Transcript Internet Economy and capital markets

Current Issues in Economics
Lecture 3
Internet Economy
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To remember
• Development is the problem of acquiring and
using productive knowledge
• There is no one single model of a successful
transformation to KE.
• Nations respond to the challenge of this
transformation in different ways, depending
on the differences of their history and culture,
national priorities, economic status, size,
geography and social capital.
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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.
• The Internet is a multi-billion dollar industry in its
own right, but more importantly a vital
infrastructure for much of the world’s economy.
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Exponential growth of Internet access with
saturation in some countries
• In January 2016, approximately 1.05 billion internet hosts
were available, almost double the amount of six years prior.
• 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
• The number of smartphone users is to grow from 2.1
billion in 2016, to close to 3 billion in 2020
• On average, 70% of households in OECD countries have
access to the Internet at home. Korea (97%), Iceland (92%)
and the Netherlands (91%)
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Internet saturatiion
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What on Net?
• The Internet is affecting nearly all sectors of
the economy, from making hard-to-find data
to transforming entire markets, as is occurring
with music, video, software, books and news,
retail, hospitality.
• Advertising represents the biggest online
market in absolute terms, followed by
computer and video games, online music and
film and video (including pornography)
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Internet economy is different in a fundamental way
Demand and supply „cross” and clearing price is
a corner stone of economics, is it really?
Market transaction i IE:
• who is:
– seller?
– buyer?
• what is:
– commodity?
– price?
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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 Google, 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 one of the fastestgrowing tech companies in the US just few years ago
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„Poor but mobile” phenomenon
People with no access to water, electricity or other
services may have access to the Internet from their
mobile phone.
Maslow’s hierarchy of needs
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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 few
• Is it possible that conventional measures of inequality
and income vastly underestimate just how good we
have it?
• Time is the only truly scarce resource; and, because
goods and services related to information require our
attention, they are time-intensive
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Digital divide?
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%
Not technical
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Pioneering activities
• Close to 50% 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,
the share is over 70%.
• Bonus of underdevelopment
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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 smart phones one can need, and
how much time spent using them
• 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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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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New heros of Internet Economy
• New type of entrepreneurs:
– Experience does not matter
– Formal education does not matter – university
dropout
– “Instant rich” motivation
• New type employees:
– Brainy kids
– No loyalty to the firm
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Internet Economy and finance
• Revolution in valuation of companies: what if E in P/E ratio
is zero?
• 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:
– Growth of venture capital
– Traditional investors chasing return in the real estate,
currencies, gold and other highly speculative and prone to
bubbles markets.
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Internet Economy and 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 adverse 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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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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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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Dot.com and public policy
• Cities all over the world 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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Dot.com crash
• The stock market crash of 2000–2002 caused the
loss of $5 trillion in the market value of
companies but no effect on the economy
• 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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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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Pros & Cons of Internet Economy
• Positive:
– Better use of resources
• Use of idle resources (prosumption)
• Replacing traditional channels of commerce
– New near free services and goods
• Negative:
– Market segmentation
– Inefficient regulation
– Systemic instability
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