From: James Fallows
To: Wen Stephenson
Date: 1/24/2002
Subject: Beyond the Bubble

It appears that the myth of the Internet as a great "democratizing" force, "leveling the playing field" and all that, has been exposed, at least when it comes to financial markets. In other words, far from "democratizing the market" and "leveling the playing field," it looks as though the new media associated with the Internet bubble -- the 24-hour cable outlets like CNBC and CNNfn, as well as the online Motley Fool, TheStreet.com, et al., and the online trading firms -- instead gave rise to new demagogues (in the form of venture capitalists, investment bankers, analysts, and business journalists), and enabled them, as never before, to manipulate the investing public. You may or may not agree with that whole premise, and I'm curious to hear your reaction to it. But I also want to ask, is there truly something about the Internet itself, as a medium, that fed the bubble? We hear how the Internet IPO frenzy "fed off of itself." Was something new going on here?

It's intriguing to think that the very nature of the technology at the heart of this financial bubble made the bubble's expansion, and inevitable collapse, more violent or volatile than they might otherwise have been. And it is probably true that the unprecedented velocity-of-gossip created by Internet technologies made the financial climate extra nervous and panicky, both on the way up and on the way down. I may be one of the few computer-owning Americans who has never bought or sold a stock online, never looked for stock tips on Motley Fool or Yahoo chatrooms, never tried to get early shares of an IPO. But even I knew all this was going on around me, and felt vaguely nervous not to be part of it. That made me feel like a chump during the boom years, and leaves me with vague dread during the slump years. After all, those other people's nutty speculative habits are dragging down even careful, stolid types like me!

However: I still think that the exact nature and effect of Internet technology was less important in creating the bubble, compared to the simple fact that the technology was new. Because it was new, a lot of people making investment decisions didn't really understand it. (I'm being generous, as you know if you ever saw some financial "analyst" -- on CNBC, for example -- look puzzled when hearing a term like "URL.") Because it was new, even people who did understand it couldn't really be sure of what its full business potential might be. Because it was new, it was like other bubbles we've experienced before -- ones involving the oil industry, or newly opened land in Florida or the West, or biotech, or the spice trade with India centuries ago. Like other aspects of modern life, this one was bigger and faster than its predecessors, but the fundamental impetus was the same.

The debate over the so-called "new economy" has been going on for some time, and we're not going to resolve it here. I'm more interested in the rhetoric of the "new economy." It's become a kind of cliché that the "new economy" thinking drove the Internet boom and that the concept was revealed as hollow once the bubble had burst. This is where the dancers on the dotcom grave seem to be dancing most gleefully. What role did the "new economy" thinking really play in the Internet boom and bust?

Just about everything concerning the Internet phenomenon benefits from separating the short-term from the long-term view. For instance: we know that in the short term the Internet has not really changed the balance of power in politics or eliminated the importance of national borders. What it will mean in the long run is another matter -- it would be like trying to foresee the full impact of automobile culture in 1905.

So too with "New Economy" rhetoric. With the advantage of hindsight we can say what the short-term importance of that phrase was during the bubble years. It was a way for everyone to rationalize what was, by any normal standards, irrational behavior. Two hundred dollars a share, for a company that's never made a profit? Sure! Don't you know how the New Economy works? And to give credit where it's due, not everyone who thought or talked this way was a huckster or an idiot. There are times in history when assumptions and operating rules change, and the people who fail to shift their thinking are the ones laughed at in retrospect. ("Those Orientals will never be able to build cars for American roads." "The customer will never need more than 48k of computer memory.")

I suspect that, fifty years from now, we'll see that information technology created a "New Economy" very much in the way that electricity, the telephone, gasoline and oil, and antibiotics-and-immunization did. That is, it will remove many barriers and limits previously assumed to be insuperable, and will be so important that its role will almost become invisible. To take one example: the same mainstream financial-and-media world that now hoots about the "absurd" Internet stock bubble still under-appreciates, in my view, the impact of the "eBay model" of doing business. The idea that millions of people can deal directly and independently with millions of others has sweeping implications, which we're only beginning to explore. To the extent people in the media world notice the "eBay way," they think of it as a way that oddballs can trade baseball cards with each other. I think it's more important than that. In the long run, I'm a New Economy optimist. In the short run, with all appropriate allowance for the people who were cynically fleecing the masses, I understand why people used the term while the bubble was being puffed up.

If I can come back to this, one of the supposedly new things about the "nature and effect" of the Internet (and, by association, the "new economy") is that it has tended to level various playing fields, thereby democratizing whatever it touches -- whether the stock market or the news media or software development. And yet, as certain critics (such as Larry Lessig, in Code and Other Laws of Cyberspace) have reminded us, the technology of the Internet doesn't have any essential qualities -- there's nothing inevitable about the social or economic effects of computer networks (or any technology), it's all a matter of how the code is written, how it's engineered. And the code can just as easily be written by large undemocratic corporations and government bodies as by democratic hordes of hackers. So if there's nothing inherently bottom-up about the Internet -- if it can just as well be programmed with a top-down agenda by the AOL TimeWarners and the MSNBCs of the world -- then is there any reason to think there's necessarily something new, in the sense of level playing fields, about the "new economy"?

First I'll agree with the premise of your question -- and then, as you're already guessing, I will disagree.

Since the time the financial markets began heading down, you could argue that the existence of the Internet -- as a technology, as a business sector, and as an economic concept -- has had an "old" rather than "new" effect on the economy. One reason is that as more and more startups have folded, the tech-and-Internet sector has become more risk-averse than the rest of the economy. Even more important, the technology and telecommunications sector has gone through a really impressive way of concentration and consolidation. Five years ago, people -- including me -- would wring their hands about Microsoft's excessive power. I still think that Microsoft's power is a problem, in its sector -- but how about the AOL TimeWarner combine, which has vaster reach? Without belaboring the points, for the last eighteen months people involved in any part of the tech industry, or allied fields like telecommunication, seem to have been acting as cautiously as anyone in the lumbering "old economy" dinosaurs, and the whole industry is at the moment concentrating itself the way the steel or auto makers did decades ago.

Moreover -- yes, there's a moreover -- we have learned from other technologies that they are not inherently democratizing or "leveling." Despite the existence of telephones and electricity and automobiles and computer chips, we still have bosses and hierarchies. On the other hand, each of those inventions has generally and eventually seemed part of a worldwide progress that has made life freer and more equal for most people. I think information technology will, generally and eventually, be part of that evolution too.

What do you think we've learned, or failed to learn, about the Internet's real importance? And what might this suggest about the true cost of the Internet bubble, not just in economic terms, but in social and even political terms? That is, what was the "opportunity cost," so to speak, of lavishing so much money, energy, and media attention on the Net economy? Now that the dust has settled (and the economy has sunk into recession), can we see any more clearly what the Internet's real value is? Are we any wiser than we were in 1995, when Netscape went public?

As we go along, I'm talking myself into a more optimistic state of mind about the Internet than I realized I had. I'm not sure there were many lastingly harmful "opportunity costs" of the bubble mentality. Yes, yes, yes: I recognize that all kinds of harm did occur. There were innocent financial errors. There was malicious financial misrepresentation. There was even a significant opportunity cost to the "real" economy. I've recently published a book, Free Flight: From Airline Hell to a New Age of Travel, which is in large measure a story of that opportunity cost. Some real inventors, who came up with a real, tangible, high-technology, manufactured product -- namely, a safe, fast, small jet that cost roughly one-tenth as much as existing corporate jets, and therefore could be used by a much broader traveling audience -- nearly went crazy trying to raise capital in the late 1990s, because the herd instinct was leading venture capitalists to "interesting" Net startup ideas.

Still, I think the opposite over-reaction, after the 2000 Nasdaq crash, against the Internet and anything associated with it, could be almost as harmful. Eventually people are bound to do more and more of their purchasing online. It would be insane for them not to -- it just allows you to do things more quickly and with more information. Eventually more and more news and "content" will be distributed that way. In the late 1990s we saw some basically crazy ideas propped up by herdlike funders. After the crash some basically sound ideas were torpedoed by the same herd reaction. After all, something like WebVan will eventually make money, as will something like the late, lamented wireless internet system, Ricochet. The volatility that drove the market up three years ago drove it back down starting early in 2001. This, I suppose, is capitalism in action -- "animal spirits" and all. And of course the dramatic change in political, military, and economic circumstances since the Sept. 11 terrorist attacks makes it even harder to know how and when the technology puzzle will sort itself out.

When you speak of "herds" and "animal spirits," do you mean "the public," as in the individual investors who bought tech stocks in such numbers during the late 90s, especially toward the end of the bubble? Or do you mean the entire investment community, from VCs and investment banks to institutional investors? Is it possible that the venture capitalists and investment bankers who, in a way, brought us the bubble -- by taking so many young companies public before their time -- are being let off the hook? Is it right to assign a fair amount of blame, or if not blame then a sizable portion of responsibility, to the funders on Sand Hill Road and Wall Street?

I think there is blame enough for everyone here. Some rogue individuals went crazy with their E*Trade accounts. But the more damaging forms of irrationality were, as you suggest, probably practiced by the "rational" people in charge of large pools of other people's money -- including the "investment" sages who put the mutual-fund hoardings of people like you and me into nutty dotcom prospects.

Putting short-term predictions aside, as you look back over the past year or 18 months, what connection do you see between the dotcom crash and the current economic (and political) climate? The whole story of the Internet economy has been eclipsed by Sept. 11 and its aftermath, but to play a kind of "What If?" game, what shape do you think the economy -- and the political debate about the economy -- would be in today if the events of Sept. 11 had never taken place? That is, in terms of the economy and the politics surrounding it, what's the more important story?

I don't know. My experience is that it takes a very long time to detect the difference between little economic bumps-in-the-road and real, historic changes. During the Vietnam war, everyone's attention was on the war itself -- and if not on the war, on the assassinations, riots, and generalized chaos of American life. Few people noticed, while it was going on, the beginnings of the historic inflation that was to become the dominant economic reality of the next dozen years. On the other hand, when the stock market crashed in 1987, people seemed more worried than they have been about our current much more dramatic (if less sudden) financial decline.

So it will be a while before anyone can really answer your question. My guess is that we'll see the tech-slide and the terrorist attack as the classic, unwholesome combination of chronic and acute problems. The chronic problem is the contraction of the tech and financial markets. The acute shock is the attack -- whose economic effects we may still be underestimating. But to return to safer ground: I don't really know.