A Digital World Jude Wanniski July 30, 1999

The regular lecture this week consists of a Q&A with our friend Reuven Brenner of McGill University, as conducted by a reporter from Investor's Business Daily. The focus is on "The New Digital Economy," as seen from Dr. Brenner's distinctive supply model. You will not find anything like it anywhere else in the world, so read it carefully, try to understand its message, and fill the SSU mailbox with questions for him. At the conclusion of the Brenner segment, I've appended a memo relating to last week's lesson on theeconomic causes of the Vietnam War.

July 30, 1999

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McGill University's Reuven Brenner On The New Digital Economy
By Doug Tsuruoka

Business cycles are less volatile if mistakes are fixed quickly -- and that's just what a digital economy helps you do, says economist Reuven Brenner. Brenner teaches economics at McGill University in Montreal. He has authored six books on financial and business subjects, and writes regularly for Forbes magazine. He has received numerous awards and recently shared the podium with ex- Federal Reserve Chairman Paul Volcker at a forum in Monterrey, Mexico, on currency matters. Brenner recently spoke with IBD about how the digital economy will differ from the old economy.

IBD: How is the digital economy impacting business cycles?
Brenner: It's dampening volatility because a quick flow of information allows you to correct mistakes faster and more efficiently. A digital economy also allows you to leverage strengths more quickly.

IBD: How, exactly?
Brenner: To understand this, you have to ask, Why do we have business cycles? We have them because asset prices vary. They vary because we make a wide variety of highly specialized investments. As time passes, we realize some of these investments were good, some mistaken. We make these realizations because we absorb information and change our expectations. Every mistake is a cost, and one way or another, people pay for these mistakes because shifting resources reduces capital. That's why absorbing information and correcting mistakes quickly is everything in a digital economy.

IBD: You talk about making ''matches'' in a digital economy. What do you mean?
Brenner: It has to do with what's called the ''economics of better matches.'' We're looking at questions like what happens in a world where innovations significantly lower the cost of matching up things like buyers with sellers, or capital with technical and organizational talent. Other implications to consider in a digital economy are what new markets and industries become viable, how do business models change and what types of companies are most likely to succeed. It's like a marriage. You're married, but you don't know if it's the right match or not. If you continue to live with a bad match, the mistakes only accumulate and it ends in a divorce. You also lose a lot of capital you invested. But if you react to every signal, mistakes are corrected faster and the marriage can turn out to be a good and lasting one.

IBD: How does the Internet fit into this?
Brenner: The quicker flow of information through the Internet allows for a closer match between suppliers and buyers. This allows better pricing information to be formed. So-called ''bit'' technology helps process old news quickly. As a result, mistakes are corrected quickly or have shorter duration. Bit technology also lowers the cost of creating new markets and diminishes price disparities. Since fewer mistakes are made, volatility in business cycles is diminished.

IBD: Can you give an example?
Brenner: Take hotels and airlines. Not long ago, my flight was canceled while I was waiting at the airport in Philadelphia. The airline immediately linked up with hotels on the Internet, who all bid against each other to place the stranded passengers. Ordinarily, any empty room represents a loss. So even if the hotel only gets $50 a night for a room that usually costs $200, they can make a $20 profit. This is because it only costs $30 to clean it up. All this is possible due to a rapid flow of information that wasn't available before.

IBD: How does a digital economy affect relations between businesses and their customers?
Brenner: The Internet allows you to look at customers differently. Quick feedback from customers is a quick way to correct mistakes. Mistakes in Linux (open-source operating software), for example, were corrected much faster than Microsoft, which keeps its software secret and doesn't allow feedback from a lot of people.

IBD: How does the Internet affect things like inventory?
Brenner: The technology that allows you to have higher capacity allows you to keep fewer inventories. Take Dell Computer. They don't keep inventory. They put the machines together only when customers order them. All this is based on new technology. Not holding inventory dampens business cycles.

IBD: Is the digital economy responsible for the superior performance of the U.S. economy?
Brenner: It's not just because of the ''economics of bits.'' It's also because of the deregulation of financial markets. The key role of financial markets is to lessen the persistence of bad decisions. For, as mistakes accumulate, financial markets advance credit on harsher terms or not at all.

IBD: Does digital technology dampen all sources of volatility?
Brenner: There's one exception. The argument doesn't take into account fiscal or monetary mismanagement. By this, I mean political mismanagement at places like the Federal Reserve. That's a source of volatility that technology can't stop.
[Wanniski: In the same light, I've been telling my friends in the Beijing government for years that they can never catch the United States as long as they do not have a constitutional democracy, especially a Bill of Rights and a First Amendment. Why? Because open channels of communication enable producers and consumers of public and private goods and services to weed out mistakes sooner than those whose governments are afraid of surface disharmony. In 1776, Adam Smith wrote in his Wealth of Nations of the "higgledy-piggledy" of the marketplace. Mass confusion seems to reign, but there is an invisible hand that moves the process to the optimum. As Reuven points out, though, the invisible hand of the private marketplace cannot counter political mismanagement at a place like the Federal Reserve. It is in a political marketplace that permits surface disharmony, dissent and confusion where the invisible hand can work... Where the best man wins.]

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Following is a memo to Max Frankel, former executive editor of the NYTimes, who responded to last week's lecture on the economic causes of the Vietnam War. Frankel, remember, was the NYT reporter who wrote the 1961 story outlining the Kennedy administration's economic prescription for the Diem government -- which I believe caused the collapse of the South Vietnamese economy -- expressed "amazement" at the idea that "fiscal policy alone could have rescued Vietnam." I sent this reply on Wednesday.

Memo To: Max Frankel
From: Jude Wanniski
Re: Economic Causes of the war

You say "I'm amazed that you think fiscal policy alone might have rescued Vietnam. That's almost worthy of some of my old (academic) Soviet pals." You missed my point entirely, so I encourage you to again read the cited report from my 1978 book. Did I ever say in my report that fiscal policy alone "might have rescued Vietnam." What I wrote, Max, is that fiscal and monetary policy destroyed the Vietnam economy, because of the poisonous advice shoved down the throat of Ngo Dinh Diem by the economic team sent to Saigon in 1961 by the Kennedy administration. Before you wave your hand and say you are amazed, you should cogitate on what I said. If you find yourself scratching your head, wondering how one thing led to another, you might consider asking me about my assertions instead of waving them away." That is always the problem of journalists who decide to stop asking questions after they have all the information they need to fit their prejudices. My ideas did not come to me from any mountaintop. Nobody fed them to me. I simply kept asking questions until I got to the bottom of things. Nobody at the Times has lifted a finger to discover the economic causes of the Vietnam War because at the bottom they would find the advice the University of Michigan economists told the Kennedy administration would improve the Vietnam economy.

Why, Max, if fiscal policy has nothing to do with war, did Kennedy insist that Diem follow the economic advice being given in order to get more military aid from the United States? I ask it again: Why, Max, if fiscal policy has nothing to do with war, did Kennedy insist that Diem follow the economic advice being given in order to get more military aid from the United States? That was the story you wrote. There were others who wrote the stories about how the Vietnam economy collapsed in the next six months. There was no attempt by the Times to find out why the economy had collapsed, or if there was any connection to the staggering tax increases Diem had to impose by dictate if he was to retain the favor of JFK. I dare you to go back in the files and find any. You simply assumed that our economists were superior to any Diem could possibly have available to him, and the process went forward. Did the conservative press in the United States complain? Not one bit, Max. At the time, the Goldwater Republicans were fighting tooth and nail against the proposed Kennedy tax cuts -- which were not enacted until after his assassination.

The Political Establishment to this day is horrified at my hypothesis. How could our wise men have caused the loss of Vietnam and 55,000 American lives? Sorry, Max. That's the way it happened. And the Times was part of that process, which only proves again that the road to hell is paved with good intentions. As I think I told you, as a young reporter and columnist at the National Observer in the 1960s, I believed all the bullcrap that I read in the major newspapers and periodicals. When things went awry, I knew I had to find out why, which is what led me into my maniacal research. Is it unusual that wars would occur over economic contractions? Max, every war in history has money at its root, including our own Civil War, both world wars, and the Cold War. Several years ago I argued with Bob Bartley, my old boss at The Wall Street Journal, that the shock therapy policy advocated by the NYT editorial page for the conversion of the USSR command economy to a market economy would cause the collapse of the USSR economy. Bartley knew it would, but unlike the NYT, which had persuaded itself would be a good thing, Bob was still bent on undermining the USSR economy to put a dagger through the heart of Moscow. So when he did lift a finger, it was to say kind words about shock therapy.

Frankly, Max, I am amazed that a man of your lifelong experience in world affairs would be amazed that there might have been economic causes to the Vietnam War. Yes, it not only happened under your nose, and you reported on it. That makes it hard to accept the fact that you may have been on the wrong side of that issue. My intent is not to make you unhappy with that fact. My intent is to have to have you, as a wise old journalistic sage, who is still writing about the world around you, take stock of your mistakes as well as your achievements. If you would do so, you might then be able to see how our Political Establishment continues to bumble its way along -- pushing poison on one poor country after another. Tax increases, currency devaluations, more tax increases and more currency devaluations. That is all the bureaucrats at the IMF know, so that's what they do. They can't be stopped, because they have powerful friends in high places, most particularly the NYT.

Why, Max, if there are so many Nobel Prizewinning economists in the United States, is there so much poverty in the world, so much disease, so much civil war? My answer is that the Nobel prizewinners are incompetent men who have arranged to give out prizes within their own little club. There is not one in the bunch of living prizewinners who I would hire at my company for $1 a year. What they know is obsolete, with a value that obtained only in a brief period of history where policymakers had to have a theory in support of political redistribution. As theories of wealth creation, demand theory of the Keynesian and Monetarist flavors are of negative value.

When Leonard Silk was still alive and writing his Keynesian columns for the Times, I at least had an inquiring mind to deal with there. Leonard would call me from time to time, we would have lunch, he would incorporate my views into his column even as he suggested they were off base. In recent years, there have been no inquiring minds at the Times when it comes to minor matters like global deflation, poverty, disease and the economic causes of regional or civil wars. None. At times, when I think maybe things have changed, I will write an op-ed and send it in, but it only appears when I am saying bad things about Republicans or conservatives. Of course there are plenty of contentious pieces on the Times editpage, but they are arguments within the Political Establishment. Shall we drop big bombs on Yugoslavia? Or small bombs? The readers of the Times have not the slightest idea that the break-up of the Yugoslav Federation was the result of IMF/World Bank policies forced down the throat of Slobodan Milosevic in 1987.

Is the Times a great newspaper? Don't kid yourself, Max. It is probably the best we have, but great it ain't. I'm not happy when I miss it for even one day, because it has the most important Bulletin Board offered by the Establishment... and I have to know what is on it. But it doesn't really attempt to get to the bottom of things, the way a great newspaper would.