A look back at the American economy shows a “pastscape” of exploded economic bubbles. These include the housing bubble and the technological .com bubble. We are probably blowing up a new bubble.
In “The End of Economic Growth?” Oxford’s Carl Frey discusses the new digital economy and presents the value of select digital companies relative to the number of people they employ. One example is Twitch, which streams videos of people playing games (and people commenting on people playing games). Twitch was purchased by Amazon for $970 million. Twitch had 170 employees. Facebook bought WhatsApp for $19 billion. WhatsApp employed 55 people at the time of this acquisition. In an interesting contrast, IBM employed 431,212 people in 2013.
While it is tempting to explain the impressive value to employee ratio in terms of grotesque over-valuation, there are other factors involved. One, as Frey notes, is that digital businesses often require relatively little capital. WhatsApp started out with $250,000 and this was actually rather high for an app as the average cost to develop one was $6,453 at the time. As such, a relatively small investment can create a huge return.
Another factor is an old one, namely the efficiency of technology in replacing human labor. The development of the plow reduced the number of people required to grow food, the development of the tractor reduced it even more, and the refinement of mechanized farming has enabled an even more dramatic reduction in labor. While it is true that people must do work to create digital companies (writing the code, for example), much of the “labor” is automated and done by computers rather than people. AI companies also hold forth the promise of eliminating even more human labor, although one should consider the potential risk of letting AI do critical work.
A third factor is the digital aspect. Companies like Facebook, Twitch and WhatsApp do not make objects that need to be manufactured, shipped and sold. As such, they do not (directly) create jobs in these areas. These companies do make use of existing infrastructure: Facebook does need companies like Comcast to provide internet connection and companies like Apple to make the devices. But, rather importantly, they do not employ the people who work for Comcast and Apple (and even these companies employ relatively few people).
One of the most important components of the digital aspect is the multiplier effect. To illustrate this, consider two imaginary businesses in the health field. One is a walk-in clinic which I will call Nurse Tent. The other is a health app called RoboNurse. If a patient goes to Nurse Tent, the nurse can only tend to one patient at a time, and they can only work so many hours per day. As such, Nurse Tent will need to employ multiple nurses (as well as the support staff). In contrast, the RoboNurse app can be sold to billions of people and does not require the sort of infrastructure required by Nurse Tent. If RoboNurse takes off as a hot app, the developer could sell it for millions or even billions.
Nurse Tent could, of course, become a franchise (the McDonald’s of medicine). But being labor intensive and requiring considerable material outlay, it will not be able to have the value to employee ratio of a digital company like WhatsApp or Facebook. It would, however, employ more people. However, the odds are that most of the employees will not be well paid. While the digital economy is producing millionaires and billionaires, wages for labor are low. This helps to explain why the overall economy is doing great, while most workers are worse off than before the last bubble.
It might be wondered why this matters. There are, of course, the usual concerns about the terrible inequality of the economy. However, there is also the concern that a new bubble is being inflated, a bubble filled with digits. There are some good reasons to be concerned.
First, as noted above, digital companies seem grotesquely overvalued. While the situation is not exactly like the housing bubble, overvaluation should be a matter of concern. After all, if the value of these companies is effectively just “hot digits” inflating a thin skin, then a bubble burst seems likely. This can be countered by arguing that the valuation is accurate or even that all valuation is essentially a matter of belief and if we believe, all will be fine. Until, of course, it is no longer fine. The economy, like religion, is faith based.
Second, the current digital economy increases the income inequality mentioned above, widening the gap between the rich and the poor. Laying aside the fact that such a gap historically leads to social unrest and revolution, there is the more immediate concern that the gap will cause the bubble to burst. The economy cannot, one might assume, endure without a solid middle and base to help sustain the top of the pyramid.
This can be countered by arguing that the new digital economy will eventually spread the wealth. Anyone can make an app, anyone can create a startup, and anyone can be a millionaire. While this does have some appeal, there is the fact that while it is true that (almost) anyone can do these things, it is also true that most people will fail. One just needs to consider all the failed startups and the millions of apps that are not successful.
There is also the obvious fact that civilization requires more than WhatsApp, Twitch and Facebook and people need to work outside of the digital economy (which lives atop the non-digital economy). Perhaps this can be handled by an underclass of people beneath the digital (and financial) elite, who toil away at low wages to buy smartphones so they can update their status on Facebook and watch people play games via Twitch. This is, of course, just a standard sci-fi dystopia.