The Growth of the Internet and the Happy Recession

Most popular web-based businesses are deflationary. They substitute expensive forms of content consumption for cheap ones, they make it logistically easier to deliver discounts to people who will respond to them, and they create numerous financially cheap forms of social status. As more activity moves on to the web, the main effect on the economy will be broadly lower prices and less need for employment.

This theme was briefly explored in the excellent The Great Stagnation, but the full impact has yet to be realized. A booming Internet sector has an almost universally negative effect on prices:

• The web makes entertainment cheaper: A crummy music experience is available for free, either low-quality music through filesharing, or music interrupted by ads. A great music experience is available for $10 per month via Spotify. Casual music consumers don’t care that much about their experience, and they’re pretty happy with the free product. Heavy music consumers care deeply about their music experience, and almost certainly spent more than $10 per month on it during the pre-Internet days.

  And music is hardly the only example. The most pernicious aspect of Internet entertainment is that it’s so easy to measure and so easy to mass-produce. So the moment something on the Internet gets fun enough to be competitive with the real-world analogue, it starts getting relentlessly improved until it’s vastly superior. World of Warcraft soaks up upwards of forty hours per week from serious fans, who pay about $15 per month for their subscriptions. Few other hobbies can consume so much time at such a low cost.

• The web offers cheap social status: In the long term, this may have a bigger effect than the web merely making digitizable products cheaper. Social status games drive a huge amount of economic activity: people strive to get into high-paying, high prestige career tracks, to win promotions and attendant raises, to live in the best neighborhoods and send their kids to the best schools. Few status games lack some kind of economic output—people who play sports well below the professional level still get some job opportunities out of it.

  The Internet creates numerous social status games running in parallel to real-world social status games, but almost none of them have the same economic impact. Sites like Reddit and Digg use leaderboards to get users to compete. And the aforementioned World of Warcraft has complex social structures in which individual players manage teams with about the same attention-to-detail as a typical corporate middle-manager (in fact, many advanced World of Warcraft players will spend lots of time using Excel to optimize their game strategy). Given the opportunity to switch from a difficult contest for social status to an easier one, people will tend to opt for the most difficult contest they have any shot at winning. Thus, online communities tend to encourage marginal corporate climbers to be satisfied with worse career outcomes, so long as they’re still well-liked within their online subculture.

  Foursquare is an interesting take on this. Foursquare’s social status games tend to focus on going to business establishments, which often involves spending money. But for someone who really wants to get to the top of that week’s leaderboard, the path of least resistance is to check in without spending money.

• The Internet offers easier access to discounts: the entire group-buying business is built on using discounts to shape customer behavior. This has always been a part of local commerce—a big part of the Sunday paper’s heft consists of coupons. But the game changes qualitatively when the cost of getting a discount in front of someone willing to act on it drops by an order of magnitude or more. This should put long-term pressure on the revenue per table at restaurants, or the revenue per attendee at yoga studios—any high fixed-cost, high gross-margin business is vulnerable.
• Easy access to information makes price discrimination much tougher. Numerous businesses succeed by offering a superficially good deal to their least sophisticated customer segment. This gets harder when people get in the habit of reading up on their purchases online. The FlyerTalk message board, for example, is full of techniques for gaming credit card rewards plans and hotel upgrade policies. When bad deals are more obvious to consumers, this puts margin pressure on the companies that live off of them.
• The web makes it easier to access non-traditional employees at much lower salaries. As we argued in our Demand Media analysis, the real story here is that a stay-at-home mom with a Masters in Journalism can write content that is good enough compared to a typical Madison Avenue copywriter, especially when the rate is $15 per article instead of six figures per year. This disaggregation of writing skill means that companies no longer have to hire good writers in order to write 5% good copy and 95% mediocre work; they can outsource the mediocre stuff and relegate the high-end work to a short-term freelancer.
• The decrease in the cost of aggregating and managing data has led to just-in-time inventory policies, which in turn weaken the inventory restocking effect at the end of recessions. This is a slightly more obscure point, but with less physical stuff sitting in warehouses or in shelves, it takes a smaller swing in unemployment to fill these areas up to capacity. That is not specifically deflationary, but it reduces the eventually-inflationary effects of a robust economic recovery.
• Internet companies have higher revenue per employee, which can be restated to note that they need fewer employees to get a given level of revenue. Multiply that by the decrease in how much revenue Internet companies generate from meeting users’ needs. Facebook and EMI Music are both in the business of entertaining users. How much more efficient is Facebook at getting as many hours of user-entertainment out of a given hour of employee work? A hundred times? A thousand times?

All this should not be especially problematic. That’s the whole point of technology: achieving more with less. It’s also part of the promise of technology: freeing people from annoying social structures that they wish they could opt out of, anyway. But there’s a problem: 30-year treasuries and defined-benefit pension plans don’t pay out in terms of hours of enjoyment or numbers of yoga classes—they pay out in dollar terms. A heavily indebted country doesn’t have the freedom to allow deflationary forces without facing some serious consequences. Interestingly enough, these consequences are somewhat balanced: older people tend to spend far more money on the Internet, and they tend to get far more of their income from fixed income sources, whatever those might be. So this web-based deflation will transfer money to older, wealthier savers—who will promptly transfer some of it right back to web companies. Whether that is an unstable equilibrium or a self-balancing one depends mostly on whether or not web companies will hire more people.