Internet revolution: a new paradigm or another bubble?

It all started in October 1969. Scientists at the University of California, Los Angeles, were ready for a critical experiment. They had a computer and communications node, while colleagues installed similar equipment up the coast in Menlo Park. They planned to test whether they could link the two computers over telephone lines to operate as one system. The researchers began to tap in the message: 'log in' to make the link. The system crashed.

Thus was the beginning of internet revolution. By the end of the month they achieved the link. Of course, the purpose in those days was to ensure that nuclear missile systems could be kept operative even if part of the network was put out of action in a war.

The commercial importance of this breakthrough was not fulfilled for another 25 years - just as the invention of the steam engine by James Watt in the 1780s did not become really useful and developed until the launch of the rail engine two decades late. Similarly the petrol combustion engine did not lead to cars and trucks for about two decades.

The significance of the internet is that it takes the computer and 'information technology' onto a new stage: computers now communicate with each other. That is producing a dramatic exponential increase in the speed of transmitting information. Computers and the microchip were for the era of the 1970s and 1980s. The 1990s and the first decade of the new Christian-based millennium are for telecommunications and the internet. The internet will expand across the globe just as the railroad did in the latter half of the 19th century and the motor car and airplane did in the latter half of the 20th century. The economic result will be a huge reduction in the time taken to transmit information and, with it, a fall in the costs of producing goods and services.

It's an old law that the doubling of microchip performance, or a halving of its cost, takes place every 12-18 months. Similarly, between 1650 and 1950, the cost of physical force to make one average unit of production things fell from thousands of man-hours (dollars) to just a few minutes (cents). In the last 30 years, the cost of transistor or memory chip has fallen from $7 to a few millionths of a cent. The internet revolution will have a similar impact.

Internet commerce

By 2003 there will be 500m people connected to the internet, or about 10% of the world's population. By 2003, over 65% of US households will be connected. In the same way that the railroad, motor car, electricity connections and the airplane developed huge new industries and capitalist conglomerates, new internet companies are springing up as fast as you can say .com. By 2004, it is estimated that worldwide business-to-business internet commerce will reach over $7trn. Internet commerce in the US will reach $2.5trn, or about 25% of the annual output of the US in that year. Already the internet companies have grown bigger in size than the former technology giants (airlines, publishing and healthcare) and are catching up the automobile industry quickly.

The impact of the internet revolution has already been felt on economic growth. The information technology sectors as a whole (computers, telecomm, internet, software etc) in the US are growing at double the rate of the rest of the US economy. They now contribute over 8% of US annual output on their own. Indeed, since 1993, without the IT sectors, US economic growth would have been 1% of GDP lower each year. In 1999, nearly 80% of all investment by capitalist companies in the US went into information technology sectors! Over one million jobs have been created by the US high-tech sector since 1993 and there are now 8m people working there at generally 50% higher average wages.

All this has convinced most capitalist commentators that the IT revolution has given the US and other major capitalist economies a new lease of life - even the magic elixir of immortality. In this 'new paradigm', economic growth will continue at breakneck pace (by that they mean about 3-4% a year) and inflation will stay low (about 2% a year). And there will be the achievement of 'full employment', something not achieved in the 200 years history of industrial capitalism, except for very brief periods. Once again, but this time with much hugely bullish confidence, the capitalist gurus are claiming that their system has now achieved perfection and will never enter a major crisis of falling output, collapsing investment and mass unemployment again.

But in their euphoria, they have forgotten the words of their own history. This is what the editors of the US journal, Business Week, said back in the summer of 1929: "there has been a breakthrough in technology and industrial management, a firmly implanted social optimism, widespread public participation in the stock market, greater access to personal credit, better statistics, better railroad transport and stabilised prosperity".

Yet look what happened over the next three years in the US to that boundless optimism about the new technology! Just six months later, Business Week said this: "Every new era in history has been based upon the exaggerated enthusiasm set in motion by some single new industry. At one time it was a gold rush or real estate boom. In our era it has been the automobile".

Salvation from the crisis?

Now in the decade of the 2000s it will be the internet. The technological marvel of the internet will not save capitalism from crisis, just as the railroad did not in 1880s and the automobile did not in the 1930s. Indeed, for some very good reasons, it will exacerbate the inevitable slump in capitalist prosperity. The first reason is that, just as the railroad and automobile before, the internet is drastically lowering costs. But this is a huge deflationary force on capitalist companies' ability to keep up prices. Intense competition and huge investment of capital is boosting economic growth now, but it is doing so at the expense of capitalist profitability.

Internet companies do not make any profit. They remain a huge cost to the rest of the economy. But investment in the new technology has become a necessity to compete. This necessity has leapt well beyond the ability to garner surplus value from the investment. Just the top nine Internet companies are worth $100bn on the US stock market. But they make sales of just $1bn, or 1%. And that is just sales. They make no profit. Compare that even to the ten leading technology companies like Microsoft. They are worth only $50bn, but they make $100bn in annual revenues (and some of these make a profit too!). Overinvestment and overcapacity will be the outcome of the internet boom.

The internet and IT revolution is a huge deflationary force on the capitalist economy. That is the result of system that develops technology through competition and private capitalist investment. Intense competition means that very quickly the profitable advantages gained by the first company to use the new technology quickly disappear. The eventual outcome is that everybody uses the new technology and nobody gains extra profit as a result. Investment eventually shoots up much faster than the extra productivity of labour created. In other words, the rate of profit in relation to each unit of capital stock begins to fall. The faster the technology is adopted, the quicker prices fall, and the speedier profitable advantages disappear. Eventually, the large swathes of the new industry will go belly up from over optimistic investment.

In the 1850s there were hundreds of railroad companies formed, asking investors for money. How many were left by 1880? Similarly in the 1920s and 1930s, there were hundreds of automobile companies formed. Ask a Rover worker how many were left by the end of the 1970s and how many there are now.

And second, the hangover from the internet investment bubble will be worse this time. The result of previous overinvestment binges was deep slump in the capitalist economy. The response was for governments to intervene: to nationalise bankrupt utilities like water, electricity, railways etc and to direct wage earners money into renewing these industrial sectors. At the same time, the welfare state was formed to provide some safety net for irate unemployed masses. Above all, work was eventually found for them in the biggest state sector of them all: the armed forces. The collapse of the railroad age in the 1880s set the stage for imperialist rivalry in Europe and eventually World War 1. The Great Depression in the 1930s after the overinvestment of the automobile/electricity boom led to World War 2.

Now many capitalist commentators reject the view that the internet revolution means another bout of deflation and slump. They argue that the internet revolution is not some huge stock market bubble. Sure, prices will fall with the new technology, but so will costs. As a result, profits will be created and that will mean new jobs for those in the new sectors, and also as these new workers spend, that will create new jobs for the displaced workers of old industries like Rover car workers. The eventual outcome, as long as government does not muck it up by intervening, will be a lower cost, lower price, more profitable, faster growth economy - in short, the new paradigm or nirvana.

But the reality of the internet boom is that while stock market prices rocket to unbelievable heights, profits of the internet companies are nowhere to be seen. Elsewhere in the economy of the main capitalist nations, growth is pitched at about 3% a year, productivity of labour at about 2% a year and prices remain low. So there is little profitability in these new investments. Just as the Asian boom of the early 1990s came crashing to an end in 1997 after a binge of overinvestment not matched by sufficient profit, so will the worldwide internet boom.

Just a matter of time

It is only a matter of time before the US internet bubble is burst, investments collapse and consumption of the masses falls back because of a loss of confidence in the 'new economy'. The internet revolution is a great technical leap forward. But under capitalism, it is being exploited by more and more precious investment capital being thrown into this tiny sector of the economy at the expense of all the rest. That happens under capitalism because there is no planning and no direction of resources. 'Market forces' mean speculative investment, intense competition between capitalist investors, and above all, huge over-investment in relation to profitability.