Think Again: The Internet Economy

The markets may have soured on Internet start-ups. High-tech oases in countries like Malaysia and India may not lift their countries out of poverty. But all those dot-coms and Silicon Valley dreams never had much to do with the real economic impact of the Internet. The new economy is alive and well.

The Death of the Dot-coms Proves the Internet Was Overhyped

The Death of the Dot-coms Proves the Internet Was Overhyped

Don’t overreact. Sure, the dot-com stock bubble has burst, helping to cut the market value of stocks traded on the NASDAQ in half. It would be a mistake, however, to extend such stock-market negativity to the economic impact of the Internet itself. After all, no one disputes the transformative impact of the railroad and the automobile even though thousands of such companies that were once in business aren’t any more. Competition winnows out the few firms that are able to survive, ensuring that the benefits of new technology are passed on to consumers.

But forget about all those start-ups for a minute. New technologies do more than just create new firms and consumer products. They change the way that firms throughout the economy do business. The potential cost savings for firms that take advantage of the Internet are significant, maybe more significant for the mainstays of the old economy than for the nimble little outfits that drove NASDAQ up in the 1990s.

The Internet makes it cheaper to design products remotely; reduces the need for vast inventories; provides a better means to target, communicate with, and service customers; cuts the costs of delivering many services and entertainment; and helps companies remove layers of bureaucratic fat. How much will all this add up to? Consider the impact in the United States alone: A study I am completing with fellow Brookings Institution scholar Alice Rivlin and a team of researchers from major U.S. universities suggests that within five years, the Internet may save Americans as much as $200 billion annually. In a roughly $10 trillion economy, this 2 percent savings translates into a potential annual productivity improvement of 0.4 percent. Doesn’t sound like much? Think again. If cumulated over 10 years, an annual improvement of 0.4 percent would increase the income of the average American by 4 percent, or roughly $1,600 — an amount larger than most of the tax-cut plans bandied about during the 2000 U.S. presidential campaign.

Similar productivity gains are possible, even probable, in other industrialized countries, according to a recent study by the United Nations Conference on Trade and Development (UNCTAD), which suggests a gain of almost 5 percent over the long run. UNCTAD is more pessimistic about the potential gains from the Internet in the developing world, although it is conceivable that the Net will jolt the inefficiencies out of firms in these countries and thus produce even larger cost savings. Already, the Internet is making big inroads in countries like Brazil, where banks are radically changing the way they do business by encouraging more customers to go online. Expect financial institutions elsewhere around the world to follow.

The Death of the Dot-coms Spells the Beginning of the End of the New Economy

Wrong again. Do not confuse the dot-coms that sprung up around the world in the last decade (especially those fly-by-night e-tailers) with the new economy, which the Clinton administration’s last Economic Report of the President defines as the "extraordinary gains in performance — including rapid productivity growth, rising incomes, low unemployment and moderate inflation — that have resulted from [the] combination of mutually reinforcing advances" in information technology, business practices, and overall economic policy.

The benefits of the Net do not hinge on the survival of any new company that the Net seemingly has created. Think of the dot-coms as the first wave of an amphibious assault on the old economy. Unfortunately, the casualties in any first attack are heavy. Take, the London-based fashion e-tailer, which, after months of intense prelaunch hype, blew through $125 million of venture capital en route to an unglamorous collapse. But the techniques and footholds these short-lived dot-coms establish pave the way for the heavy artillery to come in behind and rescue the day. As of December 2000, seven of the 10 most popular Web sites in the United States were Internet divisions of offline retailers.

The dot-coms have jolted the traditional manufacturing and service companies of our economy, not only waking them up to the importance of doing business on the Net but also to the sizable opportunities for reducing costs. Outgoing chairman of General Electric Jack Welch has ordered every business line in his company to become Internet-enabled, from the back end of ordering supplies to the front end of dealing with customers. The key will be moving all that once was on paper onto the Internet. Caterpillar, makers of heavy construction equipment (as old economy as it gets), predicts that its new Internet-based electronic marketplace will save the firm $100 million in 2001. Even independent booksellers, once thought by and Barnes & Noble to be roadkill, have joined together to form their own Web site,

Some dot-coms are expanding or simply avoiding the dot-com slump by partnering with, and modernizing, old-economy firms., the first e-commerce site in Asia for beauty products, couldn’t convince cosmetics firms to distribute to a Web-only outfit. Instead of folding, the company merged with Icon, Hong Kong’s cosmetics megastore. E*Trade, a thriving Web-based stock-trading service, announced plans to open 200 mini-branches in SuperTarget stores around the United States.

The bottom line? A new and improved old economy is being transformed by the new economy.

We Can Judge the IT Revolution by the Numbers

Hardly. Economists spend much time estimating how much the information technology (IT) revolution contributes to economic growth. Last year, the U.S. Commerce Department announced that it industries, though they account for less than 10 percent of the U.S. economy’s total output, contributed almost one third of U.S. economic growth between 1995 and 1999. But numbers alone do not fully capture the economic contribution of either the Internet or the broader it revolution. Many of the benefits of high technology are easy to intuit but hard to quantify.

Consider the convenience of being able to comparison shop and then buy items and services from your living room without driving to multiple stores. The official number crunchers find it hard to put a value on that. Similar difficulties plague attempts to quantify the benefit of being able to customize purchases so easily, as I did when I ordered the Dell computer on which this article was written. Simply put, there are no "markets" for convenience and customization that permit official statisticians to value them in the nation’s figures for total output.

What about the fact that in the near future, the Net will even save lives? No longer will pharmacists have to decipher the illegible handwriting of doctors ordering drug prescriptions, which studies confirm has contributed to needless deaths and suffering; instead, doctors will soon transmit prescriptions from hand-held computers directly to pharmacies. Not only will such technology save lives, it will make medicine more cost-effective. But none of this will show up in the gross domestic product (GDP) statistics.

Silicon Valley Can Be Replicated Around the World

It’s possible. Not likely, but possible. Silicon Valley has become the economic Mecca of the United States. Foreign business and government leaders — and even mayors and business leaders of other cities in the United States — have trooped to the valley in search of finding the magic elixir to bottle and take back home in hopes of replicating the valley’s economic miracle.

Sometimes it works. Bangalore, India, has become famous for supplying software engineers to computer centers around the world. The Tel Aviv-Haifa corridor in Israel has been a magnet for U.S. high-tech companies and a breeding ground for successful new Israeli software and Internet appliance companies. Both Finland and Sweden have become known for their prowess in wireless technologies, as has Japan for its DoCoMo wireless Internet technology. Hsinchu Park in Taiwan has become world-famous for its computer manufacturing. Even tiny Ireland has become a high-tech haven in Europe.

It is easier to identify the keys to high-tech success, however, than to replicate it. The basic ingredients? Well-developed communications infrastructure; a large pool of skilled workers, produced either by local universities that are on the cutting-edge of technology (such as in India) or by multinational companies that have been welcomed with open arms (in Ireland and Israel, for instance); an environment that encourages new business formation; and, at least for those regions that specialize in computer software and Internet-related activities, workers who are fluent in English, the language of roughly 80 percent of all Web pages.

Adding these ingredients to a more general menu of secure property rights and sound fiscal and monetary policy is a recipe for economic success in the 21st century whether or not the intention is to create another Silicon Valley. Foreign investment, and with it ideas and managerial talent, will flow to countries with educated workforces, modern communications, and secure property rights. So will venture capital.

But will such investment radically transform a country’s economy and work culture, as Silicon Valley has done in the United States? Whether success in the high-tech sector alone produces noticeable economy-wide gains depends heavily on the size of the country. In large countries like India, building a successful high-tech industry is like throwing a pebble into an ocean: There is scant evidence that the high earners in Bangalore have done much to help reduce widespread poverty elsewhere in the country. In fact, software companies only employ about 340,000 of the country’s 1 billion people; 50 percent of the population, meanwhile, is illiterate. China is a better model for other large countries: By educating its masses of children to use modern technologies, it should be able to deliver the gains promised by it throughout the population.

Meanwhile, in smaller countries like Ireland and Israel, success of a key sector like high tech can produce economic gains that are felt throughout much of the economy. In Ireland, the high-tech boom of the 1990s coincided with an 8 percent annual increase in economic growth between 1993 and 1998 and a decrease in unemployment from 20 percent to 5 percent.

The IT Revolution Will Worsen the Distribution of Income

For a time, yes. In the early 1990s, Princeton economist Alan Krueger found that Americans with computer skills earned about 10 percent more than those without them. The computer wage premium in industrialized, democratic nations should gradually fall, however, as computer education spreads throughout the school-age population and the workforce, as more computer-literate professionals emigrate from abroad, and as the penetration rates of pcs and cheaper Internet access continue to increase.

But it is hard to be as optimistic about the growing income gaps between rich Western countries and the developing world, where people are lucky to hook up to a telephone, let alone the Internet. India, frequently hailed as a high-tech success story, has only 15 telephone lines and two computers for every 1,000 citizens. It is possible that the diffusion of wireless phones will help close the gap, but even that will take time and offers no guarantees. The World Bank estimates that just establishing adequate it infrastructure in developing countries would require a $300 billion investment. Remember, one third of the world’s population does not even have electricity.

Developing countries will continue to fall behind unless they take some aggressive steps. Start with telecom reform. Charges for accessing local networks must be brought in line with costs, while customers should be charged a flat local rate that does not vary with the length of time they spend on the phone or online. Had flat-rate pricing not been available in the United States, the Internet never would have taken off as it did; just look at it giant Japan, where a near monopoly by Nippon Telegraph and Telephone Company and per-minute charges for local calls mean less than a quarter of Japanese use the Internet, compared with half of all Americans. Plus, there are creative ways to wire a country. Private-sector architects of the Barangay Payphone Program in the Philippines are installing pay phones in areas underserved by regular telephone infrastructure and building telecenters (each with a pc, scanner, printer, and Internet connection) in every one of the country’s 1,500 municipalities.

But accessing the Internet is not enough. Governments must make major efforts to provide computer training, not just for the current school population but for adult workers as well. One way to accomplish the latter is to welcome foreign companies that can help train local workforces (as they are doing in Ireland and India) and thus match the physical capital required for the Internet age with its human counterparts.

Regulation Will Undermine the Global Growth of E-commerce

Not likely. During the early years of the Net, cyberlibertarians hailed it as the only "space" in the world that was free from government intervention: no taxes, no regulation, no government! What could be better?

Not surprisingly, governments around the world have not been as overjoyed. Authoritarian leaders understandably view the Internet as a threat, a vehicle for importing subversive ideas, pornography, and other unwelcome content. Similar concerns have arisen in democratic societies, along with worries that the Net will undermine tax revenues, further erode personal privacy, and threaten the legal protection of music, videos, and other Web-based content.

Governments are gradually starting to regulate the Net, encouraged in some cases by citizens who fear its downsides and in others by businesses that simply want some clear rules. The European Union (EU) has imposed new, sweeping privacy protections, both on- and offline, and for a time appeared ready to force the United States to do the same. In the end, the EU accepted self-regulation by U.S. companies, provided that the U.S. Federal Trade Commission punish failures to honor promises to safeguard information. In the United States, Congress has enacted a law giving legal effect to "digital signatures," contracts signed and sealed over the Internet, while prohibiting states and localities from imposing any "new" taxes on Internet transactions — at least until October 2001, when Congress will revisit the issue (and very likely extend the moratorium).

Perhaps the most contentious issue is government censorship of the Net, a practice employed not only by China and Singapore but most recently by France, where a court required Yahoo to block French users from accessing Nazi material. The French ruling, perhaps more than any other by a liberal democracy, has generated fears that government regulation will become increasingly ambitious until it disrupts global Internet commerce.

The fears are justified but also must be put in some perspective. No one really knows how much money cross-border Internet commerce currently generates. The few official statistics that are available track e-commerce within countries, not between them. And even these data show that e-commerce is hardly overwhelming: about $20 billion in retail e-commerce and perhaps $100 billion in business-to-business e-commerce in the United States in 1999, a year in which total U.S. GDP was about $9 trillion.

The real question is whether some kind of international collective action will be necessary to ensure that various national regulations do not artificially choke global Internet commerce in the future. The opportunities for conflict are abundant, from taxation and rules for intellectual property to privacy, customs, rules for telecommunications services, and even the ownership of Internet domain names. There has been nongovernmental international coordination of domain names by the Internet Corporation for Assigned Names and Numbers, but its long-term future is cloudy without assurances of long-term funding.

Probably, over time international rules will slowly emerge in many, if not most, of these areas. In the meantime, efforts by individual countries to wall themselves off from the Net will almost certainly backfire. Why? Overregulating countries, their firms, and their citizens will simply find themselves bypassed by the Internet revolution — not a welcome prospect.

Robert E. Litan is vice president of research and policy at the Kauffman Foundation and senior fellow in economic studies at the Brookings Institution.

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