Rules for a Wired World

Wriston, Walter B.


Some years ago there was a popular song about true love, the lyric of which went: "Is it Grenada I see or only Asbury Park? Is it the real turtle soup or merely the mock?" This refrain comes to mind as we hear more and more about the "new economy," and that it is so different from the old that it may operate with new rules. Kevin Kelly has been one of the early and articulate proponents for this view.[1]  The legitimate question arises as to whether or not it really is a new economy, or just the same old thing with a few new wrinkles. Over the years generations of economists have formulated rules for the familiar industrial economy and are understandably loath to acknowledge that a fundamental change has occurred which might upset their calculations. Indeed very few academics have joined the voices of those, often non-economists, who see a totally new economic situation developing.

The Nobel laureate George Stigler observed that "The first and the purest demand of society is for scientific knowledge: knowledge of how the economic system works. Knowledge of the consequences of economic actions. Knowledge of the causes of unemployment, of the effects of various taxes, of the sources of income inequality. Whether one is a conservative or a radical, a protectionist or a free trader, a cosmopolitan or a nationalist, a churchman or a heathen, it is useful to know the causes and consequences of economic phenomena."[2]  This is far from an easy task as it is possible for a failed theory to disappear from scientific literature and still flourish in classrooms, the media and commonly used textbooks.

It would be my thesis today that the economy is in fact changing in very fundamental ways. The old Industrial Age in which we all grew up is morphing into a new information/networking economy that is as different from the Industrial Society as it was from the Agricultural Society that preceded it.

One of the current impediments to understanding is that we have very little time to get used to a new situation, since the velocity of change is increasing every day. The period between events gets shorter and shorter. It took 40 years for radio to get 50 million listeners here, it took 13 years for television to gain a like number, and it took only 4 years for the World Wide Web to get 50 million domestic users, and its use is growing 1000% a year. Moore's law that the speed and number of transistors double every 18 months is now more than matched by George Gilder's belief that total bandwith of the world's communication systems will triple every 12 months. As bandwith grows its cost will move toward zero. The velocity of such change has no historical precedent and makes analysis even more hazardous than usual. John Von Neuman, one of the great computer pioneers, expressed the belief that technology increases the rate of change not so much by shortening the time line, but by broadening the areas affected - political, economic and social. Actually it does both.

One of the basic ways the world has changed is the manner in which wealth is created, and when this process changes, the whole structure of a society and its economy changes. Whenever the means of creating wealth changes, conflict follows as the ruling class understandably tries to hang on to what made them rich - land in the first instance, and industrial production in the second. Just as the landed gentry ridiculed the new industrialists who sullied their farmland with huge factories, so today some industrialists ridicule the knowledge workers in the new economy contemptuously calling them hamburger flippers. The more strident among them complain of the "de-industrialization of America." What has really happened is that we are producing more and more with less and less labor. To that extent, industry mirrors what happened to farming. We used to have 20 million farmers, now we have less than 2 million and feed the world. Technology plays a big part. George Gilder has gone so far as to say: "Microchips in all their forms remain the spearhead of wealth creation in the world economy."[3]  It is certainly true that these chips are everywhere; it is estimated that there are some six billion chips embedded in everything from your car and your cell phone to the lock on your hotel room door. They are known in the trade as jelly beans because they can be mass produced at little cost. They have become part of the framework of innovation, and innovation, not the refining of the known, is now the driving force of wealth creation. Knowledge applied to work to create wealth is the predominate paradigm in our new world. In a sense this is nothing new. Joseph Schumpeter gave us the rule of creative destruction years ago and sang the song of the dynamic entrepreneur. This concept in and of itself formed a complete reversal of the earlier economics of the Cameralist in the late 18th century Germany who postulated that there were three ways to create wealth: by increasing the population, by mining, and by controlling foreign commerce. As economies change, often the conventional wisdom lags far behind reality. In today's world of rapid change will old maps and concepts of economic development help us to navigate the waters of a new economy, or will they prove to be as misleading as that map drawn by Gastaldi, the official map maker of the Venetian Republic, whose charts showed the "Strait of Anian," a body of water linking Hudson Bay with the Pacific Ocean? While the map was wrong as no such body of water exists, it nevertheless had a profound effect on accelerating the exploration of the North American Continent as one adventurer after another sought the fabled Northwest Passage in an effort to collect the huge prize offered by the British Admiralty. While strictly speaking there are no economic maps, we have learned the general shape of the economic landscape over the years.

It is fair to say that the new information/network economy clearly responds in some different ways than the industrial economy. Today the new rule of increasing returns developed by Brian Arthur, as opposed to the law of diminishing returns, seems as out of sync with conventional wisdom as did Schumpeter's dictums to the Cameralists' thinking. It used to be thought that scarcity created value and so that the more that was produced of a given item, the less value it would have in the marketplace. Just the reverse is now true in a network economy: one fax machine is worth nothing, indeed the technology lay fallow for twenty years. Two fax machines are worth something, but 1000 machines connected together create real value, and that value goes up as more and more machines are added to the network. The same is true of networked computers and every day more and more examples present themselves. Some mathematicians have proven, at least to their own satisfaction, that the sum of a network increases as the square of the number of members.

So in this sense more creates more instead of the old rule that value is created by scarcity. But while the new rule does in fact apply to the network economy, the old rule of scarcity also still works in some instances: witness the $9 baseball that Mark McGwire hit over the fence in St. Louis for home run number 70. There is only one such ball - the ultimate measure of scarcity - and it is now worth a fortune. So some times the old rules and the new can and do co-exist.

One of the big problems in sorting out the truth in economics is trying to find the words to describe a new situation. Novel situations call forth novel words. As the Agricultural Age was fading and the Industrial Society was being formed, a whole new vocabulary had to be invented to describe what was happening. Instead of seeds and crops and growing seasons, the world became familiar with terms like steam pressure, revolutions per minute, and assembly lines. As the Industrial Age fades, the development of the computer required the invention of new words like bits, bytes, CD ROM, and floppy disks to describe its workings. As digital science flourished and moved into the mainstream more and more things from music to literature were reproduced digitally. A "zero" and a "1" if properly arranged can now capture any product of the human mind. This process gives us an unreal sense of precision. While we now have the ability to rent a car at a distant airport equipped with a Global Posting System that will guide us unerringly to a hotel we have never seen, we still cannot put anywhere near the same of measure of reliance on any of our common economic measures.

To a certain extent the illusion of precision in things economic was perhaps first created by the French economist Leon Walras at the end of the last century. He was able to cast his thoughts on economics in mathematical formulas. Numbers always seem to be more definitive than words, and so his formulas tended to look more like a hard science than if he had used words alone. Today economic textbooks are full of formulas, but increasingly we are learning that the old paradigm is giving way to a new science of complexity. We are learning that instead of an item having large statistical value having great consequences, that a small, seemingly trivial event can over time create massive change. The so-called butterfly example illustrates the point. A butterfly flapping its wings in central China will affect the weather over Wisconsin many days later. In a rough sense it is a modern iteration of the old saw that for want of a nail the shoe was lost, and for want of a shoe the horse was lost, etc. Despite massive work done at the Santa Fe Institute and on many college campuses, predictions become more and more difficult. The chaos theory postulates that it is impossible to predict the weather, although we can predict the climate. The recent disastrous experience of some Hedge Funds illustrates the point. The global market today is the very model of what scientists call a complex adaptive system. These great complex systems are nonlinear and they tend to resemble biological rather than the mechanical systems of the past. Some writers like Michael Rothschild have gone so far as to state and argue "that a parallel relationship exists between an ecosystem based on genetic information and an economy derived from technical information..."[4]  The nineteenth century laws of physics on which Walras' formulas were based followed a mechanical model. Today it is fair to say that no economy behaves like a totally predictable machine, but rather like an ecosystem which is a complex adaptive system. It is for this reason that the talking heads on TV who explain why the stock market went up or down 200 points add nothing to economic knowledge but much to the art of creative writing. While this view of the economy as a kind of ecosystem has not gained wide acceptance among economists, it nevertheless seems to make great sense. The natural world runs itself, not always to the taste of some environmentalists, as many species die and disappear as new ones are formed. Similarly, with no central planning a global economic system has emerged. Like the ecosystem, it operates relentlessly and some features are criticized by people who long for a more orderly and predictable process.

This shift to an information-based global economy has had a profound effect on the way nations behave. When natural resources were the dominant factor of production, the conquest and control of territory seemed a reliable way to enhance national power. As recently as World War 11, armies fought and men died for control of the iron and steel in the Ruhr Basin because ownership of those assets conferred real economic and political power. Today these assets may constitute a liability. In the Industrial Age, plants became ever larger and less easy to move. Indeed as long as capital consisted largely of factories, heavy equipment and raw materials, there was little fear that these assets could or would move away, so the governments of the world held all the cards. In the new economy, intellectual capital becomes the dominate means of production, and it is highly mobile--it can and does move easily when the hand of government becomes too heavy or grasping. Money has always gone where it was wanted and stayed where it was well treated. It flees onerous restrictions and heavy-handed regulation. This old rule applies to both the old and new economies, but in the new economy dominated by intellectual capital it is even more important as there is nothing more portable and easy to move than intellectual capital which can walk, run or fly across borders as if they did not exist. The old metrics fail to measure this shift in value. Bill Gates, whose vision has created a company with one of the largest market capitalizations in the world, can walk by any customs agent in the world with "nothing to declare." His wife, however, may be assessed duty on her new ring.

Other perimeters are also changing rapidly. The old economy and its rules were generally framed by the borders of the nation state, while the new economy is intractably global. Indeed it is next to impossible to find a product that consists entirely of material and parts produced in one country. This extraordinary manufacturing system of value added in many countries is made possible by the fact that information moves across and over and through national borders as if they did not exist. The attempt by some nations from time to time to control some little bits of a market for its own advantage will fail even faster now than in the past. Today software written in India rides the satellite to a building site in Chicago or an accounting firm in New York, or anywhere else in the world. The writer requires no green card, no entrance visa or physical journey to earn his or her money. This phenomenon constitutes a new kind of economic organization and seriously changes the dynamics of how and where people can earn their money. It is possible to have full employment in some remote village even though no businesses are hiring people in that neighborhood, or even in that nation.

In the industrial economy it was common wisdom that direct labor--the people on the shop floor who produced the goods-- was the most productive, and the indirect labor of the technical and professional worker tended to be thought of as overhead. Today this perception is changing as information technology permits just in time inventory, direct shipments from supplier to store in response to signals created by the cash registers at the store's check-out counter. This same technology enables custom manufacturing on a mass basis of everything from men's suits to automobiles. The huge databases recording your individual preferences permit what has been called "marketing to one." In this sense the new economy is in fact truly new.

In the industrial economy, if your advanced the idea of making your company rich by pricing your product at zero and giving it away for nothing, you would earn very few promotions. In the new economy this tactic has created a whole new group of millionaires. Examples abound. Netscape gave away the first 40 million copies of its software. More recently Sun gave away its Java language, and both companies have prospered by establishing a standard and then selling upgrades or enhancements. Every newspaper you open carries an ad for a free, or nearly free, cellular phone or a free piece of software to open an online bank account -- all done in the valid expectation of making money on the future service to be provided. It is fair to say that this phenomenon is a function of the network economy and did not exist in the Industrial Age.

Not long ago the papers were full of pundits saying the beads for American productivity. America we were told was falling behind in the race for economic growth. The naysayers were wrong, because the metrics were wrong. As it turned out we were, and to a large extent still are using a measure that was designed for a different age. It is analogous to trying to describe how a computer's mother board works in term of boiler pressure and revolutions per minute. It just can't be done. Productivity was designed to measure input in and output out in the mechanical model. In a world in which some 80% of Americans work in the so-called service economy, the term is misleading at best. The current state of the art has no agreed measure of whether a computer programmer who works very rapidly but creates bugs in the software is more or less productive than one who works more slowly, but creates no glitches. When input is measured in labor and output in goods, productivity has real meaning although there is argument on the details. So far as I am aware no one has come up with a new word to describe a new measure for the new economy. When input is knowledge and not manual labor or money capital, and output is some kind of service, old methods of computing productivity no longer mean what they used to. Bad metrics produce bad decisions.

When all these facts, plus many more that almost overwhelm us, are weighed it seems clear that we have a new, and different economy. And this new economy has features that operate with new rules, rules that did not obtain in the old industrial economy.

That said, it is equally true that some old rules still apply. Markets go both up and down and mass psychology still plays an important role. The "invisible hand" Adam Smith wrote about in the 18th century still operates, albeit through the electronic network at near the speed of light. The market's functions, rules and results are unchanged, although the forum is changing and speed is much greater. The reason some of the old rules survive in this new world with new rules is because the old ones were based not only on economic dogma, but on human nature. And human nature is unchanged. What Adam Smith described as "The natural effort of every individual to better his own condition" motivates the people who drive the new economy just as it did the old. But the manner in which one achieves this result has changed dramatically.


[1] Kelly, Kevin, "The New Rules for the New Economy," Wired, Sept. 1997

[2] Stigler, George J., The Economist as Preacher, Univ. of Chicago Press, 1982, p 61

[3] Gilder, George, "Gilder Technology Report," August 1998

[4] Rothschild, Michael, Bionomics, Henry Holt and Company, 1990, p xiii

  • The document was created from the speech, "Rules for a Wired World," written by Walter B. Wriston for the Manhattan Institute for Policy Research on 6 October 1998. The original speech is located in MS134.001.014.00002.
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