Diane Coyle shows why the digital economy's continued growth will help to bury a highly damaging policy paradigm

Diane Coyle shows why the digital economy's continued growth will help to bury a highly damaging policy paradigm

The 2020s will be the decade when the idea that economic problems can be “left to the market” to solve is finally put to rest – after some 40 years during which that belief has caused untold damage to society and the environment.

We can foretell this with such confidence because of the nature of the digital economy. The long-standing economic theory, according to which firms or people deliver the best outcomes for society by acting individually to maximize profits or “utility,” has never been valid. If it were, businesses would see no advantage in becoming much larger, and advertisers would never use social pressure to manipulate consumers. But in the digital world, it is simply impossible to ignore our interdependence.

Consider today’s pervasive digital platforms. One reason why there are just a few globally dominant players is the existence of network effects: whether a platform matches diners with restaurants or enables users to connect with each other, the more users it has, the better it is for all users. As a platform becomes larger, the benefits for everyone increase, often at an accelerating pace.

Or consider the evident importance of data, the rapidly increasing volume of which is fueling artificial intelligence and other innovative services (as well as, less positively, the digital advertising market). Data have the technical economic characteristics of a classic public good (like air) in the sense that they are “non-rival” – more than one person can use data at the same time without depleting the overall stock. And basic economics shows that markets cannot be expected to generate and allocate such goods efficiently.

Moreover, raw data are processed into knowledge containing valuable information, which, even when provided by an individual, generally relates to other people or other data. In other words, the value of data-driven knowledge comes from its social context.

Digitalisation has created extended global supply chains, linking together the fates of millions of businesses. Social media are making societal influences on consumer demand more important than ever. And economic progress is more than ever driven by ideas, which come attached to people and multiply with exchange.

The observation of fundamental flaws with the methodological individualism that underpins conventional economic prescriptions is far from new. In a 1952 book based on his PhD dissertation, the late American economist William J. Baumol noted that people influence one another’s preferences, and that companies affect one another’s costs of production, depending on the scale of their operations. The assumption that interdependence could be ignored made economic analysis simpler, of course. But, Baumol wrote, “Such an assumption is not neutral; it leads inexorably to the acceptance of laissez-faire.”

Furthermore, if the assumption is false, then the conclusion is wrong – as we have seen with certain damaging economic policies since the 1980s. The deregulation of financial markets resulted in the 2008 global financial crisis, while the “market for corporate control” led to merger booms and the increased concentration of many sectors of the economy. In addition, Milton Friedman’s view that a company’s sole social responsibility is to increase its profits encouraged overpaid executives to ignore the environmental and social damage caused by their businesses. The “free” market of laissez-faire is a chimera, and if individuals do not recognize the consequences of their actions for others, the result will be markets shaped by greed and power.

This is not to argue that alternative policy approaches are easy. As I have explained in detail elsewhere, both government and market failures tend to occur in the same contexts and for the same reasons – including information asymmetries, uncertainty, incomplete contracts, and principal-agent problems. Standard government action is no more likely than laissez-faire to succeed. The nature of the digital economy makes these classic challenges even more acute, and we are just in the early stages of thinking about how best to regulate it. When hundreds of millions of people live in densely populated areas, interact in myriad ways, and depend on the actions of others who are thousands of miles away, there is no reason to expect easy solutions.

As the recent global surge of reports on competition policy and digital regulation suggests, the search for possible answers is underway. Unfortunately, academic economics is behind the curve. As Thomas Philippon remarks in his excellent recent book The Great Reversal, in studying the growing dysfunction of the American economy, “I was surprised by the gap between economic research and policy.”

Policymakers know they need sharper analytical tools to direct the economy so that it once again starts to deliver broad-based progress. To help them, economic researchers must ditch their unscientific attachment to the assumption of isolated individuals transacting in free markets, and instead focus on the economy of the 2020s.


Diane Coyle is Professor of Public Policy at the University of Cambridge. This content is © Project Syndicate, 2020, and is here with permission.

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22 Comments

The real question.
Do people have free will?

While it is true policy makers need to sharpen their tools, some have however are blunted by politicians who nolonger have the guts to stand up to the elite. Those that challenge the status quo tend to leave out of frustration.

The solution is to decentralise power, where the politicians live in the same neighbourhoods to the people they are representing; and can't hide behind their communication department and bureaucracy they have created.

As for universities, they have been advocating economics of scale for an extended period, yet ignoring the side effects this has to democracy. The thought has crossed my mind to attend economic lectures and question what has been tort (excuse the pun), only to be served with a trespass notice for my troubles.

Universities fresh from funding land banking and capital works, moved to financing IP ponzi - loading students with debt, to now living in the moment with < insert any topic > - studies and content light works to enable immigration pathways (to further the fee paying).

We will be the worse for it.

https://spectatorindex.com/2019/07/smartest-countries-in-the-world

12
up

The free market can work without the interference of politicians and central banks. Capitalism is the only system that has delivered wealth. What we have in the West at the moment is not the free market, but economies managed for the benefit of certain sectors.

.. exactly ... anyone who blames current circumstances on the " lazy fairy " economic system hasn't looked closely enough at the incompetent heavy hand of politicians and central bankers playing favourites and interference ...

Helped enormously by lick-spittle academic economists eager to provide the intellectual justification for whatever ludicrously destruction scheme needs "more regulation".

Roger,

Given your obvious distaste for 'more regulation', you will presumably welcome moves by Trump to further emasculate the Environmental Protection Agency(EPA). he proposes that environmental assessments be dispensed with and climate change ignored on major infrastructure projects, including mining.

Should our government follow this lead? Oh, just what does "ludicrously destruction scheme" actually mean? In English please.

Yes, we should follow. We all want to protect the environment, but climate hysteria has gone beyond the pale, and is causing real economic damage, see Taranaki. Ironically as is evident throughout history, lefties first wreck the economy and then the environment.

RollingOn,

"As evident throughout history, lefties first wreck the economy and then the environment". And you actual evidence for this? How about we go back to Dickens' Victorian England. No mill owner gave a toss about the environment, or their workforce. Only the rise of the union movement began the slow process of giving working people a decent wage, working and living conditions. They were certainly lefties, but strangely, they didn't wreck the economy or the environment.
Your view that we should be prepared to screw the environment a la Trump is both immoral and short-sighted. It may have escaped your attention, but NZ trades off its Clean Green image and that will actually be more, not less important in future. I can see you now embracing the role of Gradgrind.

So protecting the “economy” trumps all other considerations? You really don’t want to protect the environment at all.

News for you chum - the economy is a subset of the environment. Screw up the biosphere and we all stop making money.

Rubbish. Economic theory ignores human nature.

I have an IT degree, and while doing that learnt about writing computer code. Coding is complex because the coders must know every assumption that underlies any decision process, as well as every impact and effect those assumptions have on that process and every other part of the code. Economic theorists have it easy because they make assumptions without having to detail what they are, or what their impact is. They just create a model in which their theory 'works' without consideration of many impacts, and for all that I have looked at, especially human nature.

Human beings can be amazingly contrary and contradictory. Greed and self interest can dominate, as can altruism, or tribalism. Thus we have Governments, whose true role is to regulate human behaviour. Capitalism is as flawed as communism - no regulation versus total dictatorship. The only reason capitalism hasn't collapsed yet is because "money talks", and the wealthy manipulate Government to regulate in their favour while trying to look like the good guys. That's largely why we are in the mess we are in today.

We have not understood the assumptions that lie behind the economic theory and models that have been adapted to policy and this has allowed a minority to run amok at the expense of the rest. Fixing it will not be easy.

You are highlighting the Thinking Brain (rational, calculating, slow) versus the Feeling Brain (intuitive, impulsive, fast). Sadly for your take, the Thinking Brain ain't in charge.
Feelz are, and, worse, the two brains cannot directly communicate. Feelz is in control, but can be subtly influenced (occasionally, to some extent) by Thinker. Recommended reading: Mark Manson - Everything is F*cked. Plenty of psych and neuroscience references. Cracking read..

I believe in the free market but I do think it needs sensible regulation. For example at the moment we have a failing housing market due to over regulation and a failing environment due to under regulation. I have to do stupid safety courses at my office job due to over regulation but we have 400 people dying on the roads every year because of under regulation. We consider smoking weed a crime because it’s slightly bad for health but allow soft drink companies to advertise to children outside schools when’s its terrible for health.
We need to take the politics and bribery out of regulation and ensure that we have minimum regulation unless there is a proper reason. These decisions need to be made with proper facts and figures, not just based on what the average joe hears down at the bowls club and what people are told by corporations.

elmoboy,

can you define what you mean by 'free market'? you cannot, I assume, mean an entirely unfettered market, as that would simply be anarchy and markets would collapse. Surely, for any market to work, it must be within a framework of regulations to protect whose who operate in the market. Thus, a company-say F&P Healthcare- spends millions developing a product and seeks to protect their intellectual property through patents. Is that in your view unreasonable?
If you require an operation, I assume you expect the surgeon to be properly qualified-thus the 'market' is not free as it is not open to all. Is that unreasonable?
What about the people who teach your children? What about the food you buy? I assume you would expect it to free of lethal contaminants
I could go on, but I think you will see my point. NO market works without regulations, so in that sense, they are never free Of course, it is perfectly possible for regulations to be overly intrusive, thus rendering markets less efficient and of course, regulations can be imposed to favour one party over others, such as tariffs.

So basically the “free market” works as an imaginary science experiment free from the polluting influence of people and the world?

Sounds about right actually. As if Economics was ever a science lol

No market is 'free'. Every market exists within a context of mutual trust (however engendered - sanctity of contract is the exemplar), temporal agreement on core exchange values (currencies), and much of these are moderated by Gubmints of various stripes.

The single biggest issue with any 'alternative' to a market is how to dispose of the failures. The more these are failures of Gubmint actions, departments, policies or overall contexts, the less likely they are to be taken out to the woodshed and dispatched swiftly. Whereas non-Gubmint failures simply disappear, affecting only immediate stakeholders, suppliers, customers and other beneficiaries- Schumpeter's Creative Destruction.

What the article doesn't highlight is the inbuilt tendency to giantism in the global corporates, and their ability to arbitrage differences in national regulatory contexts. This is not unique to 'digital' but was apparent right back at the start of the 18th century - the East India Company is a classic example. More awareness of history is needed.....

Actually I blame the retirement funds and the concept of retirement. If we all just worked till we died we wouldn't need the revenue stream from pensions to live on. That also means that pensionfunds the world over wouldn't need to exist or rapaciously extract income to pay annuities. Work till you die, economic dilemma sorted.

The free market was a chimera peddled by a bunch of elites who were intent on anything but.

As for capitalism 'creating wealth', that's a falsehood too. Ask yourself what your precious proxy would buy if fossil energy wasn't there? Or Lithium, or copper? If you want to believe the economics faith, a substitute will always be found at a certain price-point. A little like the Canute story, really. It amazes me that so many don't see the problem.

We will see the elite picking up more and more, of the less and less remaining. That leaves more and more angry peasants, billions of whom are now savvy enough to work out they've been shafted. French Revolution anyone?

"Do you her the people sing?
Singing the song of angry men!
It is the music of a people who will not be slaves again!......."

This music resounded around the world in 2019, 2020 will be interesting.

Understand the origin of laissez faire and you will see a concept taken out of context and applied for the purpose of power and control by French mercantilists.

Capitalism is merely an extension of feudalism, colonialism. Same objective, different method of control and power over resources and people. Capitalism converts real wealth into illusory wealth. Remove the numbers and what is left?

Human nature has been distorted by fear created by the 'isms in use for the past few thousand years. Greed is a subset of fear.

An unusually good range of thoughtful comment to Coyle's short article. I haven't researched the women but her opinions reek of academia, or (perhaps worse) economic academia.
She leads with the claim that the 2020's will see the end of the damage caused by free market advocates. And she concludes saying policymakers (I assume she means civil servants) armed with "sharper analytical tools" (provided by economists?)...will be able to "direct the economy" so as to bring "broad based progress" once more.
How naive,...Ms Coyle needs to get out more amongst ordinary people! She certainly has a point saying the digital world will bring change, but her predictions, based upon earnest academic research, are quite a different animal. I am sure, back when newly invented steam engines came on the scene, few, ( & particularly academics) would have predicted it's largely unforseen consequences.
Like other complex issues, climate change for example, many of the "facts" used to construct a computer model, are really just assumptions used to start a conversation. Only in Coyle's world has the economy been operating on "free market" or "capitalist" principles. Maybe in the USA, but certainly not down here where pollies have been continuously busy over the last 50 years at least, dreaming up ever more complex rules to "run the country"!
No, stuff happens but human nature doesn't change.Utopia is more about Animal Farm, and much less about the nostrums produced in cloistered academia.

One of the problems with single-topic discussions, at this point in global affairs, is that all things are intertwined, with feedbacks and reversals part of the intertwining.

The neoliberal chant 'free market' was always disingenuous, but the bigger story is that if possibilities had been unlimited, the neolibs wouldn't have needed to propagandise and displace. They did so, because options were limited, and about to get more so. The question then becomes: can the growth-requiring financial tabulation system (most 'wealth' is digitally denoted, requiring only one deleting key-stroke) survive the reducing opportunities for growth? And if not, will that elite still be elite? And will those who were trickled-upon, get annoyed enough to indulge the odd reprisal?

Academia has to ask itself a question too - is it not partially funded by student debt? Is that not a case of current academia stealing from the future?