Asian Economies and the New Economy Part 1: What is the New

Economy?

December 14, 2000

Tokyo

Key Questions

• Is there a new economy?

• How does the new economy impact the way the economy works?

• How does the new economy impact the nation-state and role of government?

Is there a new economy?• Short answer: Yes•  Market changes in costs of communication and

computers have interacted with other forces (lower transportation costs, reductions in artificial cross-boundary barriers, and a variety of technologies)

•  Leading to – globalization

– innovation revolution

– marked changes in business practices and structure of the economy

The New Economy (continued)

Characteristics of the New Economy:

• New technologies

• Increased capacity to produce and disseminate information

• Increased demand for information

• Lower cost of information

The new economy? (continued)

• Lower unemployment without inflation– increased competition as a result of better information– increasing wages matching increasing productivity

(converse to productivity slow-down in 1970s)

• Increasing the Pace of Innovation– lower fixed cost of innovation– institutionalized innovation– “mechanized” innovation– more rapid dissemination of new ideas due to new

technologies

The new economy? (continued)

• Improved performance of the economy– increasing productivity (at least in the U.S.)- due to

new technologies

• End of the business cycle– Fluctuations reduced (not eliminated); shocks will

happen

– Better control of inventories

– Decreased importance of sectors that relied on inventories

 Innovation revolution– Industrial revolution changed what goods were produced

and how goods were produced

– also led to a change in where goods were produced—move from rural to urban

– New revolution is leading to a change in how ideas are produced and the importance of the production of ideas (the weightless economy)

– together with globalization can have profound effects on where and how goods are produced—no longer place-based

– Examples of Innovation effects• just-in-time production

• diversification and mutual funds

Changing structure of the economyThe new economy—and old economic laws

There have been major changes in the way the economy operates

- Manufacturing declining, services increasing (change as dramatic as the difference between agriculture and industry)- Much of what we consume today belongs to the weightless economy- Knowledge and information, which are at the heart of the new economy, are fundamentally different from conventional commodities- But economic laws—scarcity—still hold sway

Globalization

• Closer integration of world’s economies and societies through trade, capital flows, movement of people, diffusion of ideas

Implications for the Structure and Conduct of Business

• Changes in production, dissemination, and use of information due to new technologies:– Increased importance of role of information in economy– Increased capacity for processing, and producing

information; lowered costs of information– Changes in “industrial structure” of mediation: Removal of

middleman? Or increased efficiency of middleman?

– Need more nimble firms to keep up with faster pace • Small firms? Less bureaucratic firms? More decentralized firms?

Implications for the Structure and Conduct of Business (continued)

– Firms rethinking modes of operation

– Creation of new industries, while others diminish (Schumpeterian process of creative destruction)

– New problems in valuing securities

– Supply of information growing faster than ability to process it

– Challenge of controlling supply and monitoring quality of information

– Increased concern about privacy and security

Profound implications for U.S. macro-economy

• Increased pace of productivity and growth– question used to be: when would huge investments in

new technologies start to be reflected in macro-data?– answer is: Now

• Reduced magnitude of cyclical fluctuations– less importance of old cyclical industries– less importance of, and better control of, inventories

U.S. Increasing Productivity

Source: Economic Report of the President 2000

Change in productivity (output per hour of all person in the business sector)

(Percent change from preceding period; quarterly data at seasonally adjusted annual rates)

Average change in productivity

0 0.5 1 1.5 2 2.5 3 3.5 4

1960-73

1973-93

1993-96

1996-99

Imperfections in the new economy

• Significant competition imperfections– Increased possibilities for monopolies

• Network externalities (advantage of a common language) can create dominant operating systems– Implication: Given network externalities, need to

look at role of government in addressing • standard setting

• competitive effects

Implications for macro-policy

• Increased productivity and globalization has enabled lower inflation and lower unemployment

• But at the same time there are new forces of instability– cross border capital flows– exchange rate instability

• These forces may hamper national governments’ ability to control their own economic destiny– worry about exchange rate hampers use of monetary

policy– cross border capital flows may hamper effectiveness of

monetary policy

Key Questions: • What is the role for collective action at either the local,

national, regional, or global level?• What public activities can or should take place at each level?• Will the nation state’s role diminish?

• Caught between devolution and globalization• Devolution—political demand to put power closer to people• Globalization puts constraints on what countries can do

– monetary policy

– taxation• limitations on taxation of mobile factors, mobile production

– example: U.S. internet taxation debate

• With implications for inequality

• Difficult to control flow of ideas

The role of the nation state

• Globalization and devolution has forced reexamination of what national governments should do

• Local governments should be responsible for local public goods (police protection)

• National governments should be responsible for national public goods (national defense)

• Declining role of these national public goods?– especially given combined forces of

regionalization/globalization– common market

But – nation states remain locus of legal authority

• In absence of adequate system of global governance, nation state will have to take central role in defining the “rules of the game”, from competition policy, to bank regulations, to providing for a safety net for losers

Countries have responded differently to the new economy

• Different countries have participated in new economy transformations to different extent

• Differences in government policies, actions have played key role– Creating the internet– Interconnection fees (telecommunication

policies, regulations)– Broader market regulations—labor, capital, and

product markets

Eastern Divide

Per 1,000 population, 2000 China India

Telephone main lines 110 30

Mobile-phone subscribers 54 3

Personal computers 10 5

Internet users 16 4

Source: Pyramid Research IMD, Nua Internet Surveys (the Economist)

The New Economy and Equality

The Digital Divide

• Inequality across countries– Closes the divide between the developed countries and the most

advanced of the developing countries • integration with global markets

– conventional production– IT services– availability of information, knowledge (improved information will lead to

improved economic performance)– E commerce will provide direct access to Western markets

– But the new economy will increase the gap between the poorest and the richest countries

– Countries without access to new technologies will fall farther and farther behind

The New Economy and Equality

• Inequality within countries– Will new economy lead to increased inequality, or will it

help narrow the gap?

– Inequality related to “computer literacy” - New economy values skills that can manage the new information technology - those without these skills will be left behind.

Making the most of the new economy

• Ability to harness new technology based upon:– Competitive and innovative financial markets– Presence of less bureaucratic organizations that are

willing to take risks– Competitive markets that spur innovation– High skilled labor willing to take risks– Adaptable education systems– Role of government in fostering new technologies– Role of venture capital firms – providing not just

capital, but managerial and marketing assistance

Creating the new economyThrough better labor markets• labor markets

– willingness to take risks– safety nets– macro-policies (full employment)– “flexible labor markets”– with portability of pensions, other benefits

• education—– adaptable education systems– life-long learning, technology focus– broad access of high-technology learning– limiting extent of digital divide

Creating the new economyThough better capital markets• Capital markets

– Under-regulated capital markets can lead to speculative frenzies, weakening the ability of capital markets to raise funds in the long run

– auditor rules?– disclosure rules?– accounting standards?– U.S. sec committee reexamining valuation issues

• Over-regulated markets can stifle flow of funds• Goal is achieving right balance: locus of responsibility

remains with the nation state

Creating the new economy

Through synergies between research and business

• Research, with close interlinkages with business– Silicon valley brought all key ingredients

together

• But national government played key role

• Increased importance of standards– Conflict between American and European views

– Is there a need for global standards?

– Should the market be let to determine outcomes?

– Market solutions may not be efficient

– But government imposed solutions can be wrong and stifle innovation

• Increased importance of privacy, internet security, and global piracy

• Increased importance of global competition policy

• Approaches of one country, region have global impact– Toughest competition standards may set global standard

– Toughest privacy standards may set global standard

New divisions of responsibilities between private and public sectors, new complementarities

Rethinking the role of government: some basic observations

• Existing rules for evaluating governmental activities need to be updated to reflect the ongoing shift toward a digital economy.

• At turn of the century, rethinking led to new government roles– Evidenced by

• the creation of the Federal Reserve System• the Sherman and Clayton Anti-Trust Acts• the Constitutional amendment allowing a Federal income

tax

The theoretical underpinnings behind private versus public production shifts as the economy moves toward a digital one

– The public good nature of production in a digital economy, along with the presence of network externalities, may suggest a larger public role than is a bricks-and-mortar economy

– An information-based economy may also improve the quality and reduce the cost of obtaining information, which by itself makes private markets work better than before

– Government failure may be even more pronounced in the context of rapidly moving information-laden markets than in traditional bricks-and-mortar markets.

– The appropriate role of government in the economy is not a static concept: It must evolve as the economy and technology do.

Principles for On-Line and Informational Government Activity

• “Green light” for on-line and informational government activity– Principle 1: Providing public data and information is a

proper government role– Principle 2: Improving the efficiency with which

governmental services are provided is a proper government role

– Principle 3: The support of basic research is a proper governmental role

• “Yellow light” for on-line and informational government activity– Principle 4: The government should exercise caution in adding

specialized value to public data and information– Principle 5: The government should only provide public goods, even

if private-sector firms are not providing them, under limited circumstances

– Principle 6: The government should only provide a service on-line if private provision with regulation or appropriate taxation would not be more efficient

– Principle 7: The government should ensure that mechanisms exist to protect privacy, security, and consumer protection on-line

– Principle 8: The government should promote network externalities only with great deliberation and care

– Principle 9: The government should be allowed to maintain proprietary information or exercise rights under patents and/or copyright only under special conditions (including national security)

• “Red light” for on-line informational government activity– Principle 10: The government should exercise

substantial caution in entering markets in which private-sector firms are active

– Principle 11: The government (including government corporations) should generally not aim to maximize new revenues to take actions that would reduce competition

– Principle 12: The government should only be allowed to provide goods or services for which appropriate privacy and conflict-of-interest protections have been erected.

Summary

• The new economy is real– Even if it has sometimes been exaggerated– And even if market values of new economy

stocks are not real

• Changes are already affecting economy, society, and pace of innovation

• Causing changes in structure of economy

Concomitant changes in other aspects of society

• Including political life– Government will continue to have a role– The nation state will continue to have a role– But will need to redefine those roles

• Success in the new economy – as well as inequalities between and within countries – will depend on how well a country can manage the process of reshaping those roles

Role of government in establishing (strengthening) internet

• In U.S., long involvement of government in telecom - back to 1842

• Temporary exemption from sales tax unjustified - worst form of industrial policy

• But raises difficult enforcement/implementation issues

• Regulatory issues have major impact on cost of access – Worst examples in Africa– But other examples

Role of government in standard setting• Three approaches

– Let markets do the sorting– Industry standard setting– Government

• Conflict between U.S. and Europe over preferred approach

• Global markets may require global standards• Poses another example of global governance without

global government• And interests of developing countries may not coincide

with interests of developed countries– developing countries less interested in 3rd generation reforms– more interested in basic services

Role of government in standard setting (continued)

• With network externalities, there are major advantages for standard setting

• but both governments and markets may fail to pick optimal standards

• government agencies may be “captured” by special interest or an industry group may adopt anticompetitive standards

• Suggestion: if there is standard setting, any standard must be freely licensed at “fair” price (arbitration)– note conflict among intellectual property protection,

competition policy, and “standard setting”

• How important are “network externalities”?

Government role in ensuring privacy and security

• Public demand for privacy and security government involvement required, but excessive

intrusiveness of government may have adverse effects on sector

government must be “nimble” in light of fast changing sector

Is main concern protecting individuals from government? Or from the private sector? That is, is the government part of the problem, or the

solution?

Role of government in establishing intellectual property regime

• Intellectual property is at the core of the new economy

• But increased intellectual property protection increases the price of the key input into the production of knowledge---knowledge

• The effect of increased intellectual property protection on the pace of innovation is thus ambiguous

• Key example of conflict arises in copyright protection of data processing of public information

How far should government go in processing information itself?

Should government be worried about displacing the private sector, e.g. in the case of tax preparation?

• Moreover there may be important tradeoffs between intellectual property protection and competition concerns

Role of the government

Knowledge (information) as a public good might suggest a larger role of government

But faster pace of change puts government at a disadvantage—government as a less nimble institution—suggesting a smaller role

Implies partnerships between the private sector and government

Key question; nature of those partnerships

Government’s role in laying the foundations for the new economy

Government’s Key Roles:

• Reducing digital divide

• Promoting new economy

Government’s role continuedGovernment to accomplish these two objectives by:• Redesigning the education program

– promote innovation– promote life-long learning– avoid growing digital divide

• Redesigning financial system– assure funds for new industries

• Making labor markets more flexible• Promoting competition• Promoting new technologiesChange will be evolutionary -hopeless to think about planning” the process

Three keys to success in the new economy

• Flexibility– but still maintain hard-fought rights and fundamental

values (e.g. worker safety and environmental protection)

• Competition• Education

– improve skills

– life-long learning

– change mindsets