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Management Issues: Computers are transforming the economy

More has changed than the usual economic statistics would lead us to believe - much new input is simply not measured
There are two general views about the impact of new information technologies on the economy. On the one hand, you get the cynics who think it is all hype and balderdash, and that nothing has changed fundamentally. And on the other are whizz-bang enthusiasts with boundless optimism about the future who say everything is different.

The first shreds of evidence that at least something is different are being furnished right now by the US and UK economies. In both cases, there has been more growth with less inflation than the experience of the past generation has led us to expect. There might be all sorts of explanations for this, including deregulation and jobs market flexibility, but advances in technology are another candidate. After all, almost all the long-term economic growth there has ever been in the world has been attributable to technological progress.

Yet even if things are genuinely different now, it does not, as some enthusiasts seem to think, mean the laws of economics have been suspended. New structures of production and costs in the information age are amenable to analysis.

Some of the features enthusiasts tend to pick out are the least interesting. For example, the pace of technical change is certainly very rapid now: the value of computer power increases 32-fold every decade, while the value of car power grew four-fold every decade at the same stage of the combustion engine revolution.

More interesting this time around are the special features of information. Much information is non-excludable - if it is made available, there is nothing to prevent people who have not paid for it from using it. There are some technical fixes for this, such as the set-top boxes that control access to broadcast TV programmes. But it is impossible to prevent a Chinese manufacturer, say, from copying a CD or a dress design. Battles over piracy and intellectual property rights will be a recurring theme of the information economy.

Secondly, many people can use information at the same time, unlike traditional goods. The marginal cost of information - the cost of serving an extra customer - is therefore zero in one sense. The efficiency of the economy demands that the price is zero, too, because there is no consumption of scarce resources. But if the price were zero, the information would not be provided because the initial costs are often very high.

Thirdly, much information is not transparent. You don't know how good it is until you have actually tried it, and if you know what it is you already have it.

Not surprisingly, these features call for very different sorts of business strategies. One of the best recent books on what they ought to be is Information Rules by Hal Varian and Carl Shapiro.

Much of their analysis focuses on the tension between giving away your information so that people know what you have to offer, and recovering your costs. For instance, one possible strategy is to give away samples to encourage people to buy the full or premium product. Price discrimination between different types of customer is another fruitful strategy, such as making delayed information much cheaper than real-time information - rather as paperbacks are cheaper than original hardback editions.

In addition, Varian and Shapiro also emphasise the power of being first in the market in information industries: there is more value to something the more other people are using it. The fax machine is a classic example. Yours is no good unless other people have one too. Microsoft Windows is another.

The analytical framework provides some justification for the loss-making strategies adopted by so many e-businesses. They are spending on being first in the market and building up a customer base: if all your costs are upfront, the only way to reduce unit costs is to sell more units.

The policy implications are as profound as the lessons for business: we might be doomed to an environment of serial monopoly, where the biggest player in each market has to be kept in check by the competition authorities rather than direct competitors.

And a key challenge for governments will be creating an environment that fosters as many new start-ups as possible, because serial entrepreneurship is a necessary corrective to serial monopoly. As Bill Gates has often said, the biggest threat to his business is not the Justice Department but some geek hunched over a keyboard.

This is indeed a different sort of economy. In the long run, it will be a more prosperous one. Whether this is cause for feeling boundless optimism about the short run is another matter entirely.