Are Digital Transformations Artificially Bolstering the Economy?

The recent stock market volatility, soaring inflation, and run-up in home prices have many economists speculating that a recession is on the horizon. This assumption is based on the precursors to prior recessions, many of which we’re experiencing today.

However, analysts who use history as a benchmark for today’s economy are overlooking the fact that the drivers of economic growth have changed over the past 15 years. Namely, the rapid digitization of information has transformed how goods and services are marketed and sold. The rise of Instagram influencers and the ability to leverage low-cost, overseas talent are just two examples of how digitization is impacting economic growth. 

In this article, we look at the many ways in which digital transformations may be artificially bolstering the economy, which in turn, influences which indicators may be used to predict future recessions. 

What is “digitization”? 

Digitization is simply the process of converting information into a digital (e.g., computer-readable) format. Digitization is made possible by what is often referred to as “information and communications technology,” or ICT. ICT is an umbrella term that refers to the integration of telecommunications and computers—including hardware and software, middleware, storage and audiovisuals—that enables users to access, store, transmit, understand and manipulate information.  

The impact of digitization is having a profound effect on economic growth and development, not only here in the United States, but all across the world. 

4 Ways Digitization Impacts Business Growth
The ways in which digitization impacts the economy continue to evolve. According to a report by the World Economic Forum, as an economy’s digitization increases, its productivity improves. “Some jobs get replaced by technology, and lower-value-added, labor-intensive tasks go overseas to emerging markets where labor is cheaper,” the report notes.  

Specifically, digitization is impacting business sectors in four ways: 

  • Business formation: Digitization is lowering barriers to entry and expanding market reach for enterprises. For example, companies that once relied on local consumers can now leverage social media to expand their reach globally. Service providers can similarly leverage technologies like Zoom and Microsoft Teams to connect with potential clients in different time zones and all around the world. Businesses that would not have otherwise been viable due to limited market reach now have endless opportunities. In many instances, digitization has allowed individuals to test their business models prior to jumping all-in to a new enterprise.
  • Go-to-market strategies: Digitization has fundamentally changed how companies build brands, communicate their values, and market their goods and services to customers. Through strategic advertising, businesses can reach new audiences using various online platforms. The resulting explosion of e-commerce has been transformative to how products are sold.
  • Production: Digital transformations have also impacted how and where businesses produce various goods and services. For example, many companies now outsource jobs to people living overseas. There could be several reasons for this: in some cases, lower-skilled work can be outsourced to lower-paid workers abroad using platforms like Upwork and Fiverr.

    In other cases, there is value in having people work “off-hours” to quickly turn around work for clients located in the U.S. An architect, for example, may receive feedback from a client during the day, and then that feedback can go to designers abroad who can make changes to renderings overnight, allowing the architect to deliver the changes sooner than if they were relying on their local team alone.

    In any event, the ability to outsource the production of goods and services has the impact of making today’s businesses more profitable than they would have been in a non-digital era.

  • Operations: According to the World Economic Forum study, “digitization has had the greatest impact on the way companies organize and operate to generate competitive advantage.” While a growing number of workers were starting to telecommute pre-Covid, the pandemic accelerated this shift in how and where people work. Today, many companies are saving money by closing physical offices, instead opting to have their teams work remotely. Many back-office roles are being shifted to remote workers in lower-cost regions, which also boosts a company’s bottom line. 

Other Profound Economic Shifts Enabled by Digitization
While the impact digitization has had on business growth and development cannot be overlooked, there are other ways in which new technologies are bolstering the economy in ways never seen before. Here are a few examples of how this has taken shape. 

  • The proliferation of cryptocurrency. “Digital assets” like Bitcoin and Ethereum, have exploded in popularity among users and investors alike. In November 2016, non-state issued digital assets had a market cap of $14 billion. By November 2021, this had skyrocketed to over $3 trillion. Many entrepreneurs reportedly utilize cryptocurrency as a means of accessing international markets and conducting business quickly and with ease. During the last three months of 2020, there were an average of 287,000 confirmed Bitcoin transactions per day worldwide.

    On the investment front, cryptocurrency has made some ordinary individuals millionaires (even billionaires) almost overnight. In other instances, people have lost their life’s savings by gambling on an otherwise unregulated, “underground” monetary system.

  • The rise of the “creator economy”. The Kardashians are probably the most famous for being “famous” – a skill they have since transformed into actual multi-million-dollar brands. The rapid adoption of social media, from Instagram to Snapchat to TikTok, has created a new era of “social media influencers.” These influencers are the primary driver of the “creator economy,” an economic classification that did not exist a decade ago. The creator economy, which refers to anyone who uses online media to monetize their content online, has helped ordinary individuals earn six-figure (and beyond) incomes by advertising to their followers. The creator economy also includes fashion bloggers, live-streaming games and other people who have gone on to build actual companies around their online “influencer” brands. An estimated 50 million people worldwide consider themselves “creators” according to a recent study—a number that continues to grow at a rapid pace.
  • The “Robinhood effect” on the stock market. It used to be that individuals would invest in their traditional, employer-sponsored 401k plan and otherwise, engaged in very little stock trading. Until recently, most platforms (Scottrade, Fidelity and others) would charge a $7-10 fee for each trade, which inherently limited the amount of trading amateurs did. The advent of Robinhood, a platform that offers free trades with no minimum account deposit, radically disrupted the market. Now, curious traders could experiment with nominal dollars and with relative ease.

    The widespread utilization of Robinhood among retail investors has allowed these individuals, collectively, to have a dramatic impact on the stock market. The GameStop saga is one of the most notable instances of this: users from the Reddit page “wallstreetbets” gobbled up stock from GameStop, an otherwise floundering video game chain, which sent the price soaring from $20 to over $300 per share. Institutional investors who had bet against the company were forced into a “short squeeze,” where they were forced to repurchase stock as the prices rose.

    While a short squeeze is not unheard of, the fact that it was driven by retail investors using new technology and novel trading platforms forced Wall Street to pay attention to retail investors like never before. It became clear that the actions of individuals could, collectively, have a dramatic impact on the stock market. One analysis found that retail investors were indeed a driving force behind the stock market’s second-quarter rally in 2020. The impact on small-cap businesses was especially profound. “Robinhood demand accounted for 20% of the aggregate market capitalization of the [smallest 20% of stocks in the U.S. market], the study found.

    In short, the Robinhood effect is expected to cause the stock market to act more erratically than ever before, with small-cap companies expected to face the most volatility. 

 So, what are we supposed to make of all this? One could argue that these digital transformations are artificially bolstering the economy—therefore making a large-scale recession less likely due to their strengthening of the economy in a way that we have never experienced. Alternatively, one could argue that their fast-paced nature could not only create economic mayhem, but they could potentially create unprecedented distress in the market. One could also argue that there’s nothing “artificial” about these transformations at all. Digitization and the growing utilization of social media, cryptocurrency and other ICTs is simply creating new opportunities for businesses to form, grow and thrive. The drivers may be different than in decades past, but this could be looked at as an evolution of business rather than an artificial bolstering of those businesses. 

Time will tell, and nobody has a crystal ball, however, we feel that it is important for investors, economists, and other pundits to recognize that today’s economy is vastly different than any other economy that we have experienced. Historical ways of analyzing economic growth and downturns are outdated and have become less accurate when factoring in the extensive shifts that have occurred over the past 15 years because of digitization. We must be careful not to over-rely on history when trying to benchmark what to expect out of future downturns.