The Facebook economy

By R.A. | WASHINGTON

ROSS DOUTHAT revels in the disappointing Facebook IPO and takes the opportunity to slam the economic impact of the internet. His column gives me an opportunity to push back a bit at those questioning the contribution of the current tech boom to real growth. Here's the takeaway:

Despite nearly two decades of dot-com enthusiasm, the information sector is still quite small relative to other sectors of the economy; it currently has one of the nation's higher unemployment rates; and it's one of the few sectors where unemployment has actually risen over the last year.

None of this makes the Internet any less revolutionary. But it's created a cultural revolution more than an economic one. Twitter is not the Ford Motor Company; Google is not General Electric. And except when he sells our eyeballs to advertisers for a pittance, we won't all be working for Mark Zuckerberg someday.

This badly misunderstands the economic impact of the internet. A few points.

First of all, I think it's worth considering just how wrongheaded is criticism of Facebook as a flop. By now, the pure unoriginality of Mark Zuckerberg's idea is legendary. Not only did he possibly maybe borrow the idea for Facebook itself from would-be co-founders, but his social network followed in the path well-worn by sites like MySpace and Friendster. Mr Zuckerberg's extraordinary accomplishment, and it is extraordinary, was to take the prosaic idea of a place to hang out online with networks of friends and turn it into a profitable, billion-dollar company that employs thousands of people. That's amazing! So successful has Mr Zuckerberg been that he has actually confused people into thinking that Facebook is the apotheosis of the new internet economy, rather than just a particularly successful diversion. That's like imagining that the big hit of the industrial revolution should have been a company that made money giving tours of factories.

Which brings me to a second point: the web is a general-purpose technology, like electricity. Maybe some people imagined that the arrival of the web would launch an internet economy in which we all worked for internet companies producing internet. That's akin to a belief that the development of electricity should have given rise to an electricity era in which we all worked for electrical companies making electricity. Of course, there were big, successful electrical companies, just as there are big, successful internet companies; Google, the best example, is a hugely profitable, enormously valuable firm that employs tens of thousands of people. But the web, like electricity, is mostly a means to make the rest of the economy vastly more productive. Mr Douthat thinks he's making a killer point in writing:

It's telling, in this regard, that the companies most often cited as digital-era successes, Apple and Amazon, both have business models that are firmly rooted in the production and delivery of nonvirtual goods.

No kidding! Was someone arguing that we were going to begin eating applets? What Mr Douthat is missing is that companies like Apple and Amazon embody the economic power of the web in transforming existing industries, like media and retail. This will only continue as we become better at learning how to deploy the power of the web. Ultimately every company, from food co-ops to banks to manufacturing firms, will be an internet company, relying on the web to guide production, market, sell, and distribute goods.

That takes us to a third point, which is that people mistake the impact of the internet economy because they are confused about the meaning of scale in economics. The size of the large firms of the past was a function of technology, not of economic impact. It was a function of the technology of shipping, which made it attractive to focus industrial production in massive agglomerations. It was a function of the technology of production, which made it possible and necessary to employ thousands of workers at high wages turning out enormous production runs. And it was a function of the technology of communication and organisation, which made it attractive and necessary to locate much of a long supply chain in one firm under one roof, rather than across hundreds of firms and tens of countries.

Technologies have changed. It has become vastly easier for very small firms to coordinate production of highly tailored products as part of extended supply chains. The internet is part of the process of technological change that has enabled this shift. The shift itself is not indicative of a lack of economic importance. It is less impressive to some when someone supplements their income by selling niche products through Amazon than when Henry Ford builds the River Rouge plant. Not to me. What the internet is accomplishing is a huge increase in the extent of the marketplace for many different kinds of goods and services. That increase allows for extraordinary levels of specialisation and trade, which are facilitating a step change in the efficiency of economic activity. Focus on the size of the markets rather than the size of the firms or the factories, and you begin to see the internet economy in a somewhat different light.

Then there is a fourth point, which is that the jobs of the internet economy are more impactful at the local level than is manufacturing work. Adam Ozimek writes:

Ross complains that Facebook, and the internet sector in general, don't create many jobs. But as Enrico Moretti emphasizes in his book The New Geography of Jobs, the importance of the innovation sector is not just how many jobs they create directly, but how many jobs they create indirectly. Most of the jobs in an economy are local services. Increasing earnings in innovation and other tradeable sectors raises spending in non-tradeables sectors like services, and thus increases jobs and wages there. People sometimes dismiss talk of indirect jobs as PR, and done incorrectly it sometimes is, but Moretti is a serious academic economists and he is correct here. His research suggests that every new manufacturing job creates 1.6 jobs in the local service economy. But in the innovative sector the corresponding effect is more than three times larger.

There is a reasonable critique to be made of the internet economy, to which Mr Douthat glancingly refers in mentioning Tyler Cowen's book "The Great Stagnation". Mr Cowen makes the point that the highly educated rich are better able to capture both the producer and consumer surplus associated with the internet economy. The web, in increasing the extent of the market, amplifies the superstar effect; the difference in earnings between great producers and the best producers, who dominate the global market, is enormous. As supply chains break up, it may become easier for knowledge workers to capture much of the value-added in a product or service; designers and inventers with original ideas can capture monopoly returns to those ideas while sourcing production to workers in a highly competitive manufacturing sector. Apple employees get rich; manufacturing employees earn their marginal product. And educated workers may benefit most from the flow of cheap information over the web. The problem with the internet economy isn't that it is unimportant or jobless, but that its benefits are highly unequal in their distribution.

Perhaps. It is a little early yet to say. It would not be surprising, however, if something as transformative as the internet economy provoked a demand for institutional change to mitigate distributional consequences. That is precisely what occurred during the industrial revolution, after all, when the rise of the urban manufacturing economy prompted the corresponding development of the labour movement, the social welfare state, and the environmental movement. Similarly, the internet economy may encourage a rethinking of the nature of the welfare state and the importance of progressivity in taxation. If the knock-on employment effects of high-tech are the most important way in which the gains from the internet economy are transmitted to low-skilled workers, then suddenly the scope and expense of metropolitan areas become a critical factor. Just as important as the economic impact of the internet economy will be the social and political response it provokes. Social change is a measure, in many ways, of economic importance.

And of course, one has to remember that the web is still in its infancy. It wasn't very long ago that most Americans lacked an email address. A majority of Americans have yet to purchase a smartphone or order broadband internet. I suspect people will underestimate the importance of the internet economy right up to the point at which they simply start referring to it as "the economy".