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Freeman Essay #8: “Salvation Through the Internet?”

In the November 1996 issue of the Freeman I warned against utopian predictions about the then-just-emerging Internet, explaining that the price system, in many ways, is a far more reliable method of global communication.  My short essay is below the fold.

Ours is a wonderful age. Strangers voluntarily communicate around the clock on a worldwide network. News of an event, an idea, or an opportunity in any part of the world is conveyed rapidly hither and yon. Production and consumption opportunities that would otherwise remain unexploited lie within the grasp of almost anyone on earth. Global competition and cooperation intensify and wealth increases. Marvelously, the cost of using this communication system is near zero.

This communications network is centuries old. It is the price system. If not as novel as the electronic Internet, free-market pricing is far more agile, accurate, and effective at sending crucial messages to all who want them.

The Japanese want more houses? No problem. Japanese homebuilders order more lumber. Lumber inventories in Japan fall, pushing lumber prices in Japan higher. Japanese boat builders are persuaded to use less wood and more fiberglass or aluminum. The price system is the network over which some Japanese inform other Japanese that the value of using lumber to build homes has risen.

The price system also speeds messages beyond national borders. Japanese importers respond to higher lumber prices by ordering more lumber from America. Americans export more lumber to Japan. The world price of lumber rises, telling lumber firms everywhere to increase production—and telling consumers everywhere to economize on lumber use.

Without the swift and sure communication of economic information supplied by the price system, every industrial economy would collapse. But while the price system labors in relative obscurity—so effectively does it do its job—the Internet has inspired bounteous and often utopian speculations about how this high-tech marvel will transform democracy and worldwide cooperation. The Economist recently opined that representative democracy will be substantially improved (if not fully replaced) by direct collective decision-making made possible by the Internet.

The Advantages of the Market

Despite such effusive praise, the Internet is bumbling in comparison with the market. However spectacular its mode, verbal communication can never govern people and allocate resources as effectively as does the price system. (Intellectuals dispute this claim because they are word merchants. Intellectuals have incentives to magnify the importance of anything that promises to increase their own influence.) The market enjoys two significant advantages over the Internet.

First, messages sent over the Internet must be interpreted. Recipients must understand the context of the sender’s remarks, as well as any special meanings that the sender attaches to particular words or phrases. Though often effective, attempts at verbal communication among large numbers of people can too easily misfire. As evidence, notice how easily designers of opinion polls elicit diametrically different responses with only small changes in the wording of questions.

Price signals, in contrast, are more easily interpreted than words. Japanese boat builders see the price of lumber rise 10 percent relative to the price of fiberglass. The meaning of this price rise is clear: it pays to use less lumber and more fiberglass.

Second, market signals are much more trustworthy than opinions sent over the Internet. The market punishes lying as well as uninformed expressions of opinion. If share prices of lumber companies rise, you can bet that someone is genuinely optimistic about the lumber industry’s future. For me to issue an opinion through the price system about this industry’s prospects requires that I spend my own money either buying or selling shares in corporations whose business is lumber. If I lie or am rash in formulating my opinion, I will likely lose money. People risking their own wealth in the market can be trusted to make the most informed decisions, thereby sending out accurate market messages to others.

Not so on the Internet. Imagine if lumber production were decided by a nationwide town meeting over the Internet. Not only would no single message or vote delivered in this debate likely be decisive, but few participants would have a direct and personal stake in the outcome. Thus, few participants would bear personal costs from expressing one opinion rather than another. Environmentalists would exaggerate the ill effects of lumbering, lumberjacks would exaggerate the ill effects of conservation, and masses of other people with nothing at stake and knowing precious little about this issue would solemnly come down on one side or the other. With the personal consequences of expressing opinions virtually nonexistent, plenty of uninformed opinions and votes would flood the Internet.

As a forum for conversation, the Internet is dazzling. As a forum for making collective decisions, it is a formula for disaster. Happily, free markets remain available to elicit informed opinions from nearly everyone worldwide, distilling this information into easily understood prices for the entire world to read.