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The Laws of Disruption (Part I)

“The Law of Disruption,” writes Larry Downes in his new book, “is a simple but unavoidable principle of modern life: technology changes exponentially, but social, economic, and legal systems change incrementally.” (see “The Laws of Disruption: Harnessing the New Forces that Govern Life and Business in the Digital Age”)

Mr. Downes has written a book that is both a history of the information economy and a sweeping call to arms to implement legal reforms to better reflect modern realities. In the coming HS Dent Forecast, we’re going to take a look at some of Mr. Downes’s suggestions, including his proposed overhauls of the copyright and patent systems, which— in Mr. Downes’s opinion — were created for a different age and a very different kind of economy. But today, we’re going to take a look at the three principles—Moore’s Law, Metcalfe’s Law, and the Law of Disruption— that Mr. Downes uses to create a “grand unifying theory” of sorts for the digital economy.

Most readers by now have probably heard of Moore’s Law. In 1965, Gordon Moore, the founder of Intel, predicted that every twelve to eighteen months, the processing power of computers would double while prices held constant. His theory, which was made at a time when computers were the stuff of Star Trek and other science fiction, was remarkably prescient. This massive increase in computational power at ever-lower prices made the internet revolution affordable and thus possible.

Downes identifies a handful of significant implications of Moore’s Law:

1. Deflation. “Basic commodities like oil, electricity, or cotton tend to become more expensive over time, with cost increases working their way through the rest of the system. Computer prices, on the other hand, have stayed the same, or gone down. Miniaturization leads to computers in more and more products, increasing economies of scale and pushing costs down even faster.” (HS Dent Note: This is “good deflation,” or “supply-based” deflation that increases our standard of living. This is not to be confused with “bad deflation,” or demand caused by sagging demand.)

2. Abundant resources. “Oil, natural gas, coal, and many of the sources of electricity are nonrenewable—as they are used, they are also used up, raising prices and limiting further increases in productivity. But the major ingredient of semiconductors is silicon, the second-most abundant element on earth.”

3. Zero marginal cost. “For most manufactured goods, such as automobiles, price is based on the sum of the cost of developing the goods (research and development as well as marketing), the marginal cost of producing each item (including materials, distribution, and customer service), and a profit margin. Software—the programming that tells computers what to do—can be marketed, manufactured, and distributed electronically, giving it a marginal cost that is close to zero.”

We agree completely. We have written before that demographers who see long-term, systemic inflation as a risk due to forecasted labor shortages brought about by the retirement of the Baby Boomers are misguided. (This includes several financial commentators we have a lot of respect for, such as Professor Jeremy Siegel). Computational power, if anything, will make a lot of labor redundant.

We’ve used the example of American Airline’s automated phone system before. When you call American Airlines to get flight and gate information, you can have an entire “conversation” with a pleasant and polite middle-aged woman. Or, rather, a conversation with a computer that simulates the voice of a pleasant and polite middle-aged woman. A piece of software has massively reduced American Airlines’ need for human labor. And innovations like this are only the beginning.

Moore’s Law will keep deflationary pressures on our economy for a long time to come. And it will ease any threat of labor shortages in most sectors of the economy.

We’ll pick up this discussion tomorrow with Metcalfe’s Law. Until then…

Charles Sizemore, CFA

Co-author of the recently-published Boom or Bust: Understanding and Profiting from a Changing Consumer Economy