Against Incumbancy

Over at HBR, Philip Auerswald has a good guest post on innovation and the role of entrepreneurs as change agents. He writes (HBR):

As the editor of the journal Innovations, I'm asked with some regularity, "So, what is innovation anyhow? How would you..."? (eyebrows usually furrow here) "... define it?" Since I don't particularly enjoy debating definitions, I usually respond by saying: "That's a difficult question. But one thing is for sure: If you're not pissing someone off, it's probably not innovation."

I like this response because, if it doesn't end the conversation, it usually shifts it from definitions to dynamics — which is what innovation is all about, after all. But I also like it because it captures one fundamental obstacle to innovation that all would-be disruptors must be prepared to face: the potentially hostile response of incumbents who don't want to see their market advantages threatened.

And then he ties this back to Schumpeter's writing. Here's Schumpeter, from Capitalism, Socialism, and Democracy (p. 132):

To undertake such new things is difficult and constitutes a distinct economic function, first because they lie outside the routine tasks which everyone understands and, secondly, because the environment resists in many ways that will vary, according to social conditions, from simple refusal either to finance or buy a new thing, to physical attack on the man who tries to produce it.

This doesn't, of course, have to apply to a lone individual working to change the world. Apple, at least in its current iteration, is clearly an innovative company. By that I am alluding to Auerswald's definition of an innovator as one who pisses people off. On the same day that Phil wrote his piece, there was a great example of the sometimes antagonistic relationship between Apple and AT&T, this despite the fact that around 60% of AT&T's phone sales in Q1 2012 were iPhones. Check out a few of the great quotes from AT&T's CEO, Randall Stephenson (i.e. the evil incumbent) at a recent conference (NYT):

Mr. Stephenson said he worried about services that could replace the company’s own offerings. For example, free Internet-based messaging services like Apple’s iMessage are eating into the company’s revenue from text messages.

“You lie awake at night worrying about what is that which will disrupt your business model,” he said. “Apple iMessage is a classic example. If you’re using iMessage, you’re not using one of our messaging services, right? That’s disruptive to our messaging revenue stream.”

Now, if you're a shareholder of AT&T, you'd probably be pretty happy knowing that the company is actively looking for ways to retain their core profit streams. On the other hand, if you're a consumer, you're pretty happy that Apple is doing what it can to improve its customers' experience. Along the way, innovators like Apple improve consumer surplus by challenging the status quo. The lesson is that incumbents worry about potential disruption while innovators (entrepreneurs/social entrepreneurs/change agents...) lie awake at night worrying about how they can create value and change the world.

The gains to consumer surplus from increased competition are far higher than the gains to incumbents, but we spend most of our precious political capital protecting incumbents. It's time to move beyond left and right - the real debates of the 21st century revolve around how we can better enable entrepreneurs to create value and find solutions to global problems.

An Economics and Evolutionary Biology Reading List

You'll find it here, via MR. I find it to be a fine yet incomplete list. A few additions. In terms of popular books, one commenter added Eric Beinhocker's Origins of Wealth. In my mind this would be the place to start. It's great and I recommend it strongly. It seems to me that evolutionary economics offers a less complete vision than complexity theory, and you get a lot of that in Beinhocker as well. Melanie Mitchell's book, Complexity: A Guided Tour, is a good companion to Beinhocker, though off our current topic.

If you want something on the academic side, works by Stan Metcalfe (1, 2) should be included and the Nelson/Winter treatise is canonical, yet missing. Really everything by Nelson. Start there, and then read Baumol's Microtheory of Innovative Entrepreneurship, or perhaps the gentler, The Free-Market Innovation Machine.

I am less qualified to offer recommendations on the biology side, though I found Stuart Kauffman's work to be uniformly excellent. His At Home in the Universe is an easier read than Origin of Order, but both are great and highly recommended. Not all of the conclusions are universally accepted, though epistasis and fitness landscapes (and Kauffman's NK model) should be important concepts in the social sciences. Ernst Mayr's What Evolution Is, is a fine introductory book written for non-specialists.

This is all tip of the iceburg of course, but it's nice to see so much new work in this field. Most of this remains outside the mainstream of economics, with the partial exception of Nelson/Winter and Metcalfe. In part this reflects a general wariness of evolutionary concepts, which have been grossly misused in the past. But it also reflects a desire by economists, in particular, to maintain their focus on equilibrium and optimization analysis, their two primary tools. An evolutionary perspective can be made to fit these tools, but it does present a challenge to them as well.

And it should go without saying that I'd recommend reading lots and lots of Schumpeter.

From Reset to Prosperity

The recent financial crisis and subsequent recession have left many of us reflecting on our prospects for the future and even revived earlier debates about whether we should have come down from the trees in the first place. 

In “Reading About the Financial Crisis” (JEL, gated |ungated |NPR story), financial economist Andrew Lo attempts to make sense of the first wave of scholarship on the crisis. Unfortunately, according to Lo, academic economists, policymakers, and journalists have been unable to even reach agreement on the basic facts of what went wrong.

While the financial crisis still resonates because of its immediacy, several scholars have begun to make the case that the downturn occurred for systematic reasons representing broader forces. Three recent books from George Mason University (GMU) faculty, and one from a former professor at the School of Public Policy (SPP), attempt to put the recent downturn in broader perspective.

In Tyler Cowen’s provocative treatise, The Great Stagnation (2011), written for the Kindle (and only later published in hardback), we learn that the downturn is only the latest example of a broader and more  fundamental slowdown in our potential rate of growth. This slowdown arose, according to Cowen, because the costs of innovation have risen as we picked all of the low-hanging fruit. New innovations become more reliant on greater specialization and higher rates of knowledge accumulation and as a result become more difficult to produce. Since I talked at fairly great length about Cowen’s work in this earlier piece, I’ll leave it there for now.

Alex Tabarrok's Launching the Innovation Renaissance (2011) is an almost perfect companion to Cowen’s work. Tabarrok, Cowen’s co-blogger at Marginal Revolution, jumps off from the great stagnation, and then asks how we might reform our current policies to reinvigorate our innovative capacity. Tabarrok’s suggestions range from reforming our patent system, to increased reliance on prizes and other incentive mechanisms, to rethinking education and transforming our immigration system. Taken together, these two works provide a coherent view of what’s gone wrong, and one possible set of reforms we could make that would help us get back on track. In terms of "bang for the buck" you get a lot from Cowen and Tabarrok's works. Two recent books build on these themes, but devote more space and depth to their topics.

Richard Florida, a former Hirst Professor of Public Policy at SPP (and now Director of the Martin Prosperity Institute at U. Toronto) frames the recent downturn as a “great reset.” In The Great Reset (2010), Florida writes that our current recession is reminiscent of earlier severe downturns in the economy, such as the Great Depression and the Long Depression of 1873. These earlier crises are notable not just for their severity, but also because they launched new ways of thinking about the world and spurred long periods of inventiveness. These resets purge what is not working and reinforce positive trends that are leading to growth.

Throughout Florida’s narrative, we learn that our economy is currently moving through a such a reset, as we shift from a managerial economy, epitomized by General Motors, into a knowledge driven economy that relies on individuals in cities as the central unit of organization. In an interview for the Atlantic, Florida states (The Atlantic):

There are two tendencies in the world economy. There is a great tendency for low-cost, fairly standardized stuff to spread itself out, and that’s where people say, “Oh my God, the world is flat.” But there’s also this counter-tendency for things to concentrate—to take advantage of these forces of agglomeration and human capital. So what I tried to argue is that that second tendency is very important.

[…] What I tried to do in this piece is say, “I don’t think this great crisis—or great ‘reset,’ as I like to call it—will change this trend. In fact, my hunch is that, coming out of this crisis, our geography will end up more concentrated than it was before.”

One promising trend that Florida cites is the growing concentration of human capital around cities and “mega-regions” like the Boston/New York/Washington corridor. The challenge will be for isolated cities like Pittsburgh to connect to these broader networks. Connecting people in ever-denser networks has become the fundamental challenge in the 21st century.

Finally, Auerswald’s The Great Prosperity (2012) ties together these disparate themes and extends the analysis to the global economy. Auerswald sees entrepreneuers as the primary force driving the outlook and the book focuses on the remarkable actions entrepreneurs are taking to address global challenges. Like Tabarrok, Auerswald also sees incredible potential from immigration and the spread of ideas, but frames the discussion in the broader context of a growing population, which is often portrayed as a coming threat. Unlike earlier theorists like Malthus and Ehrlich, Auerswald, channeling Michael Kramer, explains how new people create new ideas and fundamentally reshape our approach to existing challenges. As in The Great Reset, we learn of the fundamental importance of creating value through connection and collaboration.

In an excellent review of Why Nations Fail, Auerswald reiterates this point (growthology, see also Fukuyama’s review for a similar take). Fundamentally the story of how institutions and economies evolve is a story about people and how: “actual people, or groups of people, acted at particular points in time to push back against incumbent interests, change institutions, and in so doing move the arrow of history."

Through case studies of disparate entrepreneurs, ranging from a mobile phone revolution in Afghanistan to Victoria Hale, who has successfully utilized “orphan drugs” to address issues of global health, Auerswald demonstrates that historically intractable problems can be solved through entrepreneurial solutions.

Our current myopic focus on the past decade and the two most recent recessions and "jobless recoveries" misses the broader and fundamentally promising trends currently underway. Florida and Auerswald both provide excellent maps of our changing terrain, and Tabarrok provides one potential path for the U.S. to escape its current malaise.

The contemporary works that Andrew Lo cites will be crucial to future historians as they reconstruct what went wrong and how we can learn from this experience. But if you're trying to get a sense of where we're headed, and why, you could instead read these two short monographs and two books. Even better, if you actaully want to participate in changing the future, these books serve as important blueprints.

The Coming Prosperity - the Movie (or at least a Presentation)

Those of you who have spent any time with Phil, either in class or in person, know how high-energy he can be and will enjoy seeing him stand steadfastly behind a podium for almost 30 seconds. After that he makes the camera person work for it. That's not the interesting part of course, so check out the talk to learn more about "the single most promising moment in human history."

Kauffman Foundation Interview with Philip Auerswald

The Second Economy

We all know that the web has transformed our lives and dramatically altered how we live. We throw around words like "transformative," and "revolutionary" without a second's thought. But in The Great Stagnation (#TGS), Tyler Cowen makes the point that the internet is mostly good for so-called "infovores" and that consumer surplus has only modestly improved.

Nor does the web provide much in terms of employment potential. Put simply, according to TGS theories, outside of Silicon Valley, the Route 128 corridor, and a few hotspots around the country, we just don't need that many engineers and computer scientists. While these new industries do create net new jobs, they are not doing enough to close the "stagnation gap" that's arisen since the 1970s. Cowen's thesis is usually presented as somewhat of a contrarian take on the web and its impacts, but it has also become one of the more hotly debated books over the past year.

But frankly, I don't think he pushes this idea very far. Brian Arthur, in a very thoughtful piece for McKinsey (The Second Economy) spends far more time focusing on how deep the information revolution really goes (also see his speech at PARC). Arthur believes we are seeing the rise of a second economy, enmeshed over our own, that is built around digital processes. In Arthur's description:

If I were to look for adjectives to describe this second economy, I’d say it is vast, silent, connected, unseen, and autonomous (meaning that human beings may design it but are not directly involved in running it). It is remotely executing and global, always on, and endlessly configurable. It is concurrent—a great computer expression—which means that everything happens in parallel. It is self-configuring, meaning it constantly reconfigures itself on the fly, and increasingly it is also self-organizing, self-architecting, and self-healing.

These last descriptors sound biological—and they are. In fact, I’m beginning to think of this second economy, which is under the surface of the physical economy, as a huge interconnected root system, very much like the root system for aspen trees. For every acre of aspen trees above the ground, there’s about ten miles of roots underneath, all interconnected with one another, “communicating” with each other.

This broader conception of the information revolution strengthens the TGS thesis. As the second economy has expanded, productivity from digitization in business processing has displaced many human processing jobs, such as secretaries, paralegals, typists, telephone operators, draftsmen, and so on. In Arthur's telling, the reason we've seen slower recoveries following the past few recessions is that structural changes are leading to TGS outcomes. Back to Arthur:

Physical jobs are disappearing into the second economy, and I believe this effect is dwarfing the much more publicized effect of jobs disappearing to places like India and China.

There are parallels with what has happened before. In the early 20th century, farm jobs became mechanized and there was less need for farm labor, and some decades later manufacturing jobs became mechanized and there was less need for factory labor. Now business processes—many in the service sector—are becoming “mechanized” and fewer people are needed, and this is exerting systematic downward pressure on jobs. [...] But the primary cause of all of the downsizing we’ve had since the mid-1990s is that a lot of human jobs are disappearing into the second economy. Not to reappear.

So where does all that leave us? One Bloomberg review summed up Cowen's thesis as, "Cowen thinks that now that America has used up the frontier, educated all of the farm kids, and built a couple of cars for every family, we might be done growing for awhile." In more prosaic econ terms, Cowen believes that our potential rate of growth has slowed, perhaps dramatically, and is unlikely to rise in the near term (this reflects slower pop growth, fewer women entering workforce, and so on).

In Arthur's version, technological change will proceed at a tremendous pace and the digital second economy will mirror the size of our traditional economy in 15-20 years. However, rising productivity will displace human workers and we will have trouble finding new jobs. In this, Arthur channels John Maynard Keynes, from his classic "Economic Possibilities for our Grandchildren:"

We are being afflicted with a new disease of which some readers may not yet have heard the name, but of which they will hear a great deal in the years to come--namely, technological unemployment. This means unemployment due to our discovery of means of economising the use of labour outrunning the pace at which we can find new uses for labour.

In one of the strongest sections of The Coming Prosperity, Auerswald connects Arthur and Cowen's writings with earlier technology pessimists, like Norbert Weiner and Keynes. Phil points out that since their warnings we have had tremendous economic growth and the world has gotten better for almost everyone.

More recently, even though the 2000s weren't great in the U.S., it was the best decade for the rest of the world. This observation forms the basis for much of The Coming Prosperity. (It's worth pointing out that Cowen is an optimist and also believes that this past decade really was the best, globally, and that future decades will only get better as well.)

One of the primary reasons for optimism stems from the remarkable actions entrepreneurs are taking to fundamentally reshape the world. Auerswald does a commendable job of portraying these trends and how entrepreneurial solutions are being applied to global challenges. If there is a shortcoming to this approach, however, it is that he only discusses these changes and their affects in the U.S. in passing (to be fair, he spends a lot of time discussing the changing structure of the U.S. economy, which I'll address in a future post).

There are a couple of ways of thinking about these issues. First, I think it's worth revisiting this idea of the frontier. In a recent twitter exchange, Gwendolynne Cross (@brainparts) asked me and a few other people why the word entrepreneurship always triggers the Star Trek TNG theme song in her mind. David Miller (@campus_entre) rightly responded that entrepreneurship is all about the frontier. So what about Cowen's thesis that the frontier has essentially closed?

The same period (post 70s) that has been identified as the era of stagnation has also been identified as the era of entrepreneurship (by Acs, Audretsch, Auerswald, Schramm...). I'll come back to this dichotomy in a future post, but for now lets just accept the resurgence of entrepreneurialism. Entrepreneurship is synonymous with the idea of the frontier.

One reason the frontier is alive and well is that entrepreneurship, despite universities near maniacal focus on technology transfer, spans industries. One example from David Miller's research, out of many cases, is Under Armour. Under Armour was started by Kevin Plank while he was a student-athlete at the University of Maryland. Plank decided to enter a tough market that was already dominated by huge companies with exclusive contracts. But success was rapid and phenomenal and Plank's achievement sparked a revolution in entrepreneurship education at UMD (read David's blog for much more on this).

But even in technology fields, new innovations are creating new needs. According to McKinsey:

There will be a shortage of talent necessary for organizations to take advantage of big data. By 2018, the United States alone could face a shortage of 140,000 to 190,000 people with deep analytical skills as well as 1.5 million managers and analysts with the know-how to use the analysis of big data to make effective decisions.

Thanks to the incredibly sharp John Wilbanks (@Wilbanks) for the link to this report. John also suggested we create an initiative to train data administrators at the community college level, mirrored after Reagan's initiative to train more nurses in the 1980s. Seems like a great idea to me.

Now, in the grand scheme of things a shortage of 140,000 to 190,000 people with "deep analytical skills" and 1.5 million data managers really doesn't amount to much. But if we could somehow add all of these workers to our economy right now, we could potentially lower our unemployment rate by a full percentage point. Obviously that's not possible, but it's something to work towards and with our dismal performance of late, it would be a welcome bit of positive news. Nor is this a lone case - without a doubt there will be many sectors of the economy that will be in dire need of smart, talented, curious, and not necessarily college educated, employees.

More generally this mirrors Alex Tabarrok's (Tyler's co-blogger at MR) call for additional vocational training, rather than continuing to emphasize higher education as the only legitimate goal (see here and here). We should pay more heed to this line of thought.

I'll wrap up this exceedingly long post by saying that there are many remedies to our ills, but that our public discussions and proposed solutions are rarely helpful or productive. It's time to change the discussion to what really matters.

Masters in Social Entrepreneurship

From the GMU Center for Social Entrepreneurship. Clearly I think this is a great step forward for the field:

It's Official! A Master's Degree in Social Entrepreneurship

Mason is proud to announce officially the launch of our Masters in Social Entrepreneurship. Enrollment begins immediately for the Fall 2012 semester. If you've always dreamed of traveling with sensei-like faculty on an interdisciplinary path to becoming a social enterprise black belt, your dream has come true. We welcome applicants from around the globe and from all undergraduate majors for this two-year program. Only a handful of universities in the world offer a graduate degree in Social Entrepreneurship. Interested? Complete this form and we'll keep the details flowing to you.

Prizes as Incentives

We've covered the use of prizes as an incentive mechanism several times before, but NPR has an interesting piece on this today. I like this example of competition based procurement policy (NPR):

Napoleon offered 12,000 francs to improve upon the prevailing food preservation methods of the time. Not surprisingly, the purpose was to better feed his army "when an invaded country was not able or inclined to sell or provide food". Fifteen years later, confectioner Nicolas François Appert claimed the prize. He devised a method involving heating, boiling and sealing food in airtight glass jars — the same basic technology still used to can foods.

Let that sink in for a minute. "Fifteen years later, confectioner Nicolas François Appert claimed the prize." 15 years! The X-prize, arguably a more complicated challenge, was initiated in 1996 and claimed in 2004 (< 10 years.) There is a persuasive argument that we are in a period of great stagnation and that it is increasing difficult to create new inventions and to bring them to market, as we have already picked the "low-hanging fruit" as Tyler Cowen says. These dark projections of the future are one possible path, but stagnation, as I'll discuss in an upcoming series of posts, is not the only trend currently shaping our economy.

The NPR piece is based on a recent NYT article, which itself is based in part on a report by Knowledge Ecology International that catalogs historical examples of prizes. The report is here.

The Coming Prosperity

New book by Philip Auerswald, and the subtitle is: How Entrepreneurs are Transforming the Global Economy. You can preorder at Amazon. Doing so affects the publishers decision to print more or fewer copies of the book, so if you think it's interesting, order now.

Phil has started blogging the book. Here's one discussion on fear (Ch. 13), from his section on what's ahead for America.

Here's a talk he gave on the Hill, summarizing some of the main points behind his approach.