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Created 2000-04-04
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What Is Truly "New" About Our "New Economy"?

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

An (early) draft of a column for Fortune.

It is not that productivity growth is extraordinarily rapid. Measured productivity growth is no faster than in the 1960s. The gap between true and measured productivity growth may be larger today than in the 1960s, but it may not--in its day the coming of TV was a very big deal--and we have no reliable speedometer with which to tell. High rates of return on investments in technology are not guaranteed, for high profits persist only if sustained by strong barriers to entry--and the new economy brings reduced barriers to entry and increased competition as part of its new technological capabilities.

What is truly new and special about our "new economy" is the new business ecology--the pattern of organizing the business of launching new technologies--that has grown up in Silicon Valley over the past generation. Even after the end of the current cycle, even if the current cycle ends in a full-blown stock market crash, much of research and development will still be handled in a new way: the business of commercializing new technologies will still be rapidly spun-off into new companies, engineers will still be motivated by stock options, venture capitalists will still trawl for good ideas, and new technologies will still be launched into the marketplace in a small fraction of the time that product development cycles used to take. As Venture Law Group principal Tae Hea Nahm has argued, the organizational capabilities and modes of thought that have been created will still be vibrant and useful even if Wall Street ceases to be so eager to snap up IPOs.

We often tend to forget how different this new business ecology is from the way things used to be. But the executives and innovators who grew up under the old system remember. Michael Hiltzik's book _Dealers of Lightning_ reports on Adobe Systems' cofounders John Warnock's and Charles Geschke's days at Xerox's Palo Alto Research Center. As Warnock remembers it: "Chuck Geschke and I had a conversation in his office and said, 'You know, we need to go do something else, because we've spent two years of our lives trying to sell this thing [internally] and they're going to put it under a black shroud for another five.'" But at the time the bureaucratic system of Xerox had its rationality. With long product development cycles, little in the way of channels for testing new products, and high costs of ramping up to full-scale production, even a Xerox could not afford to introduce many new technologies. So it made sense to pit ideas against each other internally in a bureaucratic tournament, hoping that the fittest would survive the gauntlet.

Moreover, at the time the bureaucratic system at Xerox had--and this was not clear to me until I read Clayton Christensen's brilliant _The Innovation Dilemma_--a necessary irrationality as well. A strong, competent, successful organization It was also a place where the launch of a disruptive technology was likely to be hobbled. Such a technology means that old divisions shrink and old customers are told to buy new products. But the more competent are the engineers and managers running the old divisions, the greater is the number of reasons--good reasons--they will think of that the new technology won't work. The more the company listens to its customers, the less will it be open to engineers proposing radical shifts. The things that had made Xerox successful made it hard for it to adopt disruptive technologies.

Warnock's and Geschke's company, Adobe Systems, came in the early days of our new business ecology. They were in perhaps the second generation of development of what we now see as the Silicon Valley System: rapid prototyping, short product-development cycles, early test marketing, options-based compensation, venture funding, early corporate independence, and so forth. It seems to be a highly successful system for launching new technologies into the marketplace.

How much of this Silicon Valley System could have been developed at more or less any time in the past half-century? I am becoming convinced that the answer is "not much." The late nineteenth century railroad would have been next to impossible to manage without the telegraph, and the pre-telephone investment bank of the original J.P. Morgan could only function if all the partners worked in one big room where they could talk to each other.

In a similar manner the decentralized venture-startup system of today's Silicon Valley is an extraordinarily heavy user as well as a creator of our modern information and communications technologies. Their ability to peer inside firms--and the ability of firms to communicate their detailed needs and practices to others--relies heavily upon the technologies that have been developed. Thus it is hard to see how this particular system could have been possible before their invention.

But now that this model is possible, it'll likely endure. That's because in the last analysis the Silicon Valley system doesn't rely on making a short-run killing off of a successful IPO. Instead it seems likely to be a better business ecology, and a more productive set of processes for rapidly developing and commercializing new technologies, in the long run. Amid all the hype is something truly new.


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For what it is worth, most of my friends who are not residing in NYC generally seem to feel that a Fortune column has more impact than a New York Times Business Section column. I am still uncertain, but I thought I would pass it along.

Contributed by Anonymous (anonymous@nowhere.org) on April 13, 2000.


Dear Brad,

I enjoy your e-mail column and found your recent article Speculative Microeconomics in First Monday very useful. In your column today you refer to Clayton Christensen's Innovator's Dilemma; disruptive technologies......but I think the real enabling power is disruptive ideas, for these have a different time dimension and we are moving into a virtual world where space is not limited. This changes organizational relationships with consumers and markets. Organizations must now focus on facilitating the evolution of markets. Organizations that mediate space or seek control of closed data-mines will fail.

Thus I've recently had a go at a possible new ecology; one in which communities of consumers take control of their personal information assets. The knowledge economy is changing information asymmetries in favor of consumers. I've captured this in "The COMsumer Manifesto", published at http://www.firstmonday.org/issues/issue5_5/h enshall/index.html I've had some very positive feedback and looking for both new opportunities, ways to test it and input into COMsumers.

I'm not an economist, but a marketer. I'd certainly appreciate any thoughts / comments you might have.

Best regards

Stuart Henshall GBN Global Business Network 510-547-6822

Contributed by Stuart Henshall (henshall@gbn.org) on May 13, 2000.


At 03:19 AM 5/11/2000 +0000, you wrote:

What Is Truly "New" About Our "New Economy"? An (early) draft of a column for Fortune...

***... High rates of return on investments in technology are not guaranteed, for high profits persist only if sustained by strong barriers to entry--and the new economy brings reduced barriers to entry and increased competition as part of its new technological capabilities.***

Actually, this is only true about the *relative* rate of return on tech investments vs. other investments. It is possible, though I admit far from likely, that tech returns will be so huge as to drive so much capital into tech on the margin all investments get the same high return.

***How much of this Silicon Valley System could have been developed at more or less any time in the past half-century? I am becoming convinced that the answer is "not much." The late nineteenth century railroad would have been next to impossible to manage without the telegraph, and the pre-telephone investment bank of the original J.P. Morgan could only function if all the partners worked in one big room where they could talk to each other.

In a similar manner the decentralized venture-startup system of today's Silicon Valley is an extraordinarily heavy user as well as a creator of our modern information and communications technologies.***

This doesn't fit with my experience in silicon valley. The reason it is a valley and not a nation is that people have to live near each other for it to work, so they can meet a lot and talk a lot in person. I'm not sure new comm techs have that much to do with it.

Contributed by Robin Hanson (rhanson@gmu.edu) on May 24, 2000.


Dear Dr. Delong: June 10, 2000

I read your article on p.36 in May 29 Fortune magazine and had a few comments about your "business ecology" construct. As in most "macro" systems, they are made up of "micro" events which, taken together, tend to define the whole. The underlying reason for the competitive advantage of start-ups over large public companies (or small public companies) and their respective abilities to take risks on new technologies, i.e., research (not development), is simply an accounting and earnings expectations problem. For public companies, research funding is expensed in the current quarter (even though the pay-off may be years away) and directly subtracts from reported net income. This negative pull on earnings impacts the P/E of the stock and all the unfortunate consequences that follow from that, mostly stimulated by stock analysts waiting to make their next upgrade or downgrade. In other words, the fear of change you mention which existed in a Xerox isn't the real issue. I have been doing R&D for large public and small private technology-based companies for 25 years--and the risk-averse behavior of the large public companies could always be traced back to what effect on earnings a new research initiative would have. At the small private company the research funding was much more available for "outside the box" projects and real research was possible--the kind of research which leads to truly breakthrough products. Venture capital-backed technologies at start-up companies have a much better chance of success since the process is very focused and fully funded unfettered by net income imperatives which exist at public companies. If you doubt my view, I was personally told by a vice-chairman of a very well known medical device firm (public) for which I worked 6 years (as my research project was about to be canceled), "If you can figure out a way to get your project funding off the P&L it will be funded". In other words, the selection of research projects had more to do with accounting than with merit (my project concept is now being pursued by at least a half-dozen start-ups presently).

A possible solution? What abount the option of capitalizing research (not development). Would that help public companies be more risk tolerant? I think it might help. The current venture-capital "ecology" is largely an artifact of a structural disadvantage of public companies based on their accounting principals. I am not hopeful things will change. The tail is wagging the dog.

Regards,

Contributed by Eric P. Berg (EPBMNCOM@aol.com) on June 19, 2000.


To: thomas b patterson From: Brad De Long Subject: Re: Summers San Fran. speech Status:

>Dr. Delong,
>
>Great website, thanks a lot! I was wondering if you know how to get a transcript of Larry Summers speech "The New Wealth of Nations" he presented last month. The topic was covered in today's WSJ (6/9) and sounds very interesting. Unfortunately, I haven't been able to find the speech anywhere so far.
>


I found a version of it at:

http://www.treas.gov/press/releases/ps617.htm

I also heard Larry give a version of it that seemed to me to be more interesting than the official text. My notes from his talk are attached below:

Five points on the new economy:

1. In the information age, big markets are the best markets 2. In the information age, our best resource is our people 1. Resources for education 3. Needed: a proper system for innovation 1. As important as IP protection is... 2. As important as VCs are... 3. ...knowledge is a sequential process of discovery 4. ...you can't build new knowledge on top of old if old knowledge is closely held and guarded 5. ...hence the critical importance of the public role in research and development 4. Markets need to be adequately regulated so that they serve customers 1. Competition policy 2. New technologies bring new challenges 1. Privacy 1. I want people to know I'm a tennis player so they can try to sell me tennis stuff 2. I don't want people to construct a detailed personality profile of me based on all the checks I've written over the past decade

3. Need to make sure there's no "race to the bottom" in the use of new technology 5. Include everyone 1. No excuse for not including everyone today, when in this economy we don't have people looking for jobs, we have jobs looking for people. 2. Inclusion not just necessary for the nation, but good for the nation's businesses 3. 25% of Black American families don't have bank accounts, and spend $15,000 over their lifetimes in check-cashing fees

Contributed by Brad DeLong (delong@econ.berkeley.edu) on June 19, 2000.


Dear Brad:

My old graduate school classmate Dave Mowrey recommended that I check out your work when I asked him who was writing good stuff on the "new" economy. I downloaded and read "Tools for Thought" and enjoyed it very much. I have passed it on to several of my colleagues as one of the most thoughtful pieces I've seen on the subject. I had been looking for someone to put the current situation in historical context, which is what prompted my original question of Dave Mowrey.

I do have one very minor suggestion on the text of "Tools for Thought", in the usage vein. As one who grew up in Hawaii, my understanding is that "tsunami" is, literally, Japanese for "tidal wave." If so, that puts the usage "tsunami wave" in the same class as "Rio Grande river" and "Sierra Madre mountains."

Regards, Peter Jaquette

Contributed by Peter Jaquette (peter.jaquette@weyerhaeuser.com) on September 1, 2000.


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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
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