How old is the New Economy?

There is an on-going debate about the "newness" of today's economy. University of California at Berkeley professor of economics Brad DeLong reminds us of the Silicon Valley pilgrimage that gathered legions of the powerful at the end of the twentieth century. DeLong rightly notes the analogy of this pilgrimage with the Manchester pilgrimage undertaken by Alexis de Tocqueville, Benjamin Disraeli and Friedrich Engels in the 1830s and 1840s (to see the rising British textile industry), not to mention the Detroit pilgrims in the 1920s (to see Henry's Ford assembly lines). In any case, the New Economy aficionados claim that a whole brave new world is expecting us. This world is not only about new rules, increasing productivity levels but also about Internet as an emerging democracy.

In other words what they used to teach you at the business school is outdated, no longer valid! Right or wrong? Well, read Hal Varian and Carl Shapiro and you'll get a fair description of what's going on in the so-called information economy. To put it in their own words, "the thesis is that durable economic principles can guide you in today's frenetic business environment. Technology changes. Economic laws do not." So, if there is a so-called post-industrialist world, what is the best way to describe it? Well, the best way to describe the New Economy is to shed light on its very atypical cost structure: What cost a lot to produce is the very first unit (think of a software, of a video game etc...). The following units cost almost nothing. The first unit requires a lot of inspiration and perspiration, the following ones less so. After the first unit, the cost of production is the cost of reproduction.

The problem then is the following: Microeconomics 101 teaches you that in a competitive market the price should converge to the marginal cost. In the New Economy, pricing at the marginal cost can only trigger losses. Indeed, the average cost is always above the marginal cost. Think of the first two units. They cost you the initial outlay divided by two while the marginal cost is close to nil. So marginal cost pricing is a sure loser. This is why economists have always had a hard time with increasing returns to scale: It simply does not fit the ideal competitive market model.

But how to survive in such an environment and, more precisely, how to recoup the significant initial outlay that the first unit requires? Well, the first step is precisely to leave the mold of perfect competition. As Stanford University Professor of Economics Charles Jones puts it, "the production of new goods, or new ideas, requires the possibility of earning profits and therefore necessitates a move away from perfect competition." That is profits above the normal competitive market level, namely a rent. In other words you need imperfect competition.

Somehow, the New Economy is part of what Jonas Ridderstrale and Kjell Nordstrom call "Karaoke Capitalism": "Great businessmen and women should loathe competition. They should simply adore monopolies and fall head-over-heels in love at the merest sight of one". Easy said, not easy done. Moreover, it begs the whole question of the incentive to create ideas in such a context where you're not sure of the private benefit you may reap from it. Indeed, private benefits rarely equal social benefits in the New Economy. Once an idea (leading to a new software or service etc...) has been created, anyone with knowledge of the idea can take advantage of it. That's why we have patents, copyrights and the like. That's why we also have the Open Source guys where the claim is that knowledge and ideas want to be free.

I don't know whether the New Economy is really new. But, what I can tell you is that it is challenging indeed!