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Technology is the answer, not the problem

On today's PE Hub, guest columnist Joe Weisenthal wrote about how Internet start-ups will accelerate deflation, which is a bad thing for the government, and, ultimately the country.  I don't know Joe, so I don't know if this is tongue-in-cheek.  If it is, I didn't get it.

But, there are economists who are worried about deflation, and they should be.  Although the idea of prices dropping sounds good, it can have a crippling effect on the economy.  For a short period, deflation is fine.  Everyone likes it when prices drop and their dollar goes further.  But, what if deflation becomes systemic?  What if you knew that prices would drop over the coming year?  Wouldn't you wait to buy things you didn't really need today?  After all, they would cost less in six months.  This mindset brings an economy to its knees.

In the technology sector, prices have dropped while performance has gone up.  This has hollowed out some markets, but it has also expanded them.  When PCs cost thousands of dollars, you'd live with your old one for a while.  There was a pace of change of technology, but it didn't seem as fast as it is today. 

Now, when PCs cost hundreds of dollars (and these are dollars that are worth less), it's not as significant of a purchase.  You know that in a year your PC will be outclassed by the next wave of technology.  But, since the investment isn't as significant, you live with this obsolescence.  Chances are, the PC you buy today is so much faster and better than the one it is replacing, you get your few hundred dollars of utility out of it, despite the fact that it becomes obsolete so fast.

Since PC technology moves so fast and has come down in cost so fast, the market has gotten a lot bigger.  Sure, it's ultra-competitive, and margins are thin.  That happens in any large commodity market.  But, it still is a bigger business, and creates bigger industries around it (semiconductors, software, services, Internet applications, etc.).  To Joe's point about tax revenues, I'm willing to bet that the overall tax revenues on the bigger, more commoditized PC business are higher than in the smaller, higher-margin PC business.  Don't forget to count all the forms of taxes -- payroll taxes, sales tax, and corporate income tax.

In general, I think that Internet applications will do the same thing.  We can't and won't suck all the money out of all these industries.  If we do, no one will earn a salary.  And, without salaries, no one will do the work.  Now, there have clearly been missteps that have hollowed out industries quickly, such as the music industry not paying attention to music downloads, causing a whole generation to get used to paying nothing for music.  Or, the newspapers giving away all their content for free without figuring out how they would pay for it.  But, there are also companies like Apple that make a lot of money on downloaded legal music.  And, there are media sites that have a lot of traffic (driving advertising dollars) that sell value-added services (a model that the newspapers could follow for their large online traffic).

So, I don't worry about the acceleration of technology causing deflation and leading to the collapse of our government and economy.  In general, our economy has been propped up by expansion of productivity (the positive way of looking at getting more for less).  In fact, this type of technology innovation is critical for us to get back on track.  We need to continue to press ahead with Internet businesses that have real revenue (no government support required).  We also need to develop a wide range of green energy businesses that lead to products we can build here and export.  This does require some government help in the short-term as the capital markets aren't ready to fund this fast enough, and some basic research for longer-term gains is best funded by the government.

I share Joe's concern about the size of our systemic government debt.  The short-term stimulus part of the debt doesn't worry me.  But, the debts for the coming 5-10 years are terrifying.  We need to find things that the government does not do and drop them, and we need to be realistic about taxing ourselves to pay for what we need.  We can't grow out of a large deficit.  And, inflation won't solve our systemic deficit.  It devalues our old debt, but drives up the interest costs of carrying our new debt.

Economies seem stable with very modest inflation.  When we can keep that under control, we can focus on building new industries that expand and restructure markets, leading to goods we can build and export.  And, technology advancement, including Internet applications, is the key to that.

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