How The Tech Boom Terminated California’s Economy

By Douglas Rushkoff. Published in Fast Company on 10 July 2009

However comforting it might be to blame Southern California’s movie industry for unleashing Governor Terminator on the state’s economy, the real seeds of the current crisis were sewn further north, in the seemingly prosperous corporate parks of Silicon Valley. In fact, the boom and subsequent, inevitable bust are the real causes of our economic malaise. For while Californians were hit first, hardest and most directly by the rise of capitalism, the rest of us are soon to follow.

Put simply, California cannot afford to pay its bills because its tax base contracted at the same time as its investments tanked. Like any of us contending with the double-whammy of lower pay and shrinking portfolios, the state is getting slammed on both income and savings at the same time. Unable to secure credit, the state will instead be forced pay its bills to citizens and local governments with IOUs.

While the pundits point to real estate speculation and bank insolvencies as the chief cause of California–and the nation’s–financial distress, these are both direct results of the late 90’s explosion of computer innovation and Internet proliferation. That’s right: The Internet crashed the economy.

First, and most obviously, the Internet served as a shiny new calling card for an already-exhausted equities market. The biotech boom of the 80’s had failed to spawn a successor, recession appeared interminable, and the emergence of the Internet provided a new “story” through which speculators could be encouraged to buy stock.

The boom was among the largest collective investments in American history, leading to a near doubling of stockholders–and quadrupling of the NASDAQ index. Where did all this money come from? It was printed by the Fed and then loaned by banks, who used the good times to justify more highly leveraged rates of borrowing, themselves.

Problem was, the industry–while certainly fun and wonderful–could not support this level of investment. There just wasn’t so very much more profit in doing things with chips and wires that used to be done with paper and people. Thus, the crash.

In an effort to orchestrate a soft landing, Alan Greenspan looked for someplace all the money printed for the boom to go. Real estate was the obvious choice. Banks were enabled to stay in the leveraged lending business, and homes became the asset class to fill in for and Lucent.

The real estate crash is really just the second leg of the crash–the failure of housing to absorb the tremendous cash surplus generated by the irrational exuberance of Internet investors.

And it actually goes deeper than this. The Internet is even more directly at fault. The fact is, most Internet businesses don’t require venture capital. The beauty of these technologies is that they decentralize value creation. Anyone with a PC and bandwidth can program the next Twitter or Facebook plug-in, the next iPhone app, or even the next social network. While a few thousand dollars might be nice, the hundreds of millions that venture capitalists want to–need to–invest, simply aren’t required. Entrepreneurs who do accept such exorbitant funds do so knowing full well that they won’t get paid back. The VCs investment is the entrepreneur’s exit strategy.

The banking crisis began with the industry, because here was a business sector that did not require massive investments of capital in order to grow. (I spent an entire night on the phone with one young entrepreneur who secured $20 million of capital from a venture firm, trying to figure out how to possibly spend it. We could only come up with $2 million of possible expenditures.) What’s a bank to do when its money is no longer needed? Especially when contraction is not an option?

So they fail, the tax base decreases, companies based more on their debt structures than their production fail along with them, and we get an economic crisis. Yes, the Internet did all this.

But that’s also why the current crisis should be seen as a cause for celebration as well: the Internet actually did what it was supposed to by decentralizing our ability to create and exchange value.

This was the real dream, after all. Not simply to pass messages back and forth, but to dis-intermediate our exchanges. To cut out the middleman, and let people engage and transact directly.

This is, quite simply, cheaper to do. There’s less money in it. Not necessarily less money for us, the people doing the exchanging, but less money for the institutions that have traditionally extracted value from our activity. If I can create an application or even a Web site like this one without borrowing a ton of cash from the bank, then I am also undermining America’s biggest industry–finance.

While we rightly mourn the collapse of a state’s economy, as well as the many that are to follow, we must–at the very least–acknowledge the real culprit. For digital technology not only killed the speculative economy, but stands ready to build us a real one.