Every once in awhile–and the calendar’s odometric rollover from one year to the next is as good an occasion as any–it’s wise to stand back and try to gain a little perspective.

So it is with Brian Arthur’s October 2011 piece in The McKinsey Quarterly, “The second economy.”  If you don’t recognize the author’s name, he published the eye-opening 1994 book, Increasing Returns and Path Dependence in the Economy (University of Michigan Press, December 1994), and he’s now a visiting researcher at PARC and an external professor at the Santa Fe Institute.

He argues, in a nutshell, that digitization is creating a vast, autonomous, and largely invisible “second economy,” and that it constitutes the single biggest change to economic organization since the Industrial Revolution.

Bold claims?  Sure, but not outlandish, especially when you put them in historic perspective.  Bill Gates isn’t (and shouldn’t be) recognized as a philosopher of technology, but he can take credit for saying that “We always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten.” You can quibble about what he considers short- and long-run, but he’s certainly directionally right.

Arthur lengthens the time-frame even more:

In 1850, a decade before the Civil War, the United States’ economy was small–it wasn’t much bigger than Italy’s. Forty years later, it was the largest economy in the world. What happened in-between was the railroads. They linked the east of the country to the west, and the interior to both. They gave access to the east’s industrial goods; they made possible economies of scale; they stimulated steel and manufacturing–and the economy was never the same.

Deep changes like this are not unusual. Every so often–every 60 years or so–a body of technology comes along and over several decades, quietly, almost unnoticeably, transforms the economy: it brings new social classes to the fore and creates a different world for business. Can such a transformation–deep and slow and silent–be happening today?

His core point is that transactions and processes that used to take place with human, manual intervention are now occurring invisibly as computers talk to computers:  This is what he christens “the second economy.”  Here’s an example we can all identify with:

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 TSA (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.

Perhaps the signal characteristic of this vast, unseen and unheard economy is that it operates autonomously.  Yes, human beings designed it and can reconfigure it, but much of its normal reconfiguration occurs on-the-fly as it responds to new data inputs and internally generated results of processes it alone is conducting.

Some of you know that I and my partner in Adam Smith, Esq. are building another company, JD Match, which launched this past May.  It has no physical presence whatsoever and is entirely online.  I mention it because what members of JD Match see on the website is dynamically generated and instantly updated and reconfigured depending on information they contribute and selections they make.  It’s safe to say that the system generates screens never previously displayed and which may never be displayed again in a precisely identical fashion–much as speakers and writers of English, or any modern language, can generate perfectly sensible and understandable sentences never before spoken or written.

The JD Match site, of course, is far from unusual these days: That’s the point.  These systems are becoming ubiquitous.

How ubiquitous? Arthur makes a back of the envelope calculation as follows (don’t quibble with the precise numbers; but if you can take issue with the overall thrust you’re seeing something I’m not):

  • Since 1995 when digitization began to get serious traction, US labor productivity has grown at 2.5–3%/year, smoothed out.
  • Although debatable, sound studies attribute two-thirds to all of this growth to the uses of IT.  Call it 2.4%.
  • An economy that grows at 2.4%/year doubles in 30 years (we hold the labor force constant), which  means that:
  • By about 2025 the “second economy” will have achieved the same size as the “first,” readily perceptible economy.

Of note is that while the second economy may not produce anything you can kick, like a rock (Arthur notes it doesn’t make your hotel bed or serve you orange juice), it’s doing a lot of things that make the fresh linens and orange juice available at the right time and place.  (And the literary-minded among you will note the oblique reference to James Boswell’s Life of Johnson and the hard-headed response of Johnson to Reverend Berkeley’s airy assertions that there might be no physical reality:  “I refute Berkeley thus,” and kicked a rock.)

If not a physical presence, then, what is the second economy?

Neatly, Arthur notes that from about the 1760’s (the appearance of James Watt’s steam engine) through the 1860’s and beyond–I would argue, through the universal adoption of electricity–the Industrial Revolution provided a muscular system to the economy.  The digitization economy is now supplementing that with a neural system.   

You will quickly note that a key distinction between muscular and neural systems is that the former are ultimately constrained in their growth, by the limits of flesh and bone or, with machines, ultimately by the second law of thermodynamics, but that neural systems face no such limits.  How intelligent is “too” intelligent?  It’s a preposterous question.

What’s not preposterous is to imagine how it can begin to change the ways we conventionally live and work. 

But wait, isn’t there a downside to 2.4%/year productivity growth with no increase in the workforce? Here lies the explanation for (pick your euphemistic description), the “jobless recovery.”  It’s not India and China; it’s the second economy.  Arthur explicitly notes that:

Now business processes–many in the service sector–are becoming “mechanized” and fewer people are needed, and this is exerting systematic downward pressure on jobs. We don’t have paralegals in the numbers we used to. Or draftsmen, telephone operators, typists, or bookkeeping people. A lot of that work is now done digitally. We do have police and teachers and doctors; where there’s a need for human judgment and human interaction, we still have that. But the primary cause of all of the downsizing we’ve had since the mid-1990s is that a lot of human jobs are disappearing into the second economy. Not to reappear.

We may think we’ve seen this movie before–as farm jobs disappeared, manufacturing jobs more than took their place, and when they disappeared, service jobs filled the gap–but this time is qualitatively different.  Neither Arthur nor yours truly has a glib or convincing comeback:

The system will adjust of course, though I can’t yet say exactly how. Perhaps some new part of the economy will come forward and generate a whole new set of jobs. Perhaps we will have short workweeks and long vacations so there will be more jobs to go around. Perhaps we will have to subsidize job creation. Perhaps the very idea of a job and of being productive will change over the next two or three decades. The problem is by no means insoluble. The good news is that if we do solve it we may at last have the freedom to invest our energies in creative acts. [Query how many people would or could take advantage of this–Bruce.]

[…]

This second economy that is silently forming–vast, interconnected, and extraordinarily productive–is creating for us a new economic world. How we will fare in this world, how we will adapt to it, how we will profit from it and share its benefits, is very much up to us.

You can take an apocalyptic view, of course, and see this, as Occupy Wall Street perhaps sees it, as the road to complete polarization of society, or you can take a more sanguine view and see it as placing a premium on the very characteristics that make us human.  Education is surely part of the answer–which invites its own separate debate on whether we have cause for optimism or pessimism–but clearly leadership among nations could be up for grabs yet again (as it was in the early  and mid 1800’s).

I plant myself firmly in the agnostic camp, but with a definite tilt towards the optimistic side of the gauge. 

Why?  For one thing, never in the history of the world has increased productivity been a bad thing and it’s hard to imagine how it could be that now.  But more importantly, If the first and second economies together can satisfy Maslow’s basic hierarchy of needs, perhaps more than a tiny minority of mankind will be able to focus their attention slightly higher up the pyramid.

Wouldn’t that be the most improbable payoff of all, from the triumph of the nerds?

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