Created: 1999-05-24
Modified: 1999-05-24
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Seven Questions on E-commerce

Comments at Berkeley E-conomy Conference: The Digital Economy in International Perspective: Common Construction or Regional Rivalry?

May 27, 1999

J. Bradford DeLong

Powerpoint slides.

Let me raise a few, scattered questions that a true analytic overview would have to answer--and then admit that I don't know the answers, that things are still uncertain and confused. So perhaps it's fortunate I don't have more time, because I don't think I could do a real analytic overview. But I can peer down from Olympian heights of abstraction and raise general if not precisely-formulated questions: seven of them.

Question one

Normally one would say in a situation of great uncertainty is that the right thing to do is to grope forward. Let different nations run different national experiments in policy. Then copy what works. Variation, experimentation, evaluation, and selection is, as we all know in our bones and our genes, a very powerful algorithm. Back a century ago Supreme Court justices spoke of America's federal system as creating laboratories for democratic social and economic policy.

But this time there are enormous complications--the point of the exercise, after all, is scale: connecting everything in the world together at near lightspeed, with massive disregard for the artificial boundaries of the nation-state. The economies of scale--interconnection and interoperability--are massive. Are they going to force us to do this legal and regulatory framework all at once, all over the world?

After all, last time--a century ago, during America's Gilded Age, when the spread of truly low-cost railroad transport combined with the massive economies of scale of the second industrial revolution reshaped America as an economy of industrial oligopolies and a society of bosses, workers, unions, and the FTC and the ICC--things did not work out as hoped. Instead of fruitful variation in corporate governance and organization, we had a race to the bottom as everyone incorporated in Delaware, which offered unique advantages to managers interested in entrenching themselves. Instead of fruitful variation in consumer regulation, we had the Massachusetts dairy farmers lobbying that every slab of beef had to come from a steer inspected alive in Massachusetts shortly before slaughter--thus trying to harm consumer welfare by removing consumers' opportunity to purchase low-cost beef slaughtered in Chicago, butchered, and shipped in refrigerated railroad cars to Boston--until Swift and Armour made large enough "campaign contributions" to get Congress to preempt state-level food regulation.

I think that the answer is yes: that the economies of interoperability and interconnection are going to greatly limit the range for variation and experimentation. I think that in the large we are going to be forced to do the legal and regulatory framework all at once, all over the world--do it with little idea in advance of how to do it right, and little opportunity to change it once it has been done.

Question two

Why is it so different to do it right? Skeptics with respect to ideas of the "e-conomy" say that we have already seen several enormous waves of technological revolution in this century as a whole--think of the automobilization or the electrification of America--and ask: what, if anything, makes our current wave of technological revolution extra-special? Why is it harder to regulate e-commerce?

The answer, I think, is that the current wave needs and is bringing into being a substantially new legal and regulatory framework. It is not like autos or electric motors or even textile factories which could operate perfectly well on top of the already-existing framework of laws and regulatory authorities.

It is--as Stephen Cohen likes to say, and as John Zysman already did--analogous to the enclosure of the common lands in early modern Britain. The economic agricultural revolution that paved the way for the British industrial revolution couldn't take place as long as large chunks of the fields were open for grazing to anyone's animals--it's hard to get excited about trying to grow turnips if your neighbors' sheep eat the greens when they sprout, and thus kill them. You needed new--post-medieval--definitions of (private) property (in land) and new structures of control and appropriability before you could get the incentives right for rapid agricultural improvement. (And it is important to recognize that that there were big winners--the rural rich with parliamentary influence--and big losers--the rural poor relying on traditional common rights for survival--from the positive-sum enclosure movement.)

We today are facing a similar problem: how are we supposed to structure rights of control, appropriability, and use--rights of "property"?

Question three

What should the legal and regulatory framework be? After all, the "commodities" being produced and sold don't look like the standard goods of economic theory. Standard goods are--and these are points I owe to Paul Romer of Stanford and Michael Froomkin of U. Miami Law School-; I have no enforecable intellectual privacy right to them or moral right of intellectual priority--"rival," "excludible," and "transparent." (But do see my article co-written with Michael Froomkin.)

Rivalry: "Rival" means that if Terence is making use of a good, Umberto cannot be. Terence's use thus diminishes the opportunities of others. So from the standpoint of trying to create an efficient social-allocation-and-distribution system, Terence should pay somebody the full reproduction cost of what he uses. His use is imposing a cost--diminishing the opportunities--of others. The first principle is that individuals should bear the full social costs of their actions. Thus if goods are rival, then an efficient economic system must make sure that Terence pays someone the full reproduction costs. That is necessary to get incentives right.

Excludibility: "Excludible" means that it is easy to control who gets to do what with a good. In such a situation, it makes sense to push control decisions away from Victoria at the regulatory center out to some "owner," Willis, on-the-spot, who has a better chance of figuring out what the best use of the good is. One of the major reasons the Soviet economy failed was that the center of control was making decisions about the proper allocation and use of commodities in a context in which it had none of the information it needed to make an informed decision. Decentralization--when attainable--maximizes the chance of getting the decision to the place where the information is. And decentralization is nearly costless when goods are excludible: the owner has the right incentives to monitor and assign rights of use.

Indeed, in the case of the post-medieval British enclosure movement, the central problem of the medieval commons was that your turnip patch--the turnip patch you had planted--was not excludible: you had no power to exclude your neighbors' sheep from "using"--and killing--your turnips. And the reform of the legal system to create legal rights of excludibility (coupled with the increasing cheapness of good fences) had magnificent consequences.

Transparency: "Transparent" means that you know what you are buying up front--that you are buying a good whose operation and utility you understand. This makes comparison-shopping easy and straightforward. It also limits the market power of sellers: one-shot, separate transactions mean that each seller has to be careful not to give past customers an incentive to buy from someone else in the future.

Yet more and more it seems to be the case that--in software, and elsewhere--what we are buying is not a good whose operation and utility we understand. What we are buying is a relationship. What we are buying is an upgrade path. Thus value depends on the producers' ability to keep good programmers, so that they can write a good version 4.0 in five years. And lock-in--massive market power on the part of sellers over near-captive customers who bought into the relationship based on early promises--is becoming an important feature.

Market optimality: Prices equal to full reproduction cost, control over goods decentralized to millions of different owners, easy comparison shopping and repeated arms-length transactions--rivalry, excludibility, and transparency give you Adam Smith's market as a powerful and effective mode of social organization. But "e-conomy" goods are non-rival--GoodNoise's store of tracks is not diminished at all if Xavier downloads one. They are barely excludible--only with great difficulty can Yolande restrict distribution to those and only those with valid licenses. And when you commit to using a particular company's software, how can you tell how good version 4.0 will be?

These tangled relationships between Terence, Umberto, Victoria, Willis, Xavier, and Yolande mean that the policy advisor--Zysman, say--would be ill-advised to recommend creating a legal and regulatory framework to try to replicate the ideal of economists' competitive market. In the absence of rivalry, excludibility, and transparency, trying to replicate Adam Smith's ideal might well generate something we don't like--a form of carpal tunnel syndrome of the invisible hand.

Question four

I'm almost out of time. So let me make all the rest of the questions very short. Fourth--and this is a very important question, perhaps the most important for this conference--are organizations and persons now becoming footloose? Will nation-states that diverge from the consensus path (whether the consensus path turns out to be a good one or to have some race-to-the-bottom elements) find that they have placed the economic health of their e-conomy sectors at substantial risk?

Question five

And how can we make sure that the games that nation-states will play in this arena are positive-sum games, rather then the zero or negative-sum games that we all know that governments can play with great verve and skill?

Question six

Can the conference organizers really--as happened in one Star Trek episode--instantaneously and cheaply turn recalcitrant over-time speakers into small chalk dodecahedrons about the size of a basketball?

Question seven

And--last--we are already thirty minutes behind schedule; will there be time for the next twenty-seven more speakers left on the program to have their say?

New Economy Master Page

Feedback is always very welcome...

Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax

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