Most everyone will agree that the world’s economy is undergoing historical structural changes, mostly caused by the digital technology revolution taking place all around us. In particular, ever since the explosive growth of the Internet in the mid 1990s, we are seeing the emergence of a global, digital economy. What does this mean? How can we best describe the nature of this emerging digital economy? What are some of its key implications for the overall economy?
There is clearly no simple answer to these questions. But, I recently read one of the clearest and most elegant explanations of the changes our economy is going through in an article in McKinsey Quarterly by economist W. Brian Arthur, - The Second Economy. Dr. Arthur is external professor at the Santa Fe Institute and visiting researcher at PARC’s Intelligent Systems Lab.
“Digitization is creating a second economy that’s vast, automatic, and invisible - thereby bringing the biggest change since the Industrial Revolution,” he writes at the very beginning of the article. He illustrates his point with an analogy to the transformation of the US economy by the railroads in the second half of the 19th century.”
The railroads enabled the transportation of physical goods of all sorts across the country. When we say the railroads, we don’t just mean the actual rails and trains that ran on them without which nothing could move, but also the whole ecosystem of commerce that was built around them. This made it possible for goods manufactured, mined or grown in one part of the country to be ordered from and shipped to wherever they were needed in a relatively short amount of time. It made it much easier for companies all over the country to start doing business with each other, bringing goods from far flung places to their local customers.
It is this wider definition of the railroads as a platform for commerce that made possible the transformation of the US into one of the world’s leading industrial powers at the dawn of the 20th century. The railroads and subsequent means of transportation, - e.g., trucks, cargo airplanes, oil tankers, container ships, - along with the increasingly sophisticated supply chain management that grew up around them, gave rise to our massive global, physical economy.
Dr. Arthur believes that another such major transformation is now underway.
“[All] across economies in the developed world, processes in the physical economy are being entered into the digital economy, where they are “speaking to” other processes in the digital economy, in a constant conversation among multiple servers and multiple semi-intelligent nodes that are updating things, querying things, checking things off, readjusting things, and eventually connecting back with processes and humans in the physical economy.”
“So we can say that another economy - a second economy - of all of these digitized business processes conversing, executing, and triggering further actions is silently forming alongside the physical economy.”
What is the purpose of this fast growing digital economy? What is its relation to the primary, physical economy, alongside which it is emerging? These are important but subtle questions, because as Arthur observes “. . .this second, digital economy isn’t producing anything tangible. It’s not making my bed in a hotel, or bringing me orange juice in the morning. But it is running an awful lot of the economy.” This second, digital economy is essentially acting as the neural system for the overall economy.
The biological metaphor is quite apt. A major portion of every complex biological organism, including us humans, is the autonomic nervous system. Its job is to keep us alive and evolving into the future, without having to think about it and take overt actions. It controls involuntary functions we are not consciously aware of, but without which we could not live, including heart rate, digestion, breathing, salivation, perspiration and many others. Our conscious, voluntary activities, - e.g., running, dancing, cooking, driving, reading, writing, playing chess, - are made possible by this highly sophisticated, involuntary autonomic nervous system.
The need for sophisticated control functions to help manage complex systems applies not just to complex biological systems, but to man-made ones as well. For example, about ten years ago it was becoming clear that as information technologies were getting increasingly powerful, inexpensive and ubiquitous, one of our biggest challenges was the growing complexity of the IT infrastructures we were developing and the rising costs of managing this complexity.
The only feasible answer was to develop self-managing systems, - including self-configuring, self-healing, self-optimizing and self-protecting, - based on policies and rules specified by the human operators. We launched a new initiative in IBM aimed at building such self-managing systems, and called it Autonomic Computing, because of the analogy with the autonomic nervous system in biological organisms.
Other examples are found in our social organizations. As human organizations get larger and more complex, their growing complexity is typically accompanied by an increase in administrative functions and management structures, as well as processes, rules and regulations. This is true whether we are talking about a business, a government institution, a city or an overall economy. These additional management and administrative overheads can add significants costs to the organizations, slow down decision making, and render them bureaucratic and inflexible.
It is in this context that we can best understand the value of digital economies. For the past couple of decades, companies have been embracing IT systems to significantly increase their productivity by reducing, eliminating or automating many of their processes, rules and regulations. They are leveraging IT to streamline their management structures and administrative functions and thus become more responsive and competitive.
This is clearly happening within companies, connecting all their various processes, information and people. But it is also happening across supply chains and business partners spread all over the world, giving rise to industry ecosystems. The increasing integration within and across of all these various companies, supply chains and industry ecosystems is what is giving rise to Dr. Arthur’s second economy. This second economy is essentially serving as the autonomic, neural system for the overall economy.
“Just what sort of change is this qualitatively,?” he asks. Let me conclude with the answers to this question in his own words.
“Think of it this way. With the coming of the Industrial Revolution - roughly from the 1760s, when Watt’s steam engine appeared, through around 1850 and beyond - the economy developed a muscular system in the form of machine power. Now it is developing a neural system. This may sound grandiose, but actually I think the metaphor is valid. Around 1990, computers started seriously to talk to each other, and all these connections started to happen. The individual machines - servers - are like neurons, and the axons and synapses are the communication pathways and linkages that enable them to be in conversation with each other and to take appropriate action.”
“Is this the biggest change since the Industrial Revolution? Well, without sticking my neck out too much, I believe so. In fact, I think it may well be the biggest change ever in the economy. It is a deep qualitative change that is bringing intelligent, automatic response to the economy. There’s no upper limit to this, no place where it has to end. . .”
“I think that for the rest of this century, barring wars and pestilence, a lot of the story will be the building out of this second economy, an unseen underground economy that basically is giving us intelligent reactions to what we do above the ground. . . 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.”