I. Introduction
“The proliferation of digital technologies has provided business--especially
small business--with power and utility that previously would have
taken generations to capitalize. Not since we yanked the plow
from the farmer’s weatherworn hand and summoned him to the
assembly line has more economic firepower been placed at the disposal
of the entrepreneur and sole proprietor.”
—Rick Segal1
By common consensus, the information technology (IT) revolution
in the U.S. began in the middle of the 20th
century and has continued to expand in scope and impact throughout
the latter half of the century. Labor-saving innovations such
as the photocopier gave way to a proliferation of new computer
and communications capabilities in the 1970’s which, while
saving man hours and improving accuracy, effected changes in business
structure, operation and performance. Orders and communiqués
could be transmitted almost instantaneously via facsimile machine
without requiring sometimes inconvenient human contact. Inventory
could be tracked accurately and efficiently by computer. By dint
of pagers and cellular phones executives and flunkies alike could
be reached regardless of time or location.
The IT revolution didn’t stop there; computer and communications
technology continued to evolve and then to merge. This merger
created powerful computer networks within and among businesses
and consumers that were destined to change the way the world worked;
the Internet, intranets, and extranets were born. Instantaneous
information transfer, lightning fast communications, broad dissemination
of information and more became possible and, perhaps more importantly,
relatively simple and inexpensive. Thus from the IT revolution
blossomed the “digital economy”—an economy based
on goods and services whose development, production, sale, or
provision is critically dependent upon digital technologies.
The digital economy, as might be expected, has a profound impact
on the traditional economy. Likewise, the Internet, one aspect
of the digital economy, is changing the way the economy functions.
End consumers have access not only to local retailers but also
to retailers all over the world. Businesses can “advertise”
for suppliers and employees via pages on the World Wide Web, expanding
the reach and efficiency of such advertisements. Businesses can
easily post information for suppliers and salesmen to keep them
up to date. Retailers and manufacturers alike can easily track
competitors and react accordingly. Businesses that never have
a brick and mortar storefront can not only compete with traditional
retailers but also thrive due to technological economies and economies
of scope.
What is and what will be the economic impact of all this Internet-inspired
change? This is a difficult question to answer due to the complex
and continually changing nature of the Internet as well as the
complex and expansive nature of the economy. However, certain
aspects of the economic impact are clear and others can, at the
very least, be hypothesized; while only the passage of time will
reveal the true economic impact of the Internet in the interim
some pieces of the puzzle can be fit into place and others identified.
II. A Description of the Internet
Internet technology represents a suite of communication technologies,
protocols, and standards for networking between computers. The
Internet was conceived as a method to facilitate communication
and collaboration among widely dispersed research scientists and
defense contractors in the U.S. in the late 1960’s and early
1970’s. As other academics and scientists realized the benefits
of relatively unrestricted data and information exchange the number
of connected organizations grew. By the late 1980’s e-mail
represented a popular form of communication among academics and
researchers. Before 1990 rolled around whole universities and
research and development (R&D) firms began to realize the
value of unrestricted information exchange and a flurry of gopher
and file transfer protocol (FTP) sites appeared as a means of
publishing documents for general or restricted access irrespective
of user location.
The World Wide Web (WWW), the 1989 invention of Tim Berners-Lee,
was set to take off. Not only did it, like gopher, allow unrestricted
exchange of text documents but it also allowed for graphics, charts,
tables, etc... This user and publisher-friendly interface quickly
took off and by the mid-1990’s universities and R&D firms
were joined on the Internet by corporations and individuals of
all descriptions. The WWW interface has continued to evolve, fostering
and facilitating communication and interaction between users and
publishers. Thus e-commerce—business transactions conducted
via computer networking technology—was born.
The WWW and e-mail, the two most visible and heavily used components
of the Internet, provide benefits and opportunities to consumers
and businesses alike. With an investment that can range from well
below $1,000 to several millions of dollars businesses can create
a centrally located, easily accessed and updated virtual storefront
that allows exposure to and communication with business partners,
retailers, wholesalers, and consumers. Information can be disseminated
to, bids solicited from, orders taken from, and advertising placed
in view of countless users. In short, on-line businesses can expand
sales (market share) and reduce costs by marketing directly to
the consumer. Consumers benefit from more and better information
at a lower research cost; they can easily obtain product information
from manufacturers and retailers, regardless of geographic location,
as well as order products on-line.
As available bandwidth and technology continue to improve WWW
sites will more closely mimic shopping experiences, attracting
more users and encouraging Internet innovators to construct and
deliver new and faster multimedia environments. The greater the
number of users, the greater the value of Internet technology
to all concerned, and the greater the impact Internet technology
will have on the economy.
III. The Economic Impact of the Internet—An
Overview
“...there is simply too little evidence to allow an
intelligent decision [on the reality of the new economy].”
—The Economist2
The Internet is a relatively new, complex and emerging phenomenon
whose multiplicity of tools with partial and provisional interconnections
is constantly subject to both the forces of change and the whims
of human nature. The stability of the technological artifacts
(hardware and software) which underlie the Internet is provisional
on the ingenuity of users and the development of new technologies.
Thus a constantly increasing number of users promotes technological
and functional changes; technology must change whenever an attempt
is made to provide value to a new set of users. This almost human
schizophrenia of the Internet (after all the Internet is a product
of its human users) as it continues to grow and change makes its
economic effects likely to be varied and more than marginally
unpredictable.
One respectable, albeit simplistic, position asserts that IT and
the Internet are transforming the way in which America does business
by providing new opportunities for growth in conjunction with
reduced costs, thereby allowing the American economy to grow faster
with less threat of inflation. The proof of this view would seem
to lie in the current economy’s historically unusual combination
of rapid growth, very low unemployment, and barely visible inflation.
Wall Street’s confirmation of this view has created soaring
stock prices in many industry sectors. However, many economists
believe that the combination of low inflation with low unemployment
can be explained without any reference to the Internet: the dollar
is strong, commodities are cheap, things are looking up on Wall
street, cyclical weakness exists outside of the U.S., there is
downward pressure on non-wage labor costs, etc...
In light of this discrepancy in views, it’s interesting to
note that while IT sectors are increasing productivity and creating
new and higher paying jobs faster than any other sector of the
economy e-commerce still represents less than 1% of the retail
portion of the economy. Additionally, more than 100% of the acceleration
in productivity since 1995 happened not across the economy as
a whole but in computer manufacturing which represents barely
1% of the economy. Elsewhere growth in productivity has stalled
or fallen.3 Thus it is possible
that while the Internet does have an economic impact it is not
yet of such a magnitude to allow for accurate definition and description
(see Productivity and the Productivity Patadox).
It is also important to note that the impact of e-commerce on
the economy goes beyond the dollar value of e-commerce activity
on both consumer and business ends. On the consumer end, the Internet
plays an important role in a much larger number of transactions
than those completed on-line; it is an important source of research
that influences off-line ordering and purchasing, especially for
large ticket items. On the corporate end, businesses can use the
Internet to develop competitive advantages by providing more useful
information, expanding choice, developing new services, streamlining
purchasing processes, and lowering costs. The Internet also provides
a mechanism to free businesses from geographic confines and the
costs of running actual stores; firms can deliver almost unlimited
content on request and rapidly make adaptive changes.
Other business effects include
Market structure and competition also represent candidates
for impact from the Internet. As the digital economy and e-commerce
prosper, it becomes possible that firms must go on-line in order
to preserve or extend market share, regardless of positive, negative,
or zero productivity changes. Additionally, with lower entry costs
and disintegrating geographic barriers more small businesses can
theoretically enter and compete in national and global markets.
This should level the playing field between large and small businesses.
However, anecdotal evidence suggests that the division between
cheap, low-service merchants and high-cost, service oriented merchants
in cyberspace is nearly as large as it is in conventional markets,
possibly because large businesses have the resources necessary
to utilize the most current technology to its fullest extent as
well as advertise extensively.
Regardless of the nature of changes in market structure and competition,
the changes will alter price structure. The use of the Internet
opens up new markets and adds depth to the current ones by moving
organizations closer to their current and potential customers.
Conventional wisdom is that the Internet businesses mechanisms
will create a nearly perfect market—all participants will
be perfectly informed and thus prices will be uniform across retailers
and as low as possible. Unfortunately, once again anecdotal evidence
does not support the conventional wisdom; while the Internet is
a more efficient channel in terms of price level and menu costs
the level of price dispersion suggests the retention from traditional
markets of retailer heterogeneity possibly due to branding issues,
awareness of consumers regarding other retailers, and retailer
trust (see Price Dispersion).
The current magnitude of the Internet’s economic impact and
it’s actual (rather than conventionally believed) effects
on business structure, market structure, competition, and prices
notwithstanding, the value of e-commerce transactions, while still
small relative to the overall size of the economy, are growing
at a remarkable rate. This enables and encourages new businesses
processes and models and thereby fosters economic change. Productivity,
supply, demand, the supply chain, labor, and price structure will
all be affected and the effects of the Internet on these economic
components will be additive and significant.
IV. Specifics
A. Reduced Costs & Competition
The Internet, especially the WWW, reduces start-up, entry, and
maintenance costs; rather than a brick-and-mortar storefront being
required a virtual storefront can be created with as little or
as much funding as is available. Virtual storefronts and offices
are not limited to retailing—any business can interact with
its consumers via the WWW. For example, an R&D corporation
can solicit business, locate project possibilities, and submit
proposals via the WWW, thereby significantly reducing research
and travel costs. Additionally whole, viable businesses can be
operated from a back room or basement with just a phone line and
a computer.
The reduction of entry, start-up, and maintenance costs has initially
increased the overall number of businesses in the (U.S.) economy.
Home-based businesses have flourished with the help of the WWW
as not only are they inexpensive to create and maintain but they
also are more viable due to a wider geographic reach than would
otherwise be possible. Other new retail and service-oriented businesses
have also thrived. However, at the same time that the Internet
creates a cost reduction it also creates high non-recoverable
marketing and service costs related to the necessity of gaining
customer loyalty in the face of heightened competition. Thus cheap
and easy entry does not necessarily breed success (in the form
of a profitable enterprise); whether a businesses is operating
through the Internet or in a traditional manner it must provide
something unique in order to attract and retain customers and
thereby survive.
This caveat of Internet business success helps to explain the
discrepancy between conventional wisdom and anecdotal evidence
regarding the Internet’s leveling of the playing field between
large and small businesses. While conventional wisdom would have
it that the division between cheap, low-service merchants and
high-cost, service oriented merchants would virtually disappear
in cyberspace, in actuality it is nearly as large as it is in
conventional markets. This may result from larger businesses having
more resources with which to distinguish themselves. Regardless,
the Internet seems set to work in favor of national retailers
at expense of local competitors: technology, brand and scale create
product heterogeneity and while entry costs are low, the cost
of developing a fully functional e-commerce site is prohibitive
and thus biased towards existing larger businesses. Additionally,
as consumers can easily purchase from geographically distant retailers,
local specialty shops increasingly come into competition with
non-local and national retailers. This expanding competition does
not favor the smaller retailers with their relative lack of capital
resources.
Thus while the Internet would be expected to initially increase
the number of competitors in a given market as more existing retailers
who have considerable capital resources begin to participate in
Internet markets smaller competitors (on-line or traditional)
who don’t have the resources to create and maintain product
heterogeneity will no longer be able to compete regardless of
low start-up, entry, and maintenance costs. The retailers who
cannot afford to compete will leave the market, and the tables
will turn. This turning of the tables is supported by economic
theory: as long as return exceeds costs in a given industry new
entrants will be encouraged. As competition increases, prices
decrease, costs to establish heterogeneity increase, and profits
decrease. Eventually profits become either zero or negative. If
profits are negative, participants will leave the businesses and
eventually profits will raise towards zero. At zero an equilibrium
of market participants is reached—no incentive exists for
new entrants nor for participants to leave. Smaller competitors
will not have the resources to persist as costs approach and exceed
revenues and those who initially increased market competition
will be forced to withdraw.
The Internet is therefore set to increase the competition among
geographically diverse retailers (on-line and traditional) as
in virtually all industries geographical constraints on competition
will be reduced or eliminated. As competition increases prices
should decrease. As the progression matures businesses with more
resources to draw on will naturally be favored in highly competitive
markets and smaller competitors (on-line and traditional) will
tend to disappear. In contrast, in markets where the competition
is thin to begin with the Internet may sustain increased competition
by encouraging new market entrants.
B. Firm and Supply Chain Structure
E-commerce business-to-business transactions will grow to $1.3
trillion by 2002 while in that same time period e-consumer transactions
will grow to $95 billion.
—Forrester Research4
Even before the Internet, the implementation of IT advances
influenced firm and supply chain structure. Single robots replaced
multiple individuals within the manufacturing process. Facsimile
and photocopy machines reduced the need for office workers and
couriers. Bar code scanners and the microchip made just in time
inventory systems possible. The implementation of technology changed
the way business was done and as it did it laid the groundwork
for new business models: effective vertical and horizontal integration,
cost-efficient outsourcing, international production and distribution,
global markets, etc... The Internet has continued to foster this
change.
Although on-line retailers are the most visible, most of the business
done on the Internet is conducted from firm-to-firm as the Internet
provides an easy, relatively standardized mechanism for business-to-business
interaction. Private electronic data interchange (EDI) networks
could well be considered the predecessor of the Internet in business-to-business
electronic commerce. EDI networks are proprietary computer networks
that can connect suppliers, manufacturers, wholesalers, and retailers.
Suppliers can check the parts inventory of manufacturers to estimate
production needs, wholesalers can check manufacturer inventory
and order merchandise, salesmen can monitor client invetories
and estimate orders, etc... The main fault of EDI networks is
that the the systems are proprietary and thus expensive and somewhat
inefficient to create, implement, and expand; a pan-industry standard
would reduce costs and allow more businesses to participate, thereby
creating a deeper and more efficient structure. The Internet,
especially the Web, with its global standards and capability for
private, public, and private and public sites provides an efficient,
standardized mechanism for EDI.
As the Internet allows for more efficient business-to-business
interaction the flow of intermediate and finished goods and services
among businesses should become increasingly efficient, leading
to reduced costs and higher productivity per time unit. Additionally,
outsourcing and specialization will increase as a result of more
efficient bidding and price mechanisms; the easier it is to determine
alternative production capabilities and costs the more likely
it is that businesses will locate and utilize viable and beneficial
outsourcing possibilities. For example, a manufacturer could solicit
bids to outsource a particular job via its Web site rather than
via a proprietary EDI network. As Internet access is virtually
universal when compared to proprietary EDI access, the potential
number of companies that can bid is larger and locating a feasible
outsourcing bid is more likely.
Thus as businesses can locate production partners and monitor
relationships with other businesses easily and inexpensively via
the Internet specialization will become increasingly feasible
and relationships will change between supplier and manufacturer
(vendor-managed inventories, just-in-time inventory procedures,
etc...), supplier and supplier (increased outsourcing and specialization),
and manufacturer and retailer (manufacturers can place products
directly with customers). Internet technology will also reduce
the cost of moving decision-making authority higher up the managerial
hierarchy and will create a trend towards elimination of the middle
man, thereby increasing market efficiency. Business that require
interaction with other firms can become increasing virtual. Coordination
costs will fall, coordination use will rise, business relationships
will change, limits on economies of scale and specialization feasibility
will rise and firm and supply chain structure will be altered.
In addition, as business-to-business electronic interaction requires
electronic information tracking the increased availability of
information regarding procurement, production, distribution, etc...
will allow businesses to more effectively evaluate their situation
and to react more efficiently to changes. Prices and production
strategies can be altered more promptly to reflect current conditions,
thereby creating a cost savings at many points in the manufacturing
and distribution process. Internal productivity should rise and
costs should fall. The more reliant businesses become on electronic
commerce, the more they utilize the Internet to interact with
other businesses and consumers, and the more data gathered as
a result of the first two the greater the operating gains and
efficiencies will be.
The business-to-business supply chain will also be affected by
Internet auctions which, due to two-way interactive technology
and a lack of geographical barriers, are much more successful
than physical auctions. Additionally, Internet technology allows
for “combinatorial auctions” where businesses can bid
for many things at the same time, taking into account the fact
that the different goods may be complimentary or substitutes.
Such business-to-business auctions will soon make up most of the
volume of the on-line market and will, like the use of the Internet
to replace proprietary EDI networks, increase outsourcing and
specialization.
C. Business Structure Equilibrium
The economy consists of a wide variety and large number of consumers
and businesses. As new products are introduced new businesses
and markets come into existence and obsolete ones fade away. The
impact of a new product or market, however, is not isolated within
its own market, the market of a product it supersedes, or even
its industry sector; all products and markets are interrelated
in such a way that a change in one product or market creates ripples
across the entire economic pond, sometimes very subtle, sometimes
gargantuan. Internet technology and its descendants did not create
subtle ripples in business structure equilibrium—they created
a tsunami.
Virtual retailing, the sale of goods and services via a virtual
storefront on the Internet, has introduced tremendous economies
of scope to the retailing industry. While the initial investment
to set-up an entirely virtual storefront (on-line shopping, customer
service, and ordering) is high, a certain amount of the set-up
cost is not product-specific. Thus once a virtual storefront and
distribution network have been set up for one type of product
the marginal cost of adding other product lines is smaller than
it would be in traditional retailing; the business and distribution
structure for on-line sales of one category of goods is very similar
to that required for on-line sales of other categories of goods.
These economies of scope increase the likelihood that a virtual
retailer will expand the scope of their operations to more than
one market. For example, most on-line bookstores also sell compact
discs and videos. The existence of cross-market retailers in combination
with an increasing emphasis on branding and customer loyalty will
increase the interplay between product markets. Due to a lack
of physical contact it is distinctly possible that as customer
loyalty and product heterogeneity develop a customer will be more
likely purchase product B from a retailer they are familiar with
due to the purchase of product A even if that retailer does not
have the lowest price for product B (see Loyalty). Thus
competition within a market will become less dependent on price
and more dependent on surrounding factors (brand and retailer
reputation) and thus once distinct product markets will become
interrelated. This is similar to the effect that superstores have
had on the traditional economy; customers become familiar and
comfortable with a particular retailer to the point where comparison
shopping to obtain the lowest price for individual products is
no longer a prominent concern as long as the general feeling is
that the deals are good.
The virtual retailing and business-to-business e-commerce boom
also have created additional demand for the products and services
of industries that support electronic businesses—computer
technology, monetary transaction, and transportation; these industries
are set for expansion. In contrast the Internet is reducing the
demand for the products of other industries—traditional mail,
long distance telephone, etc... Thus the Internet, like any new
product or technology, is increasing the demand for some products
and services and decreasing the demand for others; some markets
will expand, others will contract.
Still other products and markets are affected not only by changes
in demand but also by changes in product structure. Though such
economic effects are certainly not negligible, they are difficult
to predict due to the complex and changing nature of the Internet.
However such changes will require industries to reinvent themselves
in order to survive.
One example of such an effect is the newspaper industry. Newspaper
circulation is in a decline in most countries as newspapers must
compete for people’s time with new technology-based leisure
activities—demand has changed. Supply has also changed; inexpensive
(often free) news content is widely available on the Web. The
Internet, however, isn’t just replacing the content and creating
alternative products but rather is also undermining the structural
economics of the newspaper industry. The physical inputs (printing
press, delivery trucks, etc..) are no longer necessary to produce
virtually identical output and thus the package of revenue and
expense streams represented by a newspaper no longer need be delivered
as a package; specialty content, e.g. on-line classifieds, weather
pages, etc..., can be delivered on an individual basis via the
Internet. As classified ads represent nearly 1/3
of newspapers’ revenue streams in 19985
and as classifieds are cheaper and more efficient on the Internet,
separating them from newspapers becomes inevitable and thus newspapers
wind up losing a major revenue source. Without this revenue the
newspaper industry will be forced to change if it is to survive—higher
prices to counteract reduced advertising revenue, specialty publications
that represent a simpler expense/revenue combination, larger geographical
areas, etc...
D. Productivity and the Productivity Paradox
“There are good reasons to think that improved measures
[for the capital economy] would raise the long-term growth rate
of GDP.”
—Brent Moulton6
IT and the Internet have revolutionized the way companies function—altered
dealings among suppliers, customers, and business partners, revolutionized
management, changed business structures, affected products, created
a whole set of new firms to capture Internet-based gains in efficiency,
and more. In fact, it is is fair to say that productivity changes,
existent or non-existent, represent the least of the supply side
effects of the Internet. Indeed, it is not likely that the amount
of output by any given business (save for producers of computers
and software) has been directly impacted by the Internet; the
Internet alone increases neither the absolute magnitude
of demand (save for computers and associated technology) nor,
unlike IT, the technological capabilities of production; distribution
and acquisition are certainly directly affected by the Internet
but production in general is not.7
Regardless, the assumption is that IT and the Internet, by virtue
of saving labor, must be causing productivity to increase; if
it is easier and more economical to produce we must be producing
more. However, in 1987, Nobel Laureate Robert Solow observed that,
“You can see the computer age everywhere but in the productivity
statistics.” (New York Times Book Review, July 12,
1987, p. 36.) The productivity paradox was born. 12 years later,
after the appearance of the Internet on the technology scene,
Steve Lohr, in “Computer Age Gains Respect of Economists”
(The New York Times, April 14, 1999), attributed Solow
as more recently saying, “My beliefs are shifting on this
subject... I am still far from certain, but the story always was
that it took a long time for people to use information technology
and truly become more efficient. That story sounds a lot more
convincing today than it did a year or two ago.” Additionally,
at The American Economy in a World Context on May 6, 1999,
in a recent wide-ranging review of IT’s positive influence
on the economy, Federal Reserve Board Chairman Alan Greenspan
said that, “the evidence for technology-driven acceleration
in productivity is compelling, but not conclusive.” Is the
emergence and expansion of the new high-tech industries making
the economy as a whole more productive or is it changing the way
work is done without changing the magnitude of the output?
According to a 1997 report issued by several U.S. government agencies,
while gross marginal benefit varies by industry, in general IT
capital and labor (information processing and related equipment
from 1983-1993) exert a positive influence on productivity: “...IT
is helping forge a more productive American economy.”8 In support of this view, non-farm
productivity has been rising significantly since 1996 and this
rise in productivity does not just represent the putting to work
of idle capacity as happened in the mid-1970’s and mid-1980’s.9 However, this apparent productivity
increase could be a result of companies adjusting to an unexpected
rise in overall demand late in the business cycle; until this
productivity growth has survived the next economic downturn it
is not clear whether it is structural or cyclical. Further, the
productivity increase is extraordinarily concentrated in the computer
manufacturing industry; when computer manufacturing is removed
from the picture productivity has decreased since 1995.10 Regardless, the rate of return
for IT-equipment is decidedly higher than the rate of return for
non-IT equipment and, while hiring IT workers is not necessarily
more profitable than hiring non-IT workers, IT workers are, on
average, more valuable as they produce more than their non-IT
counterparts.
A possible explanation for the productivity paradox lies in the
measurement of productivity; conclusions cannot be drawn unless
productivity can be consistently and accurately measured. As the
value of e-services is not directly measured by official (current)
statistics valid conclusions about the effect of IT and the Internet
on productivity cannot be drawn based on current statistics. Some
economists believe that the inaccuracy of current statistics will
cause productivity to be understated which provides at least a
partial explanation for the productivity paradox. Adding to the
confusion, The Bureau of Labor Statistics has recently changed
inflation-measuring procedures and thereby caused an increase
in measured productivity that does not necessarily reflect actual
productivity. These new statistics cannot be compared and contrasted
with old statistics as they effectively do not measure the same
quantities.
Productivity measurement issues are further complicated by the
pervasive but unaccountable nature of qualitative improvements,
the difficulty of measuring productivity in the services industry,
and the changes in job expectations brought about by technology.
For example, a possible hidden cost of the digital economy is
a reduction in productivity due to an increased amount of non-critical
work such as reading and replying to e-mail. Is an executive who
takes time to respond to customer e-mail increasing his overall
productivity by providing customer service or decreasing the productivity
that falls within his job description by taking time to perform
tasks which are not part of his previously defined productivity?
Is there a hidden value (one beyond those banking transactions
which could be performed with the assistance of a human teller)
to the services provided by automatic teller machines? Is there
measurable productive value in the increased customer service
provided by automatic FAX and e-mail services? Once again, without
consistent definitions and measurement standards, which are neatly
negated by the changing nature of goods and services, meaningful
statistics cannot be compiled; until statistics can catch up with
the new realities dependable conclusions cannot be drawn.
Statistics aside, it is important to remember that radical changes
in a competitive economy need not yield commensurate changes in
economy-wide productivity; it is possible that firms must go on-line
(wired) in order to preserve or extend market share but in the
end are not producing all that much extra output from given inputs.
Likewise, there is also a chance that while computer technology
has proven unbelievable at reproducing itself it has not otherwise
affected productivity.
E. Labor Markets
By 2006 almost 1/2 of the U.S. work force will be employed
by either major producers or intensive users of IT products and
services.11
Increased competition, global access and organizational change
will affect labor markets by influencing employee demand, wages,
and skills requirements. As IT and Internet based industries expand
their employee demand will increase. Additionally, expanding Internet
usage and e-commerce will increase the demand for “core”
IT workers, generate new IT occupations, change skill requirements
for some previously non-IT jobs, and raise the minimum skill requirements
for many low-skill jobs. As skills requirements increase for the
majority of jobs the overall demand for skilled labor will rise,
placing upward pressure on wages. This is borne out by empirical
evidence: wages for workers in IT jobs have increased with skill
requirements and the wage gap between IT workers and all other
workers in growing. This pressure on wages may also increase wage
components other than direct monetary compensation due to the
heightened competition for IT-skilled workers; benefits structures
may change in favor of employees, a fact which may not be accurately
reflected by current wage statistics.
In addition to changing skills and wage structures, IT and the
Internet by virtue of their very nature both create and destroy
jobs. New jobs arise through new occupations (computer assembly,
programming, Internet regulation and monitoring, etc...), redefined
occupations (increased customer tracking responsibilities for
salesmen, consumer e-mail response for executives, etc...), and
increasing demand for certain goods and services (shipping and
delivery, on-line content, desktop publishing, etc...). Jobs will
be destroyed through obsolete processes, substitutions of technology
for labor, the complimenting of labor by technology, and a decreasing
demand for some service workers as consumers take more responsibility
for such services and bypass traditional delivery methods. Thus
while it is clear that IT and the Internet are increasing the
demand for skilled labor, the net effect of IT and the Internet
on the absolute demand for labor will not be known for some time
as labor markets will continue to change and adjust well beyond
the introduction of new technology.
F. Versioning
Information technology and the Internet have supported and furthered
versioning—the offering a line of products consisting of
variations on the same basic good. For example the computer and
software industries have: computers with different amounts of
RAM and processor speeds, registered and unregistered versions
of software, professional, full-featured software versus freeware
or shareware with fewer features, etc... As versioning affects
the product market by increasing the number of substitutes and
price points, it will affect the overall market for the product,
inclusive of all versions (substitutes).
The economic impact of versioning is uncertain. If, by virtue
of creating lower cost options, versioning attracts customers
who otherwise would not purchase any version of the product the
overall market size (demand), but not necessarily the total revenue,
for a particular product (inclusive of all versions) may increase;
while demand is greater a certain number of customers who would
otherwise have purchased a high-end version may instead purchase
a less expensive version. Thus as supply becomes deeper so does
demand and with more options the consumer has more market power.
On the other hand, suppliers may obtain more market power by being
able to attract otherwise uninterested customers through a low-cost,
widely utilized version; familiarity may increase future inclination
to purchase a more expensive version. Additionally, the more people
that utilize a product, regardless of version, the greater the
demand and potential markets for companion products and services.
This in turn can make the initial product more attractive to a
greater number of consumers. The global nature of the Internet
reinforces this supply-side advantage to versioning by opening
previously unavailable geographically distant markets and thereby
increasing potential demand for a product. The greater the demand
and use of the product the more valuable the product becomes and
the greater the demand will be—a self-feeding cycle. Thus
the impact of versioning will differ by market, empowering supply
in some markets and demand in others.
G. Loyalty
Sales of on-line consumer goods was $7.8 billion in
1998 and will be $108 billion in 2003
—Forrester Research12
The Internet and concomitant advances in product delivery (virtual
delivery of software, reasonable next-day delivery by private
carrier, etc...) have nearly eliminated geographic market barriers;
it is nearly as easy for a consumer to purchase from a retailer
1,000 miles distant as from a retailer 10 miles distant. Thus
there is little geographic incentive for customer loyalty while
at the same time more suppliers are competing for any given customer’s
patronage. This increase in competition should lower prices in
most markets but once prices have fallen as far as possible businesses
will need foster customer loyalty in order to retain and build
market share; the consumer will be empowered at the expense of
the seller.
As consumers’ options increase, the seller must strive to
provide more service (in the form of lower prices, higher quality,
better service, frequent-purchase programs, etc...) than the competition.
This increases product heterogeneity, possibly to the point where
multiple distinct products are created where previously only one
existed. While a strictly defined product includes only the physical
good or service received by the consumer, additional services
provided by the seller with the purchase are difficult to separate
from the product. Thus two sellers of a particular physical good
may not be strictly operating in the same market as the additional
services they do or do not provide with purchase change the inherent
nature of the good; while the physical good may be the same, the
product of the seller who provides free shipping and frequent-purchaser
discounts is no longer strictly the same as the product of the
seller who doesn’t provide such additional service.
A change in the nature of products from tangible entities to entities
that are both tangible and intangible will eventually alter the
dynamics of competition in the market for a particular good. The
goods of retailers that were once considered substitutes no longer
are considered such by the consumer and thus the retailers may
no longer be in direct competition; those sellers providing additional
services will no longer be in direct competition with those who
do not provide additional services. Thus markets may narrow by
virtue of becoming more specific to consumer priorities and the
subsequent reduction in direct competition may lead to higher
(rather than lower) prices for some products.
H. Prices
Falling prices in IT-producing industries brought down overall
inflation by an average of 0.7 percentage points13
Price levels represent an useful measure of market efficiency;
the lower price levels become the more in-line producers are with
consumers. Several factors lead to lower equilibrium prices:
and interestingly enough, all of these factors are increasingly
present due to IT and the Internet:
Anecdotal evidence supports the theory of lower prices for
some on-line markets; book and audio compact disc (CD) prices,
alone or with added costs, are lower for on-line retailers than
for traditional retailers. This price discrepancy should and has
created an higher market share for on-line retailers and, as more
consumers acquire Internet access, on-line prices should continue
to fall, increasing price differences between on-line and traditional
retailers. However, while the Internet will make prices in many
markets more efficient that does not necessarily lead to lower
prices in all product markets. For example, on-line auction facilities
have deepened the market for second-hand items causing their prices
to rise. Interestingly enough this may in turn make the prices
of new items fall due to increased competition from the second-hand
market.
Downward pressure on prices may also come from the decreased menu
costs of on-line retailers. Making a change, whether up or down,
in the price of a product is not without cost for the retailer.
The traditional retailer must change item prices, shelf labels,
print advertising, and/or any computerized records. This labor
intensive process carries an inherent expense and thus the traditional
retailer must carefully balance the benefits/profits of executing
a price change against its very real costs. On-line retailers,
in contrast, are highly computerized and thus changing the price
of an item in one or two databases may be all that is required
to completely effect a price change. This reduced menu cost makes
on-line retailers more likely than traditional retailers to make
price changes and to make smaller price changes. This decreases
“price stickiness”, the tendency for prices to remain
at a given level due to menu costs. Thus prices will be more likely
to adapt to changes in the market and markets will become more
efficient. The lowering of menu costs may even decrease the number
of large business cycles and thereby create more stable long-term
markets.
Just as retailer price sensitivity to market conditions and to
the consumer increases so does consumer price sensitivity. With
access to a greater variety of retailers and information consumers
have more power over the product and the price. This power will
likely create a more inelastic demand in most product markets.
However, the relatively high level of price dispersion among on-line
retailers and the lack of a strong, direct correlation between
price and market share strongly for on-line retailers suggests
on-line retailer heterogeneity possibly resulting from branding
issues, lack of consumer awareness regarding retailer choice,
and trust issues; the additional “space” between buyer
and seller may in fact change the psychological aspects of purchase
so as to reduce the importance of prices. This reduction in price
sensitivity could lead to more inefficient markets despite lower
prices for many on-line retailers.
Additional paradox may be created by dint of the increased ability
of retailers to track the prices of competing retailers. While
this certainly can lead to lower prices, if retailers adjust to
the price changes of their competitors more quickly than consumers,
a drift towards higher prices can result with the upward ceiling
being the level of traditional retail prices. A good traditional
example of this phenomenon is the airline industry—for any
given route there are relatively few competitors who make an extremely
aggressive practice of tracking competing prices; the airlines
often react more quickly than the consumer. This isn’t as
likely to happen in markets with a large number of competitors
but competition is limited in some markets.
Thus while there is pressure on prices in both directions, IT
and the Internet are more likely than not to reduce average market
prices; prices posted by on-line retailers are likely to be lower
than those of traditional retailers. At the same time, price dispersion
across a given product market may increase, and consumer sensitivity
to prices may decrease. All of these conclusions are market dependent;
individual product markets respond to different stimuli and thus
are likely to react in a different manner to the intrusion of
IT and the Internet.
I. Price Dispersion
As noted in the previous section, price dispersion is surprisingly
high on the Internet. The Bertrand assumptions for a perfect lack
of price dispersion assume true product homogeneity, zero search
costs and perfectly informed consumers. Thus as search costs decrease
and consumer knowledge increases, price dispersion for narrowly
defined product markets should decrease. Therefore the unexpected
level of price dispersion on the Internet must result from unobserved
differences among retailers that somehow create product heterogeneity.
Possibilities include:
These differences and the resulting price dispersion may be
the result of an immature market; on-line retailing is relatively
new to both consumers and retailers. It may however be a more
permanent characteristic of the delivery mechanism. Only time
will tell.
J. Market Mechanisms
IT and the Internet may also affect market efficiency and prices
by altering current market mechanisms in such a way as to make
them more efficient. One method of traditional retailing involves
non-negotiable menus of prices offered by the seller to the buyer.
In order for this method to be truly efficient, buyers must be
able to, at a relatively low cost, extensively research the market.
Likewise, sellers must know the market in order set appropriate
prices—their only consumer feedback is whether or not the
consumer is willing at the listed price. On-line markets and IT
reduce research costs for both buyer and seller as well as menu
costs and thus tend to make non-negotiable menu markets more efficient.
Markets, such as the used car market, that involve direct negotiation
between buyer and seller certainly have the advantages of interaction
and dialogue; buyer and seller and learn from one another during
the interactive process. However, the risk remains that the market
is not deep enough to have brought together the best combination
of buyer and seller. IT and the Internet increase the depth of
such markets by exposing more potential buyers to sellers.
Even more efficient than such one-on-one negotiation markets are
auction markets as they allow sellers to solicit a wide range
of bids from a variety of potential buyers. Traditional auctions
are quite efficient. The amazingly broad range of the Internet
makes on-line auctions even more efficient than traditional ones.
Such a deep, efficient sales process allows markets to be made
for products for which markets previously didn’t exist, save
by one-on-one negotiation. Additionally, existing markets become
deeper and more liquid due to an increase in the number of potential
buyers.
V. Conclusions
IT and the Internet will effect changes in individual businesses
as well as in the economy as a whole. Competition will increase
in many product markets and most markets will deepen. Prices will
tend fall but not necessarily across the board as pressure on
prices exists from both directions. Issues other than prices will
become increasingly important to consumers as actual contact with
the seller decreases and this will effect traditional definitions
of market efficiency as well as market efficiency in practice.
Jobs will be created in some industries and destroyed in others.
Job definitions and requirements will change as IT and the Internet
change the way most tasks are performed and thus the skills needed
to perform them. Overall productivity changes, however, are quite
unpredictable; while workers may do more they may not produce
more as measured by current statistics. Regardless, the way things
are done will change and thus labor markets will be affected.
Companies will have to pay more to attract and retain the increasingly
skilled workers they demand.
The way companies interact with each other will also change. IT
and the Internet make communication and bidirectional tracking
and monitoring a significant part of corporate structure and thus
more and more profitable associations will be made between companies.
Additionally, IT and the Internet create economical mechanisms
for becoming increasingly aware of potential business partners.
The deeper markets created will increase the ability of companies
to specialize and still remain profitable. Such economies will
reduce production costs and may help lower end-product prices.
The actual economic impact of IT and the Internet will not be
known for some time to come as the IT and the Internet change
whenever there is an attempt to provide value to a new set of
users. Additionally the Internet will continue to become more
valuable as the number of users increases, attracting more suers
and further increasing the value in a continual cycle. Such expanding
technology and Internet use are continually altering the way business
is done. Unfortunately this continual growth and change make it
difficult to accurately evaluate the economic impacts, national
or global. Regardless, IT and the Internet have changed the economy
of the United States and as the Internet moves the world toward
truly global markets, it seems likely that Internet transactions
will grow large enough to measurably impact trade flows and global
corporate structures.
VI. Bibliography
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Economics and Statistics Administration, Office of Policy Development,
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1 Segal, Rick. “Decade of the Customer.” Forbes ASAP, 1996. <http://www.forbes.com/asap/120296/html/rick%5Fsegal.htm>
2 “How Real Is the New Economy?” The Economist, July 24-30, 1999, p. 17. <http://www.economist.com/>
3 “How Real Is the New Economy?” The Economist, July 24-30, 1999, p. 17. <http://www.economist.com/>
4Orlikowski, Wanda J. (1999) “The Truth is Not Out There: An Enacted View of the ‘Digital Economy’.” May 19. <http://mitpress.mit.edu/UDE/orlikowski.rtf>
5 “Newspapers and the Internet” The Economist, July 17-23, 1999, pp. 17-19. <http://www.economist.com/>
6 Moulton, Brent R. (1999) “GDP and the Digital Economy: Keeping Up With the Changes.” May. <http://mitpress.mit.edu/UDE/demoultn.pdf>
7 While it is possible for the Internet to affect some productive capacities without an accompanying increase in demand there isn’t necessarily any incentive to actually increase output.
8 “Economy-Wide and Industry-Level Impact of Information Technology.” U.S. Department of Commerce, Economics and Statistics Administration, Office of Policy Development, and Office of Business and Industrial analysis, April 1997. ESA/OPD 97-3.
9 “The New Economy: Work in Progress” The Economist, July 24-30, 1999, pp. 22-24. <http://www.economist.com/>
10 “The New Economy: Work in Progress” The Economist, July 24-30, 1999, pp. 22-24. <http://www.economist.com/>
11 Henry, David et al. (1999) “The Emerging Digital Economy II” U.S. Department of Commerce, June.
12 Brynjolfsson, Erik and Smith, Michael, D. (1999) “Frictionless Commerce? A Comparison of Internet and Conventional Retailers.” August. <http://ecommerce.mit.edu/papers/ude/ude99.pdf>
13 Henry, David et al. (1999) “The Emerging Digital Economy II” U.S. Department of Commerce, June.
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