Thoughts of the Week

Created: 2000-02-21
Last Modified: 2000-03-18
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Building Tools for Thought

Stephen S. Cohen, J. Bradford DeLong, and John Zysman

March 2000

presentation outline slides


The U.S. today has the healthiest and most productive economy in the world. Surely some of our high-productivity information-and communications technology-based "E-conomy" exists today because of luck. But in large part it exists because of skill--both the skill of America's entrepreneurs and engineers, and the skill of America's government. For over the past fifty years we in America have by and large gotten policies right, thus enabling America's laboratories to develop information technology and--just as important--enabling America's businesses to learn how to use information technology throughout the economy.

Government got policy right under two important headings: resources and rules. America invested the resources in fundamental research, advanced engineering, and science and engineering education to create the intellectual, human, and financial capital needed for the development of information technology. And America chose the right rules-- the systems of public and private governance and market organization required to make the market for information technology work--to create and maintain open institutions and open competition.

We can see this overarching government policy of creating the resources to drive the creation and providing the rules that enabled the diffusion of information technology applied in many different areas. Consider, first, the Internet. The Defense Advance Research Projects Agency (DARPA) developed the architecture of the network and later transferred it to the National Science Foundation (NSF) for first broad educational and later general (including commercial) use. This public investment in resources sparked off the Internet explosion because it was coupled with the right rules: deregulation of telecommunications and of important user industries such as finance and airlines that opened the way for competition by firms eager to experiment in providing innovative services. The ultimate market result was the Internet boom.

Consider, second, the semiconductor. Two generations ago the transistor was developed at Bell Labs, the heavily funded research arm of the publicly regulated telephone monopoly, AT&T. A government mission--the military's needs for miniaturized electronics--created a launch market for the new technology and forced diffusion of production technologies and basic know-how.Government rules--in this case anti-trust policy--obligated ATT to actively make the technology available to all comers. The result was a merchant semiconductor industry, with firms like Fairchild, Intel and AMD making their living by teaching other firms how to exploit the possibilities of the new technologies. Public investments spawned new technologies; public rules created incentives that produced the extraordinary pace of development, innovation, and diffusion.

Today, of course, things are different. The U.S. military is no longer the dominant launch or lead user. AT&T is no longer a monopoly required by antitrust to allow others to adopt its technology. But the twin principles--that the U.S. government needs to do its part to help provide the resources to fuel the further development of our E-conomy, and that the U.S. government needs to make sure that the rules that govern the E-conomy promote both open competition and open institutions--still apply.

In today's context, government policy toward resources needs to focus not on physical investment or the cost of capital but on basic research and on human resources. The elimination of the federal budget deficit of the 1980s had the predicted macroeconomic consequence of erasing the cost-of-capital disadvantage under which American firms had suffered. Changes in "prudent man" rules and the rise of the venture capital industry have meant that high-tech innovators are by no means starved of access to capital. But there are potential weaknesses to be found in the funding of basic research and in American education.

Today's high technology is not the work of self-taught tinkers. Clever engineers working in family garages stand on the shoulders of fundamental, formal, largely academic scientists who created the enormous body of research and development on which the E-conomy rests. Basic research creates the next technological frontiers. Being close to basic research--having a constant flow of personnel back and forth--is a powerful aid to firms seeking to live on the technological frontier.

Yet companies disciplined by modern capital markets simply cannot do basic research on the scale we need. Because it is next to impossible to keep fundamental results and principles the intellectual property of a single organization, basic research doesn't help the bottom line. Only governments--or giant, enduring monopolies like the old Bell System--can make long-term, open-ended investments in fundamental research. Though it may be difficult to imagine, we may be only at the beginning of the technological revolution that is propelling our economic transformation. Yet right now we appear to be eating our research seed corn: outside of the biological sciences, government-funded research has been squeezed as the "discretionary spending" part of the budget has been squeezed.

The growth of the E-conomy requires human expertise and talent to develop, apply, and use new frontier technologies at three levels. First, it requires highly-trained and brilliant research and development engineers. Second, it requires an army of the technologically-literate and technologically-numerate to apply and work with new information and communications technologies in all sectors of the economy. Third, everyone needs to know enough about how our modern information and communications technology systems work in order to make effective use of them both at work and at home.

In the 1950s and 1960s the United States had the highest proportion of its labor force educated in college and beyond. But, as has repeatedly been called to the nation's attention, we failed to make an analogous effort to improve the quality of American education in grades K to 12. Thus today's educational paradox: universities that are the best in the world and that draw students from all over the globe sitting on top of primary and secondary education systems that all agree are much less effective than they could or should be. America has not invested enough or sufficiently well in education. In the age of the E-conomy the consequences could be disastrous. Rising differences in wages between those with more formal education and those with less, and between those with more technology-using experience and those with less, are indicators of the magnitude of change and of the potential long-run severity of the problem.

Consider mid-nineteenth century Britain, then the world's only superpower and the heart of the first two generations of the industrial revolution. But few in Britain's power elite in the mid-nineteenth century noted or cared that the British government was not building schools for the children of workers migrating to new industrial jobs in the cities. Yet it was clear to keen-eyed observers even then that industrail technology was becoming more closely linked to literacy and to technical knowledge. By the end of the nineteenth century the lack of a well-schooled workforce meant that the post-steam-engine technologies of electricity, metallurgy, and chemistry found themselves much more at home in late nineteenth-century Germany--where investments in schools had been made. Thus Britain began its half-century death-struggle with anti-democratic German regimes having already squandered a large initial edge in technology and productivity.

Moreover, what was perhaps sufficient twenty-five years ago as an average level of educational attainment during secondary school no longer is. Compared to the benchmark provided by other nations' secondary educational systems, the U.S. system looks more and more inadequate. It is hard to see how an economy can stay relatively rich and powerful when its workers lack the education of their competitors. Selective immigration, attracting and admitting the best and the brightest of other nations is now, de facto, our short-term economic solution to this problem. It is a necessary short-term solution: any approach based on successful educational reform can only be a long-term one.

It is less clear how to best shape the rules that govern the E-conomy in order to promote open competition and open institutions. It is clear that government policies that define property rights, establish default contract terms, protect privacy and security, and shape expectations of behavior can accelerate or retard economic revolutions.

Consider, for example, a case from the early days of mass production a little more than a century ago. The combination of the telegraph, the railroad and the refrigerated boxcar made possible the sale of cheap mass-produced meat. Chicago-based corporations invented the assembly (or rather disassembly) line, mass-dressed the beef in Chicago, shipped it to the population centers on the East Coast, and undercut east coast slaughterhouses by perhaps a third. The power of mass production could be realized--unless long-distance shipment was blocked by state regulations requiring on-the-hoof inspections within the state.

Without the right rules--in this case federal preemption of health and safety regulation affecting interstate commerce--America would not have developed a high productivity, mass production Chicago meatpacking industry. Consider investment in that earlier era. Massive investments in large factories were needed to realize the economies of scale possible in serving the mammoth national market; these required that savings be gathered out of tens of thousands of pockets to provide the equity capital. But who, in the absence of the protecting shield of limited liability, would commit their savings to equity investments in huge bureaucratic enterprises over which they had no control? At the time, limited liability was viewed by many as--and was--an exorbitant new privilege for investors. Yet in retrospect we see it as necessary if the possibilities for higher productivity through large-scale industry were to be grasped.

So what are the right rules to govern the E-conomy in the future? We do not know. But we do know that at least five key debates will decide what our rules will be.

First is the debate over the strength of intellectual property rights. Should our personal information--data about us as economic, social, and indeed genetic beings--be somebody's property? Can an enterprise "own" its business model?

The second debate is over industrial structure. When should monopolies be broken up? What restrictions should be placed on firms with dominant positions that some claim provide "essential services"? Will it be possible for the E-conomy to have oligopolies that produce most of the benefits of competition and most of the advantages of economies of scale, thus allowing us to have our cake and eat it too, or will we have to choose between tolerating monopoly or abandoning efficient scale?

The third debate is over access. Will firms that make up one layer of the network be allowed to prescribe their users' access to other layers--as TCI (now AT&T) cable intended in restricting its customers to @Home as their only possible ISP? Or will courts and legislatures be able to mandate access and divide up technologies in such a way as to create open and interconnected institutions?

The fourth debate is over privacy and security. Who "owns" and who can make use of the massive electronic trails that each of us will leave over the next generation? How much will each of us be able to shield knowledge of his or her actions and preferences from not just the government but also from private entrepreneurs who believe that knowledge of consumers can be turned into money and market power?

And the fifth debate is over inclusion: the digital divide. Generations ago America chose to include all Americans in the telephone system. But it was easier to create rules for universal access to the telephone than it will be for Internet based information systems. There is no single provider to internalize the cross subsidies. There is no simple equivalent of a dial tone and a local call. And unlike the telephone or television, the greater the education level the greater the value, in most cases, of the benefit of Internet access.

We believe that there has to be policy to eliminate the digital divide. For the coming of the E-conomy means, as has always been the case with technological revolutions, creative destruction: the destruction of particular jobs, professions, specialties, and the emergence of new ones. The people who fill the new jobs are not the people who filled the old ones. Hence the shift to the E-conomy will not command broad political consent unless government policy is and is seen to be based on the inclusion of everyone in the economic transformation, and the wide diffusion of the benefits. For if the benefits are not broadly understood, broadly seen as accessible, and broadly shared, the durable political coalition to support policies to speed the coming of the E-conomy will not exist. And the transformation will be stunted and delayed.

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Professor of Economics J. Bradford DeLong, 601 Evans Hall, #3880
University of California at Berkeley
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