The Microtheory of Innovation

This new book is the culmination of a brilliant career. Baumol, perhaps more than anyone, deserves the econ nobel. His new book is self-recommending, as they say and it is automatically one of the best nonfiction books of the year. The introduction is online (pdf). A blurb:

Entrepreneurs are widely recognized for the vital contributions they make to economic growth and general welfare, yet until fairly recently entrepreneurship was not considered worthy of serious economic study. Today, progress has been made to integrate entrepreneurship into macroeconomics, but until now the entrepreneur has been almost completely excluded from microeconomics and standard theoretical models of the firm. The Microtheory of Innovative Entrepreneurship provides the framework for introducing entrepreneurship into mainstream microtheory and incorporating the activities of entrepreneurs, inventors, and managers into standard models of the firm.

William Baumol distinguishes between the innovative entrepreneur, who comes up with new ideas and puts them into practice, and the replicative entrepreneur, which can be anyone who launches a new business venture, regardless of whether similar ventures already exist. Baumol puts forward a quasi-formal theoretical analysis of the innovative entrepreneur's influential role in economic life. In doing so, he opens the way to bringing innovative entrepreneurship into the accepted body of mainstream microeconomics, and offers valuable insights that can be used to design more effective policies. The Microtheory of Innovative Entrepreneurship lays the foundation for a new kind of microtheory that reflects the innovative entrepreneur's importance to economic growth and prosperity.

CSR in the Food Service Industry

It seems like its tough enough just making it in the food industry, what with the changing (fickle) taste of consumers, regulation, and a constant stream of new competitors, but a new entrant is promising to pay 1% of profits to local charities. CSR is often labeled by its detractors as a clever marketing gimmick and it's something we normally see in larger, more established industries (to be clear, I'm not saying small businesses don't give back to their communities - simply that what's most visible are the large companies that sponsor sports complexes, and the like).

I'll skip the cynicism for now and just say that this is perhaps another good reason for supporting the new food vendors that we've recently been discussing. So here is a bit about TaKorean, from their blog:

Having worked in outdoor specialty retail for over seven years, I was always inspired by Patagonia’s pledge to donate 1% of all sales to environmental causes around the globe. Patagonia started giving 1% for the planet in 1985, and since then businesses around the world have become involved. It was an easy decision for me to incorporate that same philosophy into DC Street Food, Inc. and TaKorean locally. Washington, DC is where I was born and raised, and along with delivering mouthwatering Korean BBQ tacos throughout the city, I’d like to do my part to better the community that has given so much to me throughout my life.

Each month we will blog about our chosen monthly charity in which we are donating 1% of our sales. Over the course of the year we will be able to give back to several different types of charitable organizations, fulfilling our goal of truly giving back to the local community. We at TaKorean believe that businesses have a responsibility to give back to the communities that give us the opportunity to serve them, and we are more than happy to do our part. Delicious food and a positive impact on our neighborhoods, our youth, our forests, our waterways, and our people is responsible business.

TaKorean is set to hit the streets August 30th.

Barriers to Entry

This seems like a natural follow up to yesterday's post. Word is that several area establishments and business improvement districts (BIDs) are upset by the wave of new food vendors and are trying to keep them away from existing businesses. A few details here. A good summary here. The DC government has a site for the proposed rulemaking here. My mind turns immediately to Jack High's The Politics of Purity, one of the best case studies of federal rulemaking (a relatively understudied topic) and about the politics of food quality and regulation.

Kirzner's Arbitrage Entrepreneurship

When I first moved to the DC area the food scene was just beginning to pick up. If you went to a local farmers market you were more likely to see fruit from CA than anything local. Too many of those experiences (it wasn't even organic) soured me on local farmers markets for quite a while - but thankfully things are better now.

One area that's seen particularly rapid growth is food trucks, despite red-tape and other hurdles. A new competitor, Red Hook Lobster (@lobstertruckdc) hit the streets this month and rolled into my neighborhood today. A coworker of mine went to see what the fuss was about. He waited in line for 40 minutes, came back to the office, ran some errands, and the woman who was behind him in line was still waiting (reference photo below). The funny thing is that McCormick & Schmick's is right around the corner and they sell lobster, albeit not lobster rolls. While a bit more expensive, there wasn't an hour and a half wait. Doesn't economics teach us that life is all about tradeoffs?



But of course there is no novelty and no fun in going to something old and familiar. The lobster truck is successful in part because it is new, but also because it is innovative. Here's a bit of background about the lobster company:

The Red Hook Lobster Pound was founded by Ralph Gorham and Susan Povich. While sitting at their dining table in Red Hook, Brooklyn, devouring fresh lobsters that they had just brought back from a friend in Portland, Ralph proposed to his wife Susan that they open a lobster pound in the empty storefront in the building that they owned, and were unable to develop due to the contracting credit markets.

Given that Susan’s family is from Maine, the idea was not that far-fetched. Ralph and Susan opened the Red Hook Lobster Pound six months later and it became the food success of the year, with people coming from hundreds of miles to sample the freshest lobster in NYC. Ralph drives to Maine each week, to pick out the freshest catch he can find. Susan oversees the lobster roll extravaganza, in 2009, the Red Hook Lobster Pound sold over 15,000 lobster rolls and 15,000 pounds of lobster. RHLP also puts on lobster boils all spring, summer and fall at various friends venues, including bars and restaurants. 2010 looks even better!

And of course, you know the story from there. This is a great example of Kirzner's version of entrepreneurship (background). In contrast to Schumpeter, Kirzner argued that entrepreneurs drive the economy towards equilibrium through arbitrage. In this case, our intrepid entrepreneurs, who were not able to start a different business because of credit constraints, recognized that they had access to a good (Maine lobster) that people couldn't get in NYC.

So they settled all of the tough logistical challenges and soon lucky New Yorkers were eating fresh Maine lobster. In much the same way, our entrepreneurs recognized that DC was also lacking, that is wasn't really that far away, and that it might be feasible, not to mention relatively low cost, to start a food truck here. That's to our benefit of course, and I'm thankful they didn't launch in Manhattan, Philly, or Baltimore first.

In my mind, one of the reasons economists continue to focus so much attention on perfectly competitive markets, however unrealistic they may be, is because the model presents a clear picture of the benefits from consumer surplus that emerge in equilibrium. While the real world is complex and dynamic, entrepreneurs like Ralph and Susan improve our options for consumption, increase competition, thereby limiting monopoly pricing, and generally bring the world closer to some hypothetical perfect equilibrium.

These days it's hard not to skim the blogosphere without hearing about interest rates, the Federal Reserve, quantitative easing, or aggregate demand, but it's important to recognize that while all of this is important, macroeconomists frequently (always?) miss the link between entrepreneurs and growth. Likewise, while our politicians frequently talk about entrepreneurs, few have any real conception of their importance, as Carl Schramm ably noted back in January in his State of Entrepreneurship Address (pdf):

But even when policymakers do speak of entrepreneurship, it is most often in abstract terms—how much entrepreneurs contribute to this or that indicator, as if they were more a statistic than a living, human phenomenon. And even that perspective can’t be taken for granted.

The dominant schools of economic thought in the 20th century downplayed or ignored the role of entrepreneurs, preferring instead to see all economic activity as the creature of three fundamental forces: big business, big labor, and big government. Forgotten in this equation was the fundamental fact that every big company had to start small. There are no Athenas in business, no companies that spring fully formed from the mind of their founder. They all begin with one person and an idea.

That person is an entrepreneur … and the idea is what sets him or her apart from the crowd, what compels him to leave a job, strike out on her own, and take a big risk. When that risk pans out, the result is a fast-growing company, hundreds and possibly thousands of new jobs, new wealth invested in every sector of the economy and spent in every corner of society, and—most fundamentally—a new product, service, or business model. Nearly everything we take for granted in our daily lives today began its own life in this way, as the creation of an entrepreneur. Think about automobiles, air conditioning and, more recently, software and search engines.

The bottom line is that we should all be grateful for the efforts of entrepreneurs like Ralph and Susan. While I'm not going to wait in line for an hour and a half right now, I'm sure that in time demand will settle down (0r they'll get a few more trucks) and I'll be able to enjoy a tasty Maine lobster roll. When I do I'll think about what a wonderful service they're providing, but also about the impacts their decisions will have on our world. At the same time, I'm sure their competitors will also be thinking of ways to poach their clientele. All of this competition, while difficult for producers, makes our world a much better place.

Philanthropy and Wealth Creation

Steven Pearlstein directs some much merited attention towards Phil Auerswald and Zoltan Acs' article in The American Interest from last year. The article discussed the unique role that philanthropy plays in American capitalism. While heaping some praise on their work, Pearlstein spends the remainder of his precious allotment of words on the importance of unions and the government and the hollowing out of the middle class. Phil wrote a very thoughtful follow up on his blog, which you should check out (The Coming Prosperity). Here's part of what caught my attention:

Pearlstein's lament about the hollowing-out of the American middle class--while accurate as stated--misses a bigger trend moving in the opposite direction. The fact is that, on a global scale and using measures that mean more than income, inequality has been shrinking dramatically.

The bigger trend of course is the development of a robust middle class in China, and also in India, and the connection of their populations to global supply chains and to the world stage. As these countries have prospered some of their entrepreneurs have succeeded wildly, just as entrepreneurs like Bill Gates have done here. But this begs the question of what role these new entrepreneurs will play in society. One road is to follow Russia and lock them up (a gross simplification and over generalization, I know). Another path is starting to take shape in China (WSJ Wealth Report):

Bill Gates and Warren Buffett corralled some big names when they released a list of 40 rich donors who pledged to give more than half of their fortunes to charity. But the list was underweight in one area: billionaires outside the U.S.

So the question was a natural one for Li Ka-shing, the Hong Kong billionaire who ranks as one of the richest men in Asia as well as the world. Mr. Li is already a pioneer in this area: In recent years he pledged a third of his wealth to his Li Ka Shing Foundation, which supports Chinese colleges and other causes and was among the first major charitable endeavors of Asia’s new ultrawealthy class.

(similar stories abound). Will China, India and Mexico follow the US example and incorporate successful entrepreneurs into the growing philanthrocapitalist movement or is our case something unique, another element of the American Exceptionalism that Seymour Martin Lipset wrote so eloquently about? There are countless examples of how we might treat the truly wealthy, and we've just touched on a couple of options - and I don't mean arguing about the Bush tax cuts.

But once we start thinking about the role of public policy in an entrepreneurial economy, we really hit on some of the core issues of what it means to be an American (or Chinese, or ...). Our society has a clear story built around success and potential. We believe strongly in equality of opportunity and we take great pride in rags to riches stories, however representative they may or may not be.

As developing countries begin to wrestle with these issues, they will have to define more explicitly what type of society they are and what values they hold dear. Some might go in the direction of Finland or France while others might choose a course more similar to our own. While growth is not inevitable, the rapid success in many parts of the developing world, and the fact that we are even talking about the role of billionaires in these societies, is clearly the most important development of this century.

Interviews with Hayek

GMU folks might enjoy this interview by Jack High of Nobel Laureate F.A. Hayek. There are several other videos in the series, which should appeal to everyone, especially if you want to know a bit more about Hayek than what was in the Hayek vs. Keynes rap video.

Some Reasonable Thoughts on the Stimulus

I normally steer clear of such topics, but Megan McArdle offers some good thoughts:

Wading through the online debates, I note that opinions on stimulus are nearly 100% correlated with the composition of that stimulus, and the opinionator's prior view of that activity. So when Democrats are in power and stimulus is mostly spending, liberals think that the stimulus is an issue of fierce moral urgency stymied by venal greed and rank idiocy, while conservatives develop deep qualms about budget deficits. When Republicans are in power, and stimulus consists mostly of tax cuts, Democrats get all vaporish about deficits and the income deficit, while Republicans suddenly realize that the normal rules don't apply in an emergency. When out of power, both sides will grudgingly concede that some small amount of highly temporary stimulus might be all right, but note (correctly) that the other side seems to be trying to make permanent as much of this "stimulus" as possible.

For me, then, this mostly ends up as a proxy war over the level of government spending, a war I'd rather fight honestly on value grounds rather than attempting to disguise my preferences with a shoddy veneer of "scientific" logic.

Consequences of Entrepreneurial Finance

From the NBER Digest:

Some of the 'softer' features of entrepreneurial financing, such as angels' mentoring and networks of business contacts, may have helped the new ventures the most.

Angel investment groups are an important and growing source of entrepreneurial finance. These groups - which are typically semi-formal networks of high-net-worth individuals - meet regularly to hear aspiring entrepreneurs pitch their business plans before deciding whether to invest in such ventures. In The Consequences of Entrepreneurial Finance: a Regression Discontinuity Analysis (NBER Working Paper No. 15831) co-authors William Kerr, Josh Lerner, and Antoinette Schoar analyze the role of these "angel" entrepreneurial financiers in the success and growth of new ventures. Their approach also exploits breakpoints in the funding process to separate the role of matching (that is, good entrepreneurs pairing with good investors) from the value provided by the angel investors.

What is the ROI from Higher Education?

Bloomberg this morning offers its analysis of this question. MIT comes out on top, with the highest net return on investment (about $1.7 million over 30 years), although it doesn't have the highest annualized rate of ROI. That honor goes to the Georgia Institute of Technology, which has an annualized net ROI of 14.2%. By comparison MIT's is 12.6%.

One story about the relative merit of attending MIT versus a public school with much lower in-state tuition is that entrance is equivalent to purchasing a lottery ticket (Brad DeLong discusses one version of this). MIT students will no doubt find an excellent job upon graduation, but some will find a job that is so excellent that they will soon be millionaires. Presumably the odds of becoming super-rich are higher from one of the elite schools than for one of the bargain schools. Of course, it could simply be that MIT is a great school and offers a superior education or perhaps that students who enroll are more motivated and thus just do better after graduation. Thoughts?

The Big Questions: Health Edition

From the World Policy Journal: "What is the most pressing health issue and how can it be solved?" The intro article offers several answers by a panel of experts (PDF). The TOC for the full issue, which is focused on issues of global health, is here. John Barry, the author of the wonderful The Great Influenza, has a free, ungated article on the next big pandemic (PDF). It is self-recommending, as they say.