Cosby’s Gas Station Attendant
"Arguing in my spare time," No. 2.04
Arnold KlingApril 18, 1999
May not be redistributed commercially without the author's permission.
In 1965, when records were still vinyl, I obtained a copy of "200 MPH," a Bill Cosby disc. Cosby’s theme was his love of sports cars combined with his mechanical ignorance.
"I don’t even know how to find the gas tank," Cosby riffed at one point. He described driving into a service station and finding a service station attendant (in 1965, attendants still pumped gas) who also did not know where to find the gas tank. Finally, Cosby recounts the attendant as saying, "Why don’t I just pour gas all over the car, and maybe it will seep in somewhere?"
The philosophical attitude that many sages take toward Internet mania reminds me of Cosby’s gas station attendant. I have read that Alan Greenspan, among others, has said that even though individual Internet stocks appear to be over-priced, the high rate of investment in the sector as a whole is good for the economy. If we pour enough capital into the Internet, perhaps some of it will seep in somewhere.
One way to gain insight into the current economy is to go to www.ipocentral.com and browse through the list of companies that have filed to go public. The typical Internet company shows about $1 million in revenue in the year prior to filing, with about $20 million in losses. There are exceptions, of course. One company, musicmaker.com, filed to go public with gross sales revenues the previous year of seventy-five thousand dollars.
As some readers are aware, I started and still operate one of the first commercial Web sites. We have since had many competitors, including one whose business model seems hopelessly flawed and which in fact is losing millions of dollars a year. Ordinarily, one would expect such a company to exit the industry. Instead, it is going public.
Because the public offerings that have taken place have been successful, often wildly so, venture capitalists must feel like kids at a carnival where the games are rigged to make everybody a winner. If you fund 20 companies at $20 million apiece, and just one of them makes it to the IPO stage, you probably come out ahead.
I do not know how many companies were funded last year that had operating losses of $20 million, but I would guess that it was around 5000. That would mean $100 billion in the aggregate, and that is enough to be real money. Total business fixed investment was less than $1 trillion last year, so it could be that Internet start-ups now account for over 10 percent of investment spending.
Even after they go public, Internet companies often continue to consume financial capital, either by losing money or by making acquisitions. This, too, accounts for some of the investment spending in today’s economy.
If (when?) the tolerance by shareholders for anemic profits disappears, there will be real economic impacts. Companies may lose the ability to go public before generating any profits. This in turn will dampen the spirits of the venture capitalists. The direct investment spending by Internet start-ups and by publicly-traded Internet companies will collapse.
Economists tend to under-estimate the "real" effects of a decline in asset prices. The underlying assets remain, it is argued, so what if their prices change? Most economists’ speculation about the consequences of a collapse of the Internet bubble centers on the "wealth effect." To the extent that consumers see a reduction in stock prices as a decline in wealth, they may reduce spending.
A Keynesian view would go beyond the wealth effect. Investment decisions are not always rational (Keynes coined the term "animal spirits" in this context). As Skidelsky puts it,
"Here the two main characters are the Entrepreneur and the Hoarder. . .The Entrepreneur swings from the heights of optimism to the depths of gloom; the Hoarder accumulates money to satisfy his feelings of panic - or to make a quick killing on the Stock Exchange. In fact, the Entrepreneur can turn into the Hoarder or Speculator if his anxiety or greed becomes sufficiently great. At any particular time it is the battle between the 'inducement to invest' and the 'propensity to hoard' -- a battle often raging in the mind of the same person -- which exercises a dominating influence over the level of economic activity." (The Economist as Saviour, p. 541).
In this drama, a high level of aggregate demand and economic activity is maintained when entrepreneurs are able to fund their optimistic visions. If instead the hoarders prefer safety and liquidity, then the economy will be strangled by an excess of desired saving. This is what would happen in today’s economy if we lose confidence in Internet ventures.
If Keynes were alive today, he might approve of the Internet boom. He might not share the view that pouring a lot of capital into the Internet will cause some of it to seep in to productive purposes. However, for Keynes, the challenge of keeping people fully employed looms so large that he was willing to see workers paid to dig ditches and fill them in again.
Because the collapse of the Internet bubble is likely to bring on a recession of painful severity, perhaps comparable to the experience in Japan the past several years, one might be tempted to recommend that policymakers try to pop the bubble sooner rather than later. But for Keynes, breaking the hearts of the entrepeneurs serves no useful purpose. He probably would recommend that we enjoy it while it lasts.