[Viewpoint] 2021 New Economy Theory: Is Innovation Without Performance Truly Innovation?

Hong Ki-hoon, Professor of Business Administration at Hongik University

Looking back on 2021, which is now less than three months away, it seems to have been a year marked by an investment frenzy. In particular, interest in platform companies was intense.

However, the New Economy theory that was popular during the IT bubble and the platform economy theory we are currently facing seem to share many similarities. In this column, I will discuss what the New Economy theory is, the similarities between the New Economy theory and the platform economy theory, and what investors should learn from the failure of the New Economy theory.

The New Economy theory refers to the phenomenon where new promising sectors emerge or expand based on information and communication technology, and economic growth coexists with price stability. The theory posits that IT technological innovation leads to productivity improvements. As a result, in the New Economy, contrary to diminishing marginal returns, there can be increasing returns to scale, where the marginal returns increase as production increases.

Consequently, since the marginal cost decreases as additional units of a particular product are produced, profits increase as production volume increases. Supporters of the New Economy theory argued that increasing returns to scale are a key characteristic of the IT industry.

For example, the information and communication industry requires enormous costs to build basic infrastructure, but once a certain level of infrastructure is successfully established, the marginal cost of additional network construction actually decreases. Due to this increasing returns to scale phenomenon, productivity growth rates exceed wage growth rates, enabling a boom with reduced unemployment without inflation. The New Economy theory centered on the optimistic view that the information revolution could break all existing economic theory frameworks and thus enable a long-term boom.

Simply put, the New Economy theory can be described as economies of scale driven by technology and the resulting cost savings. When looking at the New Economy theory, one naturally thinks of the platform economy theory advocated by startups like Coupang and Toss, which led the market in 2021. The two are very similar.

"Since it takes significant costs to dominate a platform, enduring the current massive operating losses will eventually achieve economies of scale and generate profits."

In conclusion, the New Economy theory of 2000 ended in a major failure. Of course, there were various reasons including the Greenspan put, but the most important reason for the failure of the New Economy theory is as follows.

People claiming innovation with "this time is different" repeatedly brainwashed the public into believing the stock market had entered a new phase, and the phrase "this time is different!" became a slogan of the stock market. However, the stock market failed to reflect fundamentals under the framework of internet technology, and there were cases where the stock prices of companies that could not even generate revenue, let alone profits, doubled immediately upon their initial public offerings (IPOs).

I believe the lessons current investors should learn from the 2000 New Economy theory and its outcomes are as follows:

1) We must consider whether innovation without performance is truly innovation or deception.

2) Forecasts can deceive, but performance cannot.

3) Even within the IT bubble, well-designed business models survived with excellent performance.

4) Stock prices cannot keep rising indefinitely.

5) The true meaning of the phrase "this time is different" must be carefully examined.

Hong Ki-hoon, Professor, Department of Business Administration, Hongik University