical about the Gordon hypothesis. They point to the fact that overallproductivity growth in the late 1990s was actually above the long-term trend. They also arguethat much of the benefit of the information revolution is not captured in the official numbers.

Some economists believe that productivity continues to be significantly underestimated fornon-pre-packaged software and communications equipment. This of course would notreverse the finding of no productivity acceleration outside the new economy sectors.

Another source of skepticism about the Gordon hypothesis is that many of thecontributions of the new economy are enjoyed by consumers who save by shopping on theInternet, or save time and postage from the switch from snail-mail to e-mail, or enjoy theconvenience of cellular telephones none of these show up in measured productivity.

Yet another possibility is that the true gains from computers lie in the future. Stanfordeconomic historian Paul David, who has studied past inventions like the electric motor,believes that it takes decades for the economy to reap the full benefits of fundamentalinventions. However, Figure 12 above, which shows the relative price movement ofelectricity and computers, casts some doubt on the David counterpoint view. Computers haveactually been an important feature of the economy for at least four decades, and the relativeprice movement has been must steeper than that of electricity. After computer prices havefallen by more than a factor of 100, it is difficult to believe that we are just beginning to seethe benefits of computerization.

6. ProfitsOne important question is what the new economy has done for profits both in the

overall economy and in the new-economy more narrowly focused.

a. Aggregate profits

There are many cross-currents operating on profits in the present economy. On thewhole, the rhetoric of American capitalism would lead us to believe that profits were beingrelentlessly ground down by the forces of competition. Heightened international competition,

lower trade barriers, better price discovery through the Internet, deregulation in manymarkets, the trend to commoditization all these should be operating to reduce supernormalprofit rates. On the other hand, improved management practices and inventory control,increased out-sourcing, reduced power of labor unions, a conservative and pro-marketpolitical trend these would tend to lower costs and to increase profit rates.

Figure 16 shows the post-tax profit rate on U.S. non-financial corporations. The fact isthat the profit rate has grown steadily over the last two decades, although it has not reachedthe peak of the 1960s. Surprisingly, the profit rate has stabilized since the mid-1990s. How


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Rate of Profit of Nonfinancial Corporations

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Figure 16 . Rate of profit on U. S. domestic non-financial corporations.

[This is total profits and interest after tax as a percent of the replacement cost of tangiblecapital for all non-financial corporations. Source is Bureau of Economic Analysis and usedunrevised data on profits and capital.]

reported corporate earnings could have grown so sharply with a near-constant rate of returnis a puzzle for accountants to explain.

b. Profits in the new economy

Productivity growth is the social return to new and improved technologies; profits are

the private return. An interesting question is how profitable the new economy has been.Here, as in the old economy, forces are operating in many directions. Some new-economyfirms,


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Price- Market Earningsearnings value

Sector ratio [billions] [billions]

Software and Programming 85.2 $1,017.9 $11.9Computer Storage Devices 59.8 142.5 2.4Computer Services 384.6 444.0 1.2Computer Peripherals 34.6 54.8 1.6Computer Networks 139.7 487.0 3.5Computer Hardware 54.5 674.8 12.4

All new economy firms* 85.7 2820.9 32.9

All new economy firms lessbig 5 162.3 1566.5 9.7

big 10 348.3 1173.4 3.4

S&P 500 less new economy 26.6 9276.5 348.9

* With market capitalization above $1 billion in January 2000.

Figure 17 . Valuation of New Economy Firms, May 2000.

such as Microsoft, have built up enormously profitable empires; on the other hand, manynew Internet dot.com companies seem to produce mainly prodigious losses.

Figure 17 gives an idea of the basic dimensions of private profit as of May 2000. Thistable shows a rundown of the position of the 200 largest new economy firms.

A few points emerge. First, outside of a few standouts, this sector has yet to showsubstantial profits. Figure 18 compares the capitalization of new and old economy firms. Itshows that, after the top ten (IBM, Microsoft, Cisco, Hewlett-Packard, etc.), the next 190 neweconomy firms earned about $3.4 billion last year. They had a market value of $1.2 trillionand a price-earnings ratio of 348. It strains the imagination to project a scenario in whichfuture developments could rationalize the markets view of their value. If there is one singleplace to locate the irrational exuberance described by Robert Shiller, it is in the startups ofthe new economy.

The last two exhibits described the markets view of the future of new economy firms.Another measure is the rate of profit on investments of new economy firms. Thesecalculations are tricky, however, because much of the investment in this sector is not


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Price-Earnings Ratios: Old and New Economy

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NE less big10

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Figure 18 .

tangible capital but software development and other forms of intellectual and humancapital.

Together with Jason Cummins of NYU, I have developed alternative measures of therate of return on investment of different firms. These calculations estimate the real return(profit-type income) on total tangible and intangible capital. To make this calculation, we

have capitalized research and development (R&D) and added that to estimates of thereplacement cost of capital for firms. The data are for publicly held firms that are reported inthe Compustat data base.


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-20%

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1 9 8 5 1 9 86 19 8 7 1 9 8 8 1 9 89 1 99 0 19 9 1 1 9 9 2 1 9 9 3 1 99 4 19 9 5 1 9 9 6 1 9 97 1 99 8 19 9 9 2 0 0 0

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IBM

All firms

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Figure 19 . Rate of Profit on Invested Capital and Research and Development in Old andNew Economy Firms.

The results of this calculation are shown in Figure 19 . A few points are interesting.One is the astonishing and growing profit rate earned by Microsoft over the last decade.While the protagonists will continue to debate Microsofts future structure, there can be littledoubt that the firm was a prodigious money maker.

The second surprise is that software firms as a whole (excluding Microsoft and IBM)have earned a respectable profit on their investments, with the profit rate approaching 20percent after tax by decades end. These profit rates may overstate profits because they onlycapitalize R&D and may omit other similar investments, such as those for advertizing, butthey do suggest that this area as a whole has been a fruitful source of social investments.


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IV. Summary on the New Economy

We can summarize the major points about the new economy as follows:

The new economy involves acquisition, processing and transformation, anddistribution of information. The three major components are the hardware(computers) that processes the information, the communications systems thatacquire and distribute the information, and the software which with human helpmanages the entire process.

The computer sector has produced a phenomenal record of technologicalimprovement unparalleled in recorded economic history.

The new economy has been a major force in the economic resurgence of theUnited States in the 1990s. It has added approximately 1 percentage point to thegrowth of real potential output, and there is no reason to believe that theimpetus is slowing.

On the basis of industrial data through 1997, there no sign that the neweconomy is yet producing an acceleration of productivity growth outside itsboundaries in electric and non-electric machinery and communications. Thistentative conclusion is likely to be revised when the industrial data is availablelater this summer.

The new economy sectors as a whole are earning an above-average return oninvested capital and R&D even excluding the extraordinary profit rate ofMicrosoft which reached 88 percent in 1999.

The stock markets enthusiasm for the new economy is remarkable. Outside ofthe top ten profitable firms (Microsoft, Cisco, IBM, etc.), the price earnings ratioon the top 190 new-economy firms was 348 in early May 2000. A rough guess isthat the overvaluation in that sector is approximately $2 trillion.


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V. Policy in the New Economy

The growth of the new economy raises many important questions, and I willsample a few of those in this concluding section. In one sense, from a policy perspectivethere is nothing fundamentally new in the new economy. The objectives of governmentpolicy remain largely the same in new and old economy promoting efficiency,ensuring stability and economic growth, and fostering a fair and equitable distributionof economic opportunities and outcomes.

The trillion dollar question is whether the major changes in informationtechnology will put new and important strains on the economy. Information isbecoming cheaper over time at a phenomenally rapid rate and this might well lead tosignificant economic impacts. I will address four questions that seem to me important:the generation of new knowledge, the impact on governments control of the economy,competition and antitrust policy, and the impact on international trade.

A. The generation of new knowledge

The new economy involves acquisition, processing, transformation, anddistribution of information. It is a marvelous device for allowing us to collect andtransmit existing information, of which there is an enormous amount dispersed aroundthe world. But will the new economy encourage or discourage the production andgeneration of new knowledge? The answer is unclear.

On the one hand, the rules of the new economy promote the generation of new

knowledge because the lower distribution costs make the potential market for newinformation much larger and more lucrative. On this other hand, the lower cost oftransmission and distribution may erode the property rights in intellectual propertyand make the production of new knowledge less profitable. How these two forces willbe resolved is unclear.

The history of the encyclopedia is an instructive one in this regard. For morethan two centuries, knowledge was codified in major encyclopedias, of which theEncyclopedia Britannica is justly thought the most impressive of the modern era. TheBritannica contained impressive articles by major scholars and was the authoritativeword on major questions.

Encyclopedias have much the same cost structure as the new economy. Marginalproduction costs for books are typically between 10 and 20 percent of the price. Theencyclopedia enterprise was economically viable because the encyclopedias wereexpensive to produce and virtually impossible to reproduce in their entirety. Thisallowed the Britannica to survive competition, war, and alternative sources ofinformation for almost two centuries.


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What brought down the Britannica was new technology, first the CD-ROM andthen the Internet. The first CD encyclopedia was introduced by Grolier in 1985. In 1993,Microsoft released Encarta , a multimedia encyclopedia on CD-ROM, which was oftengiven away. A version of Encarta 98 on CD can today be bought for $5.75 plusshipping. Faced with the dirt-cheap computer version, Britannicas market began tocrumble, as it reduced its price from $1500 to under $1000 and then eventually turned

to a CD version, currently selling at $49.95.

The long-run question is whether high-quality encyclopedias will simplydisappear because the market will not support them. The scholarship and informationprovided by high-quality encyclopedias is now freely and quickly available on theInternet or on cheap CDs. Internet information is, however, often of questionableaccuracy and sometimes has a commercial motivation. What happened was that low-price information drove out high-price information, but the low-price information mayturn out to be low-value information as well. Whether this history will be repeated inother areas, whether the quality of the commercial and non-commercial research andscholarship will decline under the avalanche of free information, is worth pondering.

B. Government control of the economy

One of the most intriguing questions is the implication of the new economy forgovernments control of the economy whether through regulation, taxation, or simpleapplication of laws. Many analysts have argued that the new economy, particularly theInternet, sounds the death knell for governments because individuals can easily evadegovernment rules and controls in the new borderless world. Others worry that

government revenues will fall sharply as the cost of smuggling goods and servicesthrough increasingly porous borders falls sharply. Unpopular, despotic, andundemocratic governments surely worry about the ease with which protests, samizdatliterature, and conspiracies can be facilitated through electronic communication. Andall these trends will surely be exacerbated as cheap and virtually unbreakableencryption technologies come into widespread use.

I believe that some of these trends are inevitable. It will no longer be possible inmoderately open societies to wall out subversive information that the governmentwishes to contain, and this is surely a trend that most people will welcome.

However, most of the hysteria involves the possibility that Internet commercewill lead to a rapid erosion of government revenues, particularly taxes on consumption,such as state sales taxes in the United States or value-added taxes in Europe. I thinkthese concerns are highly exaggerated for three reasons. (This discussion has beeninform ed by Austan Goolsbee, In a World Without Borders: The Impact of Taxes onInternet Commerce, forthcoming, Quarterly Journal of Economics.) First, my reading ofthe potential of e-commerce is that it is unlikely to penetrate as far into the economy as


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Cate or

Personalconsumptionex en d it ur e

Potential

share ofpurchasesfrom Internet

Purchases frome-commerce

Share of Total

Consumptionfrom e- commerce

Personal consum tion ex enditures

Durable goodsMotor vehicles and arts 316.1 25 79.03 1.3%

Furniture and household equipment 290.5 20 58.10 0.9% Other 152.1 20 30.42 0.5%

Nondurable goodsFood 904.1 5 45.21 0.7%

Clothing and shoes 306.3 20 61.26 1.0% Gasoline, fuel oil, and other ener oo 138.7 5 6.94 0.1% Gasoline and oil

Fuel oil and coalOther 494.0 20 98.80 1.6%

ServicesHousin 902.5 2 18.05 0.3%

Household operation 362.2 5 18.11 0.3% Electricit and as

Other household operationTrans ortation 255.0 2 5.10 0.1%

Medical care 941.3 2 18.83 0.3% Recreation 246.2 10 24.62 0.4% Other 948.4 10 94.84 1.5%

Total 6257.4 559.29 8.9%

Figure 20 . Estimate of the Potential Share of E-commerce in Personal ConsumptionExpenditures

many advocates believe. As noted above, to date the share of B2C commerce is stillrelatively small (0.6 percent of retail sales). While it is growing rapidly, there arenatural limits on its size. Figure 20 shows illustrative estimates of the penetration of e-commerce in personal consumption by sector. These guesstimates lead to an estimate ofthe penetration of e-commerce in the order of 10 percent of personal consumption. (Thisapplies to actual purchases as opposed to bill paying.) It is simply not credible that a

major share of housing, food, energy, or medical consumption will be conducted online.

Second, there is no intrinsic reason why governments should lose control of thetax base just because people buy goods and services electronically rather than inperson, by mail, or by the telephone. In some respects, indeed, electronic purchases are


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more easily tracked than other kinds of purchasing as they leave an electronic papertrail around the country (as Gates and Co. were reminded in the Microsoft antitrustcase). To evade consumption taxes, purchasers would have to purchase from a firmoutside the countrys jurisdiction and gain delivery without customs or other deliveryagents recognizing that a taxable transaction took place. The one major exception to thisis sale of electronic material (such as CDs, software, or movies on line). This is likely to

be a relatively small fraction of total sales. Moreover, the problems in collectingrevenues are spreading beyond governments to the owners of the intellectual propertythemselves; as the owners of electronic property begin to lose control of sales, as iscurrently occurring for music and video, the owners themselves are likely to take stepsto change the legal regime or the technological format so as to frustrate thieves andpirates.

Finally, for countries with value-added taxes, the share of value added that takesplace through electronic commerce is likely to be relatively small. If I ever were to buyan automobile on line, it is likely that 95 percent of the value added would take placeupstream from my purchase. I estimated above that the value added of e-commerce istoday only 0.16 percent of personal consumption expenditures. Moreover, to the extentthat there are large economies of scale in e-commerce, it is likely that sales will beconcentrated in a small number of sellers, like Amazon.com. This will actually makethe tax collection problem easier than in todays bricks-and-mortar-with-Mom-and-Popeconomy, where underreporting of proprietors incomes in the United States is todayestimated to exceed 50 percent of income.

In short, I believe the e-commerce tax problems are ones that can be readily

solved.C. Competition and antitrust policy

One of the major questions that is likely to arise in the new economy is the roleof competition policy. Here of course the fate of the giant software company, Microsoft,looms large, and there is the further question of whether our future is likely to be full ofother wicked Microsofts in new arenas.

To being with, I would observe that informational technology contains powerful

structural features that lead to market power or even monopoly. This tendency arisesbecause information, particularly in the case of software, has high setup or fixed costsand low to zero marginal costs. Once a piece of software has been written, it costs nextto nothing to distribute it (and the costs may be literally zero over the Internet) andthere is no limit on production runs. When zero marginal production costs arecombined with strong network effect, as is the case with the Windows operating systemas well as applications packages such as word processors or spreadsheets, themonopoly may become deeply entrenched. When to these two characteristics are added


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rough and nasty business practices, we get the Microsoft case, which is the majorAmerican antitrust case of the last two decades and the first major new economyantitrust case. The case raises important issues concerning the definition of predatorypricing, predatory innovation, and anticompetitive behavior in the new economy.

Along with three other economists, I intervened as an amicus curiae in the

remedy phase of the Microsoft case. (We were not on the payroll of any organizationand intervened as public parties. Our brief can be found athttp://www.econ.yale.edu/ ~nordhaus/homepage/homepage.htm ) We argued thatthe most satisfactory approach to remedying the anticompetitive practices is the fulldivestiture option. This would combine the functional divestiture of separationwhich was proposed by the government and accepted by the court with a monopolydissolution. The novel feature in our proposal was the monopoly dissolution, underwhich the illegal monopoly (that part of the company owning the Windows operatingsystem) would be divided into three identical companies, each of which would ownand sell Windows products. We argued for this further step as the most effective wayof guaranteeing competition in the operating-system market, of reducing theapplications barrier to entry, and of reducing or removing Microsofts ability to projectits operating systems monopoly into other markets. While the courts remedy is a firststep, it is worrisome in that it leaves two powerful monopolists in adjacent marketswho, like barons on the Rhine river in medieval times, will pile market power onmarket power.

Our proposal, radical to be sure, was criticized as a quixotic solution. In fact, it isa new economy remedy one reflecting the evolution of our economy from one

based primarily on tangible and natural-resource assets to one based increasingly oninformational assets. Informational capital like software has a crucial difference fromtangible capital in that it is expensive to produce and inexpensive to reproduce. Earlierphysical-capital-intensive monopolies like Standard Oil or AT&T could be broken up,but they could only be reproduced or duplicated at extraordinarily high costs.Informational capital in software like the Windows operating systems, by contrast, canbe replicated at a cost that is far lower than the costs of developing it. The costs are notzero, because some of the informational capital is embodied in people who havedeveloped or are operating the software, and are therefore necessary forunderstanding, further developing, and adapting it to new uses. Still, the costs of

creating a new and independent operating system are modest relative to their originaldevelopment costs a major difference from the industries previously subject todivestiture orders.

The informational nature of Microsoft's assets therefore motivates a completelydifferent approach to structural reform in structural antitrust cases. Once this point isgrasped, we see that the monopoly dissolution we proposed has important precedentsin conduct and licensing remedies even though there are no important precedents in


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-4

-3

-2

-1

0

1

2

65 70 75 80 85 90 95 00

Net exports as % of GDP

Figure 21 . Net exports, 1965-2000

A second question is the impact of the new economy on a nations real incomeand comparative advantage. Standard international trade theory would suggest thatchanges such as those currently driving information technology would affect a countryboth through the effect on relative domestic costs in different industries and throughthe standard terms-of-trade channel. The net impact will depend upon the relative sizeof the changes to domestic costs and world prices as well as on initial trade flows. The

net impact is likely to be extremely complex.

One simple case provides a clear and somewhat paradoxical result, however. Ifthere is no change in domestic costs, we have the conclusion that externaldevelopments in the new economy would harm countries whose exports are relativelyinformation-intensive and benefit those who are information importers. This is easilyillustrated in the case of software and computers. Most countries are importers of Intelmicroprocessors and Microsoft software. Prices of both have fallen substantially overthe last decade. This change in the terms of trade has improved the real incomes ofimporting countries who benefit from substantially cheaper computation costs. The


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Nova Economia Commoditizacao