Man Without Qualities

Wednesday, July 30, 2003

Mania, Panic, Crash II

The Man Without Qualities has received an e-mail from a very astute reader essentially saying that my prior post on the dotcom "bubble" is a bunch of malarky, although my learned reader uses better form and language than that. Specifically, the e-mail notes:

Granting that the internet had (indeed, still has) the possibility of dramatically improving productivity through disintermediation, why do you think that the companies which are the disintermediators would earn more than a trivial share of the productivity gains? After all, very little of the gains of electrification went to electric companies (and wouldn't have, even if they were unregulated). None of the gains of facsimile transmissions went to the fax manufacturers (other than normal economic profits). Without barriers to entry either from superior skill or patents, why should the internet be anything different?

That said, I agree that someone needs to do the actual research on bubbles, not just blather on about theoretical models, but this time was one of the rare times you leave me unimpressed with the elegance of your insights.

I completely agree with my reader, as far as this analysis goes. In fact, where the internet has been effective to date, it generally provides generalized productivity increases which have been very hard for any one player to capture, just as suggest by this reader. But, as a preliminary matter, it is worth recalling that some dotcom investors had all those "stickiness" and "first off the boat" theories. I, personally never bought into those theories, which may be one reason why I, personally, never bought dotcom stocks at all. But I don't think it was clear that those theories were groundless or constituted "economic irrationality" at the time.

But there is a bigger gap in these observations. One dream of the boom-era dotcom investor was to purchase a portfolio of "new economy" stocks that represented a sector (that is, the dotcom sector or "new economy") that would grow without "old economy" restrictions like entrenched intermediaries, regulator and tax drag, etc. If that "new economy" grew at, say, 7% or 9%, the bet would have paid off.

Hence the possible significance of the Microsoft anti-trust suit developments, which helped to kill the optimism of the internet sector investors (as opposed to the "big kill" investors, who thought some company like Amazon would win big on "stickiness" theories and the like).

In any event, it is not easy to conclude that the thinking of the sector investors was "economically irrational." They certainly had a timing problem.

My reader's e-mail points that my prior post can be read as suggesting that the only way diversified-up-to-sector investors were expecting their returns was by hitting a few jackpots. That is not correct,and the post's suggestion was inadvertant . Generalized growth in the new economy at something like 7% to 9% would have been enough for that kind of play if the portfolio were a basket sufficient to capture the growth in a representative fashion. In this sense, diversified new economy sector investors essentially assumed that the new economy as a whole manifested "superior skill" or "claimed a niche" that would keep much of the new economy profits within the new economy. They may have been wrong, but they were expecting to get paid - a lot.

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