In 2001, the global stock market peaked. At left, the technology-heavy NASDAQ composite shows what happens when a mind-bogglingly huge amount of speculative investment cash chases companies that don’t have any hope of turning a profit.

A new analysis by Shane Greenstein, an economist at Northwestern University who has studied adoption of broadband Internet, sheds some light on why - aside from investor wariness - the rapid global adoption of the internet since 2001 hasn’t succeeded in re-inflating the economy.

Greenstein asserts in an essay originally published in IEEE Spectrum that, despite the speculative bubble, the first wave of internet companies did in fact create a great deal of never-before-seen value. Greenstein notes that, for every Pets.com, there was also an Amazon or eBay–tech giants that have fundamentally re-shaped commerce into the present day.

The biggest increase in electronic retailers occurred during the first wave. Firms such as Amazon, E-Bay, Expedia, and a host of catalogue converts, such as L.L. Bean, arrived in that era, as did tens of thousands of specialty retailers selling everything from Vermont maple syrup to 3D puzzles.

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New services, such as those found during the first wave, were almost pure value creation. The number of users who subscribe to an Internet service provider (more than seventy million) or the size of the revenue (more than forty billion) provides a good sense of the scale.

Keep in mind that the first bubble was over before more than 10% of Americans even had broadband Internet. Given that it’s ten years later and broadband Internet now reaches six times as many U.S. households, where is the growth that we would have expected from both the furious pace of IT R&D and such widespread deployment?

Greenstein’s answer is simple: the second wave of internet businesses haven’t led to overall growth because, unlike the first wave, they are simply cannibalizing the business of off-line retailers.

The pattern is clear, and has been repeated again and again: online music sales have cannibalized the revenue of brick and mortar music retailers. Online advertising, especially on Google, has taken revenue from newspapers, magazines and even television.

This has fundamentally shifted the retail and media landscape, redirecting revenue to countless new outlets and individual retailers and content creators who did not even have an audience before the web became widespread. These changes have also meted out financial rewards and punishment (mostly the latter) to existing properties that are struggling to maintain momentum in an increasingly digital world.

There is also a second, more sinister implication of Greenstein’s analysis, however: it’s entirely possible that, by occupying our time more cheaply than ever, the web has actually been a force for decreased economic activity. How much does it cost Zynga to occupy you with an hour of Farmville? Now imagine what those millions of users would have been doing with that time had they not been distracted.

Online services that cannibalized offline services also provided a new gain, but–wait a minute–the amount of online activity is not the same as the value created. A lot would have happened offline had the broadband Internet never been built. The net improvement was a lot lower than the levels of online activity.

Greenstein concludes by noting that those who see the progress of the Internet as an endless succession of ever greater human and technical accomplishments are, from an economic perspective, engaged in magical thinking.

They simply aren’t looking at the value of what the Internet has destroyed when getting all starry-eyed about what it’s giving us in lieu of what we once had. (I.e., physical books, record stores, getting out of the house, etc.)

More to the point, the first wave of investment brought considerable economic value. Not necessarily with the second. The first wave introduced new services to consumers whereas the second mostly cannibalized service already in existence offline.

Thus, the first wave was not necessarily prologue for the second wave. Rather, the first wave of the Internet created economic value because it helped create services where there had been none. This difference between waves is related to why the future might not resemble the past. The broadband economy created value, but this value might not be much if broadband only (or mostly) incrementally improves what already exists.

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