Sunday, July 5, 2009

Innovative Deflation

In recent posts, I have:

...Questioned whether Intellectual Property Law spurs innovation or hinders it.

...Suggested that one need not change IP law to have it lose in the long run to the culture of free (or the "culture of participation", if you prefer Craig Newmark's lingo).


...Claimed that we shouldn't abandon traditional economies in favor of a "knowledge economy" that may not be the panacea that some claim it to be. This comes largely out of Jeff Jarvis' recent thoughts on innovation yielding efficiency more than it yields growth. I argue that this efficiency doesn't just shrink some markets in isolation, but can lead to deflation of the economy as a whole. Innovative deflation.

I wanted to dig into this last point a bit more and get a discussion going on how to substantiate or dismiss such a claim: "Is the knowledge economy ripe for growth, or is it the means by which traditional economies are shrunk?"

My argument is two-fold. First, that the Internet is an all-encompassing agent of change for the global economy, allowing efficiencies that bring down prices and increase services, but also cost jobs and lower wages, without replacing them elsewhere. Second, that it does not replace the lost jobs and wages with new equivalents, because so much of the displacement is owed to the burgeoning "culture of free", and that this trend will likely increase over time, not decrease.

The Deflationary Pressure of Internet Efficiencies

Maybe the reason we're having such a hard time finding out ways to monetize various internet services like Twitter, Facebook, and Youtube, is that they can't be monetized, (See Mark Cuban's "When You Succed With Free, You Are Going To Die By Free") or at least not at replacement rates to the industries and services that they're supplanting. This is exactly what they print media is finding out the hard way as it tries to shift to an online model.

The fact that the Internet allowed efficiencies that pressure traditional industries to shrink (as Jeff Jarvis puts it) is fairly self-evident. These examples either have happened already, or are being ushered in in the very near future:
  • Online music sharing prompts the RIAA into agreements with iTunes and Rhapsody, etc.
  • Social Networking reduces the need and efficacy of radio play for promotion of music.
  • Craigslist undercuts the print media's business model based around classified ads.
  • Online news reduces the relevance of the print media's daily news cycle, and eliminates the need for the production and delivery of news on paper.
  • Social Networking gives access to news events as they happen, further reducing the relevance of the daily news cycle, and the need for editorial story selection, as we editorialize for each other directly.
  • Retail locations reduce in scope and relevance due to online shopping.
  • Efficiencies in targeted online marketing greatly reduce traditional marketing's influence (whose monetization model was built around grossly inefficient metrics, such as magazine circulation, instead of click-through.)
  • Social Networking further reduces the efficacy of traditional advertising as we announce and review goods and services for each other.
Each of these is likely to (or already has) cost jobs and are not likely to replace them. Too many of these jobs relied on the traditional inefficiencies of their business models--inefficiencies that have been *eliminated*, not just shifted to new markets. The closer the markets are to intellectual property, the faster they fall.

Lastly, all of these displaced professionals are going to go seeking work in still-viable markets, if they can attempt the transition at all. The labor supply will increase as both knowledge markets and traditional markets restructure to take advantage of new efficiencies, and that restructuring will include taking advantage of the aforementioned increase in labor supply. Hours will be cut. Wages will fall. So too will the cost of living fall as these efficiencies are passed on the consumer. The balance between these two forces will be the key to determining how painful the transition is.

The Increasing Supply from the Culture of Free

The last time there was a major shift in the economic base was the transition to mass markets/mass production/mass media in the 20th century. It gave us lots of things that society didn't really have before, but most importantly--and I'm not joking here--it gave us weekends.

I could lay out a long argument here, but I could not do it the justice that Clay Shirky did at the Web 2.0 conference in 2008. You should immediately jump over and read the whole transcript, but here's the key passage:
If I had to pick the critical technology for the 20th century, the bit of social lubricant without which the wheels would've come off the whole enterprise, I'd say it was the sitcom. Starting with the Second World War a whole series of things happened--rising GDP per capita, rising educational attainment, rising life expectancy and, critically, a rising number of people who were working five-day work weeks. For the first time, society forced onto an enormous number of its citizens the requirement to manage something they had never had to manage before--free time.

And what did we do with that free time? Well, mostly we spent it watching TV.

We did that for decades. We watched I Love Lucy. We watched Gilligan's Island. We watch Malcolm in the Middle. We watch Desperate Housewives. Desperate Housewives essentially functioned as a kind of cognitive heat sink, dissipating thinking that might otherwise have built up and caused society to overheat.

And it's only now, as we're waking up from that collective bender, that we're starting to see the cognitive surplus as an asset rather than as a crisis. We're seeing things being designed to take advantage of that surplus, to deploy it in ways more engaging than just having a TV in everybody's basement.
Shirky lays out a whole series of examples and data that backs up his assertion that, as a culture, we are heading permanently towards more participation, and that this participation is based on our ability and desire to harness our free time not just for consumption, but for creation, and sharing.

Much of the efficiency of the Internet is based solely on the nature of the medium, but the real game changer isn't HTTP, or increasing bandwidth into our homes--no traditional industries would suffer from that if we didn't fundamentally change the way we interact with each other with the Internet, which is exactly what the culture of participation is.

Would the RIAA have opted to sell you a song for $1, even though the technology existed to do so if they weren't competing with free peer-to-peer music sharing?

Would the worlds most popular web server (Apache), or the OS it runs on (Linux) ever get written if individuals didn't collaborate with the ease that the Internet allowed them to?

These efficiencies that are causing traditional markets to shrink are largely created by our culture of participation.

Putting it All Together

The culture of participation is forcing efficiencies that can have deflationary effects on our economy. This allows us to purchase more with less, but also gives us less to purchase with, if it is forcing upon us lower wages and fewer work hours. What it may give us is *more free time* (whether we want it to or not). So if that free time is part of what allows this culture of participation to help create these efficiencies, and the efficiencies create more free time... Then you have not just deflation, but a deflationary spiral that doesn't end until the traditional economies (based on real scarcity) have absorbed the new efficiencies.

Jeff Jarvis, at the Aspen Ideas Festival, asked Eric Schmidt, CEO of Google, "Is what we're going through right now more than a recession or a financial crisis, or is it a fundamental restructuring of the economy and society, going past the industrial age of mass production/media/marketing into something based on knowledge and abundance?". Kai Rysdall followed up with his own question to Schmidt: "Do you not then believe that this economy has, over the last two years, been fundamentally reset?". Schmidt's answer was:
Where's the data? Almost all the money, and all the people, and all of the capital, is *not* going to where you described [a knowledge economy]. It's going into traditional businesses and traditional industrial and service operations.
Where did the money go? To traditional enterprises based on "atoms, not bits" (to borrow one of Jeff Jarvis' excellent terms). Surely part of this is due to the heavy government involvement trying to preserve failing traditional industries in the face of innovative deflation, but a lot if it is returning private investment in the economy, trying to make their own smart decisions. The market isn't going to buy into a bubble with no solid monetization scheme, especially after the lessons learned from the dot-com bubble of 2000.

So if the knowledge economy isn't much of an economy, what economy will be left standing? While these traditional industries are likely to be greatly impacted by the kinds of efficiencies that Jarvis cited, they can't escape the laws of supply and demand because they're still based on real and scarce resources (unlike intellectual property, where supply is constricted largely due to laws and not actual scarcity) . That these are the very same industries that Schmidt cited as the beneficiaries of much of our recovering economy is no coincidence.

We're told to believe in our future in a knowledge based economy, but nobody has really figured out how to make real money of it. Of those who are making money off of it (Craigslist, Google), they are making pennies per dollar in the old markets that they've upset or practically eliminated with their innovation. This isn't because we haven't found the right monetization scheme yet. It is because innovation is leading to efficiency and not growth and that is exerting deflationary pressure on bloated industries. Moreover, it is largely being done by us, the end-user, in our free time, because we want to create and share, not just consume.