The first is that we’re living in a time of astonishing progress with digital technologies—those that have computer hardware, software, and networks at their core. These technologies are not brand-new; businesses have been buying computers for more than half a century, and Time magazine declared the personal computer its “Machine of the Year” in 1982. But just as it took generations to improve the steam engine to the point that it could power the Industrial Revolution, it’s also taken time to refine our digital engines.

 

So this is a book about the second machine age unfolding right now—an inflection point in the history of our economies and societies because of digitization. It’s an inflection point in the right direction—bounty instead of scarcity, freedom instead of constraint—but one that will bring with it some difficult challenges and choices.

 

This situation has come to be known as Moravec’s paradox, nicely summarized by Wikipedia as “the discovery by artificial intelligence and robotics researchers that, contrary to traditional assumptions, high-level reasoning requires very little computation, but low-level sensorimotor skills require enormous computational resources.”

 

This situation has come to be known as Moravec’s paradox, nicely summarized by Wikipedia as “the discovery by artificial intelligence and robotics researchers that, contrary to traditional assumptions, high-level reasoning requires very little computation, but low-level sensorimotor skills require enormous computational resources.”

 

Nine years later another computer hit 1.8 teraflops. But instead of simulating nuclear explosions, it was devoted to drawing them and other complex graphics in all their realistic, real-time, three-dimensional glory. It did this not for physicists, but for video game players. This computer was the Sony PlayStation 3, which matched the ASCI Red in performance, yet cost about five hundred dollars, took up less than a tenth of a square meter, and drew about two hundred watts.11 In less than ten years exponential digital progress brought teraflop calculating power from a single government lab to living rooms and college dorms all around the world. The PlayStation 3 sold approximately 64 million units. 

 

When we adopt the perspective of the new growth theorists and match it against what we see with Waze, Innocentive, Kaggle, Quirky, Affinnova, and many others, we become optimistic about the current and future of innovation.

 

The economist Julian Simon was one of the first to make this optimistic argument, and he advanced it repeatedly and forcefully throughout his career. He wrote, “It is your mind that matters economically, as much or more than your mouth or hands. In the long run, the most important economic effect of population size and growth is the contribution of additional people to our stock of useful knowledge. And this contribution is large enough in the long run to overcome all the costs of population growth.”

 

“Most economic fallacies derive from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.” —Milton Friedman

In addition to their vast library of music, children with smartphones today have access to more information in real time via the mobile web than the president of the United States had twenty years ago. Wikipedia alone claims to have over fifty times as much information as Encyclopaedia Britannica, the premier compilation of knowledge for most of the twentieth century.3 Like Wikipedia but unlike Britannica, much of the information and entertainment available today is free, as are over one million apps on smartphones.

 

Because they have zero price, these services are virtually invisible in the official statistics. They add value to the economy, but not dollars to GDP. And because our productivity data are, in turn, based on GDP metrics, the burgeoning availability of free goods does not move the productivity dial. There’s little doubt, however, that they have real value. When a girl clicks on a YouTube video instead of going to the movies, she’s saying that she gets more net value from YouTube than traditional cinema. When her brother downloads a free gaming app on his iPad instead of buying a new video game, he’s making a similar statement. 

 

Free: Good for Well-Being, Bad for GDP In some ways, the proliferation of free products even pushes GDP downward. If the cost of creating and delivering an encyclopedia to your desktop is a few pennies instead of thousands of dollars, then you’re certainly better off. But this decrease in costs lowers GDP even as our personal well-...

 

A simple switch to using a free texting service like Apple’s iChat instead of SMS, free classifieds like Craigslist instead of newspaper ads, or free calls like Skype instead of a traditional telephone service can make billions of dol...

 

Just as free goods rather than physical products are an increasingly important share of consumption, intangibles also make up a growing share of the economy’s capital assets.

 

User-generated content, for example, involves unmeasured labor creating an unmeasured asset that is consumed in unmeasured ways to create unmeasured consumer surplus.

 

The effects are astonishing: it has been estimated that more photos are now taken every two minutes than in all of the nineteenth century.4 We now record the people and events of our lives with unprecedented detail and frequency, and share them more widely and easily than ever before.

 

While digitization has obviously increased the quantity and convenience of photography, it has also profoundly changed the economics of photography production and distribution. A team of just fifteen people at Instagram created a simple app that over 130 million customers use to share some sixteen billion photos (and counting).5 Within fifteen months of its founding, the company was sold for over $1 billion to Facebook. In turn, Facebook itself reached one billion users in 2012. It had about 4,600 employees6 including barely 1,000 engineers.

 

Contrast these figures with pre-digital behemoth Kodak, which also helped customers share billions of photos. Kodak employed 145,300 people at one point, one-third of them in Rochester, New York, while indirectly employing thousands more via the extensive supply chain and retail distribution channels required by companies in the first machine age.

 

Contrast these figures with pre-digital behemoth Kodak, which also helped customers share billions of photos. Kodak employed 145,300 people at one point, one-third of them in Rochester, New York, while indirectly employing thousands more via the extensive supply chain and retail distribution channels required by companies in the first machine age.

 

Contrast these figures with pre-digital behemoth Kodak, which also helped customers share billions of photos. Kodak employed 145,300 people at one point, one-third of them in Rochester, New York, while indirectly employing thousands more via the extensive supply chain and retail distribution channels required by companies in the first machine age.

 

Photography has never been more popular. Today, seventy billion photos are uploaded to Facebook each year, and many times more are shared via other digital services like Flickr at nearly zero cost. These photos are all digital, so hundreds of thousands of people who used to work making photography chemicals and paper are no longer needed. In a digital age, they need to find some other way to support themselves.

 

But companies like Instagram and Facebook employ a tiny fraction of the people that were needed at Kodak. Nonetheless, Facebook has a market value several times greater than Kodak ever did and has created at least seven billionaires so far, each of whom has a net worth ten times greater than George Eastman did.

 

In fact, software and hardware have progressed so rapidly that by 2009, chess programs running on ordinary personal computers, and even mobile phones, have achieved grandmaster levels with Elo ratings of 2,898 and have won tournaments against the top human players.

 

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.

 

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. In contrast, the economics of personal services (nursing) or physical work (gardening) are very different, since each provider, no matter how skilled or hard-working, can only fulfill a tiny fraction of the overall market demand. When an activity transitions from the second category to the first the way tax preparation did, the economics shift toward winner-take-all outcomes.

 

What’s more, lowering prices, the traditional refuge for second-tier products, is of little benefit for anyone whose quality is not already at or near the world’s best. Digital goods have enormous economies of scale, giving the market leader a huge cost advantage and room to beat the price of any competitor while still making a good profit.14 On...

 

A similar dynamic comes into play when technologies like Google or even Amazon’s recommendation engine reduce search costs. Suddenly second-rate producers can no longer count on consumer ignorance or geographic barriers to protect their margins.

 

In a traditional camera store, cameras typically are not ranked number one versus number ten. But online retailers make it easy to list products in rank order by customer ratings, or to filter results to include only products with every conceivable desirable feature. Products with lower rankings or only nine out of ten desirable features receive disproportionately lower sales from even small differences in quality, convenience, or pricing performance.

 

Even as the technology destroys geography—a barrier that used to protect authors from worldwide competition—it opens up specialization as a source of differentiation.

 

Instead of being the thousandth-best children’s book author in the world, it may be more profitable to be the number-one author in Science-Based Advice for Ecological Entrepreneurs, or Football Clock Management.

 

In other words, we believe that employers now and for some time to come will, when looking for talent, follow the advice attributed to the Enlightenment sage Voltaire: “Judge a man by his questions, not his answers.”

 

As futurist Kevin Kelly put it “You’ll be paid in the future based on how well you work with robots.”

 

By May 2013, Khan Academy included more than 4,100 videos, most no more than a few minutes long, on subjects ranging from arithmetic to calculus to physics to art history. These videos had been viewed more than 250 million times, and the Academy’s students had tackled more than one billion automatically generated problems.

 

One of the most interesting experiments in this area came in 2011 when Sebastian Thrun, a top artificial intelligence researcher (and one of the main people behind Google’s driverless car), announced with a single email that he would be teaching his graduate-level AI course not only to students at Stanford but also as a MOOC available for free over the Internet. Over 160,000 students signed up for the course. Tens of thousands of them completed all exercises, exams, and other requirements, and some of them did quite well. The top performer in the course at Stanford, in fact, was only the 411th best among all the online students. As Thrun put it, “We just found over 400 people in the world who outperformed the top Stanford student.”

 

The tremendous experimentation now underway with massive online open courses, or MOOCs, is especially encouraging.

 

In many cases, we can expect to see schools ‘flip the classroom’ by having students listen to lectures at home and work through traditional ‘homework’—exercises, problem sets, and writing assignments—in school, where peers, teachers, and coaches are available to help them.

 

Foreign-born people make up less than 13 percent of the country’s population in recent years, but between 1995 and 2005 more than 25 percent of all new engineering and technology companies had at least one immigrant cofounder, according to research by Wadhwa, Saxenian, and their colleagues.32 These companies in total had more than $52 billion in 2005 sales, and employed almost 450,000 people.

 

In cases like these, most economists advocate taxing the pollution. Such taxes are called “Pigovian” after Arthur Pigou, a British economist of the early twentieth century who was one of their early champions. The taxes have two important benefits. First, they reduce the amount of undesirable activity; if a utility gets taxed based on the amount of sulfur dioxide it releases into the atmosphere, it has strong incentives to invest in scrubber technology that leaves the air cleaner. Second, Pigovian taxes raise revenue for the government, which could be used to compensate those harmed by the pollution (or for any other purpose). They’re a win-win. Taxes of this type are popular across the political spectrum and among people in many fields; members of the “Pigou Club,” a group of advocates identified by economist Gregory Mankiw, include both Alan Greenspan and Ralph Nader.

 

Congestion-reducing activities like carpooling, off-peak commuting, bicycling, telecommuting, and mass transit would all increase with congestion pricing in effect. Already Pigovian principles have been applied to revenue-generating segments of infrastructure like toll roads and London’s congestion zone, which reduces traffic and takes in money by charging motorists to drive into the city center during peak times. Meanwhile, Singapore has implemented an Electronic Road Pricing System that has virtually eliminated congestion.

 

Americans collectively spend over one hundred billion hours stuck in traffic jams, a testament to the fact that road pricing is not yet widely adopted. By some estimates, the revenues from optimal congestion pricing would be enough to eliminate all state taxes in California.

 

“Work saves a man from three great evils: boredom, vice, and need.” —Voltaire

 

We are also skeptical of efforts to come up with fundamental alternatives to capitalism. By ‘capitalism’ here, we mean a decentralized economic system of production and exchange in which most of the means of production are in private hands (as opposed to belonging to the government), where most exchange is voluntary (no one can force you to sign a contract against your will), and where most goods have prices that vary based on relative supply and demand instead of being fixed by a central authority. All of these features exist in most economies around the world today. Many are even in place in today’s China, which is still officially communist.

 

Mechanical Turk, which quickly became popular, was an early instance of what came to be called crowdsourcing, defined by communications scholar Daren Brabham as “an online, distributed problem-solving and production model.”

 

Reengineering consultants like to tell the story of how, in the seventeenth century, cows roamed around Boston Common and the neighboring areas. Over time, these cow paths became well-worn, and as shops and homes were constructed, people used the same paths for their carts and carriages. Eventually cobblestones were installed, and by the twentieth century most of the paths had been paved over with asphalt, with no more cows to be seen. As anyone who’s tried to drive in Boston can appreciate, having traffic flow designed by cows may not be the best way to lay out a modern city.

 

As Hans Moravec put it, “it is comparatively easy to make computers exhibit adult level performance on intelligence tests or playing checkers, and difficult or impossible to give them the skills of a one-year-old when it comes to perception and mobility.”