Eli Noam is a professor of economics and finance at the Columbia Business School, as well as director of the Columbia Institute for Tele-Information (CITI). CITI is a research center that concentrates on strategy, management, and policy issues in telecommunications, computing, and electronic mass media. His WTF 2004 comments on market failure in the media sector focused on the volatility of information-based markets, how a series of successes can still lead to failure, and why the economics of information might not improve. What follows is a partial transcript of his talk.
I’m directing a Columbia institute. We’re not commercial. We don’t do work for anybody. In this environment, people get very nervous about who do you work for. I’m also writing a column for the Financial Times online edition, which I think led to my being here. Some of the things I’ve written about in the last few months included a piece called “Let Them Eat Megabits” and “Why the Internet is Bad for Democracy.” That piece almost got me excommunicated. We all believe in democracy. We all believe in the Internet.
What I’m interested in, though, is not getting from here to there but what will happen when we get there. I’m interested in longer-term, fundamental impacts of new technology. It’s not that I’m a luddite, but economists make a fundamental difference between micro and macro impacts. If you’re standing in a parade and can’t see very well, if you stand on the tips of your toes to get a better view, thats micro. But if everyone else does this, doesn’t see any better, and is uncomfortable, that’s macro.
The entire information sector is in a fundamental structural crisis. The sky was the limit for a number of years. Products were plentiful. Process was cheap. Convergence was innovative. Now, we know about the Internet crash, the dotcom bubble, the telecom crisis, the advertising dump, the semiconductor slump, and the R&D crisis. Why do all of these things sweep over information?
A few weeks ago, I was going around some very industry-specific meetings and heard a lot of complaints by CXO people. Everyone directed the problems to their own industry. But it hit me, just as we’re going to have a convergent digital industry, we’re going to have a convergent digital headache. The problem is not only the information industry’s. Every industry has information problems and are unstable.
There are two explanations. The first, the Perfect Storm scenario, is that it’s caused by a gloomy economy, greedy investors, bumbling managers, and gullible journalists. Such confluence is not likely to happen again for a good time. This view, as populist as it is hopeful, is also one of denial. Of course things will come back. That’s not the end of the story. We need to look at fundamental instability. Convergence has been accelerating that instability. Everything is now subject to some form of a gigantic market failure in slow motion.
Market failure exists when market prices cannot sustain a market structure. The failure of the entire market segment has far-reaching, fundamental effects. We are causing it because we are so successful. The information product has high fixed cost, cheap distribution, economies of scale with incentives to oversupply, and commoditization. Prices for content and network distribution are collapsing across a broad front. It’s become difficult to charge anything for information products and services. That’s a symptom of a chronic price deflation that shows no sign of abating. That’s good news for consumers and bad news for providers. The price is approaching marginal cost, which can near zero.
The tools are all there. Arbitrage removes the ability to maintain prices. But there’s more trouble ahead. With convergence, the sub-industries in the information sector affect each other more than ever before. The swings of the overall economy were the swings of the sub-industries. Before, those were relatively dependent. They’re much more interdependent now. The collapse of Web sites affects tech magazines, which affects telcos and R&D.
The information industries themselves go through boom and bust cycles. As information is commercialized and commodified, it becomes prey to price models of other commodities. So people outsource to cut costs, use new processes, break up the value chain, personalize, and bundle to get out of the commoditization trap.
The key strategy is to innovate and differentiate, but that’s not something everyone can do. People’s attention does not increase at the rate of Moore’s Law. You can’t run an entire economy on niches. That’s the embarrassment of niches. So people will consolidate to maintain prices. As a result, hopefully, prices will rise, which will lead to expansion, entry, and a new price collapse.
Those fluctuations can be exacerbated by credit cycles. The price deflation will also drag down the rest of the economy through a multiplier effect. Look at offshoring. It’s led to the collapse of international telecom prices. The losses of manufacturing and white collar jobs in the U.S. are the collateral damage of investments that have bombed. Even in large markets, tiny prices and tiny price margins may not turn out to be profitable.
Information economies are more volatile economies. What are the policy implications? Long-term efforts are still victim to the instability and the tragedy of the commons. Therefore, governments will be drawn into stabilization. That’s not a recommendation. It’s a prediction. Governments are in the business of giving people stability. Even if the pressure for government to do something is there, it’s easier said than done. Government strategies are industrial era strategies. The problem is not inadequate demand. In fact, demand is booming even at the slow-growth rate of the last few years. It’s the prices that are the problem. Oversupply, competition, and structural price deflation is the problem.
We could let industries become more consolidated to reduce competition. That would need to happen internationally. But in the end, that might not work very well at all. So what should government do? Look at an economy as an investment portfolio and not put all your eggs in one basket. The success of such a strategy exposes the entire national economy to increased volatility and disruption. Take Finland as an example. Nokia doesn’t even account for the secondary effects, the restaurants that feed their employees, their houses. If telecom becomes week, the whole country would be affected. Investors have already moved away from smart industries and information industries to low-tech industries, even dumb industries and manufacturing industries that are information rich.
I don’t think any of the policy efforts will work very well. In some ways, the notion that an information-based economy will be inherently prosperous must be reconsidered. Yes, information wants to be free. Now we have to cope with the consequences. That’s not a fun conclusion for me to reach. I am usually optimistic. But I am an economist, and they do call it the dismal science. We need to pursue creativity, but we have to have the foresight for obstacles ahead and avoid the hype of previous years.