Technology and Opportunity

1
Technology and Opportunity

• J. Bradford DeLong
• U.C. Berkeley and NBER
• October 8, 2002
• For the Francisco Partners Fall 2002 Investors
  Conference
• The Inn at Spanish Bay, Pebble Beach, CA

2
Weve Had Our Crash

• Shiller's Irrational Exuberance predicted an up
  to 50 percent decline in the SP Composite.
• Weve already had it.
• We are still not back to historical price
  patterns
• Current earnings yield on the SP is 3 percent.
• Historical average yield is more like 5 to 7
  percent.
• Historical average pricing patterns never made
  any sense
• They made diversified equities overwhelmingly
  attractive.
• But betting against them is very risky
• The market can remain irrational longer than you
  can remain solvent."
• We live in interesting times indeed.

3
Reasons for Investors to Be Optimistic

• The information-age technological revolution
  continues as fast as ever, even through the
  recession.
• Officially-measured labor productivity growth
  rate of 5 percent in 2002 is not out of the
  question.
• Crude corrections for statistical biases lead to
  the guess that the average American worker will
  be 6 percent more productive in 2002 than in
  2001.
• 6 percent productivity growth coupled with 3.5
  percent output growth bad news for workers
• American workers will work 2.5 percent fewer
  hours in 2002 than in 2001--and the unemployed
  are not pleased.
• Such an upward storm in productivity is unheard
  of in recession while the unemployment rate is
  still rising.

4
Durability of Productivity Surge

• Unheard-of (for a recession) upward storm in
  productivity.
• Most productivity gains will be captured by
  consumers and workers in lower prices and higher
  wages.
• But some will be captured by firms in higher
  profits.
• And the faster the productivity growth in the
  2000s, the greater is the profit slice of the
  pie.
• Productivity in computation has improved at a
  steady pace of 60 percent per year since the end
  of the 1940s.
• Our current technological revolution looks to
  be--relative to the size of the economy--fifteen
  times as big a deal as the original industrial
  revolution.
• And the original industrial revolution was a big
  deal indeed.

5
Industrial Revolutions Create Mismatches

• Huge mismatches between supply and demand
• Newly-wealthy consumers demand things that do not
  yet exist.
• Innovative producers see ways to produce what has
  been demanded in vastly cheaper ways.
• Instead of a smooth flow of supply and demand,
  the economy becomes full of turbulence
• Each vortex is the source of a fortune.
• What kind of mismatches should we expect to see?
• Historical analogies.

6
Historical Analogy Railroadization

• Like much of telecom, software, and even
  hardware, railroads promised enormous economies
  of scale
• Build it once, and then run any number of trains
  over it.
• Like our modern data processing and data
  communications technologies, the railroad was an
  enormous technological leap
• It lowered the cost land bulk transport by a
  hundredfold.
• Like our internet boom, there was extraordinary
  and wild enthusiasm
• If they could capture as profit just one-tenth of
  the cost savings the railroads
• And like our internet bust, there were moments
  when investors in New York and London suddenly
  realized that they had been total fools.
• Plus huge frauds

7
Fraud, Bust, and Reorganization

• In the 1880s and 1890s J.P. Morgan and its
  clients picked up bankrupt railroads with greatly
  distressed debt for a song
• Crammed unattractive junior securities down the
  throats of bondholders.
• Found managers who could run them efficiently and
  profitably.
• Without the burden of amortizing debt issued
  during the previous bubble the new managers could
  slash rates.
• Vicious price wars.
• Consequences of newly-cheap land transportation
• Sears, Roebuck and Montgomery Ward.
• Meatpacking. Swift and Armour.
• But Federal preemption of state-level health and
  safety regulations.

8
Applying the Analogy

• For the Baldwin Locomotive Compan of
  Philadelphia, read "Intel."
• For Carnegie Steel, read "Cisco."
• For the Central Pacific with its repeated
  bankruptcies, read "Global Crossing
• lthough somehow I don't think we are likely to
  have a Winnick University at the end of all this.
  
• The mass bankruptcies of 19th century railroads
• Had everything to do with
• Financial management.
• Irrational exuberance
• Had nothing to do with
• technological opportunities and long-run benefits
  of rail transportation
• So today's shakeout has little to do with
  ultimate economic benefits of computers and
  communications.

9
And What Are the New Industries of the Future?

• Where are today's counterparts of Sears, Roebuck
  and Montgomery Ward?
• Who will find that modes of information and
  product distribution that had previously been
  unthinkably costly are now gold mines?
• Where are today's counterparts of Swift and
  Armour?
• Who will build technologically-sophisticated
  systems--the equivalent of assembly-line
  slaughterhouses and refrigerated transport
  cars--on top of vastly cheapened high-bandwidth
  links?
• If we can get the regulatory framework right.
• Where are today's equivalents of Singer Sewing
  Machines?
• Singer found that it could not sell sewing
  machines in its early years without providing a
  salesman to provide hands-on training in how to
  teach people to use sewing machine to each
  wholesale customer.
• Could it have afforded to keep a large-enough
  sales force without the railroad?
• I'm a professor. So I'm allowed to say that I
  leave these extensions as exercises for the
  students.