October 8, 2011


The second economy: Digitization is creating a second economy that's vast, automatic, and invisible--thereby bringing the biggest change since the Industrial Revolution. (W. Brian Arthur, October 2011, McKinsey Quarterly

[I] want to argue that something deep is going on with information technology, something that goes well beyond the use of computers, social media, and commerce on the Internet. Business processes that once took place among human beings are now being executed electronically. They are taking place in an unseen domain that is strictly digital. On the surface, this shift doesn't seem particularly consequential--it's almost something we take for granted. But I believe it is causing a revolution no less important and dramatic than that of the railroads. It is quietly creating a second economy, a digital one.

Let me begin with two examples. Twenty years ago, if you went into an airport you would walk up to a counter and present paper tickets to a human being. That person would register you on a computer, notify the flight you'd arrived, and check your luggage in. All this was done by humans. Today, you walk into an airport and look for a machine. You put in a frequent-flier card or credit card, and it takes just three or four seconds to get back a boarding pass, receipt, and luggage tag. What interests me is what happens in those three or four seconds. The moment the card goes in, you are starting a huge conversation conducted entirely among machines. Once your name is recognized, computers are checking your flight status with the airlines, your past travel history, your name with the TSA1 (and possibly also with the National Security Agency). They are checking your seat choice, your frequent-flier status, and your access to lounges. This unseen, underground conversation is happening among multiple servers talking to other servers, talking to satellites that are talking to computers (possibly in London, where you're going), and checking with passport control, with foreign immigration, with ongoing connecting flights. And to make sure the aircraft's weight distribution is fine, the machines are also starting to adjust the passenger count and seating according to whether the fuselage is loaded more heavily at the front or back.

These large and fairly complicated conversations that you've triggered occur entirely among things remotely talking to other things: servers, switches, routers, and other Internet and telecommunications devices, updating and shuttling information back and forth. All of this occurs in the few seconds it takes to get your boarding pass back. And even after that happens, if you could see these conversations as flashing lights, they'd still be flashing all over the country for some time, perhaps talking to the flight controllers--starting to say that the flight's getting ready for departure and to prepare for that.

Now consider a second example, from supply chain management. Twenty years ago, if you were shipping freight through Rotterdam into the center of Europe, people with clipboards would be registering arrival, checking manifests, filling out paperwork, and telephoning forward destinations to let other people know. Now such shipments go through an RFID2 portal where they are scanned, digitally captured, and automatically dispatched. The RFID portal is in conversation digitally with the originating shipper, other depots, other suppliers, and destinations along the route, all keeping track, keeping control, and reconfiguring routing if necessary to optimize things along the way. What used to be done by humans is now executed as a series of conversations among remotely located servers.

In both these examples, and all across economies in the developed world, processes in the physical economy are being entered into the digital economy, where they are "speaking to" other processes in the digital economy, in a constant conversation among multiple servers and multiple semi-intelligent nodes that are updating things, querying things, checking things off, readjusting things, and eventually connecting back with processes and humans in the physical economy.

So we can say that another economy--a second economy--of all of these digitized business processes conversing, executing, and triggering further actions is silently forming alongside the physical economy.

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.

The metaphor isn't perfect: this emerging second-economy root system is more complicated than any aspen system, since it's also making new connections and new configurations on the fly. But the aspen metaphor is useful for capturing the reality that the observable physical world of aspen trees hides an unseen underground root system just as large or even larger. How large is the unseen second economy? By a rough back-of-the-envelope calculation (see sidebar, "How fast is the second economy growing?"), in about two decades the digital economy will reach the same size as the physical economy. It's as if there will be another American economy anchored off San Francisco (or, more in keeping with my metaphor, slipped in underneath the original economy) and growing all the while.

Now this second, digital economy isn't producing anything tangible. It's not making my bed in a hotel, or bringing me orange juice in the morning. But it is running an awful lot of the economy. It's helping architects design buildings, it's tracking sales and inventory, getting goods from here to there, executing trades and banking operations, controlling manufacturing equipment, making design calculations, billing clients, navigating aircraft, helping diagnose patients, and guiding laparoscopic surgeries. Such operations grow slowly and take time to form. In any deep transformation, industries do not so much adopt the new body of technology as encounter it, and as they do so they create new ways to profit from its possibilities.

The deep transformation I am describing is happening not just in the United States but in all advanced economies, especially in Europe and Japan. 
The two most important adjectives are, of course, fast and efficient.  And while everyone recognizes the digital revolution what too few seem to recognize is that with so many jobs performed in the digital economy fewer need performed in the human economy.  That's sort of the point of efficiency.

This brings us to the point where the two views of what an economy is for diverge: on the one hand many people seem to have concluded that an economy exists primarily to create jobs, whereas the real purpose is to create wealth.  Jobs have, of course, traditionally served as an accepted means for distributing that wealth.  The revolution we're in the midst of consists of how to distribute that wealth when ever less work is required to create ever more wealth.  The fact that we consider this an unpleasant problem would make our ancestors want to spank us.

Working in the Dark: a review of Grand Pursuit: The Story of Economic Genius By Sylvia Nasar  (Robert M. Solow,  September 28, 2011, New Republic)

I thought I knew what this book was going to be about when I started it, but by the time I came to the end I was no longer sure. There is a prologue that begins with Charles Dickens's observations and depictions of miserable London poverty, and then moves naturally to the classical Malthusian trap as the only explanation offered by the political economy of the time: any improvement in the general standard of living will be wiped out by increased population, so nothing much can be done except perhaps exhortations of abstinence. [...]

So far as economics, as understood by economists, is concerned, Schumpeter contributed one important and fertile idea, and he had formulated it by 1912. It was the insight that the dynamics of a capitalist economy are driven by technological and organizational innovation, and the key figure in this process is the entrepreneur who mediates between sheer invention and the market economy. He also emphasized the importance of credit creation as the mechanism that places resources in the hands of active entrepreneurs.

As part of his theory, Schumpeter developed and dramatized the central concept of "creative destruction." Many important innovations render existing goods, methods of production, and forms of organization obsolete, or otherwise displace them. Economic value and social status are brusquely destroyed. Pre-existing expectations are overturned. But this is the way a capitalist economy has to advance if it is to advance at all. This was Schumpeter's way, and the right way, to dispel the classical economists' pessimistic vision of the "stationary state," enforced by diminishing returns and the Malthusian iron law of wages.
No one dies because we don't produce enough food.  They die because of maldistribution.

Posted by at October 8, 2011 10:18 AM

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