In May 2022, Y Combinator warned its portfolio founders to “plan for the worst”. Cutting expenses and, if that wouldn’t suffice to reach profitability, raising capital was the name of the new game. The subject line read “Economic Downturn”. Clearly, the long honeymoon of venture-backed tech startups was over. Tech winter was coming, and now it’s here.
But how long and how deep will it be?
Looking back at recent tech history, we find two different models:
- the burst of the dot-com bubble in 2001
- the Great Recession in 2008
The former was a deep shock, and it took years for the tech industry to recover. The latter was, in hindsight at least, a minor blip. But what it set in motion was a long period of cheap capital, fuelling the tech revolution for 15 years.
The Great Recession and its aftermath, the financial crisis, led central banks to a policy of low, sometimes even negative interest rates. In addition, they absorbed a lot of treasury bonds. Governments could load up new debt without worrying about rising interest rates. Many companies and private individuals followed suit. Rising house prices were partly stoked by this cheap money.
And the same is true for the meteoric rise of Big Tech stocks. A lot of the abundant money available went to the stock market and tech stocks in particular. As growth stocks, low interest rates gave them an advantage. That’s because markets are supposed to discount future earnings. Profits in the future are worth less than profits today.
How much less is influenced by interest rates. The lower they are, the lower the discount rate. Profits in the future become more valuable. Thus, economic long-term thinking and sustainability get tailwinds. Low interest rates dampen the breathless short-termism of the capital markets. The long- and medium-term future is coming into view.
The role of inflation
This also works the other way around. Inflation compelled central banks to raise interest rates. As soon as stock markets started to anticipate this, tech stocks began to tumble. In early 2023, the question is how long and how deep the tech winter will be. To find an answer, we need to look at inflation.
Last year, inflation rose to levels unseen since the early 1980s. Inflation had already crept in over the course of the pandemic, when strained supply chains caused shortages and rising supplier prices. After Russia invaded Ukraine, energy prices soared, leading to another systemic shock. And since energy is (more or less) involved in every economic activity, inflation eats through all areas of the economy.
The good thing is that this situation will eventually normalise. But alongside the direct loss of wealth from having to pay more for the same, countries with higher energy prices will lose energy-intensive industries to other parts of the world. There will be second- and third-order effects of the energy crisis.
Inflation rates will only go down after economies adapt to the new normal. This takes time, and the new normal is looking like a moving target. When we’re talking about not a single crisis, but a polycrisis or permacrisis, adaption is hard. Thus, inflation might be here to stay for a while.
This in turn will likely mean even higher interest rates. Central banks are expected to raise interest rates until inflation dies down to the 2 per cent target level. This, again, may take some time.
In the meantime, will economic activity decline (a recession, in other words)? So far, we don’t know. But in a recent survey, most economists polled expect a global recession in 2023.
Tech winter may slow down innovation
What does this mean for the tech winter? Tech start-ups will find it harder to raise capital. The more capital-intensive a start-up is, the harder it will become to get financed. The crisis will favour bigger players which can always turn a profit by cutting costs, maybe sacrificing growth, but not their future.
The longer and deeper the winter, the stronger the shake-out. This can slow down tech innovation. But higher energy prices will lead to more investments and more innovation in the energy sector. As far as this accelerates the green energy revolution, there is nothing wrong with it. We certainly need a decade of massive investments in clean energy.
But this can come at the expense of innovation in the tech sector. The next phase of the digital revolution may arrive later than many players anticipate. So, will the current tech winter be more like the 2001 dot-com shock or the 2008 blip?
If this year or in early 2024:
- the pandemic ends
- China somehow muddles through the current wave of infections and subsequent ones
- the war in Ukraine ceases
- energy prices find a new plateau
- the recession remains mild or does not materialise at all
- inflation declines significantly
- central banks loosen their monetary policy
…then tech winter will be mild and short. These are big ifs. It would be a best-case scenario. However, not all of the above issues need to be solved for the tech winter to be over. Spring will arrive as soon as some of the problems are gone.
The next tech boom
The big question is whether we’ll see the return of low interest rates anytime soon. Personally, I doubt it. A full interest rate cycle needs some time. In the US, the average rate tightening cycle has lasted 21 months. Meanwhile, the next tech boom will have to look elsewhere for its fuel.
This could be a new fundamental innovation like Web 2.0 and the iPhone in the 2000s. Web 2.0 was decentralised and led to the rise of Facebook (now Meta). The iPhone was developed by a single company, fueled the meteoric rise of Apple and led to the creation of two mobile ecosystems (Apple/Android).
Over the last decade, we saw many candidates for the next big thing, like blockchain, VR/AR, AI, or even quantum computing. None of them has yet proven to be what we are looking for. Blockchain still has a long way to go till mass consumerisation. It’s unclear whether VR/AR will ever get out of the gaming niche, although Mark Zuckerberg has bet his company on it.
At the moment, AI is on a roll, with new creative tools like Midjourney and ChatGPT. But what kind of boom could this fuel? To find out, we need to play with these tools. A lot. And this will require time and capital.