for the full article, see http://www.nytimes.com/library/opinion/krugman/070200krug.html >July 2, 2000/ New York TIMES >RECKONINGS / By PAUL KRUGMAN >Going for Broke< In this article, PK is talking about companies that lose tremendous amounts of money up-front in order to make profits expected in the future. The old model of this was that described by John Kenneth Galbraith, who talked about the "planning sector" (a.k.a., the "monopoly capitalist" sector) which was insulated from market forces and therefore could afford to take a long-term perspective. The "new model" is Amazon.com. >... What is new is the sight of Amazon and other companies pursuing a full-scale go-for-broke strategy right from the start, losing hundreds of millions before anyone is even sure that there is money to be made in their businesses. When Mr. Galbraith was writing, it seemed obvious that only large, well-established companies with plenty of profits from their existing businesses could afford to make big bets on the future. When people thought about private-sector innovation, they had in mind I.B.M.'s development of the 360 series of computers, or Boeing's development of the 747. In fact, as little as six or seven years ago the common view was that Japanese companies would steadily gain the technological upper hand over their American rivals because only the Japanese -- not faced with annoying pressure to satisfy the financial markets -- could afford to take the long view, and ignore short-term losses. >But in the last few years our [i.e., the US rich folks'] stock market has proved willing and eager to finance brand-new companies with highly speculative business plans that require years of losses before anyone will know whether they make sense.... >How did this happen? I suspect that the emergence of our innovation-friendly finance markets was less inevitable than many people imagine. And it is by no means certain that the new era will last. For a while almost every I.P.O. was enthusiastically welcomed by markets... That euphoria has faded; but will it eventually be replaced by cynicism, by the demand that new businesses show an actual profit before they can raise large sums of money? >Amazon may be the test case. If the company proves the pessimists wrong, the golden age of the individual entrepreneur will certainly go on for a while longer. If Amazon really does go under, we may be headed back to the era when only big companies could afford to make big innovations.< What's notable about this generally-reasonable (but somewhat padded) discussion is what's left out. The innovation-friendliness of the finance markets that PK posits is basically the same thing as what Alan Greenspan calls "irrational exuberance." Financial markets like the stock market are irrational in the way that John Maynard Keynes described back in 1936: the speculators don't care about the fundamentals -- such things as the soundness of Amazon's business plan -- as much as how others in the market perceive the profit prospects of the company. As Keynes noted, it's like a beauty contest in which people bet not on which contestant is most handsome but instead on which is _perceived_ as best by others. Further, speculators rate stocks _relative_ to each other, not according to _absolute_ standards. Amazon is perceived as doing well relative to other companies. This kind of market, as more and more economists have finally become aware, is subject to manias (not to mention panics). It's an "electronic herd" (in Thomas Friedman's apt phrase), which stampedes with unpredictable regularity. Currently, we are in the tail-end of a mania phase, in which the speculators are stampeding in the optimistic direction, willing to gamble that Amazon will pay them well. It's not that the "market" is innovation-friendly as much as it's innovation-friendly _now_. Very soon, however, that mood will have been totally reversed, especially given indications that stock markets have been putting dramatically excessive value on stocks (cf. Robert Shillers' book, IRRATIONAL EXUBERANCE). On average over time, I'd say, stock markets aren't "innovation friendly" at all, favoring instead quick returns from momentary profit blips. Galbraith's point that large companies with monopoly power (or government subsidies) are needed for large innovations still holds in general. Another point: is "the market" really being "innovation-friendly" to an entrepreneurial project or something like IBM's introduction of its model 360? After all, Amazon _already did_ its innovation, while I'd bet that the company is no longer very small. (7600 employees sounds small compared to IBM or Microsoft, but what about the subcontractors?) What Amazon is doing right now seems simply a matter of building on its previous success, spreading out of selling books into selling other stuff using the same software. That's not exactly innovation. It seems to me is that speculators are betting not on the success of Amazon's innovation -- but instead on Amazon's ability to survive the ongoing shake-out of the on-line services. That is, they're betting on Amazon's being able to garner some monopoly power as its competitors fade from the scene or as it merges with another, similar, business. Further, they're betting on its ability to keep its exemption from state sales taxes and its artificial advantage vis-a-vis its non-web-based competitors, also a basis for future monopoly power. But mostly, they're simply betting that the price of Amazon's stock will go up before they sell it. That could be very soon. Jim Devine [EMAIL PROTECTED] & http://bellarmine.lmu.edu/~jdevine
