Understanding the Digital Economy pot

Understanding the Digital Economy

This Page Intentionally Left Blank

Understanding the Digital Economy

Data, Tools, and Research

edited by Erik Brynjolfsson and Brian Kahin

The MIT Press, Cambridge, Massachusetts, and London, England

© 2000 Massachusetts Institute of Technology

All rights reserved. No part of this book may be reproduced in any form by any

electronic or mechanical means (including photocopying, recording, or information

storage and retrieval) without permission in writing from the publisher.

This book was printed and bound in the United States of America.

Library of Congress Cataloging-in-Publication Data

Understanding the digital economy : data, tools, and research / edited by Erik

Brynjolfsson and Brian Kahin.

p. cm.

Includes bibliographical references and index.

ISBN 0-262-02474-8 (hc : alk. paper)

1. Electronic commerce—Congresses. I. Brynjolfsson, Erik. II. Kahin, Brian.

HF5548.32 .U53 2000

330.9—dc21 00-033947

Contents

Introduction 1

Erik Brynjolfsson and Brian Kahin

The Macroeconomic Perspective

Measuring the Digital Economy 13

John Haltiwanger and Ron S. Jarmin

GDP and the Digital Economy: Keeping up with the

Changes 34

Brent R. Moulton

Understanding Digital Technology’s Evolution and

the Path of Measured Productivity Growth: Present

and Future in the Mirror of the Past 49

Paul A. David

Market Structure, Competition, and the Role of

Small Business

Understanding Digital Markets: Review and

Assessment 99

Michael D. Smith, Joseph Bailey, and Erik Brynjolfsson

Market Structure in the Network Age 137

Hal R. Varian

The Evolving Structure of Commercial Internet

Markets 151

Shane Greenstein

Small Companies in the Digital Economy 185

Sulin Ba, Andrew B. Whinston, and Han Zhang

vi

Contents

Small Business, Innovation, and Public Policy in

the Information Technology Industry 201

Josh Lerner

Employment, Workforce, and Access

Technological Change, Computerization, and the

Wage Structure 217

Lawrence F. Katz

The Growing Digital Divide: Implications for an

Open Research Agenda 245

Donna L. Hoffman and Thomas P. Novak

Extending Access to the Digital Economy to Rural

and Developing Regions 261

Heather E. Hudson

Organizational Change

IT and Organizational Change in Digital

Economies: A Sociotechnical Approach 295

Rob Kling and Roberta Lamb

Organizational Change and the Digital Economy:

A Computational Organization Science Perspective 325

Kathleen M. Carley

The Truth Is Not Out There: An Enacted View of

the “Digital Economy” 352

Wanda J. Orlikowski and C. Suzanne Iacono

Contributors 381

Index 389

Introduction

Erik Brynjolfsson and Brian Kahin

“The digital economy—defined by the changing characteristics of infor￾mation, computing, and communications—is now the preeminent driver

of economic growth and social change. With a better understanding of

these fundamental transformations, we can make wiser decisions—whether

we are investing in research, products, or services, or are adapting our

laws and policies to the realities of a new age.”—Neal Lane, Assistant to

the President for Science and Technology, April 1999

Although there is now a substantial body of literature on the role

of information technology in the economy, much of it is inconclu￾sive. The context is now changing as the success of the Internet and

electronic commerce (“e-commerce”) introduces new issues of

influence and measurement. Computers created a platform for the

commercial Internet; the Internet provided the platform for the

Web; the Web, in turn, provided an enabling platform for e￾commerce. The Internet and the Web have also enabled profound

changes in the organization of firms and in processes within firms.

The Internet links information to locations, real and virtual. It

links the logic of numbers to the expressive power and authority of

words and images. Internet technology offers new forms for social

and economic enterprise, new versatility for business relationships

and partnerships, and new scope and efficiency for markets.

The commercial Internet has only had about six years to play out

in earnest, but the numbers show a remarkable acceleration—a

doubling of Internet connections year after year and, more re￾cently, a variety of figures on e-commerce showing even faster

growth. Web transaction costs are as much as 50–99 percent less

2

Brynjolfsson and Kahin

than conventional transaction costs.1

It is this chain of drivers and

its implications for the economy and society as a whole that leads

us to speak of a digital economy.

The term “information economy” has come to mean the broad,

long-term trend toward the expansion of information- and knowl￾edge-based assets and value relative to the tangible assets and

products associated with agriculture, mining, and manufacturing.

The term “digital economy” refers specifically to the recent and still

largely unrealized transformation of all sectors of the economy by

the computer-enabled digitization of information.

Because of its mandate in matters of interstate commerce and

foreign trade, the federal government has primary responsibility

for evaluating the health and direction of the economy. The

emerging digital economy makes commerce less local, more inter￾state, and, especially, more global, in line with a long-term trend

toward market liberalization and reduced trade barriers. At the

same time, the picture presented by public information sources is

becoming less and less complete. What we know about e-commerce

comes from proprietary sources that use inconsistent methodolo￾gies. Economic monitoring, like policy development, is challenged

by quickly evolving technologies and market practices.

The nature and scope of the digital economy are matters of

concern to nations at all levels of development. Like consistent

legal ground rules, an open, testable platform of public economic

information is essential to investment and business decisions. It is

also essential to sound monetary policy and to setting taxes and

spending budgets. Ultimately, understanding the digital economy

is relevant to a wide range of policies: R&D investment, intellectual

property, education, antitrust, government operations, account￾ing standards, trade, and so on.

All countries must confront the unfettered flow of information

on the Internet and the ease with which international transactions

and investments can take place. While the digital economy is

known as a generator of new business models and new wealth, it is

also undermining old business models and threatening invest￾ments and jobs in certain established businesses. With the excite￾ment comes anxiety and concern about the how the ingredients of

the digital economy should be configured for optimal advantage.

Introduction

3

Outside the United States, it is sometimes viewed as a suspect

phenomenon, deriving in part from American strengths in com￾puter technology and software, flat-rate phone service, and the

scale advantages of the English language. For all these reasons, it

begs investigation.

In April 1998, the U.S. Department of Commerce issued The

Emerging Digital Economy, a landmark report that recognized the

accelerating importance of the Internet and e-commerce in the

national economy. Bearing the imprimatur of the federal govern￾ment, the report offered new perspective on the role of informa￾tion technology in productivity, inflation, economic growth, and

capital investment. It has been cited frequently and succeeded by

a number of reports assessing these and other developments.2

In November 1998, as part of the second phase of an initiative on

global electronic commerce, President Clinton charged the assis￾tant to the president for economic policy to undertake an assess￾ment of the digital economy. In addition to asking the Department

of Commerce to update The Emerging Digital Economy, the president

asked that experts be convened to assess the implications of the

digital economy and to consider how it might best be measured and

evaluated in the future. Accordingly, an interagency working

group on the digital economy planned a public conference, which

took place on May 25–26, 1999, at the Department of Commerce

(www.digitaleconomy. gov). The conference was sponsored by the

Department of Commerce, the National Science Foundation, the

National Economic Council, the Office of Science and Technology

Policy, and the Electronic Commerce Working Group, the um￾brella interagency group for the administration’s global e-com￾merce initiative.

The conference sought a common baseline for understanding

the digital economy and considered how a clearer and more useful

picture of that economy might be developed. While recognizing

the convergence of communications, computing, and informa￾tion, the conference looked beyond those sectors to focus on the

transformation of business and commerce, processes and transac￾tions, throughout the economy.

This book’s four parts mirror the four basic topics considered at

the conference:

4

Brynjolfsson and Kahin

• The macroeconomic perspective: How do we measure and assess “the

digital economy” and its implications for the economy as a whole?

• The texture of the digital economy: How do firms compete and how

do markets function, and how is this different from traditional

competition? What are the opportunities for and impediments to

the participation of individuals and small businesses?

• The impacts on labor demand and participation: Do the new tech￾nologies exacerbate inequality? What skills, technologies, and

institutions are needed to support broader access to the benefits of

the digital economy by different individuals and groups?

• Organizational change: How does the digital environment affect

the structure and operation of firms and institutions?

The Macroeconomic Perspective

Information technology is playing an increasing role in growth,

capital investment, and other aspects of the economy. The scope

and significance of these transformations remain open to question,

however, in large part because underlying measurement and meth￾odology problems have not been resolved.

• How should we identify and measure the key drivers of the digital

economy?

• What are the industry-level and economy-wide investments re￾lated to e-commerce, including investments in information tech￾nology equipment and workers?

• What are the implications for growth, employment, productivity,

and inflation?

• How should we account for intangible consumer benefits and

burdens?

There are three chapters in this part. In “Measuring the Digital

Economy,” John Haltiwanger and Ron Jarmin note that the emer￾gence of e-commerce is part of a broad spectrum of changes over

several decades related to advances in information technology and

the growth of the broader digital economy. After reviewing the

current activities of federal statistical agencies, they conclude that

current data collection activities are inadequate and provide some

Introduction

5

practical advice on how to improve measurement of the digital

economy.

In “GDP and the Digital Economy: Keeping up with the Changes,”

Brent Moulton argues that inadequate measurement of the true

output of the digital economy has contributed to past difficulties

economists have had in identifying the productivity benefits of the

IT revolution. He shows that despite these measurement difficul￾ties, the measured contribution of computers to GDP has grown

substantially in the late 1990s, and he outlines an agenda for

improving research in this area.

In a seminal paper a decade ago, Paul David noted that new

technologies such as electric motors or computers require enor￾mous complementary investments, such as changes in organiza￾tional structure, in order to reach their full productive potential.3

In his chapter, “Understanding Digital Technology’s Evolution

and the Path of Measured Productivity Growth: Present and Future

in the Mirror of the Past,” David provides a detailed review of the

subsequent literature and shows how much of the micro and macro

evidence on IT and productivity affirms the importance of organi￾zational complements.

Market Structure, Competition, and the Role of Small Business

The digital economy includes information and communications

technology, e-commerce, and digitally delivered services, software,

and information. The characteristics of these goods and services

(including factors such as economies of scale, network effects,

public good characteristics, and transaction costs) can lead to

different market structures and competitive conditions. Unfortu￾nately, such characteristics are difficult to measure, technologies

are changing rapidly, and relevant market boundaries are fluid and

difficult to define. Some have speculated that the Internet and e￾commerce hold great promise for small firms, by liberating them

from proprietary value chains, diminishing transaction costs, and

providing access to global markets, but without adequate data it is

difficult to test this speculation.

• What are the relationships and interactions between the eco￾nomic characteristics of digital technologies, products, and ser-

6

Brynjolfsson and Kahin

vices and the structure and competitiveness of markets?

• What are the key determinants of prices (overall price levels,

price flexibility, price dispersion, etc.), market structure and effi￾ciency (competitive, noncompetitive, segmented, etc.), and com￾petition (price based, market share based, etc.)?

• What roles do startups and small firms play in different segments

of the digital economy? What are the barriers to launching and

growing small firms?

• How and to what extent do the Internet and e-commerce either

benefit or handicap entrepreneurs and small- to medium-sized firms?

The five chapters in this part review the empirical evidence on

how competition and strategy differ in the digital economy. Two of

the chapters specifically look at the changing role of smaller firms.

In “Understanding Digital Markets: Review and Assessment,”

Michael Smith, Joseph Bailey, and Erik Brynjolfsson summarize the

recent literature on how the Internet is affecting competition and

market efficiency. They start with findings for several dimensions

of market efficiency and then focus on the puzzling finding of

unusually high price dispersion on the Internet. They conclude

with a set of developments to watch and provide an annotated

appendix of research on the Internet and competition.

In “Market Structure in the Network Age,” Hal Varian shows how

several fundamental principles of economics can be used to in￾crease understanding of how e-commerce changes competition.

He analyzes versioning, loyalty programs, and promotions, in each

case illustrating his points with examples from e-commerce and

outlining the research issues raised.

Shane Greenstein admirably demonstrates the value of develop￾ing new data sources in his chapter, “The Evolving Structure of

Commercial Internet Markets.” He focuses on the commercializa￾tion of a key link in the e-commerce value chain: the Internet

Service Providers (ISPs) who supply access to the Internet for

millions of consumers and businesses. Using this example, he

analyzes a set of broader questions that are important for research￾ers, policymakers and managers.

In “Small Companies in the Digital Economy,” Sulin Ba, Andrew

Whinston, and Han Zhang outline some of the Internet’s special

Introduction

7

opportunities and challenges for smaller enterprises. They focus

on the way information asymmetries on the Internet enhance the

importance of branding and of trusted third parties, and they

describe some significant technologies that are likely to help with

these issues.

In “Small Business, Innovation, and Public Policy in the Informa￾tion Technology Industry,” Josh Lerner documents the ambiguous

overall role of small business in innovation but shows that a

particular subset of small businesses—firms that are venture

backed—have been particularly strong innovators. He focuses on

the concentration of venture financing in IT industries and con￾cludes by discussing recent changes in intellectual property laws

that appear to favor larger firms, drawing some implications for

policy makers.

Employment, Workforce, and Access

As information and communications technologies transform the

global economy, they are changing the U.S. workforce in terms of

size, composition, and the knowledge and skills required for

success. Indeed, the competitiveness of nations and companies

appears increasingly dependent on the ability to develop, recruit,

and retain technologically sophisticated workers. There are con￾cerns that the U.S. workforce is already unable to meet the market

demand for skilled and knowledgeable workers and that this gap is

growing. Furthermore, there is growing concern that the benefits

of the digital economy are not equitably shared, giving rise to a

“digital divide.” There are a variety of options for overcoming

barriers to participation, and it is important to understand the

extent to which such options are available, utilized, and cost￾effective.

• How reliable are current models for projecting the size and

composition of labor markets in occupations where technologies

are changing rapidly? How can they be improved?

• How does the growth of e-commerce and investment in the

Internet and related technologies affect the level and composition

of labor market demand? How can these influences be untangled

from other factors?

8

Brynjolfsson and Kahin

• What can be learned from firm-level or industry-level studies as

compared to aggregate labor market models?

• What barriers impede the diffusion of e-commerce across the

society?

• To what extent and in what ways does e-commerce enhance,

preserve, or diminish diversity? To what extent does e-commerce

work to increase or lessen opportunities for economic progress for

disadvantaged individuals, groups, and regions?

The three chapters in this part raise troubling questions about

growing inequality and underscore that the benefits of the digital

economy are not necessarily evenly spread among different groups

in society.

In “Technological Change, Computerization, and the Wage

Structure,” Larry Katz discusses one of the most troubling eco￾nomic phenomena of the past two decades. Wage inequality has

expanded dramatically, making the rich even richer relative to the

poor. Katz notes that this widening inequality has coincided with

growing use of IT and is particularly closely linked to increased

relative demand for more educated and skilled workers. He reviews

the existing literature and suggests some new empirical approaches

that might help us identify the relationships among computeriza￾tion, demand for skilled labor, and income inequality.

Donna Hoffman and Thomas Novak summarize a range of

statistical evidence in “The Growing Digital Divide: Implications

for an Open Research Agenda.” They highlight the differential

levels of computer adoption and Internet usage among various

demographic groups. The provocative facts they review raise im￾portant questions for researchers and policy makers who are

concerned about the potential gap between information “haves”

and “have-nots.”

In “Extending Access to the Digital Economy to Rural and

Developing Regions,” Heather Hudson examines opportunities

for extending Internet access to disadvantaged groups in industrial

nations and also to populations in developing nations. She docu￾ments some striking disparities in basic measures of access, such as

telephone lines, and provides a useful guide to future research in

this area as well as an appendix summarizing some of the available

technological options.