THURSDAY 20 APRIL 2000

DR MICHAEL I SHAMOS

  680. Good morning, Dr Shamos. It is good of you to appear in person to give oral evidence. We have been struck by the way in which the Internet has speeded up our life—the fact that you have already sent us your written response to the questions we proposed to ask this morning—so we have evidence of this acceleration. We have circulated your answers to the Committee, who may wish to return to some of the questions posed. May I ask you first to tell us something about your central role at Carnegie Mellon University. You were recommended to us by Warwick Business School. Perhaps, being a little bit cheeky, we may ask why you are currently in Europe, who you are seeing, and what you are finding. The Stock Markets have been in a state of turbulence over the past week but there appears to be a certain settling down. In your opinion, do you think this is temporary? Can we expect to see more turbulence possibly? Do these phenomena represent a market adjustment or is there a downturn in the critical path of e-commerce, perhaps as a pre-route to a further rise? In short, where do we stand, and what is the market telling us? Could I also ask you perhaps, maybe a little later, to speculate about the shape, the size, and the pervasiveness of the electronic world, say, in five or ten years' time. Maybe we will come to that a little bit later.

  (Dr Shamos) I wonder if we could take the questions one at a time. I remember some large fraction of them but certainly not all! Carnegie Mellon is a leading technological university in the United States. It also happens to have a fairly strong business school. Several years ago our customers, whom we regard as the companies that hire our graduates, began asking us whether we were training anyone capable of running an electronic business. After brief critical reflection we realised that we were not doing so. That the computer scientists that we were training knew virtually nothing about business, and would not have acquired any such knowledge during any of our courses. The business school was not training technologically savvy people, although they seemed to have substantial other quantitative skills in the business industry. So we determined that the only way to train e-commerce graduates would be to establish a joint venture between the School of Computer Science and the School of Business. That was accomplished in the summer of 1998, when we began a crash programme to develop a 12-month curriculum, leading to a Master of Science degree in electronic commerce. We believed that e-commerce was moving so fast, that potential practitioners would not be willing to spend more than one year obtaining education because of the opportunity costs of doing so. So the two committees were created to develop curricula on the business side and the technology side, all of which could be crammed into 12 months, where we would feel comfortable at the end in certifying to employers that these people could be integrated directly into the company in beginning to establish electronic businesses. One of our founding principles is that the School of Computer Science and the School of Business are co-equal in all of this. That required the nomination of a director from the business school and a director from the computer science. When the dean asked for volunteers, the rest of the members left quickly. I was the last one sitting in the room and I was nominated to be the Director of Computer Science, so I had responsibility for the technology infrastructure of the programme, and also designing and staffing all of the technology courses. The purpose of the Institute principally is to grab master's degrees in e-commerce. We will have 70 students entering a class within two weeks. It is a May-to-May programme, so we are starting the second year in a few weeks. Of those, more than half are from outside the United States. Among the 70 students, 20 countries are represented. The second objective of the Institute for eCommerce is to serve as a focal point for all e-commerce activities at Carnegie Mellon, including a PhD research programme. We have scientists who are looking at what are the emerging technological difficulties that might prove barriers to e-commerce, so that work can begin on their solution.

  681. Is any other university doing this or have you the leading edge on it?

  A. There are many universities that offer various kinds of e-commerce education. By far the most common is something called the e-commerce track within an MBA programme at a business school. In those programmes one takes a normal business education, with concentration in e-commerce, consisting of some three or four courses during that time. In our programme we teach the equivalent of 11 and a half courses instead of the three or four. Furthermore, since 50 per cent must be technological—and these are serious computer science courses, they are not an appreciation of nature—the people who go through our programme are able to deal directly with vendors. They understand the cries of programmers and other technologists. They are able to critically evaluate one proposed solution over another, which we felt was a skill that was missing from the graduates of other programmes. So, in our own field, which is 50/50 technology and business, there is no school that we know of in the United States which is offering such a programme.

  Baroness O'Cathain: Incredible.

  682. And this is a basic level degree you are talking about?

  A. It is a master's degree.

  683. And the PhD programme is also structured like this?

  A. No. The PhD programmes, those will be administered either by the School of Computer Science or by the Business School, and they will be heavily focused on one or the other. At that level, it is very difficult to find people with sufficient credentials in both fields, to do genuine research in both and at the same time.

  684. Of course. And, as a supplementary to that, would you recommend (I guess the answer is yes) that other countries should really look at this, in their higher education fields, of having this type of structured course?

  A. I am in conflict since, in my view, it is the best thing to do; but it would be nice if we were the only ones doing it for some substantial time. However, it is my recommendation, everywhere I go—including the United States, including Warwick and our other schools—that they do such a thing. There are administrative barriers, we understand. There are numerous universities, such MIT, Stanford, Berkeley, who have excellent business schools and have excellent schools of computer science but apparently, for political or administrative reasons, they are unable to co-operate to the degree that we are able to at CM.

  685. Is that because you have two people at the head who get on well with each other? The computer science and the business people.

  A. It has been a substantial benefit that the co-director from the business school and I do tend to see eye-to-eye on almost everything in the programme, so we have a very cordial relationship, but that is partially because we are co-equal and if we did not agree there would be deadlock. So we are forced by the fact that there are only two on the committee to agree more often than not.

  686. Professor Targett is from Imperial College, the Business School. He understands what you are saying about those administrative barriers. Now, your European trip.

  A. Everything I do these days, save for a brief vacation in August, has to do with electronic commerce. Whenever my body is in motion, it is going from one e-commerce thing to another. This trip began in New York where I was doing consulting work on electronic commerce for Bell Atlantic and Morgan Stanley Dean Witter, electronic commerce strategies. Fortunately, they did not require my services over the weekend, so I was able to fly to Kitzbühel to McKinsey's Alpine University, where I gave a training course to McKinsey consultants in the basics of e-commerce technology. In between that, and flying to do such another course in Paris, I have alighted in London for the day to give testimony here. This cycle essentially repeats itself every month. I go somewhere else to do these things: to talk to companies and give training courses.

  687. Perhaps you might care to speculate on the market. We were out there in Washington last week—the week after we had seen the Microsoft decision—so we were right there at the time. Then the market started falling.

  A. My Lord Chairman, my belief is that part of the fall can be ascribed to a certain awareness among the investors that many or some of the business models that have been used by companies currently selling stock are unrealistic and cannot possibly bear fruit. An example—I am not claiming at this moment that Amazon is one of these—however, when Amazon was selling only books, it was computed that every book sold in the world would have to be purchased through Amazon.com to even come close to justifying its market capitalisation. They have subsequently branched out into other activities. What has happened is that investment capital has been drawn in huge quantity to engineer businesses, largely because the investors are unable to determine in advance which of the businesses will be successful. When they are successful, the capital gain is so huge that it is able to pay for many failures. The expectation was that after investment within some rational number of years, profits would ensue, and everybody has been watching carefully. When the profits have not materialised, that has resulted in a serious devaluation of the businesses. There are some that remain healthy, and must remain healthy, particularly the infrastructure providers. So, for example, even before the recent Stock Market difficulties, Cisco had recently passed Microsoft as the corporation with the highest market capitalisation. I expect that to continue because right now one measure of expansion of the Internet is the number of registered domain names. The number of registered domain names passed 72 million in February. It is expected to pass 100 million in January 2001. It is really rationally expected to attain 1 billion registered domains in August 2005. It is essentially impossible to build so many domains without purchasing a huge amount of infrastructure equipment, including radars and other things, which is precisely what Cisco sells. An analogy is often made to the United States' Gold Rush of the 1840s, in which many families lost their fortunes seeking gold nuggets, but the people who made profits were the hoteliers and the manufacturers of pick axes and shovels. So wherever there is a boom, those who provide the tools for the boom are the winners.

  688. What kind of mood do you sense in Europe as you go round? We particularly picked up one of the differentiating factors. Particularly the willingness of venture capital to go into start-ups at the very early point; whereas, in Europe, there is a tendency to see whether it looks as if it might be a good bet before venture capital will come forward and take the risk.

  A. This is my fourth trip to Europe within the past four months. I have been to many cities and had discussions with many parties about very similar issues. One problem with attracting venture capital into e-commerce is that the investors must believe that the company is facing a potentially huge market. So as long as there remain barriers to market expansion, there is no point in investing in even a potentially successful technological enterprise if people are not able to access the website that is created because of prohibitive telecommunications costs. Indeed, it is true. We have noticed several phenomena. For example, the total number of applicants to our programme at Carnegie Mellon from Europe, the first year was zero and the second year was two; whereas we have huge numbers of applicants from the areas of the world that are the fastest growing in e-commerce, particularly from Asia and the United States. In an almost self-defeating language, Europe is constantly pointing out that it is behind the United States in e-commerce. The e-Europe Report is laced through with language of that kind, although the Europeans proudly point out that they are ahead of the States in global telecommunications. Both of those are true. I do not think they need to remain true but they are true today.

  689. What kind of a mood do you pick up when you are going round meeting business people in Europe? Do they feel they are in second place to the States?

  A. The mood could be described as ebullient. Everyone sees what is happening to e-commerce. They have a clear focus on what is preventing it from expanding and would like to see something done about that. They assume it will be done and then the business will expand.

  690. I suspect there is a slight touch of cynicism about that. In other words, you do not actually believe it is going to happen; that we are going to be caught short. Do you think that?

  A. I do not think that at all. It will happen but it will not be easy. It is the job of legislators and Parliaments to make it happen. I am not sceptical of the ultimate future.

  691. But do you think the will is there? You have made four trips to Europe in the last four months. Do you think the will is present amongst legislators to do just that?

  A. I do not have enough exposure to legislative initiatives in Europe to know that. What I sense from businessmen and consultants is that things are happening and they believe that the climate will improve. The largest barrier has to do with the cost of Internet access. I am reliably told in France that it is possible, after one active night of surfing the Internet, to run up a bill of £100 to £200. That is impossible when you compare it to the zero marginal cost of Internet access in the United States.

  692. In reply to the question about the role of government, which was in the notes we sent to you, we sent a note that says: What is the role of government as a fundamental peripheral? In your answer you make a point about governments seeing e-commerce as a source of new tax revenues.

  A. Yes.

  693. I think this whole question of tax is a very interesting one. I wonder if you could just first talk around the whole question of government tax and e-commerce for a moment.

  A. It appears to be the desire of legislators to raise taxes in as unobtrusive a fashion as possible. If they can be made invisible, or if the taxes can be shunted off to those who are not resident in their own jurisdiction, (as Florida successfully does with its hotel taxes), then all the better for the politicians. It is possible, on the Internet, to assess taxes that are essentially invisible. One does not receive a bill. One does not receive an itemised statement that says there is this much tax, because electronic mechanisms make it possible to assess the tax even without informing the taxpayer, at that moment, that the tax is being charged. So it bears a tremendous attraction to taxation on the Internet. That was largely responsible for United States Congress's response to the Internet tax moratorium that said: "Wait. We have to have a chance to study this before various jurisdictions all over the country attempt to levy new taxes." The United States is in a strange position with respect to sales and new taxes. There are 50 states, all of which either have them or do not have them, do not have or charge different rates; but there are constitutional principles in the United States which forbid one jurisdiction from being compelled to collect taxes for another jurisdiction. So a very common mechanism legally to avoid sales taxes in the United States is to make a purchase from a vendor in another state and have the vendor ship the goods into one's own state. On the Internet, however, it is possible to monitor all of this activity and attempt to have some kind of negotiation, where there is some kind of split of taxes between the two states, and levy such taxes. Right now that is impossible. On the Internet, because there is this moratorium, one cannot levy taxes until 2001. Now, there has been discussion of what is the correct means, if any, to tax activities on the Internet, including such proposals as a bid tax, in which every bid that moves on the Internet would generate a tax. That is a hard-line prospect because the number of bids per day, which move on the Internet, is doubling approximately every 98 days. Therefore, tax revenues from that would then double every 98 days, producing a windfall of ludicrous proportions. So the issue really is that we need to have a very efficient Internet infrastructure, just in the same way as we have an efficient road structure, public highways. One needs to raise taxes in order to build and maintain highways. One needs to raise taxes in order to build and maintain the Internet structure. The question is: is the tax to be levied on the direct user or society, as a whole? since society, as a whole, is the beneficiary of both the public highway system and the Internet. So there can be effective tax mechanisms but economists need to be called in to study this very carefully because the burgeoning growth of the Internet makes small things explode exponentially in a very short time.

  Lord Chadlington: When you look at the systems that are options available to us, what direction is your mind going in? Is there not another side to this, which is lost revenue? In some taxation systems, as things move on to the Internet, it is probable that some countries will lose traditional methods of raising capital.

  Chairman: As, indeed, some states are losing at the moment.

  694. Yes, as some states are losing it.

  A. Precisely. They are losing it because they were not ready for electronic commerce. I see a future world in which essentially all transactions are negotiated and concluded over the Internet. It then may remain to engage in a physical delivery of the goods. If all of the transactions are occurring on the Internet, then details about the financial aspects of those transactions will exist in digital form and will be processable. It has always seemed to me that the right mechanism is essentially an electronic value added tax, where every time there is a transaction, a tax is levied between businesses or between consumers. It will be scrupulously fair because everyone will be taxed. There will be an Internet everywhere. All transactions will be part of the measurable economy.

  695. And the technology will collect it.

  A. Well, that is another issue we have to talk about. The absence of effective handling.

  Baroness O'Cathain: But who will get it?

  696. This is a terribly important area. This would be a variable value added tax, in your mind? It would be a tax that was applied to certain goods—luxury goods would have a higher level than other goods. Do you see that happening or a straight level? Can we answer the question that Baroness O'Cathain is asking? Who would get the money?

  A. I have a radical proposal along those lines. I have not discussed it in public anywhere until today because I have not been asked the question! As to whether the tax should be variable or not, this is an area certainly outside of my expertise. I have always been uncomfortable with use of the taxation system for selective incentives and disincentives. I have always viewed taxation as a purely revenue raising matter. That is a personal view. On the other hand, I have been both the beneficiary and loser from selective taxes, so I might not be the one to comment personally. As to the issue of who gets the tax, I will give an example from the United States. Let us suppose that a transaction is being engaged in between someone in Pennsylvania and someone in New York. Pennsylvania taxes certain goods at 6 per cent. New York taxes certain goods at 8 per cent. The proposal would be that in that transaction the actual tax is the average of the two taxes, so 7 per cent would be levied but it would not be split equally. It would be split in ratio to eight to six, which is the ratio that the States have determined by legislation and regulation that they would like to see the tax from the transaction. So we tax the transaction and we distribute it to the two jurisdictions involved, assuming that there are only two, and assuming that we can determine which the two jurisdictions are, which is another very difficult issue. This is because if the Internet is global and is abstracted away from geography, where is the authority at all to do the taxation? Initially, at least in the United States, everyone has a domicile. In general, the jurisdiction that geographically controls their domicile has certain taxation rights. When someone receives goods, the state in which the goods are received has a right to levy a use tax on those goods. We always have ultimately a recipient of goods or services, and a vendor of goods and services, and if we can tie those down to which jurisdictions are entitled to levy taxes, then we can get to the point where we can share these revenues in the appropriate ratio.

  697. The next one is the technology and compliance.

  A. The technology is not a difficulty. The problem is that in order to monitor all these transactions, one must engage in very intrusive digital collection of information. So, for example, the state will be entitled to know, and multiple states would be entitled to know, details of every financial transaction. Now, of course, in over-the-counter sales of goods, the merchant is required by the state to levy taxes and to collect the taxes in trust for the state. However, the state may not have detailed information about what goods were purchased, although they can certainly learn that through subsequent sales tax orders. I am not sure that the digital situation is substantially different from the real or physical situation that we have now.

  698. Will it not result in tax competition with mail order, for example?

  A. Yes. In fact, the United States Federal Trade Commission is examining right now the effect that the Internet has had on mail order. They are considering revising their telephone mail order regulations to make the Internet at least as regulated a place as mail order and the telephone, so that there is not such a lop-sided advantage to the Internet. The issue is one which should genuinely have efficiency. If it is more efficient to purchase goods over the Internet than to use mail and telephone order, the world will gravitate towards that, whether we like it or not. So if telephone and mail order cannot match those efficiencies, which will be reflected in the prices that will have to be charged, then they deserve to go out of business.

  699. Is this not the fundamental point of the whole operation? The Internet, e-commerce, and all the electronic peripherals, are just another way of doing business? There are a few add-on businesses like ISPs, which enable the whole operation to work but, nonetheless, if you have not got a basic product to sell, the Internet is not going to help you.

  A. In my view, the Internet is a vast global conduit with information, but it is important to remember that the only thing that ever passes on the Internet is information. So if there is an economy that is based on physical goods, then the utility of the Internet is to enable people to learn about those goods and their characteristics; to learn the reactions of others who have previously purchased those goods from their vendor; the availability of competitive goods at competitive prices; the ability to negotiate and conclude a transaction. I think the new enterprises that the Internet has given rise to are the information vendors. Those whose only good, if you can call it a good, is information; something that is requested and delivered directly over the Internet instantaneously. In a sense, it is another way of doing business, but it is a way of doing business that we have never seen before because it is tremendously empowering to the consumer. There is a visibility to make product comparisons. In fact, companies are searching very hard for a way of recapturing the advantage away from the consumer.