A primer on internet economics: macro and micro impact of the internet on the economy

Business Economics, Oct, 1999 by Albert E. DePrince, Jr., William F. Ford

Tracking the Internet Companies

As the Internet economy is evolving, the financial community is attempting to reorganize its efforts to provide better insights on its prospects to the investing community. Goldman Sachs, for example, has developed a proprietary Internet technology index (CSTI) that tracks Internet firms. The Internet firms in the Goldman index cover hardware, software, semiconductors, multimedia networking. Internet access providers and service providers. The recently inaugurated Dow Jones Internet Index (http://indexes.dowjones.com/djii/djiinews.html), which went on line in February 1999, also focuses directly on Internet companies. Its objective is to represent 80 percent of the "Internet equity universe." It is divided into two segments: (1) commerce, i.e., those who derive 50 percent of their revenue through sales over open networks such as the Internet; and (2) services, i.e., companies that derive 50 percent of their revenue from providing Internet access or enabling services to Internet users.

In addition to tracking broad groups through Internet market indexes, the market's valuation of such Internet firms is clearly staggering. For example, as of April 14, 1999, Goldman Sachs reported that the market capitalization of the Internet exposure of the eighty firms that are in various broad market indexes was $412 billion. America Online alone, for example, was then valued at $155 billion. While one may debate the rationality of such valuation levels, the capital markets have sent a clear message: Internet commerce is here to stay, and the surviving firms will be high earners. If current prices were reflective of future earnings, for example, the market capitalization of just eighty firms would be consistent with future earnings of $16.5 billion per year, based on a modest price-earnings ratio of 25.

The Macroeconomics of the Internet Economy

During the past eight years, the U.S. economy has compiled a remarkable record of noninflationary growth, coupled with rising productivity and record low levels of unemployment. As a result of this phenomenal performance. business economists have steadily revised their estimates of the economy's growth potential upward and its presumed NAIRU downward. When pressed for ex post explanations of these persistently better-than-forecasted results, the profession has turned increasingly toward identifying accelerating technological progress as one of the main driving forces. In this section of the paper, we discuss some roles the Internet is apparently playing in promoting the economy's improved macroeconomic performance.

The Information Revolution's Impact on U.S. Manufacturing Industries

The information revolution has impacted the U.S. economy in a number of ways. The changes stemming from the Internet are only the latest contribution to this wave. Federal Reserve Chairman Alan Greenspan (Greenspan, 1999a, 1999b) has often commented on the general power of the information revolution and the particular contribution that the Internet will likely make to our economy's overall growth.