The political economy of networks

by John Quiggin on July 5, 2008

I’ve had this post in mind for quite a while, and never got in finished to my satisfaction, but it’s been stimulated to a significant extent by reading Clay Shirky, so I thought I’d pop it up now, somewhat half-baked while he’s visiting here at CT.

I’ve updated it a bit, incorporating some comments and responding to others

The biggest single question in political economy is whether and to what extent we can achieve social equality without sacrificing other goods like liberty and prosperity. Neoclassical economics (a project in which I’m a participant) begins with models which imply that, with competitive markets, all factors of production will earn their marginal product. This in turn implies that any intervention that shifts wages or returns to capital away from their marginal product must imply a loss in aggregate income.

There are all sorts of problems with this result, and particularly with simple-minded applications of it, which are legion. For a start, it can only ever be true at the margin – everyone in a modern economy depends for their income on the centuries of effort that have gone into creating that economy. There are also plenty of technical issues which have been debated for a long time, such as the famous capital controversy. I’m particularly interested with questions relating to whether the standard result, derived under the assumption of certainty and perfect information, works under conditions of uncertainty (in my view, much of the activity of the social democratic welfare state can be explained as a form of collective risk management).

Still, in an economy that fits the standard model of lots of competing firms, all operating in a region where constant returns to scale apply, the standard neoclassical analysis has considerable force. But the growing part of the economy centred on the Internet doesn’t fit this model at all. The Internet is a network and the economies of networks are different, in critical ways, from those of the standard neoclassical model.

There are two largely separate bodies of economic literature on network economies; although the approaches are quite different, the implications of the two are similar in important respects.

One literature is based on the idea of network externalities. In this literature, a network is simply a large collection of nodes, each connected to all the others, like the telephone network. The crucial point is that the benefit of each additional connection is not realised only by the person connected, but by all those already in the network. Hence, in economic terms, networks are characterised by externalities; that is, the productivity of one firm or household is affected by the actions of others. What this means is that market returns won’t produce an optimal network in general.

The other literature, still largely confined to theory, focuses on the stability and topological structure of small-scale networks. (I’m aware of course that economists are coming late to a field in which sociologists and others have been active for a long time). Here’s a typical example, by a couple of the leading figures in the field, Matthew Jackson and Anne van den Nouweland.

The central question is whether there exists a set of payoffs to the participants under which the network can be sustained. The answer is sometimes positive and sometimes not, but to my mind, the really striking feature of this literature is the absence of any concept remotely comparable to marginal product. There’s no general reason to suppose that a network that is stable (in the absence of intervention) is socially optimal in any sense, and hence that there is any particular reason to respect the payoffs generated by the network.

In the context of the Internet, for example, it seems pretty clear that the relationship between the social value of a contribution to the Internet and the capacity to realise a return is tenuous at best. In obvious cases, such as that of spammers, it’s negative. But even for something like Google, which is clearly beneficial in total, there is no clear relationship between contribution and return.

Taking myself as an example, I don’t think I’ve ever clicked on a Google ad, so my contribution to their returns is (or ought to be zero). On the other hand, as a general Internet user, I’ve used Google a lot and, as a blogger, I’ve got lots of readers from Google. But, on the third hand, as a site owner, I spend an inordinate amount of time dealing with comment spam aimed at promoting the Google rank of various scumbags. And of course, Google’s value depends entirely on the fact that millions of people (including me) have created websites, blogs and so on for Google to catalog and search, mostly for no reward or very little. On balance, it’s hard to say which way the net flow of benefits goes, and that’s pretty much par for the course with networks.

So while I’m grateful to Google in many ways, I wouldn’t feel the least bit concerned about a political-economic tax and expenditure regime that limited Sergey Brin and Larry Page to millions instead of billions, and helped others in the network economy (for example, by providing low-cost access to more people).

That’s not (as some commenters seem to have supposed) to suggest a specific intervention targeted at stripping the Google guys of their wealth. I’m merely pointing out that when I think about a more actively redistributive tax-expenditure system, I’m not going to be concerned about the fact that it will change the incentives facing Internet investors and entrepreneurs. Those incentives bear no real relationship to social costs and benefits, so there’s no reason to worry about “distorting” them (in the standard jargon of economists).

The more that we see the network economy as the paradigmatic form of organization, the less reason there is to regard the distribution of income thrown up by the market as having any claim to be normative. The topology of a network economy is inevitably a matter of social choice, and the same applies to the associated distribution of income.

{ 49 comments }

1

James Wimberley 07.05.08 at 8:37 am

Would traditionsl cultural and scientific networks, mediated by print or speech, be open to a similar analysis? St. Augustine say benefited from the large network of Latin-reading bourgeois in his time, so we still read him. A contemporary of equal insight who wrote in Syriac would not be read today. Jesus’ discourse in Aramaic only survived because it was transmitted in the other mega-language, Greek.

PS: (JQ)”I spend an inordinate amount of time dealing with comment spam aimed at promoting the Google rank of various scumbags.”
Should we call these scumbots?

2

Gabriel 07.05.08 at 9:14 am

bq. “[…] models which imply that, with competitive markets, all factors of production will earn their marginal product […]”

At particular scales of operation! Distribution is determined by _the whole equilibrium_, whatever that will be. — Teleport a bunch of programmers to Sub-Saharan Africa and see what marginal product they have there, as opposed to the one they have here.

(Neoclassical economics is much better when it doesn’t leave itself open to shrilling, misunderstanding heterodox attacks. Just saying.)

3

aaron_m 07.05.08 at 10:47 am

The original problem formulation seems to assume that one can equate liberty and prosperity with maximizing aggregate income. But the link between these is actually highly impossible as Rawls made abundantly clear. Although the pseudo utilitarian reasoning on social justice often offered by economists regularly makes this assumption it is actually rather hard to see why the link between liberty and maximizing aggregate income seems attractive to economists. Following standard economic theory one would clearly expect that one could not both maximise individual liberty and aggregate income in any given state (even libertarians who are only concerned with negative rights would agree to this). And of course simply equating ‘prosperity’ with maximized aggregate income says nothing whatsoever in normative terms about how we ought to distribute resources given the effect of various distributions on total consumption.

Once it is clear that maximizing aggregate income is not linked to liberty/ aggregate wellbeing in the suggested way then it is also clear that the conclusion about the internet market should be the same for ‘other’ markets; i.e. ‘we should not regard the distribution of income thrown up by the market as having any claim to be normative. Maximizing aggregate income vs accepting less total consumption for the sake of other goods is inevitably a matter of social choice, and the same applies to the associated distribution of income.’

ps Don’t we have the exact same externalities in regular markets as those described in the post, the only difference being that we notice them less than for the internet because we have become so accustom to them (e.g. I do not watch TV ads)?

4

Kenny Easwaran 07.05.08 at 11:13 am

Stability and optimality obviously come apart in some sorts of situations – I’ve generally taken that to be the real message of the Prisoner’s Dilemma, since the unique Nash equilibrium is clearly socially suboptimal.

5

Tim Worstall 07.05.08 at 11:22 am

Er, your argument about Google. You gets lots of benefit from its existence but contribute not financially to those who brought you those benefits.

So, at least as far as you are concerned, Brin and Page are offering you a public good aren’t they (well, not quite, but sorta)? To which the normal social democratic response is that we should all be taxed so as to finance said public goods for without such support we’ll have a less than socially optimal amount of it produced.

Doesn’t this mean we should be sending them tax money rather than they sending us some?

6

Robert 07.05.08 at 11:28 am

Those complex technical issues are that the marginal productivity theory of distribution is illogical and incoherent.

7

abb1 07.05.08 at 11:44 am

Sounds like this new science is light on economics and heavy on sociology. Seems to me, if you limit the scope by production/consumption, the internet is just a means of communication. The spammers are not different from the guys who put flyers under your windshield wipers, google is no different from a set of reference books.

8

Kevin Donoghue 07.05.08 at 12:54 pm

Tim Worstall: So, at least as far as you are concerned, Brin and Page are offering you a public good aren’t they (well, not quite, but sorta)?

Google doesn’t look even kinda, sorta like a public good to me. The internet as a whole is a kind of public good. As a rough analogy, I would say the internet is like a city centre and Google is like the maps you often see in public spaces, with adverts on the reverse side (or around the borders) which pay for the maps. Spam is the work of the graffiti artists, or the dogs shitting on the footpaths if you prefer. abb1 is Banksy.

And John Quiggin is the man giving out free ice-cream, for which I am grateful.

9

bdbd 07.05.08 at 1:17 pm

and the Google advertisers no different from someone who sticks business cards between the pages of the reference books.

how about “spambags?”

10

engels 07.05.08 at 1:30 pm

the internet is like a city centre and Google is like the maps you often see in public spaces, with adverts on the reverse side (or around the borders) which pay for the maps

And a camera hidden behind the map (which is made of one-way glass) which keeps a record of everywhere you go. For your own benefit! In case you get lost! And the map company keeps these records indefinitely and stores them in the US.

11

Rick Dubin 07.05.08 at 1:37 pm

“If all economists were laid end to end they would not reach a conclusion.” GBShaw

I am certainly out of my depth here but, wrack my poor brain as I am able, I cannot fathom a restriction on social equality leading to a benefit for the economy, the state, or the culture.

One should remember that a rather profitable adjunct for Google is the gathering of information about those who utilize its services. Whether one clicks on an ad or not simply by searching one adds to that companies bottom line.

12

seth edenbaum 07.05.08 at 3:35 pm

As always I return to the same points: the necessity for (and the obvious presence of) divided loyalty among individuals [or “nodes”] and the strange willingness of academic intellectuals to accept self-reported data as long as they’re the one’s reporting it.

No one network can foster both dynamism and stability, only multiple overlapping networks, constructed among the same points. The only way to avoid recognizing this easily demonstrated fact is if out of little more than ideological bias, you choose to see yourself as undivided, as a unified reasoning mechanism. There is no evidence for this in human history.

The definition of a renaissance is of a moment of dynamic tension between individuals and community. It’s not freedom that produces such moments. but the discovery of freedom by those still bound by obligation. The dynamism of social democracy is the dynamism of self-interest held in check by community. I’ve been reading recently that Descartes is associated with the birth of the subject. The only people who could argue this are those ignorant of both Michelangelo and Shakespeare. I myself would say Masaccio, whom Michelangelo revered. Self-awareness begins not with a fallacious clarity but with an acknowledgment of anxiety and doubt.

Why has no one ever responded to my comments over these past few years about my old landlady and our neighbors who refused to charge market rent? There has to be a way to put this data [and it is data!] into an economic model. Why does DeLong throw up his hands in frustration at the existence of the Scandinavian model? The answer is that economists like DeLong and you can’t allow for the presence of competing imperatives in the same body: people must be either selfish or selfless, they must make a choice! But they never do. The genius of European social and cultural life is not idealism (far from it) but the pressures that designate money and wealth as vulgar, that keep the fact of it a little below the surface. A community of entirely and openly self-interested monads will fail. So a statement that “all people are self-interested” means nothing, unless it is tied to a further statement “all people are bound by obligation.”

Another study someone should make: Compare Google to Apple. Google deals in information and money and in the the esthetic of the abstract and intangible.
[On money and invisibility I owe a debt to my old roommate. I’m one of the two dedicatees for that paper so I’m returning the kindness.]

Apple is preoccupied not only with abstraction but with the material presence of it’s products, not only with conceptual but physical design. It’s an example of a boutique capitalism that’s also as a result self-limiting. The only way for Apple to go beyond it’s chosen niche would be for it to be joined under a conglomerate cf.: Moet Hennessy Louis Vuitton.
Steve Jobs will never be as rich as Bill Gates and Apple will never be as malign a force as Microsoft, or this site’s chosen idol, Google. You prefer the latter because unlike Microsoft, it’s a competent organization, but if anything that makes it more dangerous. Competent hegemons always are, yes?

Again and again: The genius of our justice system is not in complex networks but in the adversarial relations of two: the prosecutorial network and the network of the defense attorneys.
The genius of consciousness is not in one complex system but in the overlaying of neural networks of computation with those of conditioned response that compete and contradict.
It doesn’t matter how complex your system is. If you’re only building one you’re wasting your time.

I still have a comment in moderation limbo here

13

PersonFromPorlock 07.05.08 at 3:35 pm

I sense, somewhere in this argument, Philosopher-Kings, probably with degrees in sociology or economics.

Taxing money away from those who make it on the internet to subsidize those who don’t is far less likely to improve the internet’s utility than it is to turn into shameless rent-seeking. The real thrust of modern business is to capture markets through (eagerly!) co-opted government power and there’s no reason to think that once government puts its hand on the internet, it won’t immediately sell its influence to the highest bidders.

14

enigma_foundry 07.05.08 at 3:47 pm

There are all sorts of problems with simple-minded applications of this result. Still, in an economy that fits the standard model of lots of competing firms, all operating in a region where constant returns to scale apply, the standard neoclassical analysis has considerable force.

Many economists disagree with thise presumption–of course you are leaving a little wiggle room when you say “considerable force.”

The main problem, brought up esp. by the a diverse group, including the likes of Karl Polanyi, Edward Wilson, is the economy is embedded in a larger framework, including society and the environment.
Thus, many of the costs created by the way neoclassical economics have been blindly applied ahve been unpriced.

The burden on both society and the environment has become intolerable, and things have got to change.

http://rodrik.typepad.com/dani_rodriks_weblog/2008/06/a-washington-consensus-i-can-live-with.html

15

Slocum 07.05.08 at 5:35 pm

o while I’m grateful to Google in many ways, I wouldn’t feel the least bit concerned about a political-economic tax and expenditure regime that limited Sergey Brin and Larry Page to millions instead of billions.

Millions instead of billions? When I do that math, that comes out to a 99.9% capital gains tax rate. So how would confiscating 99.9% of Brin and Page’s equity differ from nationalization of the company? Are there other tech companies and founders who should be subject to the billions->millions treatment? Gates? Ellison? Bezos?

16

Righteous Bubba 07.05.08 at 6:00 pm

So how would confiscating 99.9% of Brin and Page’s equity differ from nationalization of the company?

It would differ in that Google would not be nationalized.

17

abb1 07.05.08 at 6:23 pm

Yeah, Slocum, really, come on. Nationalization is public ownership; taxation of the shareholders, no matter how progressive, is something completely different.

18

Jake 07.05.08 at 6:55 pm

Page and Brin don’t have billions of dollars, they have an ownership interest in Google that is theoretically worth billions of dollars. I suspect that they enjoy running Google more than they’d enjoy having millions of dollars, so if you institute a taxation regime where selling their interest in Google only gets them millions, they won’t sell. So then you’re left either forcing them to sell the company to someone else (who is likely to do a worse job of running it or at the very least change it to something wholly unlike its current self) and taxing the proceeds, or taxing their ownership interest directly – nationalization.

19

geo 07.05.08 at 7:23 pm

Like Aaron (#3), I’m unhappy with the original formulation. There is no good reason to define “prosperity” as maximum aggregate income rather than maximum well-being. Nor any reason to limit “liberty” to actions restricted by redistribution and exclude actions enabled by redistribution. The only reason of any kind that I can see for either usage is that economists are too mentally lazy and morally benumbed to recognize their ideological bias. Present company excepted, of course.

20

seth edenbaum 07.05.08 at 8:04 pm

“Are there other tech companies and founders who should be subject to the billions->millions treatment? Gates? Ellison? Bezos?”

Craig Newmark has said he doesn’t want to be a billionaire and he keeps turning down offers to sell.
Personally I say shunning would be a good social policy.

Again, following the logic of market theory greed is good. But most of us aren’t taught to be amoral, including most people who defend the logic of the market. The question is how to be a “realist” about human behavior without being a cynic; and to understand that the difference between European social democracy and the American model begins not with the rules and regulations, but with the people. Whatever anyone may say about Dani Rodrik this is just annoying. More system-building.

In order for the market to function well the market needs a counterforce. It needs an opposition.

ABC announced on Monday that it would broadcast three more seasons of its hit castaway mystery, “Lost,” ending the show in 2010 after a run of six seasons.

The announcement has been expected since January, when the creators of the show told a group of television writers that they wanted the network to set a definitive end date for the series.

Such a date was necessary, they said, so that they could begin planning how to unravel the multiple mysteries that beset the fictional survivors of Oceanic Air Flight 815, which crashed on an uncharted island en route from Sydney, Australia, to Los Angeles in September 2004.

But the move by ABC is nevertheless unusual because networks usually try to milk profits from their successful series as long as possible, a strategy that often results in convoluted story lines, shake-ups among production staff and dwindling fan bases.

That is exactly the situation that Damon Lindelof and Carlton Cuse, two of the show’s executive producers, said early this year that they wanted to avoid. When they announced their desire to set a specific end date to the series at a January meeting of the Television Critics Association in Pasadena, Calif., they surprised even the ABC executives who were attending.

“We have always envisioned ‘Lost’ as a show with a beginning, middle and end,” Mr. Lindelof and Mr. Cuse said in a statement, which was re leased over the weekend to The Hollywood Reporter and to the rest of the news media on Monday. “By officially announcing exactly when that ending will be, the audience will now have the security of knowing that the story will play out as we’ve intended.”

Give me a simple definition of the multiple logics behind ABC’s choice. You won’t be able to.

Just to add the link on “amoral” is to a post of George Soros and his childhood experience with the Nazi’s. And it’s not the experience I’m responding to its his lack of nightmares. I understand his logic and sangfroid, and I may even share it, but that doesn’t mean I approve of how he used it later in life: he became what he is by existing outside civil society and now he’s using to help build what he has no place in.

21

seth edenbaum 07.05.08 at 8:06 pm

Along with the blockquotes again [textile!] I’m also in moderation… again.

22

abb1 07.05.08 at 8:19 pm

This is purely a matter of semantics, Geo. Their definitions of “liberty” and “prosperity” are not incoherent or absurd, just technical. Though I agree, it would’ve been much better if they used jargon and left common words like “liberty” alone.

23

Bruce Wilder 07.05.08 at 9:03 pm

The neoclassical model rests on a production function, that asserts that (maximum) output is a function of inputs, and output is assumed to be at its maximum. You can regard this gambit as just a clever way to narrow the focus of economics to allocational efficiency issues, by simply assuming away all issues of technical, engineering and managerial efficiency. But, it’s consequence is to ignore not just network efficiencies, but all issues of technical and managerial efficiency.

In a world of risk and uncertainty, in which technical and managerial problems cannot be assumed away, but are, in fact, only partially solved problems, output is not maximized by assumption, is not maximized in any transcendant sense at all, and output is not a function of inputs. Let’s repeat: output is not a function of inputs.

Output is not a mathematical function of inputs. A few seconds of thought experimental should be sufficient to convince you that this is the case. The same inputs can be used to produce any number of various outputs. And, if technical and management problems persist in a world of risk and uncertainty, you can never be sure of having achieved even an ephemeral unique maximum output. Indeed, “maximum output” can have no well-defined meaning. If output is not unique for a given set of inputs, output is not function of inputs.

This brings us back to income distribution, because the production function is the original model for income distribution. If the production function is “wrong” about output being a function of input, then the neoclassical model of income distribution, which confidently predicts that every factor will receive its unique marginal marginal product, and all income from output is exhausted, is also wrong. Technological determinism of income distribution rests on the plausibility of the existence of, and achievement of, a “maximum” output (with all technical and managerial problems resolved as far as they possibly can be).

If uncertainty, risk, engineering and management is allowed into the abstract imagining of the production process, then output is a function of inputs plus technology and management. In the simplest abstraction I can imagine, control of the production process matters. Technical and managerial control of the production process matters to technical efficiency (which can be conceived abstractly as the control of error) as well as to allocative efficiency.

Control matters, because the most effective economies, the economies which result in elevation of total factor productivity, are the technical efficiencies that reduce error. And control means power as an economic force. And, that means that income distribution is a function of power. Not a surprise to most sentient non-economists, but, perhaps, a surprise to neoclassical devotees.

And, if we are in a world of risk and uncertainty and error and experiment, then insurance matters. Actual output is risky and uncertain, and so the incomes of inputs are risky and uncertain.

Efficiency of the whole system requires that everyone acts, without risk aversion or desperation, choosing on the basis of expectations. No one can do that without insurance, without some institutional assurance that actual results will not deviate from expected results. Winner-take-all is a recipe for social and economic disaster, in which many are made risk-averse peons or desperadoes.

Insurance — lots of insurance — is necessary to an efficient economy. This is a conventional result of sound economic reasoning. Anything else is ideological claptrap of a low order and no real legitimacy.

Political arguments about the distribution of income should not be arguments about the legitimacy of marginal product, but about insurance, and the most efficient way to provide sufficient insurance to achieve optimal, distributed decision-making. As few peons and desperadoes as possible, thank you very much.

In fact, most political policymaking in relation to the distribution of income is about the provision of insurance. Conservatives, of course, want to reduce low-cost, government provision of insurance, so that wealthy people can enhance their incomes by using private wealth to provide insurance on terms unfavorable to most people. The conservatives want to relax labor laws, consumer protections, subsidies for education, etc. etc., all with the singular aim of redistributing risk, and with the redistibution of risk, redistribute income.

24

John Quiggin 07.05.08 at 11:29 pm

Bruce, I entirely agree, as I’ve written here (PDF). (HTML here

25

geo 07.05.08 at 11:40 pm

abb1: Their definitions of “liberty” and “prosperity” are not incoherent or absurd, just technical. Though I agree, it would’ve been much better if they used jargon and left common words like “liberty” alone

So it’s just an innocent misunderstanding? But then, if it’s clear even to not-very-smart people like me that their terminology is confusing and liable to ideological misappropriation, why haven’t they changed it? It’s not as though economists are generally reluctant to use technical language.

26

geo 07.05.08 at 11:51 pm

John, the paper of yours that you linked to above, “The Risk Society,” is terrific. Any subsequent writings, by you or others, in that vein?

27

lemuel pitkin 07.06.08 at 1:25 am

Those complex technical issues are that the marginal productivity theory of distribution is illogical and incoherent.

Robert, that’s my understanding too. But John Quiggin, who no doubt is perfectly familiar with the Cambridge controversy and all that, continues talking as if the distribution between wages and profits can be explained in terms of marginal products. And yet I bet, if you put him on the spot, he’d agree that there is no logically consistent way for this to be true.

Why is this? Is it that the marginalist approach is a reasonable approximation in some important way? Or is it because “thinking like an economist” requires, on a certain level, not acknowledging these arguments? Or….?

And why, more generally, has the Sraffian critique been so completely ignored by the economics profession?

28

Slocum 07.06.08 at 2:11 am

Yeah, Slocum, really, come on. Nationalization is public ownership; taxation of the shareholders, no matter how progressive, is something completely different.

Except that Brin’s and Page’s billions consist of equity in Google, not a really, really big piggy bank. That being the case, how would you reduce their billions to millions except by either confiscating their equity or taxing their (unrealized) capital gains (at a 99.9% rate), forcing them to liquidate their stock holdings to pay the tax?

Or, as Jake points out, if you’re not going to try to reduce their billions until they get tired of running Google (possibly decades from now — they’re pretty young guys), you’ll not have changed much of anything about the wealth, power, and influence of Page, Brin and Google during that time span. And, as Jake says, in that case they’ll hold off selling as long as possible.

And by the way, if Quiggin wants to better understand the ‘Radical Skepticism’ of the ‘delusionists’ he might ponder whether their opposition derives at least in part from their sense that more than a few of those who favor strong action on climate change also favor modest proposals like the 99.9% solution under discussion here (and may attempt to use the former as a justification for leftish social/political/economic transformations).

29

geo 07.06.08 at 2:59 am

Slocum, you’re overexcited. A reduction from billions to millions needn’t be a reduction of 99.9 percent, as you keep insisting. For example, a reduction from 2 billion to 900 million is a reduction of 55 percent. I don’t know exactly what the person who proposed “billions to millions” had in mind, but then, neither do you.

30

Lee A. Arnold 07.06.08 at 4:55 am

John Quiggin, I am having trouble understanding your post. I wonder if you would please point to a description and explanation of exactly how a “network economy” is supposed to be different than the regular one. Please keep it to moneymaking, so I can wrap my simpletonian brain around it!

Because I think that, in a money sense, the internet has only two things going on and they are both regular economics:

(1) Businesses can advertise and interact with customers. So, at the ends of making and providing their real competitive goods and services, won’t they will all be earning their marginal products, more or less?

(If anything, the ubiquity of the internet allows easier startups and more competition.)

BUT the internet as a whole thing is NOT an economy. It’s more like one big worldwide newspaper — a two-way newspaper, with movable pages, and with automatic searching and archiving functions.

So that brings us to the second economic thing going on:

(2) Brin and Page were the first to realize that, by supplying the searching function, you can proceed to create, and then corner, the advertising department for this whole newspaper.

That’s just another specialized monopoly, perhaps the only one (so far) that works at the level of the whole internet — (and I would argue that an alternative definition of any monopoly is that it is the chief beneficiary of all network externalities.)

However, there is competition coming to run this advertising department:

Microsoft, Murdoch, and others are trying to get hold of databases to build searching upon. Microsoft is after Yahoo, Murdoch picked up MySpace, Barry Diller bought Ask Jeeves. The game is to beat Google, otherwise these guys will end up with peanuts.

Now, the immediate problems with their various strategies are, again, that the internet is ONE thing, and information can be duplicated. It is hard to get a foothold. They have to provide searching good enough to rival Google’s, and after that, offer advertisers a better deal than Google does.

But I think it could happen — and at that point, won’t competition to run the advertising department tending to force the competitors to earn their marginal products?

(Indeed I would guess that Brin and Page think it could very easily happen, and their acquisitions are part of a strategy to forestall it.)

P.S. I am under no impression than the real economy is anything other than a concatenation of monopolistic competitors, nor that the present distribution of income is completely justified.

31

Lee A. Arnold 07.06.08 at 4:59 am

typo “at that point, won’t competition to run the advertising department TEND to force the competitors to earn their marginal products?”

32

John Quiggin 07.06.08 at 6:13 am

We had a bit of a debate about the Cambridge controversy here. From my perspective, the controversy showed that there was no good reason to believe in the existence of a meaningful aggregate called “capital” or an aggregate production technology with “capital” as an input.

Much the same point can be made about nearly all the aggregates that economists talk about, including the “price level”, “GDP”, “employment” and so on. Using these aggregate terms as anything other than convenient simplifications is dangerous, but also pretty much inevitable.

None of this has much direct relevance to the result I’m alluding to above (grandly known as the Fundamental Theorem of Welfare Economics). The standard derivation by Arrow and Debreu makes no reference to “capital” and regards each kind of physical input (machines, factories and so on) as being a separate commodity, and the same for different kinds of labor input.

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abb1 07.06.08 at 7:50 am

@25: yeah, they politicize, of course. Technical abstract models attempting to optimize certain narrowly-defined outcomes shouldn’t become political tools, but they always do, they always will, and that’s all there is to it.

To me the trick is to ignore the connotations, emotional overtones of loaded words they use. Is “liberty” a good thing? Who knows. As Lenin once said: “freedom – yes, but whom? to do what?” Same deal with “prosperity”.

34

Tom 07.06.08 at 8:21 am

As a reflection on the point raised with respect to the “relationship between the social value of a contribution to the Internet and the capacity to realise a return”, I think we need to go back to the underlying social motivations for the contributions AND then look at models that work and which don’t merely extend or force what has been traditionally done in connecting content to revenue.

35

seth edenbaum 07.06.08 at 3:37 pm

Sergey Brin and Larry Page “invented” something. They’re taking a “cut” on other’s activities the only way now possible, through advertising. But they have equity in something that is valuable because it is ubiquitous. They make the free phonebook that everybody uses. The market’s valuation is perverse. But there’s nothing new in that.

Your response to that fact depends on psychology, on your willingness to see yourself as a member of multiple social and economic networks rather than just one. If it’s about money, then money is money and it doesn’t matter how you got it as long as it’s legal. But why are there fewer Slocums in some countries than in others? Social democracy is not social bureaucracy it’s the massing of social networks that make the existence of such a bureaucracy socially acceptable.
I asked common sense questions I get nothing.

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John Emerson 07.06.08 at 6:17 pm

And by the way, if Quiggin wants to better understand the ‘Radical Skepticism’ of the ‘delusionists’ he might ponder whether their opposition derives at least in part from their sense that more than a few of those who favor strong action on climate change also favor modest proposals like the 99.9% solution under discussion here….

As Slocum points out, global warming deniers seldom have any interest at all in climate per se.

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John Quiggin 07.07.08 at 5:41 am

#26 Geo, I’m planning more on this Real Soon Now.

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Robert 07.07.08 at 8:42 am

John and others seem to want to say that if markets only were competitive with no network effects or whatever, then the distribution of income thrown up by markets would be fair or just. This strikes me as silly.

Anyways, John’s new formulation draws on General Equilibrium theory. So in his imaginary world with a fair income distribution, all forward markets must exist for all commodities, including those whose delivery is contingent on the state of the world. And trade must be suspended at disequilibrium prices. This is a picture of no possible capitalist economy.

Besides, I would think John couldn’t object to lump-sum transfers and the invocation of the second welfare theorem.

I guess a lot of what John wants to say is packed into his usage of the word “earn”. Try substituting “make” in John’s post and see how it reads.

By the way, ownership of capital goods is not a contribution to production.

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not wishing to be named 07.07.08 at 4:19 pm

Lee: here’s a take on the difference between “normal” and “network” economies.

There’s two distinct fields that come under the “network economy” name, which is what Quiggen alludes to with his “two literatures” remark.

One of them derives from sociology (eg: social network analysis) and some branches of game theory (eg: “games on graphs”). Conceptually these approaches proceed in the following order:
– assume individuals
– assume (ranges of) behaviors (formalized as outputs in reactions to input, eg production decisions in response to inputs or game moves in response to other game moves)
– assume some connection topology between members (eg: perhaps everyone is directly connected to everyone; perhaps, as in the real world, everyone is connected to everyone, but sometimes in circuitious paths — like 6 degrees of separation; perhaps, as in the real world, everyone is connected to everyone, but the overall structure resembles a hierarchical tree)
– analyze, based on agent dynamics and network topology, how the individual nodes will behave, and attempt to reason about the characteristics of any “equilibrium” the network will converge to with time

This is almost precisely the opposite conceptual order from basic “normal” economics, which proceeds like so:
– assume a very specific network topology (eg: everyone is directly connected to everyone)
-assume an effectively infinite set of nodes
-assume equilibrium
-assume actors with simple behaviors
-calculate actions taken by actors in that environment, and/or how that aggregate set of actors arrives at a new equilibrium

In the case of “everyone is directly connected to everyone” along with rational actors the two models mostly agree:
– “everyone is connected to everyone” is ~ the same as perfect information
– “everyone is connected to everyone directly” is ~ the same as zero transaction costs
– “~infiinite set of nodes” is ~ infinitely deep markets

…but there’s the basic difference: “normal” economics is a field that starts with a big wooly-headed abstraction (the market), and proceeds from there down to the level of individual agents; the “network” economics (still in its infancy) starts from individual agents and their interconnections and attempts to proceed from there.

Why hasn’t “network” economics (in this vein) advanced sooner as a field of study? I’d argue for a handful of reasons:
– the math is harder than that used in classical micro/macro ec (b/c you’re always dealing with a very large system of coupled differential equations, if you’re doing it right), and many of the mathematical tools weren’t well-developed until after 1950
– good empirical data wasn’t nearly as obtainable as it is today, and calculating social-network-analysis-related things like power and centrality were hard to do until after computers became mainstream
– the results are less appealing to just about every ideology out there: whereas rent-seeking is a kind of ill-defined epithet in normal economics talk, it can be much more defined much more precisely in a network context (look for agents or groups of agents with (collective) chokeholds over connections between two otherwise-disconnected entities, and see how much they can extract); in this framework just about all “wealth creation” arises from rent-seeking…topology, not marginal utility, determines profitability. On the other hand, many of the left-aligned would see how little reason they have to believe their policy proposals would work, either.
– there’s an incumbent effect: to use the social-network language makes it hard to talk with an economist, b/c you’re starting from opposite ends of the conceptual model; using the language of economics, though, makes it hard to convey the salient points without a ton of waffle words.

In a nutshell that is the sociology derived literature: in time it may develop into a real field in its own right, and it certainly — to me — starts from a more realistic starting point; it’s just a matter of waiting for better data sets, better analytic tools, and so forth makes it more than a very niche field.

The other literature on “network” economies is the study of network externalities and so on. Places where these “network” economies diverge from the basic, ec101 type of economies:
– the value of a good depends heavily on other users of that good (a phone network with 0 users is worthless; a phone network everyone uses is worth quite a lot)
– the good you’re buying isn’t so much a one-off consumable purchase (like a barrel of oil) but more an ongoing commitment to a particular pattern of behavior (i’m going to use software package X for a very long time after purchase)
– consequently, the utility calculations of a given purchase depend very heavily on the action(s) past and present of everyone else in the world, and also on your past actions (thus “transitivity” is broken)
– in particular, the calculation of marginal utility of purchasing X, if you are currenlty using Y instead, decomposes as a comparison between “marginal utility of Y” versus “cost of Y plus cost of stopping use of X, including converting old data, retraining, and a sundry host of opportunity costs”, which means that the maker of X can extract from its users an amount much greater than the naive marginal utility of X (the limit they can charge is ~ anything just under the cost of switching to Y).

Thus, in these environments you expect a lot of pathological behaviors compared to what you’d expect in “normal” economics:
– the largest price a software package can go for is roughly the Net Present Value of switching to a competing package (effectively the “ransom cost”), not the marginal utility it offers; without the stickiness and switching costs it’d sell for an amount comparable to its marginal utility — and to win new customers it may sell near there — but existing customers “needing” to upgrage (b/c their older versions are not capable of reading files generated by the newer versions other customers have bought…) can be held up for much more than marginal utility.
– tremendously high (nearly infinite) startup costs for rival providers of comparable (but not interoperable/compatible) products, b/c the value of a product is more in who else uses it and not in what it does (…what it does is only the bait to get the value-providing user base); thus instead of just having to worry about cost of capital and amount of capital, there’s a huge unknown factor in terms of being able to attract/lure away existing users.

And, these are the norms in any software/communications sector without some interoperability standard; they bear so little resemblance to the “revenue = marginal utility” view of market outcomes that, as Quiggen says, it’s hard to justify the entirety of the gains derived from “success” in these areas as somehow “earned” by those making the gains (in the same way that, to some people, it’s hard to call the “gains” made by buying-and-flipping land or domain names “earned” in the same way that gains made from operating a widget factory are “earned”).

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Sebastian 07.07.08 at 5:18 pm

“I’m merely pointing out that when I think about a more actively redistributive tax-expenditure system, I’m not going to be concerned about the fact that it will change the incentives facing Internet investors and entrepreneurs. Those incentives bear no real relationship to social costs and benefits, so there’s no reason to worry about “distorting” them (in the standard jargon of economists).”

I’m a little put off by this. In your post you seem to be saying that we don’t have a very firm handle on how the economics of networks work. (You can see this in things like “On balance, it’s hard to say which way the net flow of benefits goes, and that’s pretty much par for the course with networks.”). But given the lack of understanding you don’t seem to be too worried about radically changing the entire incentive structure. That doesn’t seem wise.

Also, as slocum points out, you can’t just redistribute the money in Google without effectively nationalizing it, because nearly all of the money is in equity.

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Slocum 07.07.08 at 5:34 pm

That’s not (as some commenters seem to have supposed) to suggest a specific intervention targeted at stripping the Google guys of their wealth. I’m merely pointing out that when I think about a more actively redistributive tax-expenditure system, I’m not going to be concerned about the fact that it will change the incentives facing Internet investors and entrepreneurs.

I can’t say I’m any more reassured by an unspecified overhaul of the tax system that would have prevented Brin and Page from becoming billionaires in the first place. Some detail would be useful — how would a tax system prevent a future Google from achieving an enormous market capitalization?

Most likely any such system would only prevent future entrepreneurs from becoming billionaires here — since there seems to be no shortage of nations that would be willing to be the home of the next Google.

Slocum, you’re overexcited. A reduction from billions to millions needn’t be a reduction of 99.9 percent, as you keep insisting. For example, a reduction from 2 billion to 900 million is a reduction of 55 percent. I don’t know exactly what the person who proposed “billions to millions” had in mind, but then, neither do you.

OK, Brin and Page are both worth about $20 billion, so reducing that to under $1 billion means a tax rate on the order of at least 95% (a rate that once inspired a George Harrison song).

As Slocum points out, global warming deniers seldom have any interest at all in climate per se.

That cuts both ways. Many on the left clearly see action on global warming as a way to force living patterns (density, mass-transit) and the global economy (the rich north subsidizing the poor south) in directions they’ve always favored, quite independent of climate change. How much is concern for climate and how much is enthusiasm for use of climate as a means of implementing leftist policies?

If global warming action proponents were really worried about global warming above all else, they’d propose actions in political/economic forms most palatable to their political opponents, wouldn’t they?

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abb1 07.07.08 at 6:37 pm

Why, they could, for example, start heavily taxing profits (or even revenues) of large corporations (‘large’ in the market-cap sense; tax rate goes up with market capitalization), thus turning them, effectively, into non-profits. That would turn their equity from billions into millions quick. No? And it would make sense too – don’t grow into a behemoth, let the others be and compete.

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John Quiggin 07.07.08 at 8:56 pm

Slocum, as I’ve pointed out many times, the main actions proposed to deal with global warming (the creation of new markets for emissions rights) ought to be entirely palatable to free market supporters. And the smart ones, in the financial sector love the idea.

The fact that they are being proposed by people in the environmental movement who aren’t in any wedded to market outcomes or the financial sector (many of whom originally wanted lots of regulation and intervention) ought to reassure these folks that we see a real problem and want to deal with it in the most effective way possible.

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Slocum 07.07.08 at 9:51 pm

Slocum, as I’ve pointed out many times, the main actions proposed to deal with global warming (the creation of new markets for emissions rights) ought to be entirely palatable to free market supporters. And the smart ones, in the financial sector love the idea.

Yes, well Enron absolutely loved the idea, too. There would undoubtedly be prime opportunities for astute, politically-connected companies to make enormous sums of money (see Archer Daniels Midland and corn ethanol). That prospect does not warm the heart of free-market libertarians — quite the opposite.

I understand that emissions-rights trading is a more market oriented approach than direct regulation. But there are crucial differences between national vs global markets and SO2 vs CO2. SO2 emissions were not fundamental to nearly everything an economy does. Having to purchase rights to emit CO2 is not entirely unlike having to buy permits to breathe.

Some years ago I watched a documentary about a team of seismologists trying to predict an earthquake accurately enough for an evacuation. They were keenly aware they weren’t going to get to try, try, try again — a false alarm or two, and their credibility would be gone and nobody would heed another call to evacuate.

Similarly, I don’t think there are going to be a lot of chances for do-overs on global climate action, and there have been a number of not very good signs in the preliminary rounds. It seems to me that global warming activists should be very concerned about ‘public choice’ kinds of issues — how could this approach be exploited? How could that one? Rather than just trying to steamroll the opposition and get any sort of follow-on to Kyoto pushed through.

I don’t want to see an overheated planet, but nor do I want to see the global economy fubar’ed, and the latter is a more immediate prospect than the former.

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Righteous Bubba 07.07.08 at 9:55 pm

There would undoubtedly be prime opportunities for astute, politically-connected companies to make enormous sums of money

Good god! Stop the presses!

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Lee A. Arnold 07.08.08 at 3:56 pm

#39 — Thank you for taking the time to write such a comprehensive overview! I need much more time to think about it — but it strikes me right away that an additional answer to your question “Why hasn’t “network” economics (in this vein) advanced sooner as a field of study?” is because of the other vein: it would apply mostly to communication and transportation innovations without interoperability, and, in the United States at least, the telephone company was accepted as a public monopoly until its breakup — the intellectual need for the idea of “network economics” was obscured by the study of monopoly. Does this seem accurate?

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John Quiggin 07.08.08 at 10:11 pm

“not wishing to be named” at #39. Can I add my thanks also. Maybe I should get you to write my posts, as your exposition was much better than mine. If not for your nym, I’d cite you, but as it is, I will certainly appropriate at least some of this.

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John Quiggin 07.08.08 at 10:13 pm

Lee, I think your suggestion is plausible. Certainly interest in network economies in transportation grew in the period after deregulation.

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Brett Bellmore 07.10.08 at 12:32 am

“There is no good reason to define “prosperity” as maximum aggregate income rather than maximum well-being.”

Nah, there is: One is comparatively objective, and thus at least capable of being approximated as a real world measure, the other is radically subjective, and NOT capable of being approximated as a real world measure. Unless, of course, you decide to assign preferences to people, rather than letting them have their own.

It’s fairly sensible to define “prosperity” as something you can measure, rather than something you can’t.

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