Paul Krugman Got Something Very Right About the Internet, the Fax Machine and the Economy

(Bloomberg) -- Paul Krugman recently wrote a post that was dismissive toward Bitcoin, as he’s done many times in the past. So of course the dunkers were out in full force to remind the New York Times columnist of one of his most-infamous predictions about the impact of the internet on the economy, likening it to the fax machine. 

So the first part of Krugman’s prediction was obviously, completely, unequivocally wrong. It turns out that people have a lot to say to each other. More than we ever thought. A total zero on that one. Points to the dunkers.

The more interesting half of the quote though — and the one that the critics mostly remember — is the second part about the impact on the economy being no greater than the fax machine. This one is completely defensible. 

As Skanda Amarnath, head of research at Employ America, wrote to me, what people see as a major economic impact is really the social impact. From a true data impact, Krugman wasn’t wrong. “Productivity growth has been substantially weaker during the age of the internet,” Amarnath wrote. “The same deceleration is visible in terms of both nominal and real investment in software and even the broadest definition of hardware (information processing equipment). There has been some shifting and cannibalization of activity as a result of retail moving to e-commerce channels, and new media dominating advertising services at the expense of old media, but if we’re talking about macro impact beyond substitution, the burden of proof is with those eager to mock Krugman on this point.”

You can see the chart here, showing that the era of the internet has not been an impressive one for tech investment. And we all know, of course, that measured productivity states have been mediocre.

Furthermore, as Matt Darling, vice president of behavioral economics lab Ideas42, has pointed out, the quote came in the context of a big, national debate about how the internet would have some turbocharging effect on economic growth. There was for example a WSJ piece by Rudi Dornbusch that year arguing that we would experience a forever boom.

There was also a great Businessweek profile of former Sun Microsystems CEO Scott McNealy that came out in 2004, which had this line:

McNealy would have none of it. Time and again, Zander would end staff meetings by saying: "Well, what do you guys want to do?" says a source who was in the room. As the execs went around the table expressing their views, it was clear everyone believed in some sort of austerity plan -- except McNealy. McNealy was convinced that the Internet had fundamentally changed the nature of the economy. He thought the highs and lows of the business cycle would be far more extreme and short-lived than in the past, with sharp spikes up and down. "We don't have rolling waves," he said during a conference call with analysts in 2001. "We seem to have real edges."

So again, there was a considerable discussion at the time that the internet would fundamentally change something. Either lead to a perma-boom, or faster growth, or greater productivity, or something fundamentally new in how business cycles worked. And yet we've seen none of that. Instead we’ve had mediocre growth, long broad downturns, and declines in both productivity and general tech investment.

So yes, for sure Krugman was wrong on the societal impacts, such as how much we all have to say to each other. But on the question of the difference between the internet and the fax machine, the data back him up.

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