Current Issues in Economics Internet Economy 1. Internet – short history The Internet began as a way of linking different computers over the phone network,

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Current Issues in Economics

Internet Economy

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Internet Economy

Internet – short history

• The Internet began as a way of linking different computers over the phone network, but it now connects billions of users worldwide from wherever they happen to be via portable or fixed devices.

• People with no access to water, electricity or other services may have access to the Internet from their mobile phone.

• The Internet is a multi-billion dollar industry in its own right, but it is also a vital infrastructure for much of the world’s economy.

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Internet Economy

Exponential growth of Internet access with saturation in some countries:• There were about 733 million registered Internet hosts

worldwide in 2010, 17 times more than in 1999.• On average, 70% of households in OECD countries have access

to the Internet at home. Korea (97%), Iceland (92%) and the Netherlands (91%)

• Broadband subscriptions grew 20 times over the past decade.• Between 2004 and 2010, the number of registered Skype

users increased by almost 30 times, up to 560 million worldwide

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Internet Economy

Pioneering activities• Close to 40% of people in OECD countries use

banking services on the Internet. In the Nordic countries and in the Netherlands over 75% of individuals use the Internet for banking.

• Almost half of Internet users use the Internet for formalized education activities. In Finland, Portugal, Iceland and Luxembourg the share is over 70%.

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Internet Economy

• The Internet is affecting nearly all sectors of the economy, from making hard-to-find data available online to transforming entire markets, as is occurring with music, video, software, books and news.

• Advertising represents the biggest online market in absolute terms, followed by computer and video games, online music and film and video, end pornography

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Internet Economy

Internet economy is different• Market transaction: • who is:– seller?– buyer?

• what is:– commodity? – price?

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Internet Economy

Macro consequences of Internet Economy:• Some vital parts of the Internet Economy barely register in

the GDP. While GDP measures the market value of all goods and services produced within a country, many stars of IE (think Wikipedia, Facebook, Twitter, Mozilla, Netscape, and so on) produce no goods and provide free services.

• IE tend to undercut both, the traditional and IE businesses. Skype is killing the international phone calls. Free navigation apps have shrunk sales for Garmin, the GPS pioneer that was once one of the fastest-growing companies in the US.

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Internet Economy

Wealth effects• Today, nearly every resident of a developed country – and

soon most of the rest of the world – can easily afford a smartphone, thereby gaining inexpensive access to a universe of human knowledge and entertainment that, until a generation ago, was far beyond the reach of all but the rich.

• Is it possible that conventional measures of inequality and income vastly underestimate just how good we have it?

• Depends how we value our time. Time, like money, is a scarce resource; and, because goods and services related to information require our attention, they are time-intensive.

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Internet Economy

• We spend, on average, two hours a day with our audio-video devices. Assume that the opportunities provided by the rollout of broadband Internet has doubled the utility – the pleasure – that we get during that time. That is the equivalent of receiving an extra two hours of free time every day

• The question then becomes whether our smartphones, Kindles, tablets, and computers actually do provide us that extra utility. Are Facebook „friends” more valuable than “off-line” friends?

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Internet Economy

• We do not consume goods and services in a vacuum. Part of the pleasure we receive from them derives from a feeling that our status is rising relative to that of our peers.

• Keeping up with the Joneses • „Poor but mobile” phenomenon

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Internet Economy

Maslow’s hierarchy of needs

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Internet Economy

IE and national wealth distribution:• As the better off become richer much of their rising income will

not be spent on ICT-intensive goods and services. There is a limit to how many iPads and smart phones one can need, and their price continues to plummet.

• An increasing share of consumer expenditure is devoted to buying goods and services that are rich in fashion, design, and subjective brand values, and to competing for ownership of location-specific real estate.

• Land on which the desired houses and apartments sit is in limited supply, the inevitable consequence is rising prices. The price of land is rising because of rapid technological progress and exorbitant revenues of IE entrepreneurs.

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Internet Economy

Labor and capital in IE:• One consequence is the striking phenomenon

of huge wealth creation with very little labor and capital input.

• Facebook has an equity valuation of $170 billion but employs only around 6,000 people.

• The investment that went into building the software that runs it entailed no more than around 5,000 software engineer man-years.

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Internet Economy

IE and Labor Market• Generates new type of entrepreneurs: – Experience does not matter– Formal education does not matter – university

dropout– “Instant rich” motivation

• Employees:– Brainy kids– No loyalty to the firm

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Internet Economy

IE and capital markets• The low cost of capital (low interest rates) because

of the reduced demand for capital for investment in Internet based business. If you can start a $170 billion company in a dorm room and then bring it to the market with just 5,000 software engineer man-years, you don’t need to borrow much money.

• In effect, financial investors chasing return in the real estate, currencies, gold and other highly speculative and prone to bubbles markets.

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Internet Economy

IE in capital markets• IE gradually reconfigure a notable part of the capital market,

particularly in consumer finance, while challenging regulators to adapt.

• Internet-driven lending and borrowing initiatives in consumer financial services seek to compress net interest margins, including through lower expenses and more efficient data assessments and aggregation, and by targeting an enhanced consumer experience.

• Such empowerment schemes could serve to reduce the cost of financial intermediation while providing for fairer risk-pooling outcomes and better credit underwriting.

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Internet Economy

Economy is likely to suffer two adverse IE side effects: • First, it may be inherently unstable, because the more

wealth resides in real estate, the more the financial system will provide leverage to support real-estate speculation, which has been at the heart of all of the world’s worst financial crises.

• Second, it may be a highly unequal society. The modern economy may resemble that of the eighteenth century, more than the middle-class societies in which most developed countries’ citizens’ grew up.

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Internet Economy

Digital divide? Not technical

Fixed subscriptions: 2007a 2010a 2013a,b

Africa 0.1% 0.2% 0.3%

Europe 18.4% 23.6% 27.0%

Mobile subscriptions: 2007a 2010a 2013a,b

Africa 0.2% 1.8% 10.9%

Europe 14.7% 28.7% 67.5%

a Per 100 inhabitants. b Estimate

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….. but on substance?

• Distant learning education vs. traditional face-to-face education:– transfer of knowledge– verification of progress– nonverbal– networking

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Internet Economy

Dot.com story• Due to the rise of commercial growth of the Internet,

venture capitalists saw record-setting growth as dot-com companies experienced meteoric rises in their stock prices

• VC moved faster and with less caution than usual in financing new firms, hedging the risk by starting many contenders and letting the market decide which would succeed.

• The low interest rates in 1998–99 helped increase the start-up capital amounts.

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Internet Economy

Dot.com company's business model • It relied on harnessing network effects by operating at a

sustained net loss to build market share. These companies offered their services or end product for free or with losses with the expectation that they could build enough brand awareness to charge profitable rates for their services later.

• The "growth over profits" mentality led some companies to engage in lavish internal spending, such as elaborate business facilities and luxury vacations for employees. Executives and employees who were paid with stock options instead of cash became instant millionaires when the company made its initial public offering

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Internet Economy

Dot.com public and private infrastructure• Cities all over the United States sought to become

the "next Silicon Valley" by building network-enabled office space and offered tax exemptions and subsidies to attract Internet entrepreneurs

• Communication providers, convinced that the future economy would require broadband access, went deeply into debt to improve their networks with high-speed equipment and fiber optic cables.

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Internet Economy

Dot.com aftermath• The stock market crash of 2000–2002 caused the loss

of $5 trillion in the market value of companies• Investment guru and billionaire Warren Buffett had

just one message for investors following the bursting of the internet bubble "Value is destroyed, not created, by any business that loses money over its lifetime" referring to the business model dot.coms employed - to enrich investors through rising share prices rather than profits.

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Internet Economy

Dot.com failures and successes• Pets.com was never able to give pet owners a compelling

reason to buy supplies online. A customer had to wait a few days to get delivery and Pets.com lost money on most of the items it sold. Despite this, Pets.com raised $82.5 million in an IPO in February 2000 before collapsing nine months later.

• However, there were remarkable and enduring successes during this period - Amazon, eBay, Craigslist, Yahoo, Google

• Amazon.com stock went from $107 IPO to 7 $ per share, but a decade later exceeded $400 per share

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Internet Economy

Future:• Positive:

– Replacing traditional channels of commerce– Internet of things– Zero marginal cost society (better use of resources) – Near free services and goods– Private currencies

• Negative:– Net segmentation– Net filtering (censorship)– Lost privacy– Hacking to destruction (latest Sony case)