The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologies (20 page)

Most of all, the payoff will depend on which inputs to production are scarcest. If digital technologies create cheap substitutes for labor, then it’s not a good time to be a laborer. But if digital technologies also can increasingly substitute for capital, then capital owners shouldn’t expect to earn high returns either. What will be the scarcest, and hence the most valuable, resource in the second machine age? This question brings us to our next set of winners and losers: superstars versus everyone else.

*
This echoes the productivity effects of electricity discussed earlier. As with digital technologies, the biggest gains did not occur until factories were redesigned, and even workers who didn’t work directly with the new machines were significantly affected.

*
The effect on the economy overall would depend on how other companies reacted. Output would likely increase at companies that design and build robots and, depending on how capital-intensive they are, the net ratio of capital to labor in the overall economy could increase, decrease, or stay the same. We’ll discuss these effects in more detail in chapter 12.

“One machine can do the work of fifty ordinary men. No machine can do the work of one extraordinary man.”

—Elbert Hubbard

W
E
’
VE
SEEN
THAT
SKILL
-
BIASED
technical change has increased the relative demand for highly educated workers while reducing demand for less educated workers whose jobs frequently involve routine cognitive and manual tasks. In addition, capital-biased technological changes that encourage substitution of physical capital for labor have increased the profits earned by capital owners and reduced the share of income going to labor. In each case, historic amounts of wealth have been created. In each case, we also have seen increases in the earnings of the winners relative to the losers. But the biggest changes of all are driven by a third gap between winners and losers: the gap between the superstars in a field and everyone else.

Mind the Gap

Call it talent-biased technical change.
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In many industries, the difference in payout between number one and second-best has widened into a canyon. As a controversial Nike ad noted, you don’t win silver, you lose gold.
¹
When ‘winner-take-all’ markets become more important, income inequality will rise because pay at the very top pulls away from pay in the middle.
²

The growing gaps in wages between people with and without college education, and between capital owners and workers, have been dwarfed by even bigger changes at the very top. As noted earlier, between 2002 and 2007, the top 1 percent got two-thirds of all the profits from the growth in the U.S. economy. But who are the 1 percent? They aren’t all on Wall Street. University of Chicago economist Steve Kaplan found that most of them are in other industries: in media and entertainment, sports, and law—or they are entrepreneurs and senior executives.

If the top 1 percent are stars of a sort, they can look up to superstars who have seen even bigger increases. While the top 1 percent earned about 19 percent of all income in the United States, the top 1 percent of the 1 percent (or the top 0.01 percent)—saw their share of national income double from 3 percent to 6 percent between 1995 and 2007. This is nearly six times as much as the 0.01 percent earned between World War II and the late 1970s. In other words, the top 0.01 percent now get a bigger share of the top 1 percent of income than the top 1 percent get of the whole economy. Because it is hard to maintain anonymity when reporting data for small numbers of people, it is hard to get reliable data at income levels higher than the top 0.01 percent. After all, while there are over 1.35 million households in the top 1 percent with an average income of $1.12 million, the 0.01 percent represents just 14,588 families each with incomes over $11,477,000.
*
³
But the evidence suggests that the spread of incomes continues at high levels of income with a fractal-like quality, with each subset of superstars watching an even smaller group of super-duper-stars pulling away.
†

How Superstars Thrive in the Winner-Take-All Economy

In the previous chapter, we saw Intuit’s TurboTax automate the job of tax preparation, allowing a machine to do the jobs of hundreds of thousands of human tax preparers. That’s an example of technology automating routine information-processing jobs, and also an example of capital substituting for labor. But most importantly, it’s an example of the superstar economy in action. Intuit’s CEO made $4 million last year and Scott Cook, the founder, is a billionaire.
⁴
Likewise, the fifteen people who created Instagram didn’t need a lot of unskilled human helpers and did leverage some valuable physical capital. But most of all, they benefitted from their talent, timing, and ties to the right people.

Top performers in other industries have also seen their fortunes rise. J. K. Rowling, author of the
Harry Potter
series, is the world’s first billionaire author in an industry not known for minting the super wealthy. As George Mason University’s Alex Tabarrok notes of Rowling’s success:

Homer, Shakespeare and Tolkien all earned much less. Why? Consider Homer, he told great stories but he could earn no more in a night than say 50 people might pay for an evening’s entertainment. Shakespeare did a little better. The Globe theater could hold 3000 and unlike Homer, Shakespeare didn’t have to be at the theater to earn. Shakespeare’s words were leveraged.
⁵

J. R. R. Tolkien’s words were leveraged further. By selling books, Tolkien could sell to hundreds of thousands, even millions of buyers in a year—more than have ever seen a Shakespeare play in four hundred years. And books were cheaper to produce than actors, which meant that Tolkien could earn a greater share of the revenues than did Shakespeare.

Technology has supercharged the ability of authors like Rowling to leverage their talents via digitization and globalization. Rowling’s stories can be captured in movies and video games as well as text, but each of those formats, including the original books, can be transmitted globally at trivial cost. She and other superstar storytellers now reach billions of customers through a variety of channels and formats.

More often than not, when improvements in digital technologies make it more and more attractive to digitize something, superstars in various markets see a boost in their incomes while second-bests have a harder time competing. The top performers in music, sports, and other areas have also seen their reach and incomes grow since the 1980s.
⁶

At the same time, others working in the content and entertainment industries have not seen a big increase. Only 4 percent of software developers in the burgeoning app economy have made over a million dollars.
⁷
Three-quarters of them made less than thirty thousand dollars. While a handful of writers, actors, or baseball players can become millionaires, many others struggle to make ends meet. A gold-medal winner at the Olympics can earn millions of dollars in endorsements, while the silver medal winner—let alone the person who placed tenth or thirtieth—is quickly forgotten, even if the difference is measured in tenths of a second and could have resulted from a gust of wind or a lucky bounce of the ball.

Even top executives have started earning rock-star compensation. The ratio of CEO pay to average worker pay increased from seventy in 1990 to three hundred in 2005. Much of this growth is linked to the greater use of information technology, according to research that Erik completed with his student Heekyung Kim.
⁸
One rationale for this increase in executive pay is that technology increases the reach, scale, or monitoring capacity of a decision-maker. If executives use digital technologies to observe activities in factories throughout the world, to give specific instructions for changing a process, and to make sure instructions are carried out with high fidelity, then the value of those decision-makers increases. Direct management via digital technologies makes a good manager more valuable than in earlier times when managers had diffuse control via long chains of subordinates, or when they could only affect a smaller scale of activities.

Direct digital oversight also makes hiring the best candidate rather than the second-best that much more important. Companies are ready to pay a premium for executives whom they perceive to be the best, reasoning that even a small difference in quality can have huge consequences for shareholders. The bigger the market value of a company, the more compelling the argument for trying to get the very best executive.
⁹
A single decision that increases value by a modest 1 percent is worth $100 million to a ten-billion-dollar company.

In a competitive market, even a small difference in the perceived talents of CEO candidates can lead to fairly large differences in their compensation. As economists Robert Frank and Philip Cook note in their book,
The Winner-Take-All Society
, “When a sergeant makes a mistake only the platoon suffers, but when a general makes a mistake the whole army suffers.”
¹⁰

When Relative Advantage Leads to Absolute Domination

The economics of superstars was first formally analyzed in 1981 by economist Sherwin Rosen.
¹¹
In many markets, buyers with a choice among products or services will prefer the one with the best quality. When there are capacity constraints or significant transportation costs, then the best seller will only be able to satisfy a small fraction of the global market (for instance, in the 1800s, even the best singers and actors might perform for at most a few thousand people each year). Other inferior sellers will also have a market for their products. But what if a technology arises that lets each seller cheaply replicate his or her services and deliver them globally at little or no cost? Suddenly the top-quality provider can capture the whole market. The next-best provider might be almost as good, but it will not matter. Each time a market becomes more digital, these winner-take-all economics become a little more compelling.

Winner-take-all markets were just coming to the fore in the 1990s, when Frank and Cook wrote their remarkably prescient book. They compared these winner-take-all markets, where the compensation was mainly determined by
relative
performance, to traditional markets, where revenues more closely tracked
absolute
performance. To understand the distinction, suppose the best, hardest-working construction worker could lay one thousand bricks in a day while the tenth-best laid nine hundred bricks per day. In a well-functioning market, pay would reflect this difference proportionately, whether it could be attributed to more efficiency and skill, or simply to more hours of work. In a traditional market, someone who is 90 percent as skilled or works 90 percent as hard creates 90 percent as much value and thus can earn 90 percent as much money. That’s absolute performance.

By contrast, a software programmer who writes a slightly better mapping application—one that loads a little faster, has slightly more complete data, or prettier icons—might completely dominate a market. There would likely be little, if any, demand for the tenth-best mapping application, even it got the job done almost as well. This is relative performance. People will not spend time or effort on the tenth-best product when they have access to the best. And this is not a case where quantity can make up for quality: ten mediocre mapping tools are no substitute for one good one. When consumers care mostly about relative performance, even a small difference in skill or effort or luck can lead to a thousand-fold or million-fold difference in earnings. There were a lot of traffic apps in the marketplace in 2013, but Google only judged one, Waze, worth buying for over one billion dollars.
¹²

Why Winner-Take-All Is Winning

Why are winner-take-all markets more common now? Shifts in the technology for production and distribution, particularly these three changes:

a)
the digitization of more and more information, goods, and services,

b)
the vast improvements in telecommunications and, to a lesser extent, transportation, and

c)
the increased importance of networks and standards.

Albert Einstein once said that black holes are where God divided by zero, and that created some strange physics. While the marginal costs of digital goods do not quite approach zero, they are close enough to create some pretty strange economics. As discussed in chapter 3, digital goods have much lower marginal costs of production than physical goods. Bits are cheaper than atoms, not to mention human labor.

Digitization creates winner-take-all markets because, as noted above, with digital goods capacity constraints become increasingly irrelevant. A single producer with a website can, in principle, fill the demand from millions or even billions of customers. Jenna Marbles’s homemade YouTube video “How to trick people into thinking you’re good looking,” to take one wildly successful example, garnered 5.3 million views the week she posted it in July 2010.
¹³
She’s now earned millions of dollars from over one billion viewings of her videos around the world. Every digital app developer, no matter how humble its offices or how small its staff, almost automatically becomes a micro-multinational, reaching global audiences with a speed that would have been inconceivable in the first machine age.