The Second Economy

We all know that the web has transformed our lives and dramatically altered how we live. We throw around words like "transformative," and "revolutionary" without a second's thought. But in The Great Stagnation (#TGS), Tyler Cowen makes the point that the internet is mostly good for so-called "infovores" and that consumer surplus has only modestly improved.

Nor does the web provide much in terms of employment potential. Put simply, according to TGS theories, outside of Silicon Valley, the Route 128 corridor, and a few hotspots around the country, we just don't need that many engineers and computer scientists. While these new industries do create net new jobs, they are not doing enough to close the "stagnation gap" that's arisen since the 1970s. Cowen's thesis is usually presented as somewhat of a contrarian take on the web and its impacts, but it has also become one of the more hotly debated books over the past year.

But frankly, I don't think he pushes this idea very far. Brian Arthur, in a very thoughtful piece for McKinsey (The Second Economy) spends far more time focusing on how deep the information revolution really goes (also see his speech at PARC). Arthur believes we are seeing the rise of a second economy, enmeshed over our own, that is built around digital processes. In Arthur's description:

If I were to look for adjectives to describe this second economy, I’d say it is vast, silent, connected, unseen, and autonomous (meaning that human beings may design it but are not directly involved in running it). It is remotely executing and global, always on, and endlessly configurable. It is concurrent—a great computer expression—which means that everything happens in parallel. It is self-configuring, meaning it constantly reconfigures itself on the fly, and increasingly it is also self-organizing, self-architecting, and self-healing.

These last descriptors sound biological—and they are. In fact, I’m beginning to think of this second economy, which is under the surface of the physical economy, as a huge interconnected root system, very much like the root system for aspen trees. For every acre of aspen trees above the ground, there’s about ten miles of roots underneath, all interconnected with one another, “communicating” with each other.

This broader conception of the information revolution strengthens the TGS thesis. As the second economy has expanded, productivity from digitization in business processing has displaced many human processing jobs, such as secretaries, paralegals, typists, telephone operators, draftsmen, and so on. In Arthur's telling, the reason we've seen slower recoveries following the past few recessions is that structural changes are leading to TGS outcomes. Back to Arthur:

Physical jobs are disappearing into the second economy, and I believe this effect is dwarfing the much more publicized effect of jobs disappearing to places like India and China.

There are parallels with what has happened before. In the early 20th century, farm jobs became mechanized and there was less need for farm labor, and some decades later manufacturing jobs became mechanized and there was less need for factory labor. Now business processes—many in the service sector—are becoming “mechanized” and fewer people are needed, and this is exerting systematic downward pressure on jobs. [...] But the primary cause of all of the downsizing we’ve had since the mid-1990s is that a lot of human jobs are disappearing into the second economy. Not to reappear.

So where does all that leave us? One Bloomberg review summed up Cowen's thesis as, "Cowen thinks that now that America has used up the frontier, educated all of the farm kids, and built a couple of cars for every family, we might be done growing for awhile." In more prosaic econ terms, Cowen believes that our potential rate of growth has slowed, perhaps dramatically, and is unlikely to rise in the near term (this reflects slower pop growth, fewer women entering workforce, and so on).

In Arthur's version, technological change will proceed at a tremendous pace and the digital second economy will mirror the size of our traditional economy in 15-20 years. However, rising productivity will displace human workers and we will have trouble finding new jobs. In this, Arthur channels John Maynard Keynes, from his classic "Economic Possibilities for our Grandchildren:"

We are being afflicted with a new disease of which some readers may not yet have heard the name, but of which they will hear a great deal in the years to come--namely, technological unemployment. This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour.

In one of the strongest sections of The Coming Prosperity, Auerswald connects Arthur and Cowen's writings with earlier technology pessimists, like Norbert Weiner and Keynes. Phil points out that since their warnings we have had tremendous economic growth and the world has gotten better for almost everyone.

More recently, even though the 2000s weren't great in the U.S., it was the best decade for the rest of the world. This observation forms the basis for much of The Coming Prosperity. (It's worth pointing out that Cowen is an optimist and also believes that this past decade really was the best, globally, and that future decades will only get better as well.)

One of the primary reasons for optimism stems from the remarkable actions entrepreneurs are taking to fundamentally reshape the world. Auerswald does a commendable job of portraying these trends and how entrepreneurial solutions are being applied to global challenges. If there is a shortcoming to this approach, however, it is that he only discusses these changes and their affects in the U.S. in passing (to be fair, he spends a lot of time discussing the changing structure of the U.S. economy, which I'll address in a future post).

There are a couple of ways of thinking about these issues. First, I think it's worth revisiting this idea of the frontier. In a recent twitter exchange, Gwendolynne Cross (@brainparts) asked me and a few other people why the word entrepreneurship always triggers the Star Trek TNG theme song in her mind. David Miller (@campus_entre) rightly responded that entrepreneurship is all about the frontier. So what about Cowen's thesis that the frontier has essentially closed?

The same period (post 70s) that has been identified as the era of stagnation has also been identified as the era of entrepreneurship (by Acs, Audretsch, Auerswald, Schramm...). I'll come back to this dichotomy in a future post, but for now lets just accept the resurgence of entrepreneurialism. Entrepreneurship is synonymous with the idea of the frontier.

One reason the frontier is alive and well is that entrepreneurship, despite universities near maniacal focus on technology transfer, spans industries. One example from David Miller's research, out of many cases, is Under Armour. Under Armour was started by Kevin Plank while he was a student-athlete at the University of Maryland. Plank decided to enter a tough market that was already dominated by huge companies with exclusive contracts. But success was rapid and phenomenal and Plank's achievement sparked a revolution in entrepreneurship education at UMD (read David's blog for much more on this).

But even in technology fields, new innovations are creating new needs. According to McKinsey:

There will be a shortage of talent necessary for organizations to take advantage of big data. By 2018, the United States alone could face a shortage of 140,000 to 190,000 people with deep analytical skills as well as 1.5 million managers and analysts with the know-how to use the analysis of big data to make effective decisions.

Thanks to the incredibly sharp John Wilbanks (@Wilbanks) for the link to this report. John also suggested we create an initiative to train data administrators at the community college level, mirrored after Reagan's initiative to train more nurses in the 1980s. Seems like a great idea to me.

Now, in the grand scheme of things a shortage of 140,000 to 190,000 people with "deep analytical skills" and 1.5 million data managers really doesn't amount to much. But if we could somehow add all of these workers to our economy right now, we could potentially lower our unemployment rate by a full percentage point. Obviously that's not possible, but it's something to work towards and with our dismal performance of late, it would be a welcome bit of positive news. Nor is this a lone case - without a doubt there will be many sectors of the economy that will be in dire need of smart, talented, curious, and not necessarily college educated, employees.

More generally this mirrors Alex Tabarrok's (Tyler's co-blogger at MR) call for additional vocational training, rather than continuing to emphasize higher education as the only legitimate goal (see here and here). We should pay more heed to this line of thought.

I'll wrap up this exceedingly long post by saying that there are many remedies to our ills, but that our public discussions and proposed solutions are rarely helpful or productive. It's time to change the discussion to what really matters.