A Philosopher's Blog

A Bubble of Digits

Posted in Business by Michael LaBossiere on January 12, 2015

A look back at the American (and world) economy shows a “pastscape” of exploded economic bubbles. The most recent was the housing bubble, but the less recent .com bubble serves as a relevant reminder that bubbles can be technological. This is a reminder well worth keeping in mind for we are, perhaps, blowing up a new bubble.

In “The End of Economic Growth?” Oxford’s Carl Frey discusses the new digital economy and presents some rather interesting numbers regarding the value of certain digital companies relative to the number of people they employ. One example is Twitch, which streams videos of people playing games (and people commenting on people playing games). Twitch was purchased by Amazon for $970 million. Twitch has 170 employees. The multi-billion dollar company Facebook had 8,348 employees as of September 2014. Facebook bought WhatsApp for $19 billion. WhatsApp employed 55 people at the time of this acquisition. In an interesting contrast, IBM employed 431,212 people in 2013.

While it is tempting to explain the impressive value to employee ratio in terms of grotesque over-valuation (which does have its merits as a criticism), there are other factors involved. One, as Frey notes, is that the (relatively) new sort of digital businesses require relatively little capital. The above-mentioned WhatsApp started out with $250,000 and this was actually rather high for an app—the average cost to develop one is $6,453. As such, a relatively small investment can create a huge return.

Another factor is an old one, namely the efficiency of technology in replacing human labor. The development of the plow reduced the number of people required to grow food, the development of the tractor reduced it even more, and the refinement of mechanized farming has enabled the number of people required in agriculture to be reduced dramatically. While it is true that people have to do work to create such digital companies (writing the code, for example), much of the “labor” is automated and done by computers rather than people.

A third factor, which is rather critical, is the digital aspect. Companies like Facebook, Twitch and WhatsApp do not manufacture objects that need to manufactured, shipped and sold. As such, they do not (directly) create jobs in these areas. These companies do make use of existing infrastructure: Facebook does need companies like Comcast to provide the internet connection and companies like Apple to make the devices. But, rather importantly, they do not employ the people who work for Comcast and Apple (and even these companies employ relatively few people).

One of the most important components of the digital aspect is the multiplier effect. To illustrate this, consider two imaginary businesses in the health field. One is a walk-in clinic which I will call Nurse Tent. The other is a health app called RoboNurse. If a patient goes to Nurse Tent, the nurse can only tend to one patient at a time and he can only work so many hours per day. As such, Nurse Tent will need to employ multiple nurses (as well as the support staff). In contrast, the RoboNurse app can be sold to billions of people and does not require the sort of infrastructure required by Nurse Tent. If RoboNurse takes off as a hot app, the developer could sell it for millions or even billions.

Nurse Tent could, of course, become a franchise (the McDonald’s of medicine). But, being very labor intensive and requiring considerable material outlay, it will not be able to have the value to employee ratio of a digital company like WhatsApp or Facebook. It would, however, employ more people. However, the odds are that most of the employees would not be well paid—while the digital economy is producing millionaire and billionaires, wages for labor are rather lacking. This helps to explain why the overall economy is doing great, while the majority of workers are worse off than before the last bubble.

It might be wondered why this matters. There are, of course, the usual concerns about the terrible inequality of the economy. However, there is also the concern that a new bubble is being inflated, a bubble filled with digits. There are some good reasons to be concerned.

First, as noted above, the digital companies seem to be grotesquely overvalued. While the situation is not exactly like the housing bubble, overvaluation should be a matter of concern. After all, if the value of these companies is effectively just “hot digits” inflating a thin skin, then a bubble burst seems likely.

This can be countered by arguing that the valuation is accurate or even that all valuation is essentially a matter of belief and as long as we believe, all will be fine. Until, of course, it is no longer fine.

Second, the current digital economy increases the income inequality mentioned above, widening the gap between the rich and the poor. Laying aside the fact that such a gap historically leads to social unrest and revolution, there is the more immediate concern that the gap will cause the bubble to burst—the economy cannot, one would presume, endure without a solid middle and base to help sustain the top of the pyramid.

This can be countered by arguing that the new digital economy will eventually spread the wealth. Anyone can make an app, anyone can create a startup, and anyone can be a millionaire. While this does have an appeal to it, there is the obvious fact that while it is true that (almost) anyone can do these things, it is also true that most people will fail. One just needs to consider all the failed startups and the millions of apps that are not successful.

There is also the obvious fact that civilization requires more than WhatsApp, Twitch and Facebook and people need to work outside of the digital economy (which lives atop the non-digital economy). Perhaps this can be handled by an underclass of people beneath the digital (and financial) elite, who toil away at low wages to buy smartphones so they can update their status on Facebook and watch people play games via Twitch. This is, of course, just a digital variant on a standard sci-fi dystopian scenario.

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10 Responses

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  1. WTP said, on January 13, 2015 at 1:03 pm

    You know nothing about economics. Please stop pretending that you do. We’ve been over and over and over economic topics until you ultimately either declare victory and run away, dissolve the discussion into sophistry, or pretend your inability to understand is somehow proof of your point.

    • Michael LaBossiere said, on January 14, 2015 at 8:37 pm

      So, go through my claims and show they are in error. Should take a matter of minutes…if I am as awful as you claim.

  2. WTP said, on January 15, 2015 at 10:46 am

    Been there, done that before…but I will start all over again only if you promise to stay with the conversation, answer the questions honestly. No playing silly word games, no clown nose, no sophistry, and no abandoning the discussion when things get uncomfortable for you. I’ve invested time in this effort in the past and I found it very disrespectful when you avoided addressing the point of the question or you just dropped the subject. Can you do that, Mike? Stay with the discussion that is. Or will to waste more of my time? Of course asking such a question is absurd when dealing with a believer in the Costanza defense, but such is my faith. A character flaw, I am sure.

    • Michael LaBossiere said, on January 16, 2015 at 6:57 pm

      I don’t see any actual criticism of my claims. Just an attack on me.

      • wtp said, on January 16, 2015 at 8:03 pm

        I don’t see an answer to my question, just AGAIN avoiding the issue at hand. Unless you are willing to engage in an actual debate, no running away, it is not worth my time. I am not attacking you, I am describing your past behavior. I will not be your fool. We can engage in discussion of issues, but we must engage. No waving of the hand, as Magus says, no running away, no clown nose, no Costanza defenses. If you agree to these terms I will engage in a discussion of the issues. But if you disrespect me or you disrespect facts and logic, why should you expect respect in return?

        • Michael LaBossiere said, on January 17, 2015 at 11:36 am

          I am asking for just that. Pick a substantial claim I made in the essay, then show it is in error.

          • wtp said, on January 17, 2015 at 12:47 pm

            Agree to the ground rules and I will. You seem to have a very hard time with commitment.

            • Michael LaBossiere said, on January 19, 2015 at 12:02 pm

              That is what my ex-wife said.

            • WTP said, on January 20, 2015 at 10:53 am

              Now I’m feeling sympatico with someone’s ex-wife. That’s certainly a rare event. Can’t imagine how your ex-father-in-law felt about the breakup.

              So back to the clown-nose it is. You can’t commit to an honest debate on a subject, yet you will continue to whine and feel all butt-hurt when your views are criticized. And you call yourself a “philosopher” and an expert on “ethics”. Cowardly, pitiful, and absolutely pathetic.

            • WTP said, on January 20, 2015 at 10:55 am

              Though on second thought and looking for some good here, I do appreciate your honesty in this matter. At least you know yourself well enough to know you lack the character to stay with such a discussion in an honest and reasonable manner. So at least there’s that.

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