In defense of the dot-com bubble, ten years on

It has been ten years since the dot-com bubble burst. On March 10, 2000 the tech-dominated Nasdaq index peaked at 5048.62. Today it closed at less than half that level, at 2358.95.

Many now see the end of the tech boom as the beginning of the most recent financial crisis. On the Opinion page of the Wall Street Journal today, author and former hedge fund manager Andy Kessler blames government policy for the misallocation of capital from the dot-com days  until now: from the telecom reforms of the late 1990s, to the Alan Greenspan Federal Reserve's low interest rate policy after the tech bubble popped, to Fannie and Freddie's housing loans, to TARP and Ben Bernanke Federal Reserve's quantitative easing.

I agree with Kessler and others that there is a continuity over the past decade, but it mainly has its roots in the market economy, rather than government policy. The general stagnation of the profitability of industry from the late 1990s meant that capital was not reinvested but instead took the form of a surplus in search of alternative investments. Compared to traditional industry, high-tech looked very promising. As we know, that was not sustained, and the tech boom became a bust. Surplus money then sought other avenues, leading to financial flows towards real estate, private equity and the general expansion of credit (which took different forms). The government-related factors Kessler cites were not insignificant, but paled in comparison with this underlying tidal wave.

Looking back, there is a common tendency to see the dot-com era as silly (pets.com and wasting millions on 90 second Super Bowl commercials). It's also seen as a period of hubris - who were these people, thinking they could just invent something and become rich? We know better today, we would never do something so brash and dumb.

It's here that I would stick up for the dot-com era, despite its flaws. While both the tech bubble and the financial bubble shared common roots in terms of surplus capital looking for a home, I see a distinction between two bubbles, in that at least the tech bubble involved investments in productive industries, unlike the financial "innovation" of the noughties. I agree with Kessler when he says that the dot-com started to deliver "a productive, wealth-producing economy". Far too much was invested in long-haul fibre optic systems, which led to bankruptcies, but as the Financial Times points out, "the wave of cash at least created the global communications backbone for the current generation of more successful internet services". While some tech companies eventually emerged as strong ones, as Jason Zweig notes elsewhere in the Journal, "by far the biggest beneficiaries of the internet boom were the companies that adopted the new technology rather than those that provided it".   

Ten years after the tech collapse, investment in new startups remains weak. According to the National Venture Capital Association (as cited in the FT), investment by VCs has declined from $100bn in 2000 to $18bn in 2009. VC-backed IPOs numbered 264 in 2000, but there were only 12 last year. Once again, I agree with Kessler when he concludes:

It's been ten long years since the economy has created real wealth, as opposed to easy-credit induced real estate or paper wealth.... Maybe it's time that the market transitions back to investments that drive productivity and increase living standards rather than just paper profits.

The economic talk today is all about stimulus spending, financial reform and deficits, but it would be far more worthwhile if we focused on the question of how to create a dynamic and innovative economy.