Arnold Kling  

Internet Bubble and Growth

Surveys Vs. Revealed Preferenc... Defending Imperfect Markets...

Brad DeLong argues that the failure of many Internet-based enterprises does not imply a social loss.

profits are not the same thing as social value...Profit is primarily a signal about the size of a set of enterprises: If too small, then customers are desperate for your products, prices are high, and profits abundant; if too large, then customers are satiated, you can barely give the stuff away, and profits are absent. If profits are high, the industry segment should grow; if absent, it should shrink.

That the dotcom and telecom sectors needed (and need) to shrink has next to nothing to do with how useful their products will turn out to be. The US airline industry is a perpetual loss machine. Yet the service it provides the rest of us is incredibly valuable.

The question of whether the Internet Bubble was good or bad for economic growth will be debated for some time. Another optimistic picture was painted by Steven Johnson.

What the bubble did do, though, is popularize the medium at an unprecedented pace, and explore the possibility space of interesting Net-based models with incredible precision. My 89-year-old grandmother one-click shops on Amazon via her cable modem. Would she even be using email now if it weren't for the bubble? I doubt it.

Economists taking the contrary position include Stephen Roach of Morgan Stanley, who wrote that

the bubble-induced boom of business capital spending led to an overhang of new information technologies and other forms of capital equipment in the late 1990's. The result was excess supply, a textbook recipe for lower prices.

...History tells us that when major asset bubbles burst, deflation is often the result.

Another negative assessment comes from D. Quinn Mills:

There would have been a better economy and you wouldn't have had the economic recession we're in now with the risk of a substantial decline behind it. So you would have simply have had better economic growth. [The Internet bubble] did not contribute to the success of the American economy during [the 1990s]. In fact, if anything, it constrained it.

For Discussion. Mills is saying that the opportunity cost of the investment in Internet-related companies was investment that might have been made in other industries where it might have earned a decent return. Others might argue that the opportunity cost was low because the resources otherwise might have been unemployed or allocated to consumption instead of investment. Do you think that the Internet bubble took resources away from more productive investments?

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COMMENTS (2 to date)
Jake writes:

First, its good to see that the question posed is more nuanced than a simple "internet bubble - good or bad". The internet bubble is a dramatic lesson in human nature, mass psychologies and manias. The overinvestment into the internet bubble was the result of excellent initial returns that demonstrated true value in the sector. Unfortunately, the world's best and brightest followed this up with dubious businesses designed to exploit the inherent weaknesses in our capital markets (underregulation, valuation obsfucation and management v. shareholder agency conflicts). That being said, I think the answer is more complex than whether or not the bubble took away resources from *more* productive investments. I believe that it did. As an investment banker that worked with both technology and *non-technology* companies, I saw the excess capital that poured into technology, and abandoned more traditional (and stable) businesses. However, I would note that there has been so much excess capital to be invested, that even traditional businesses had access to capital during the tech boom. (Just not at the generous valuations afforded technology companies.) While I don't have specific statistics to back it up, I believe that the amount of capital available to all businesses rose substantially during the period before and during the bubble. I guess I would say that it was more of a case of tech companies experiencing excess capital than a dearth of capital to traditional businesses. I think everyone would agree that the valuations assigned to technology sector were excessive and the people who made that mistake are paying for it.
The real disruption in my mind is the effect the bubble is having on the investment public that has been whip-sawed by returns in the equity markets for the last five years. This will definitely affect the public's risk tolerances and that may have significant effects on the future of capital formation for new businesses in the future.

Eric writes:

If the Internet bubble *constrained* economic growth, what the heck would the growth rates have been without it?!? And what was the cause of the spike in economic growth, especially in 1999 and the beginning of 2000?

The Internet Bubble is a very conveniant explanation for why growth was so strong at the end of the 1990s. If you're going to say that it wasn't the cause, then you have to give a better explanation for why growth took off.

I can think of a couple of reasons. Captal gains tax cuts for one, and the elimination of profits on the sale of homes from taxation for two. Those are biggies. The Asian crisis probably helped more than anyone is willing to say. While it killed our export sector, it resulted in a collapse in commodity prices that helped boost the domestic US economy. I was filling my gas tank for $0.89 a gallon in 1998. That freed up a lot of money to mess around with computers.

Newt Gingrich doesn't get enough credit. Like him or not, he and the Republicans of 1995 restrained federal government spending to the point where the growth of government spending fell below the growth of tax revenues, probably for the first time since the 1920s. If you want to know where the surplus came from, look no further.

There could be so many reasons. Maybe we should reject the Internet Bubble theory simply because it is too conveniant and blinds us to the many other factors that explain the spike in economic growth.

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