How the Tech Boom Terminated California's Economy

However comforting it might be to blame Southern California's movie industry for unleashing Governor Terminator on the state's economy, the real seeds of the current crisis were sewn further north, in the seemingly prosperous corporate parks of Silicon Valley. In fact, the dot.com boom and subsequent, inevitable bust are the real causes of our economic malaise. For while Californians were hit first, hardest and most directly by the rise of dot.com-style capitalism, the rest of us are soon to follow.

Put simply, California cannot afford to pay its bills because its tax base contracted at the same time as its investments tanked. Like any of us contending with the double-whammy of lower pay and shrinking portfolios, the state is getting slammed on both income and savings at the same time. Unable to secure credit, the state will instead be forced pay its bills to citizens and local governments with IOUs.

While the pundits point to real estate speculation and bank insolvencies as the chief cause of California—and the nation's—financial distress, these are both direct results of the late 90's explosion of computer innovation and Internet proliferation. That's right: The Internet crashed the economy.

First, and most obviously, the Internet served as a shiny new calling card for an already-exhausted equities market. The biotech boom of the 80's had failed to spawn a successor, recession appeared interminable, and the emergence of the Internet provided a new "story" through which speculators could be encouraged to buy stock.

The dot.com boom was among the largest collective investments in American history, leading to a near doubling of stockholders—and quadrupling of the NASDAQ index. Where did all this money come from? It was printed by the Fed and then loaned by banks, who used the good times to justify more highly leveraged rates of borrowing, themselves.

Problem was, the dot.com industry—while certainly fun and wonderful—could not support this level of investment. There just wasn't so very much more profit in doing things with chips and wires that used to be done with paper and people. Thus, the crash.

In an effort to orchestrate a soft landing, Alan Greenspan looked for someplace all the money printed for the dot.com boom to go. Real estate was the obvious choice. Banks were enabled to stay in the leveraged lending business, and homes became the asset class to fill in for Pets.com and Lucent.

The real estate crash is really just the second leg of the dot.com crash—the failure of housing to absorb the tremendous cash surplus generated by the irrational exuberance of Internet investors.

And it actually goes deeper than this. The Internet is even more directly at fault. The fact is, most Internet businesses don't require venture capital. The beauty of these technologies is that they decentralize value creation. Anyone with a PC and bandwidth can program the next Twitter or Facebook plug-in, the next iPhone app, or even the next social network. While a few thousand dollars might be nice, the hundreds of millions that venture capitalists want to—need to—invest, simply aren't required. Entrepreneurs who do accept such exorbitant funds do so knowing full well that they won't get paid back. The VCs investment is the entrepreneur's exit strategy.

The banking crisis began with the dot.com industry, because here was a business sector that did not require massive investments of capital in order to grow. (I spent an entire night on the phone with one young entrepreneur who secured $20 million of capital from a venture firm, trying to figure out how to possibly spend it. We could only come up with $2 million of possible expenditures.) What's a bank to do when its money is no longer needed? Especially when contraction is not an option?

So they fail, the tax base decreases, companies based more on their debt structures than their production fail along with them, and we get an economic crisis. Yes, the Internet did all this.

But that's also why the current crisis should be seen as a cause for celebration as well: the Internet actually did what it was supposed to by decentralizing our ability to create and exchange value.

This was the real dream, after all. Not simply to pass messages back and forth, but to dis-intermediate our exchanges. To cut out the middleman, and let people engage and transact directly.

This is, quite simply, cheaper to do. There's less money in it. Not necessarily less money for us, the people doing the exchanging, but less money for the institutions that have traditionally extracted value from our activity. If I can create an application or even a Web site like this one without borrowing a ton of cash from the bank, then I am also undermining America's biggest industry—finance.

While we rightly mourn the collapse of a state's economy, as well as the many that are to follow, we must—at the very least—acknowledge the real culprit. For digital technology not only killed the speculative economy, but stands ready to build us a real one.

Douglas Rushkoff is the author, most recently, of Life Inc.: How the world became a corporation and how to take it back.

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15 Comments

  • Nick Fitzpatrick

    Blaming the dot com boom for the failing economy may be the best way to go. There are many businesses all over the world, not just in California that are victims of the internet. casino online

  • Robert Einspruch

    If this article had a bit more polish you could call it poorly written and poorly researched. There are too many things to point out, but what does the following statement mean?

    "The banking crisis began with the dot.com industry, because here was a business sector that did not require massive investments of capital in order to grow."

    The next sentence is anecdotal and then the next paragraph jumps to the conclusion. Wow! Banks have never been part of the VC/startup equation. If they were, Facebook would have taken out lines of credit instead of raising multiple rounds of capital.

    What an odd article. C'Mon Fast Company!

  • Iggy Dalrymple

    Don't blame Arnie and don't blame the internet. It was just another cyclical bubble, exacerbated by do-gooder politicians pushing lenders into bad loans. In 50 or 60 years, when this is a dim memory, there will be another whopper.

  • Richard Lipscombe

    Douglas Rushkoff understands the real impact of our transition from an analogue to a digital economy and thus he has explained it very well.

    The digital economy is a networked economy - amazingly this is not a new phenomenon because in the 1950s Tupperware built a "micro networked economy" with its home-based sales, customer service, viral marketing,innovative feedback loops, etc. Tupperware Parties were the core element in a devolved company structure. It worked then much as web-based enterprises like Threadless, Linux, Google, Twitter, Facebook, etc work today but Tupperware worked long before the world wide web came to town.

    The essence of difference between analogue and digital technologies as instruments for organising economic activity is the former is "exclusive" and the latter is "inclusive". The analogue economy builds value by excluding everyone who does not pay the price set in a long line of so called "value adding" processes. Most of these processes do little or nothing to enhance the product or service yet they add costs to the consumer. Value adding is a strange concept in today's world because it belongs to a bygone era of urban industrial production - auto manufacture being the prime example. Alfred Sloan (GM) built a management system for autos that later spread to banking (yeah banks) wherein each person who did something in the process of producing, marketing, selling, servicing, etc a product or a service was deemed to be "value adding".

    In a digital economy "value adding" has been replaced by the simple and much longer lived notion of "use value". The process of exclusion - ie you are excluded from consuming until you pay a price for entry or for your consumption rights - is being replaced by the process of inclusion wherein the product, platform. or protocol (for example Google Wave) is free unless or until you have some remarkable or customised wants and needs.

    Douglas is correct the old analogue economy is dead - long live the new digital economy.

  • David Beckemeyer

    "Anyone with a PC and bandwidth can program the next Twitter... the hundreds of millions that venture capitalists want to--need to--invest, simply aren't required."

    What a crock. This myth has hurt a lot of people and it needs to end. There is a big difference between "a few thousand dollars" and "hundreds of millions" of dollars in investment. Whether you call it "venture capital" or not, most startups need at least enough cash invested to pay a few people and their service providers until their exit or until they reach positive cash flow (which neither Twitter nor Facebook has done yet) - that's going to take A LOT more than "a few thousand dollars."

    Your example of Twitter is hilarious because they've burned a large amount of cash and have huge operating expenses, independent of salaries, for their SMS telecoms bills, for example. "Anyone with a PC" might think up Twitter, and even code it, but as @Bjorn said, they are not going to be able to operate it as a business.

  • Harry Otsuji

    Thanks for your insighful analysis about the truth and consequences of California's current economic plight, which will apply to the rest of the nation. Clever and powerful policy makers,politicians,financiers and others cannot for long defy economic principle which have been applicable to humankind from the beginning of time, without having to pay the piper. Unfortunately, the rest of us suffer the unpleasant conseqences along with the perpetrators, to the extent and egregiousness of previous profligacy. Ultimately the debits and credits will be balanced, painful as it may and will be. Just ask Mr. Madoff!

    Faithfully yours,

    /s/ Harry H. Otsuji

  • Gregg Oldring

    Although the economic analysis is more than suspect, I loved this bit: "The fact is, most Internet businesses don't require venture capital. The beauty of these technologies is that they decentralize value creation. Anyone with a PC and bandwidth can program the next Twitter or Facebook plug-in, the next iPhone app, or even the next social network. While a few thousand dollars might be nice, the hundreds of millions that venture capitalists want to--need to--invest, simply aren't required. Entrepreneurs who do accept such exorbitant funds do so knowing full well that they won't get paid back. The VCs investment is the entrepreneur's exit strategy." This has been my experience with most so called Internet entrepreneurs.

  • Scott Hollander

    Let no one forget that after 9/11 the flow of talented folks from India and other parts of the world went down to a trickle as we made it more difficult for folks with foreign sounding names to come to this country and feel welcomed. Also, their native countries, especially India, made it easier for them to start up and build their companies with new technology at "home". Part of it is the law of unintended consequences

  • Scott Hollander

    Let no one forget that after 9/11 the flow of talented folks from India and other parts of the world went down to a trickle as we made it more difficult for folks with foreign sounding names to come to this country and feel welcomed. Also, their native countries, especially India, made it easier for them to start up and build their companies with new technology at "home". Part of it is the law of unintended consequences

  • Scott Hollander

    Let no one forget that after 9/11 the flow of talented folks from India and other parts of the world went down to a trickle as we made it more difficult for folks with foreign sounding names to come to this country and feel welcomed. Also, their native countries, especially India, made it easier for them to start up and build their companies with new technology at "home". Part of it is the law of unintended consequences

  • Scott Hollander

    Let no one forget that after 9/11 the flow of talented folks from India and other parts of the world went down to a trickle as we made it more difficult for folks with foreign sounding names to come to this country and feel welcomed. Also, their native countries, especially India, made it easier for them to start up and build their companies with new technology at "home". Part of it is the law of unintended consequences

  • Scott Hollander

    Let no one forget that after 9/11 the flow of talented folks from India and other parts of the world went down to a trickle as we made it more difficult for folks with foreign sounding names to come to this country and feel welcomed. Also, their native countries, especially India, made it easier for them to start up and build their companies with new technology at "home". Part of it is the law of unintended consequences

  • Michael Lum

    @ Bjorn I think you're missing the point. Building a website takes resources like anything else, but the Internet has still dramatically reduced the expenses associated with developing a business idea. You don't need factories, and you don't need tons and tons of workers. Just look at Twitter - 43 employees, yet it's made an impact across the world, not to mention its effect on politics (eg. Iranian election).

    Yes, there's no such thing as a free lunch, but one could say lunch on the whole is getting cheaper.

    --
    My Blog on Society/Technology:
    http://www.mikailum.com

  • Bjorn Tipling

    "nyone with a PC and bandwidth can program the next Twitter or Facebook plug-in, the next iPhone app, or even the next social network. "

    More like:

    "Anyone with a PC and bandwidth can write an ignorant article".

    Building a scalable website takes many full time engineers and designers, who don't pay for their mortgages and expensive gadgets and cars with peanuts, and also project management and a whole host of other resources, none of which is free. So excuse me while I laugh at your article.