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Many ideas about how the Internet will effect the world are right only in certain situations, yet they are held to be true about all situations and stated in a manner that leads to overly broad interpretations.

Let’s examine some commonly held ideas about the Internet more closely:

The Idea of Disintermediation:  “The Internet allows people to contact each other directly without a middleman, and in so doing eliminates the economic value of the middle man.”

When people interact they do so in an environment that has been paid for by someone and potentially benefits someone.  If you meet someone at a club, it is paid for by the club owners, and potentially benefits the club owners.  If the environment is a sidewalk or other public location, it is paid for by taxes, and may benefit retail stores or billboard companies nearby that location.  If people interact over a phone it is paid for by one or more of the participants and benefits the telecommunications companies that provide the service.

Changes in technology can cause the manner and types of human interaction to change significantly.  People now interact on Google, Amazon, Yahoo, Youtube, Ebay, Skype, Flickr, blogs, and countless other places on the Internet.  These environments and tools clearly can generate tremendous benefits for those setting up the meeting place.

More powerful digital tools and distribution are becoming available to greater numbers of people, allowing Youtube celebrities, Ebay store owners, and others to prosper. Yet the largest single monetary reward goes to the founders of the companies that create the most useful environments. New companies may unseat old ones in creating the environments and tools that people want to use, but until all the services that all people want done for them can be done best without cost or advertising, the creator of the environment will continue to receive a generous helping of the monetary rewards.

The Idea of the Death of Distance:  “Technology allows digital work to be done from anywhere with an Internet connection and is driving down the cost of transporting goods, so technology is eliminating the importance of location.”

This idea is correct only in a certain context.  Yes, American tax returns are being created by Indian workers, Russian programmers create some Chinese websites, and the coffee beans you just imbibed travelled a great distance to find you.  Capital, workers, information, and goods are being transported and organized in global supply chains more efficiently than ever.  You can hire a tutor from abroad to teach you a language through video chat (see edufire.com) or help you gain new skills. These changes are very important economically and socially.

Yet it is also true that even as the market economy gives significant rewards to creative people who can devise new ways of serving other people, such people are flocking to certain physical locations.  The maps that Google makes of the search queries it receives across the globe are not distributed equally according to population density, they are focused in certain cities rich in human capital. This is because creative people want to cross pollinate in ways that are difficult to do across just the Internet. They want to get a feel for what tools and ideas others are adopting, and that’s hard to follow purely on the Internet. It’s also sometimes hard to spot a business opportunity if you’re not immersed in the local environment, at least for part of the time.

We live very important parts of our lives in the location we are at, establishing friendships that teach us, pick us up when we stumble, and are rewarding in their own right. Digital tools can supplement those needs, but are unlikely to completely supplant them because many types of experience are linked irrevocably to sharing a location. In some ways, particularly in finding people who will share major life milestones and experiences, location is more important than ever.

The Idea that Open always beats Closed:  “Information wants to be free of constraints, walled systems are always defeated by open systems, and open source products will always beat closed source products.”

This idea rose to prominence largely due to the distaste that many had for the media company’s takedown of Napster, for the contempt they had for the design of AOL’s service, and for the hatred they held for the product design and market dominance of Microsoft. It’s easy when there are dominant companies with inconvenient rules or poorly designed products to imagine the benefits of taking products out of their control or creating a product that is free and open.

Even frustration over a single feature in a proprietary product can lead those who want to tinker to demand a more open system. The low and diminishing cost of distributing the best, cheapest solution to everyone suggests all products and services in a digital age should be easy to tinker with and free of cost to the user.

Yet many of the most respected technology companies that provide services today are not completely open, are not open sourced, and are not free. They are adept at leveraging free or commodity services and products in building proprietary products that have closely controlled elements which are hard for their competitors to duplicate.

Apple is perhaps the poster child for the economic value and dominance that can be created using closed designs and systems. Although it uses open source components for significant parts of its software stack, it does not reveal the source code for its operating system or any of its major applications, it requires the coupling of its hardware and software, it is famously secretive about the design of future products, and in the ipod, iphone and iTunes system it has created a very dominant closed system. Apple has allowed media companies some measure of control over their content, telecommunications companies some measure of reward, and provide software developers some ability to innovate, but Apple retains both ultimate control and the primary share of the monetary reward.

Google uses linux, cheap commodity computing hardware, and makes many contributions to open source projects. Yet it also closely protects its brand and it does not release the source code for any of its major products (gmail, Google news, Google Apps, etc.). It is highly secretive about future products, the methods it uses to rank search results, the methods it uses to serve relevant advertising, and the ways in which it has organized itself.

Ebay closely controls the reputation system which gives buyers and sellers historical information about each others trustworthiness. Facebook opened its system to application developers, but keeps close control of the stream of activities your friends are up to. Even Craigslist charges for some listings to reduce spam. None of these companies reveal the source code for their websites. Even the companies that do reveal the source code for their products charge for certain levels of support and installation services, which is in effect charging for certain kinds of proprietary information.

When do companies do well with closed products? Sometimes closed systems have a design purity that creates the right customer environment or solution, sometimes closed systems discourage behavior that would detract from the community that is formed, and sometimes they simply serve people better than open systems. Sometimes they don’t. Firefox is a great web browser, but Apple thought it could create something simpler and faster and more ubiquitous in Safari. To think that one is destined to be better than the other in the marketplace simply because of their open or closed nature is to grossly oversimplify the factors that lead to product distribution and adoption.

In trying to understand a new phenomena, it’s important to form ideas about it, but also understand when those ideas don’t apply. A trail of wrong predictions and sloppy writing can drill into our heads ideas that are sometimes very false. I have learned that if I can’t name a context in which an idea is false, it is a dangerous idea to rely on. As Emile Chartier stated, “Nothing is more dangerous than an idea when it is the only one you have.” (see my favorite quotes)

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else, by Hernando de Soto.

A criticism of capitalism is that even though it drives technological change and reduces the price of goods, those without capital are deprived of its rewards. The argument that the poor and disenfranchised are not well served by capitalism is usually followed by an explanation of the need for a stronger social safety net. Another potential solution would be to make sure everyone has capital, but how this can be done fairly is an issue of great political controversy.

The Mystery of Capital explores how capitalism evolved historically, how capital has been obtained in the past, and then lays out policy prescriptions for reducing the barriers that prevent the poor from developing wealth today.

A Review of the Past

Part of the book is a fascinating examination of the historical evolution of the modern market economy. In aristocratic societies only those of noble blood and the powerful guilds were allowed to undertake certain trades. Those with political power could bar competition with their monopolies. Drawn by economic opportunity, slums of workers formed around cities. Workers in the slums tried to organize their own economic activity. Out of the slums came goods of far lower price, and often equal or better quality. Aristocrats and guilds detested the slum dwellers, and would decry and criminalize such competition. The politically powerful would obtain rights of monopoly from the throne, burn down parts of the slums, and put large groups of people to death. These struggles over the right to compete could result in uprisings. For example, Mr. De Soto describes a killing of thousands of seamstresses (motivated by a desire to preserve aristocratic and guild monopolies in the cloth trade) as one of the causes of the French Revolution.

The historical review is particularly fascinating because of some counterintuitive insights. Mr. De Soto points out that in the early United States illegal squatters would adversely possess land owned by someone else. Unlike in Europe, where such action was dealt with harshly, in America if enough squatters occupied a region they could elect representatives who would change the laws to legalize their squatting. Although such an action could be seen as a violation of the absent landowner’s property right, in practice recognizing the work done by squatters on land allowed people who would diligently improve land to create capital and encouraged landlord’s to put their property to better economic use.

A Prescription for the Future

The Mystery of Capital proposes a number of powerful policy ideas. It argues capitalism is at its best when everyone is allowed to compete and it points out that to compete all segments of society need to be able to adequately describe and protect their assets. This allows those assets (1) to be traded to whomever might have the best use for those assets, (2) to be used to borrow against for other productive enterprises, and (3) to be purchased using debt financing as opposed to lump sum payments.

The book demonstrates how most of the non developed world, including those places where capitalism has been perceived to have failed and the modern Western nations before they became developed, fails to adequately describe and protect assets. Mr. De Soto explains that it takes hundreds of steps and significant resources to legally start a business or own a home in different parts of the modern world. The records of who owns what are often murky and difficult to resolve. He explains how government policies are poorly adapted to the lives of those who live on the outskirts of cities. In desiring not to encourage the growth of slums, governments prevent those who dwell in them from recognizing their assets and improving their lives. Mr. De Soto explains that the poor often are in control of assets that they can not monetize or use to obtain funding because their assets are outside of the legally recognized system.

In the absence of legal mechanisms to recognize and enforce rights, slum dwellers often turn to organizations in their own communities such as unions and worker collectives, in effect creating their own extra-legal system. Yet this extra-legal system is only recognized in their own communities, making economic trading difficult, and making it difficult for the poor to fully realize the benefits of their work. Mr. De Soto points out that although their amount of assets are small, given the number of people involved, if the land and homes of the poor were legally recognized these stealth assets would add tremendously to national capital and help encourage development of that capital. People are better served by being brought into the market system, yet laws often exclude them or their resources from it.

One criticism that has been made of de Soto’s argument is that the amount in unrecognized assets, divided among the number of people involved, results in an average of $2000 to $3000 of assets per capita, which is not sufficient to solve the problem of world poverty. The fallacy with this counter argument is that (a) that much in assets greatly exceeds the current wealth per person of the people at question, (b) while modern Western businesses are generally hard to capitalize on this small amount of money (counterpoint: Dell Computer was started on this much) a great many businesses in developing nations could be started by borrowing on this much in assets, and (c) making these assets liquid would encourage companies to serve these unserved peoples because they would form a gigantic market and it would allow for these assets to be traded to whomever would most productively use them. Mr. De Soto argues persuasively that legally recognizing the assets will cause them to grow in market value.

The Mystery of Capital is well worth reading and its ideas deserve to be widely disseminated. If you find them interesting, you can find out more about Hernando de Soto and his ideas at his wikipedia page, at google news, at the website of his organization The Institute for Liberty and Democracy, and at his blog.

Has Siegfried Woldhek deduced what Leonardo da Vinci looked like?  Judge for yourself:

The link: http://www.ted.com/index.php/talks/view/id/235