Commentary: The Net And Emerging Markets: Both Wild, Both Vital

It's dangerous on the frontier--whether you're talking about emerging markets or the Internet. That lesson was driven home painfully this past summer as U.S. equities plunged because of the deepening crisis in Asia, Russia, and, most recently, Latin America. As the market tumbled, the fast-moving companies that are taming cyberspace and creating a new online economy also lost ground.

From the investment euphoria for tulip bulbs in 17th-century Holland to the bubble in biotech stocks in the early 1990s, it's easy to dismiss the market's recurrent manic moods. The mid-'90s stampede into emerging markets certainly looks ill-advised now, and the billion-dollar valuations on Internet companies with little revenue and no profits seem equally preposterous.

But simply wagging a finger at the excesses misses a fundamental point about emerging markets and Net startups. In both cases, we're talking about frontier economies with few rules or traditional guideposts. It's a Wild West where no one really knows what will work and what won't.

This we do know: It would take far longer for these economies to develop without Wall Street's enthusiasm for funding entrepreneurship in the hope of making a financial killing. After all, it's only with hindsight that we really learn which projects were genuinely wacky and which ones were surprisingly sound.

WITHOUT A MAP. The parallels between emerging markets and the Net are striking. Both are trying to cope with difficult transitions without a blueprint. From Russia to Indonesia, state-dominated economies are striving to create private enterprises, stable banking systems, and other institutions vital to sustaining rapid economic growth.

Net companies, meanwhile, are inventing a profit-making cybereconomy in what once was a noncommercial frontier. Most Net investors have yet to experience the kind of pain that, say, owners of ruble funds are feeling. And although some Web highfliers are ascendant again, more dislocations are inevitable. "In both cases, it's the changing of the rules that is proving so troublesome," says Esther Dyson, a high-tech maven who also advises Russian companies.

And, in both contexts, profits are elusive during the transition. Dealmaking flourished after the collapse of communism and the embrace of laissez-faire economics in emerging markets. But foreign capital fled once investors realized that debts were enormous and earnings nonexistent. Dealmaking is all the rage in cyberspace, even though few Net companies are making much money. "Lots of capital is looking for a get-rich-quick-scheme off the Internet," says Edward E. Yardeni, chief economist at Deutsche Bank Securities Inc. "The Internet stocks could implode as rapidly as the emerging markets did if the rate of return isn't there."

While great speculative bubbles usually end badly for investors, the underlying economic gains in most cases endure. For instance, in the late 1860s, Europeans invested in the world's biggest emerging market--the U.S. Much of the money flowed into high-risk, high-return railroad securities. But capital fled in 1873 as investors recoiled at the railroads' crippling debt burdens and mounting evidence of widespread corruption, according to J. Bradford de Long, professor of economics at the University of California at Berkeley. The U.S. economy tanked as a result. Yet the railroads stayed, a new national infrastructure that played a vital role in the fivefold increase in net national product and a near-tripling in real per-capita incomes between 1870 and the outbreak of World War I. In the same way, despite all the turmoil, Asia still has a superb workforce and savvy entrepreneurial class, which will eventually translate into genuine market power and economic growth. It's the same with the Net, although, blessedly, the cybercrunch won't cause social fallout on the scale of the emerging-market bust. Companies will disappear, products will vanish, but the Net will remain.

Financial history tells us that stock prices can get far out of whack with the fundamentals--it is the nature of the beast. Pioneers and visionaries often fail. Investment scams and scandals are inevitable along the economic margins. But quality will out. And the frontier economies of tHe Net and emerging markets are moving closer toward the ecoNomic mainstream.

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