Knowledge, the Appreciating Commodity Nations' real wealth doesn't reside in forests of rubber trees or acres of diamond mines, but in the techniques and technologies for exploiting them.
By Thomas A. Stewart

(FORTUNE Magazine) – So much for the new economy," a friend said the day the Dow dived 512 points. With all due respect--and he's a smart cookie, so respect is due--my friend got it exactly wrong. First, the new economy was never about the market's irrational exuberance, though some of its boosters and bashers linked the two. Instead, the new economy is about the growing value of knowledge as an input and output, making it the most important ingredient of what people buy and sell; it is about the rise in the relative weight of intellectual capital vis-a-vis real estate, plant and equipment, and financial capital; and it is about the development of new techniques and technologies to manage and measure knowledge materials and assets more effectively. The bull displayed (and has sometimes exaggerated) those happenings, but they are not bull.

Second, and more important, the Saint Vitus' dance of world markets is in fact another manifestation of the emergence and the workings of the new economy. The financial chorea carries at least one significant lesson about this new world, not only for economies but also for companies and managers. The lesson is called the "commodity trap," and there are any number of ways to hang a tale on it. We might begin ours on a hot night in the Amazon jungle.

In 1839, Charles Goodyear discovered how to vulcanize rubber, a process that turned it from a curiosity into a useful material. In the years that followed, thanks especially to cars, great fortunes were made in rubber. Ground zero of the rubber boom was the Brazilian city of Manaus, which sits smack in the middle of the Amazon rain forest, halfway between the great river's source and its mouth. A century ago Manaus stank of money. It was the second city in Latin America to be electrified, and had an electric tramway before Boston did. The most conspicuous relic of the rubber boom is the city's famous opera house, its marble and bronzes and chandeliers imported from Europe, its auditorium ringed with busts of great European composers and playwrights. Rubber barons' mansions stud the city and its surrounding jungle like cloves in ham fat.

The boom went bust; booms do. In the 1870s an Englishman named Henry Wickham managed to elude Brazilian inspectors and smuggle rubber-tree seeds out of the country. They were planted at Kew Gardens outside London. From there, seeds were sent to tropical British colonies in Malaya and Ceylon, and rubber plantations were created. When they became productive, in the years just before World War I, the price of rubber plunged, and Manaus' prosperity with it.

You'll hear the story time and again in Manaus, and always with the wrong moral. One version emphasizes the perfidy of Albion and foreign investors generally. Another argues that unmanaged or sustainable rain forest harvesting can't compete. The tale I heard from a jungle guide says that Big Money was so burned, it vowed never again to let the people of the forest prosper from its wealth. After the rubber boom ended, he said, "they" hatched a lengthy conspiracy; over and over "they" have blocked the development of a periodic tableful of Amazon gold, niobium, and on and on. "They" have, most recently, concocted environmental scare stories to keep the forest off-limits because if the wealth of the Amazon basin found its way to market, prices would plunge and dozens of banks would fail. I didn't ask, but "they" no doubt are conspiracy theorists' usual cabal--Jews, Freemasons, bankers, and bought pols--up to their usual sinister tricks.

A circle of light in a dark forest is a perfect place for far-fetched paranoia, surrounded as one is by inexplicable sounds, crocodiles with glowing eyes, hordes of insects, and lord knows what else. (By the same token, a house in a First World suburb is a perfect setting from which to oversimplify the struggles of people living in developing countries.) It almost seems possible that city slickers in air-conditioned rooms could maintain, for decades, a global plot to keep valuable resources off the market, even though the interests of most of the conspirators would be better served by developing them. Occasionally a demagogic genius can turn that nonsense into horror.

But the really dangerous fantasy, because it has condemned hundreds of millions to poverty, is mundane: the all-too-common dream that wealth can be found in commodities. Money doesn't grow on trees, and never did, not even in the rubber boom. The money made by Dunlop and Michelin and Goodyear dwarfs what the world's rubber growers made. In 1995 world crude natural rubber exports, worth $5.4 billion, were less than half of Goodyear's sales. Gold, black gold, black earth, it doesn't matter: Every commodity is a mug's game.

The reason: Over time all commodities decline in price. They always have; they always will. To build your economic house on commodities is to build it on an inexorably sinking foundation. People keep getting this fact wrong too. They multiply Malthusian logic by the law of diminishing returns but leave out innovation, and come to the conclusion that led Paul Ehrlich, author of The Population Bomb, to make his celebrated losing wager with the late Julian Simon, a professor of business at the University of Maryland. Simon bet that a basket of five metals chosen by Ehrlich--copper, chrome, nickel, tin, and tungsten--would be cheaper in 1990 than in 1980.

To Simon, it was the surest thing since Citation. He wrote later: "The costs of raw materials have fallen sharply over the period of recorded history, no matter which reasonable measure of cost one chooses to use." The International Monetary Fund's index of real non-oil commodity prices, for example, is today about one-third the level of its 20th-century peak at the end of World War I; the IMF calculates that real commodity prices have declined on average 0.6% a year since the turn of the century. DeBeers, which not only mines the world's priciest commodity but has a near monopoly on it, has begun burning a brand inside its diamonds to protect their value.

Yet nations rich in natural resources still fall into the commodity trap, the belief that their mines, rather than their minds, are the source of their prosperity. Little do they understand that a wealth of natural resources will be exploited by people with a wealth of knowledge; that it represents value extracted from a place, rather than value created in a place.

Not that gold in the ground is worthless: All else being equal, I'd rather have it than not--but the "all else" is what really matters. Asia's a mess, but notice that its most successful postwar economies and the ones that have hung toughest in this crisis--Japan, Hong Kong, and Singapore--boast nary a smidgen of natural "wealth." By contrast, Russia and Indonesia are rolling in resources, and in the gutter. No wonder: Commodity prices are down 20% this year. The global markets' fits have more to do with the senescence of the old economy than the nascence of the new. It's the prospect of a further meltdown in commodity prices that has economic pundits sweating, not the fear that Amazon.com's stock is too high.

This is a management column, and I promised you a managing lesson. The lesson is about price. If the world is in a low- or no-growth patch--and it is, with Asia in recession or worse and U.S. and European growth flattening as a result--then there are two ways to grow the top line, thereby getting yourself a raise and impressing your shareholders. One is to take advantage of cheap capital (your stock may be less overvalued, but interest rates are still low) to make acquisitions--a few of which will turn out to be smart. The rest of them will just make you bigger, not more profitable, but you will seem to be growing and can probably fool investors long enough to make a killing on your options. Later your successors can make another killing by undoing the deals.

The other way is to command higher prices for your work. Don't laugh: Real price increases are still possible for those who deliver more real value. How? Let's go macroeconomic again for a bit. You won't get price from raw materials, because (a) they keep getting cheaper, and (b) in the new economy they don't count for much. John Thornton, an OECD staff member, did a study for the IMF that shows that there is no discernible causal link between world commodity prices and retail prices. If anything, Thornton found, retail price changes are more likely to cause changes in raw-material prices than vice versa. Thornton's case was Britain, but there is no reason to think his conclusions are not applicable to other advanced economies.

Who gets price increases? While raw-material prices fall, the price of services rises. In the past 40 years U.S. consumer prices for services have octupled, rising more than twice as fast as prices for consumer durables, which rose 3.3 times. In the past ten years, services prices have risen three times faster than durables. Prices for labor confirm the trend: Goods producers' compensation has been rising at a 2.6% annual rate, vs. 4% for service producers'. Why do you think Jack Welch and Lou Gerstner have pushed their companies into services?

And within the service sector, which includes everything from short-sellers to short-order cooks, the price winners are--you guessed it--the intellectual capitalists, companies that offer knowledge- intensive services such as consulting, legal counsel, medical care, research, and financial services. High-brainpower activities produce knowledge products for which people pay a premium. Many are monopolies because they are inherently unique (there is only one Alan Dershowitz, thank goodness) or enjoy intellectual property protection; others are quasi-monopolies because they can be customized or can become an industry standard.

One smart way to play the price game is to look for these knowledge products and develop new ways to price and sell them. Chances are you already create many more knowledge products than you know about because they are bundled with something else, or you don't exploit your knowledge products well because it hasn't occurred to you that you can do better. Arthur Andersen's KnowledgeSpace, for example, takes knowledge the firm produces in the course of its consulting business--such as its best-practices database--and sells it by subscription on the World Wide Web. Advertising agencies are starting to unbundle their services--ad placement, ad creation, and marketing consulting--and price them separately. Ditto stock brokerages. When E-Trade realized that winning a price war has a downside, the superdiscounter began offering customers the chance to pay extra to get research reports; Morgan Stanley, which gives full-commission customers access to all its research, now has a limited package of research for sale to its discount-brokerage customers. How long, I wonder, before they offer the product to buyers, whether or not they use Morgan Stanley's brokerage operations?

Every business these days--manufacturers, service companies--claims it sells "solutions." The way out of the commodity trap is to price your wares as if you mean what you say