Growthology

An Exciting Day

I just received in the mail a copy of Matt Ridley's forthcoming book, The Rational Optimist. I was fortunate enough to be able to attend a seminar last year at which Ridley discussed the book and solicited input and ideas.

Based on that discussion and Ridley's extraordinary intelligence and writing ability, this book will be stupendous, no doubt about it. Check out his blog here; good stuff.

From a Drunkard's Walk to a Pile of Drunks

This morning Paul wrote a very insightful post about job creation by new companies, trying to put things in a larger economic and mathematical context. (I am one of those (blessed? unfortunate?) people who thinks the game of baseball explains everything in life, including the economy, so it helps me to think of Paul's post in terms of the never-ending debate between sabermetricians and those who prefer a non-statistical view of baseball. In this view, Paul's post is the equivalent of putting a 5-hit game on Opening Day in a larger context of probability, rather than imbuing it with deeper meaning.)

I want to try to round out Paul's point by discussing the accumulating universe of firms over time (or, the accumulating pile of drunks in Paul's illustration). In an economy with a more or less steady influx of new firms and more or less consistent survival rates, we will have an accumulating number of firms as an economy moves through time. And, in any given year, "young" firms (5 years old and younger, including brand new startups) will constitute the largest percentage of the overall number of firms. By sheer arithmetic, then, shouldn't we expect that we will see a large number of new jobs from the largest cohort of firms? Maybe, maybe not.

Here is how it might work. Let's start with an economy with zero firms. In Year 1, we have 700,000 new businesses started (firms plus establishments; my thanks, by the way, to Mike Horrell for research assistance). Using survival rates calculated from the Business Dynamics Statistics database, we know that the average survival line for firms founded each year since 1977 looks like this:

So twenty percent of new firms survive to age one, two-thirds to age two, and so on to age 5. For age 6 and up, Mike used imputed survival lines extrapolated out from age 5. The real-world will be lumpier, but from what research I've seen from the SBA and others, the survival line post-age 5 is mostly a smooth downward slope. At some point, it likely becomes a near-asymptote, although some organizational research does suggest that survival for several decades, say to age 40 and beyond, is quite rare--conceivably, all firms die at some point.

Using these survival rates we can construct a chart showing the birth, death, and survival of firms as an economy moves forward from Year 1. In the first year, there are the 700,000 new firms. In Year 2, the initial batch of startups now consists of 552,440 firms, joined by the second year's round of incoming startups, another 700,000. So there are now 1,252,440 firms in this economy. If we continue this process out to, say, year 25, the process looks something like this:

 By year 10, firms ages 5 and younger account for nearly two-thirds of all firms. By the end of the series, in year 25, firms ages 5 and younger account for one-third of all firms. With assumed constancy of startups and survival rates, the absolute number of firms younger than age 5 remains the same but constitutes a decreasing proportion of the entire universe of firms. It remains true, however, that in any given year, young firms make up the largest cohort of companies. This would be reinforced if we added a constraint that no firm survives past, say, age 20. The point is that if the level of firm formation is steady (which it has been in the United States), and if survival rates for new firms have been consistent (ditto), than this is what an economy's population of firms would look like over 25 years.

What does this mean for job creation? It means we should expect the largest number of new jobs from the largest cohort of firms. I don't think is purely a function of the numbers, however--data from economists at the Census Bureau indicate that young firms add, on average, 3.7 (net) jobs per year. Firms ages 6 to 28, meanwhile, add (net) about one job per year. The oldest firms (age 29 plus) add nearly two and a half (net) jobs per year--still fewer than young firms. So it's true that young firms are adding one to two more (net) jobs per year than older firms, but this might be where Paul's drunkard's walk comes in.

So if young firms add 4 jobs per year, that means they add, in net terms, about eight million per year. In year 25, for the other 5 million firms in the economy, they will add about five million jobs; in year 10, they will add four million. (Note that in year 25 we haven't yet reached a point with any 29-year-old plus companies.) Many of those older firms will of course be larger than young companies, but we're talking about their net incremental contribution to American employment. 

None of this changes the fact that young firms account for most net job creation in the United States over time. What I'm wondering about is the why of this. Is it a subjective or normative comparison: young firms are "better" than all other companies? Or is it (partly) a function of mathematics and probability? What, if anything, does this mean for policy? It's never a bad thing when commentators and policymakers begin to realize the importance of new and young companies and stop seeing the economy solely in terms of our behemoth firms, but it's not clear what policies fall out of this if what we're talking about is a natural accumulation of firms and the ensuing natural distribution of net job creation. There is still plenty of dynamism to be worked in here--job creation, job destruction, the outstanding growth of certain companies--but this is (I think) an important point to make. 

It parallels something else I've been working on with regard to high-growth or top-performing firms. When we say that young firms create X% of jobs, or high-growth firms account for X% of job creation, should we be surprised that reality looks this way? Or, should we be more surprised if the economy did not look like this? In the case of high-growth firms, the question is: are we surprised that we find something resembling a Pareto distribution? Don't get me wrong--this does not belittle the importance of new and young firms and what they contribute in terms of jobs and innovations. Far from it. But it is important to keep things in perspective, mathematical and economic. Kind of like an Opening Day performance.

Startups in an Evolutionary Model

In describing how human knowledge advances, Donald Campbell devised the BVSR model to explain the evolutionary way in which knowledge accumulates. BVSR stands for Blind Variation and Selective Retention and is more or less natural selection applied to creativity and epistemology. Others have explored Campbell's with great insight and how it applies to fields such as organization science.

Evolutionary economics moves in and out of fashion but for the most part remains on the fringes of economic thought. Prompted in part by Paul's post earlier today, I'm wondering today about startup firms in a BVSR model of economic dynamics. It's no surprise (and, I don't think, controversial) that free market competition works through an evolutionary process of selection. Individuals and companies try various things (new products, services, processes) and their fate hinges on whether or not the market "selects" them vis-a-vis competing ideas. These new products and services are the variations in BVSR, whether radically new innovations or incremental improvements on something that already exists. We throw lots of spaghetti against the wall to see what sticks. Economic variation, of course, is not completely random since firms often seek to satisfy a previously identified market need or solve a heretofore unsolved problem. Variation is, however, blind in Campbell's sense, in that we do not know beforehand what will or will not succeed. "Blind" refers to our knowledge (more specifically, our lack of knowledge) about the consequences of any particular variation.

So we continuously introduce new variations into the market. The manner in which they are winnowed and propagated is "selective retention." Selection is clear: a new market variation either succeeds or it doesn't. Or, more precisely, it either survives (is selected) or doesn't survive (is not selected or selected against), with survival not always a proxy for subjective superiority. Here, it seems like the BVSR model advances somewhat beyond the standard view of the free-market-as-natural-selection (in addition to the explicit recognition that variations are blind). Once a variation is selected, what happens to it? It is retained, meaning it somehow propagates through the population. A variation doesn't merely survive--it grows and spreads. 

How would you increase economic growth or increase innovation through the BVSR model? Let's say each element is multiplied by the others, so growth or innovation is the result of V x S x R, all divided by B. Increasing any one element in the numerator should theoretically increase the product. (It's not clear that this should be true, by the way. I haven't convinced myself that multiplication is correct here. I suppose it's conceivable that it could or should be, for example, "+" R. This isn't a research paper and I'm just following an idea here, so please feel free to take issue with this. At this point, it's of de minimis concern.) According to this, then, you could increase growth or innovation by increasing variation (the introduction of new products and services), improving the selection process (so only "good" or "right" variations are selected), and improving retention, to the properly selected variations quickly achieve rapid scale and propagation, disseminating their benefits to everyone.

How would we approach startups here? Obviously, startups are one type of variation (at the population-level of the economy). They are selected for and against: roughly half of new firms (48%) survive to age five, with the survival curve slowly falling after that. (I've seen some data indicating that one-third of new firms survive to either age 7 or age 10.) Survival, of course, tells you little about success or quality, and selection in the case of firms is an ongoing process. Some research suggests that only the tiniest handful of companies survive for more than a few decades (suggesting that groups such as those companies on the Fortune 500 are both an incredibly small minority and, perhaps, a secondary story--maybe failure is the dominant story of economic selection). Retention could be either the organic growth of young companies or, I suppose, acquisition by larger, more established companies. (Revenue or employment growth or both would here serve as a proxy for another way of looking at retention: spread of a company's product through the market.) With the denominator, "Blind," we might want to reduce the blindness of our variations--that is, wouldn't we want to have a better idea of the prospective fate of new firms? Or, should B be another multiple here? Would increasing blindness be better because it would throw more of the burden onto the competitive process? Perhaps B is neutral here? That is, perhaps it cannot be increased or decreased? 

In any case, let's assume, with good reason, that startups are absolutely essential to innovation and economic growth. To increase these, what would we do with startups in the BVSR model? To begin with, could we reduce the blindness of a particular startup's fate, or the fate of all startups together? (It's not clear, moreover, what Blind should refer to here: mere survival to a certain age? Success, however nebulously defined?) Let's say Blind refers to the state of knowledge facing the founders of a new company: they do not know, and can't know, whether or not they will "succeed," however they define that term. (Although, if your objective is to simply work for yourself or the ability to wear flip-flops to work, then merely starting your own company can be considered success.) From a macro perspective, it's not clear that we can either reduce or increase blindness at the startup stage--the figure given above for survival to age five (48%) has been remarkably consistent across time. The survival rate for new firms, that is, doesn't appear to vary much founding year. There is some variance by sector but again, the survival lines within each sector are rather consistent, so it's not clear how we could either raise or lower the survival line. Of course, if survival rates have been consistent for thirty years, then perhaps the Blind element is neutralized: there is a 50-50 chance your firm will still be around five years from now.

Now, to Variation. Here, you would simply want to increase the number of new firms that are founded each year, with the expectation that trying more new variations would lead to more "good" things being selected and retained in the economy. An increase here means an increase there. I am sympathetic to this strategy, but I'm unclear as to how we do it. Firm formation in the United States has been pretty steady for two or three decades and the question of how we increase it is not so simple. Things like awareness and lowering barriers to entry are probably our best bets but these will vary by sector and geography and characteristics of the founder. All of this assumes, of course, that a basic increase in startups (more variation) will result in an increase in innovation and growth. And this assumes that we would see a similar proportion of innovative ideas and potentially successful firms in a larger pool of variations--is that a valid assumption? 

Selection of startups occurs through a variety of mechanisms. One, of course, is the market itself: you start a new firm and quickly find out whether or not it will selected in or out. If we increased the number of startups (increased V), then conceivably our selection mechanisms could remain the same, simply working on a larger population of firms. If, however, V remained constant, we might want to intensify S by looking more carefully (somehow) for promising ideas or "sure-thing" innovations. I suppose this is the role played by venture capital firms and accelerators such as Y Combinator. They have many entrepreneurs approach them and apply to them, but only select a few for funding or developing. Those that they do not select still go on to start new companies, so the claim of these particular selection mechanisms is that they are intensifying S so as to increase R: selecting the "best" of V, those with the most potential for retention and propagation by the market. As an overall strategy to enhance Selection, we would look to increase market competition in general, removing protective barriers around certain industries and firms, for example. A perennial complaint about some European economies (and conclusion of numerous McKinsey reports) is that they are not as competitive as the United States--stultified selection suppresses innovation and economic growth. It's also conceivable that simply increasing V would naturally increase S (they are, after all, multiplied by each other)--more firms overall would mean more firms competing. 

These notions of Selection, however, presume that any selection process, whether in biological evolution or in free market competition, is an optimizing one--that the "best" organism or population or idea or company always beats out inferior competitors. Adaptive fit, after all, implies such optimization. Yet we know that natural selection is only one way in which genes and organisms are winnowed and propagated. The role of accident and randomness in evolution cannot be forgotten: we like to think of dinosaurs as having met their proper evolutionary fate because they were all slow and dim-witted. But many evolutionary theorists have pointed out that, if a meteor or volcanic explosion did the dinosaurs in, then that isn't necessarily "natural selection" in terms of adaptation and competition. It was an exogenous event and the emerging population of smaller mammals happened to be better suited for survival. So, yes, an exogenous event "selected" out dinosaurs, but it wasn't necessarily the "optimizing" path we like to imagine. The same applies to the selection process in terms of firms and ideas: Silicon Valley bested Boston and Dallas because it had a better ecosystem, the selection process was more optimizing. But what if William Shockley's mother lived in Dallas, not Palo Alto? What if Frederick Terman had not contracted tuberculosis and had ended up returning to MIT? I realize these are entirely speculative and that the obvious riposte is, 'Well, that's just how things happened.' My point is simply that we shouldn't assume that Selection always implies optimizing; human behavior and group dynamics are such that the economic process contains plenty of satisficing behavior. (We also shouldn't forget that an entity such as a firm can become over-adapted to certain circumstances and thus too sessile to change; selection could work too well.)

Finally, how would we enhance Retention? What would this mean? It could entail somehow promoting those firms that are selected--say, those that survive to age six--via certain rewards such as a retroactive tax credit or something like that. Or, it could mean favoring those firms that grow rapidly in their first few years and have rapidly passed through V and S and we want to enhance their retention and propagation. It could mean reducing barriers to "scale," whether in the form of regulations, corporate taxes, whatever. (I continue to maintain, however, that the effect of certain taxes on entrepreneurship is not nearly as straightforward as some might like to believe.) Maybe we think of Retention as going public, in which case perhaps changes need to be made to Sarbanes-Oxley. Over the past few years, around 80% of VC exits have been acquisitions, not IPOs, and many of the companies coming out of accelerators are acquired by companies such as Google.

In any case, I don't know if this has added anything to the general discussion of entrepreneurship and economic growth or not. If we think about startups through the BVSR model, there are probably certain areas in which we can make changes to enhance the economic impact of startups, although some of them steer quite close to "picking winners." In general, as I said, I favor increasing V, but I'm as yet unclear as to how we go about doing this. Importantly, increased Variation should apply to firms of all types, not simply in favored sectors or those sectors we think (or would like to think) represent promising areas of innovation. Firm formation and innovation are compounding phenomena, so increasing the overall level of startups should (emphasize, should) raise our rates of innovation and growth, and this should be true whatever sector of the economy we are discussing. Information technology has been hugely important for American productivity, both in its production and its use in sectors like retail. We needed IT, but we also needed all those new retail outlets and supply chain innovations for the IT to become productive. It's possible that a BVSR-type of analysis in, say, 1995 might have concluded: we need more IT startups and fewer new retail stores. The economy might not have performed as well as it did.

Why Should Complexity Imply Fragility?

Last week historian Bryan Ward-Perkins authored an interesting Financial Times op-ed in which he compared the present recession to the post-Roman Empire economy in the British Isles. Conditions then, needless to say, were "extremely bleak." Part of the reason for this, wrote Ward-Perkins, was that there was such a long way to fall from the advanced Roman economy. Going further, however, he explicitly links the collapse to the level of advancement--no matter what type of wings Icarus wears, he will always fail simply because he flew so high and close to the sun.

"Almost certainly the suddenness and the catastrophic scale of the crash were caused by the levels of sophistication and specialisation reached by the economy in Roman times. The Romano-British population had . . . relied on widespread markets to sustain their specialised production. When insecurity came in the fifth century, this impressive house of cards collapsed."

Well, there you go: an economy can only push Adam Smith so far. Apparent market sophistication--trade, division of labor--will eventually (and, seemingly, inexorably) become a weak structure, vulnerable to the slightest perturbation, upon which it will collapse:

"The more complex an economy is, the more fragile it is, and the more cataclysmic its disintegration can be."

That second clause seems pretty valid: the higher you fly the further you fall. But I think it's actually quite arguable, and the reason is because the first clause, Ward-Perkins' main point that complexity increases fragility, is wrong. It makes intuitive sense, of course, and the house of cards analogy misleadingly reinforces that intuition. The more cards you add, after all, the more fragile that house becomes; everyone knows that.

But a complex economy is not like a house of cards. Much of the complexity research over the last thirty years or so--however you may judge its worth en toto--has demonstrated the robustness of complex networks. And, as readers of Joseph Tainter know (I assume Ward-Perkins has read Tainter), there is little reason to think that a complex society like Imperial Rome, having weathered many different stresses over several centuries, should all of sudden turn to a house of cards because of the very complexity that made it strong in the first place.

To argue that complexity is equivalent to fragility requires you to increasingly argue backwards for why complexity turns from strength to weakness. The ultimate cause for the collapse of complex societies, as Tainter showed, is not their complexity. It may end up being a proximate cause or contributing factor, but not the ultimate reason. The reason, in Tainter's telling, is the marginal returns curve: at some point, a society's investment in complexity may yield diminishing marginal returns. When and if collapse does occur, moreover, it is not necessarily a bad thing; to be sure, it may bring all sorts of negative consequences. But, if the marginal returns hypothesis is correct, then the disintegration of a once-complex society into several simpler constituent parts should reset that curve and yield, once again, increasing marginal returns. People may be better off and, in many cases, actively choose to dissociate from complexity.

It's easy, of course, to argue too far in this vein and rely wholly on the supposed robustness of complex systems as a reason why they should perpetuate themselves. The reason complex systems persist and survive shocks is not their innate robustness; it is that they contain deep wells of potential adaptations (exaptations). It's also tempting to ascribe too much worth to complexity in and of itself. In social science and many of the natural sciences we continue to equate "complex" with "better," "simple" with "worse." The notion of progress up a ladder of complexity is seductive, and underlies the arguments of both avid proponents of complexity and those, like Ward-Perkins, who see the danger in too much sophistication.

The Market is Moral

Nobel laureate Edmund Phelps (also a Kauffman grantee) published this stellar essay last month, which I belatedly read today:

The definition of economics with which most textbooks begin—“the study of the allocation of scarce resources”—is accurate but misleading, for it leaves out the most interesting part of the problem. 

In truth, we are forever innovating to stretch our resources. Transportation was one of the scarcest goods during the first half of America’s nineteenth century, but by the end of the century the railroads had made it so abundant that the face of America changed irreversibly. That could be said today about information. Innovation makes scarce goods abundant. This quest to do better, to go farther, to extend our reach is part of what makes us human. There is more to economics than the desire to consume and to avoid risk.

Which brings us a step closer to connecting morality and economics. Morality, after all, is more than obedience to the rules of social conduct; to be moral is to foster the betterment of humankind. If we place innovation at the center of economics, then we in effect make a sweeping assertion about human nature—for we claim, at some level, that man is an innovator. 

 

The Not-So-Simple Role of Energy in the Economy

Last week Tim wrote about a New York Times story on "biophysical economics," a small but apparently growing group of scholars who seek to make economics more in tune with the laws of thermodynamics and energy use. Several blogs linked to the story, which I take to mean that this line of thinking was somewhat new to the economic blogosphere. Many of the ideas put forward by these thinkers, however, are not new and if you happen to be interested in things like "net energy" and "energy return on investment" (EROI) and the continuing viability of civilization, you would not have been too surprised by the story.

Tim used the story as the latest installment in his "Pernicious Dystopian Myth" series, which I wholeheartedly applaud and periodically endorse. But for the sake of intra-blog dialogue, I was a bit confused by some of Tim's points. To recap: Tim says "efficiency in energy consumption" will continue," "efficiency in goods consumption is a dominant feature of economic growth," and that since services are less physical than goods, we should expect a less energy-intensive economy.

Let's take these in reverse order. First, services have never been a smaller share of the United States economy than manufacturing. This goes all the way back to 1789. Services have always been an important part of the economy, so it's not necessarily true that more and more services (there has to be a ceiling on this, one would think) will lead to a less energy-intensive economy. Furthermore, services are not necessarily more friendly toward energy efficiency. One of the great ironies of the "intangible" new economy is that many of things techno-utopians like to laud as transformational (the Internet, Web 2.0 companies, software startups, etc) are fundamentally dependent on something as physical as energy. Specifically, electricity and thus coal and water and nuclear power. The computing cloud that is a favorite futurist topic would not exist but for ways to generate electricity. Thus, we have no choice but to remain focused on energy use and extraction and efficiency, notwithstanding our so-called intangible services economy. 

(As an aside, something as cutting edge as IBM's push into services science recognizes the enduring physicality of many service systems.)

Second, yes, efficiency in goods consumption has been a mark of economic growth. This doesn't mean it will continue to be. More deeply, some research does show that we have had to use more and more energy (as well as debt, a subject for another day) to generate incremental increases in economic output.

Tim's third assertion was that energy efficiency in general will continue. Efficiency here is a slippery term; the biophysical economics crowd, as noted in the NYT story, focuses on something called the energy return on investment (EROI), which basically measures the cost-benefit ratio for energy production and consumption. What is the marginal energy return on increasing investments in energy generation? You could still see positive efficiency even if the EROI is narrowing. And, in fact, mounting research does indicate that, at least when it comes to petroleum, the EROI has been falling. We are expending more and more energy to extract energy: the marginal return is falling. So even if "efficiency" appears to continue, it doesn't mean everything is fine and dandy.

In fact, there is nothing dystopian about saying that, pending a negative EROI on the source of energy that makes the world economy run, we are in for a rude awakening when it comes time to transition to whatever comes next. (Natural gas?) It might actually help if the biophysical economists made some headway and expanded the purview of economic analysis to include the things that actually make the economy go. (In this vein, Steven Johnson's latest book, The Invention of Air, includes some delightfully pithy observations about the sometimes invisible, sometimes ignored, connections between what is in the ground and what occurs in the human economy.)

So anyway, Tim's right that pessimism can go too far. But that doesn't mean pessimism is unwarranted.

Economics Bloggers Video

Here's a video of the Kauffman Econ Bloggers Forum:

Thanks to Matt Pozel and Matt Long for an awesome production effort.

The Distinct Dystopian Possibility

Tim posted two interesting entries in recent days, both touching on the recurrent question of whether or not we are entering an extended period of Dystopia. Given that it's been just over a year since I happily discounted the possibility of American Dystopia, I thought I might weigh in here. I won't keep you in suspense: I dramatically downgrade my optimism.

There are two related questions here, one pertaining to recent history, the other toward future projections. The first is whether or not the United States economy has really performed as well as we all like to think it has over the past two or three decades. This is a contentious issue among economists and I have nowhere near adequate space to address it, so I'll confine myself to Tim's point:

". . . the existence of the pernicious Dystopian Myth that middle class incomes are stagnant. The Dystopian Myth is social poison, a fiction shouted by the negative nabobs that convinces voters the American economic system is failing them."

Say it ain't so . . . but I will: it's sort of true. In June, Monthly Labor Review published this article, the abstract of which reads:

"OES [Occupational Employment Statistics] data from 2002–2007 reveal that an overall shift in employment towards occupations with lower mean wages hindered growth in the U.S. real average wage and that wage growth was concentrated in higher paying occupations; the data also show a shift in employment from the middle-paying occupations to the highest and lowest paying occupations."

The gist, as you can tell, is that real wage growth in this recent five-year period was basically stagnant overall because of the large growth in jobs paying the lowest wages--which actually appears to have come at the expense of better-paying jobs. The MLR article conveys the image, though not in so many words, of an emerging barbell-shaped wage distribution. Heartening. (I should just point out that Tim's characterization of the myth as a ploy to fool American voters is actually somewhat true--because voting participation follows income. Self-flattery as political vote-buying.)

Onto the larger point: is the United States now entering a Dystopian period of slow or stagnant growth, marred by class conflict, a dysfunctional national legislature (oh, wait, we already have that), and a "new normal" of diminished living standards? Again, this is a subject for a much longer disquisition, but for what it's worth, some recent reading I've been doing--and too many conversations with Paul Kedrosky--has me convinced that we are in for some very trying times ahead. We will see a short-term bounce in GDP growth here in the next quarter or two, but possibly 2010, and more likely 2011 and beyond, will bring discord, precipitated in large part by not only a higher "normal" of oil prices but also the realization that we are about to enter, prepared or not, a serious energy transition. Oh, and China's entire economy might be a bubble and we might be on the brink of having a failed state on our southern doorstep--because of plummeting oil production, not drug lords. (But they don't help; of course, if California legalizes marijuana to deal with its fiscal problems, this would be a boon for Mexico. Wouldn't it be ironic if the United States, irrespective of what party is in power, supported drug legalization because it would forestall the development of a basket case next door?)

OK, so I sound semi-apocalyptic. Don't get me wrong: I don't expect (at least, I don't think I expect) a Joseph Tainter-esque societal collapse. But there is a worrying disconnect between everyone who claims to see "green shoots" around every corner, even those who foresee a longer recession but eventual "normal" recovery, and the reality of long-term energy trends. Look, there is a reason why the Industrial Revolution has been more aptly named the Promethean Revolution (one of the best books on it is Landes' The Unbound Prometheus): humans harnessed inorganic energy. Our entire economic model is based on the premise of cheap coal and cheap oil: techno-utopians consistently ignore the inconvenient fact that much of that computing power they love to tout runs on such energy.

The obverse is that our economic model is not premised on permanently higher oil prices, whatever climate feedback loops we may be instigating, and the nontrivial risk of geopolitical instability. (The U.S. military, by the way, has little room for anything but a realistic appraisal of the future.)

Little of this will be new to readers: we all know we have energy issues to deal with. And, sometimes it's much easier to be pessimistic than optimistic about the future. To be sure, there are a few reasons for optimism. One is that humans are adaptive and we will likely find a way to adapt to the energy challenge. The profit motive will, or should, play a key role in this transition--this doesn't mean there is no role for government. Obviously, there is and should be: federal labs will be critically important going forward, but we need to unlock the innovations in those labs more efficiently. But government's role will be to do what it always does when it acts as facilitator, viz. frame incentives. In this case, it seems that a carbon tax would be an almost no-brainer. Then again, the fact that a carbon tax is treated like a shoot-the-moon option simply reinforces the pessimistic outlook. 

A key piece to moving forward through the next energy transition--and to possibly suppress or at least mitigate whatever geopolitical unpleasantness arises therefrom--is the supply of entrepreneurs. I don't just mean clean tech. We're talking about wholesale economic and social changes here--let's hope in slow motion, rather than abruptly. Don't just take it from me. At the recent World Economic History conference, Robert Ayres presented this wonderful presentation on the relationship between energy and economic growth, concluding that only entrepreneurs can take us forward. How's that for framing a policy debate?

(This pessimistic outlook, of course, will bring some amusement, namely, the perpetual cognitive dissonance of so-called conservatives and liberals as they endlessly bloviate in endless legislative fights. Rightward-leaning folk don't really seem to have dealt with the inherent tension between their Edmund Burke impulse and their defense of free-market capitalism as a ceaseless source of creative destruction. You can't sanction one type of change and seek to prevent the other. And liberals--or in today's parlance, progressives--haven't reconciled the exact opposite dichotomy: their embrace of "social change" as an all-encompassing yet vacuous strategy, but their readiness to preserve nostalgic remnants of the mid-twentieth century economy.)

The most frustrating thing about such a discussion is that it's quite difficult to talk about an alternative future because all we have to structure our imagination of that future is the present state of affairs. When we're trying to imagine what the next economic model will be, and how it will differ from the one that has carried the world forward for the last century and a half, we have little to draw on by way of reference points. But this, oddly, might be the strongest case for optimism: human knowledge always advances in a desultory fashion. We adapt by trial and error and adoption. The potential for future innovation and new knowledge creation shouldn't be in doubt--it's the institutional response, the adoption and absorption, that should be of concern. 

What's important is that we stop discounting the very real possibility that the future could be anything but bright: the fact that the last two hundred years have seen more or less upward progress in terms of human living standards, steadily spreading over the entire globe, is not a reason to believe that the future will simply be a continuation of this. Believing so is the mistake made by Taleb's "turkeys."

Back to the (Sessile) (Corporatist) Future

Sometimes you read something and you almost can't believe that it is a serious attempt at an idea. Such was the case when I perused Michael Lind's recent essay, "The Case for Goliath." To briefly summarize: bigger is better.

In a twist on the stale discussion of regulation v. deregulation argument, Lind proposes that the United States should seek to resurrect what he calls "utility capitalism," characterized by cartels, regulated oligopolies, and higher prices. His rationale is that such a system--particularly in finance, automaking, aerospace, energy, and much of the nontradable service sector--would restore middle-class prosperity and promote innovation. The latter would occur, according to Lind, because large, oligopolistic companies have more incentives to invest in innovation. (He predictably relies on Schumpeter's famous capitalism-to-socialism prediction, but apparently someone failed to tell him that Schumpeter's prediction was actually semi-ironic. Thomas McCraw discusses this well.)

There's really not much to say here except, wow. Lind proposes, for example, that we should consolidate the domestic auto industry down to one national champion to enhance global competitiveness. Wait, is he saying that the bankruptcies of GM and Chrysler came about because we had too many auto companies? As it happens, I read Lind's essay shortly after reading Jonathan Zittrain's intriguing op-ed in yesterday's Times in which he highlighted the threats to freedom and creativity of bigness on the Internet. The dangerous irony touched on by Zittrain, one that Lind would do well to keep in mind, is that the world-changing Web 2.0 innovations we all like to think are propelling us into a glorious world of individual creativity are highly dependent on a handful of extremely large companies like Google and Microsoft. You don't get the globe-spanning impact of Facebook and Twitter without Google's ginormous server farms.

At any rate, there are really three small points I wish to make regarding Lind's piece. First, he either badly confuses or purposefully conflates the monopoly power of dominant firms (a bad thing) and the temporary monopoly profits that serve as the reward for entrepreneurs and the incentive for persistent innovation (a good thing). There is a big difference.

Second, in support of his cumbersome-is-best argument for "utility capitalism," Lind says, "Most of the major breakthroughs on which the modern technological revolution depends took place before the era of deregulation--and often in the labs of monopolistic corporations like IBM, AT&T, and Xerox." True, but you really shouldn't stop reading history in the 1970s: Bell Labs did not use the transistor to launch the semiconductor revolution; Xerox PARC did not take the graphic user interface and launch the PC revolution. These inventions would not have been breakthroughs but for the work of entrepreneurs who worked outside the confines of large companies. This is the recurring pattern of economic history.

Finally, there is this: "The fact that such unfunded regulatory mandates would drive many small service-sector enterprises out of business might be a blessing, not a curse. After all, what is the point of celebrating job creation by small business if thejobs are awful and unstable?"

Well, you know, JOBS. 

(Two of my points here--regarding the Internet and job creation--are not to gainsay the importance of high-growth firms. This, in fact, is an as-yet incompletely worked out area--the tripartite tension among new, young firms, the rapid growth of a handful of them, and their transformation into large companies. A subject for another day.)

Insurgent Capitalism

Dane Stangler - growthology.org Guest Blogger - wrote up a typically deep and insightful essay over at Real Clear Markets:

The challenge is to orient regulation such that it protects access to entry—our economic policy must, in other words, become pro-insurgent. It must seek to maintain competition and help structure the economic playing field so as to give the widest scope to individuals and companies working at the margins to challenge existing ways of doing things.

BitTorrent, Harbinger of a Tech Downturn?

In this latest financial downturn, many market analysts have said that technology companies look to be okay. BitTorrent begs to differ, searching as it is for both a business model and a new mission. What are the implications?

From The New York Times's blog,

Today BitTorrent informed about half its employees, or 18 people, that they were being let go, according to a person familiar with events inside the company. That is in addition to a 20 percent staff reduction in August. In addition, a co-founder, Ashwin Navin, said yesterday that he was leaving the company, although he informed the board of directors of his exit in March.

A person with knowledge of BitTorrent’s plans also said the company would soon close its BitTorrent Entertainment Network, once conceived — and covered in the press — as a rival to iTunes. The company, with its remaining 20 employees, will focus on BitTorrent DNA, a content delivery network that helps media and video game companies distribute their products cheaply over the Internet.

It seems problematic for the company to actually turn a profit. Although the company has struggled to find its market niche, BitTorrent is actually used heavily. The Pirate Bay, a popular and semi-legal downloading site, now includes nearly 25 million peers.

Ashwin Navin, BitTorrent's former CEO, will be starting a start up incubator with several other Silicon Valley types from YouTube on down. Even as most pundits focus on the capital side of capitalism, the growth side of capitalism with its churning labor markets and innovative entrepreneurs continues unhindered.

Last month, my good friend (and GMU professor) Garett Jones surveyed the bailout mania rampant in Washington, DC and muttered the funniest line of the season: "Creative destruction, it was fun while it lasted." I tend to agree in spirit, but don't think mere national governments can stop human ingenuity. Oh, but they'll try ...

The Slippery Slope to Socialism

I learned yesterday that the presidential election has renewed a conversation in America about socialism. It is good that none of the candidates are embracing the moniker of socialism, but you would be surprised how easy it is for a people to slip into a socialist mindset, regardless of what we call it. Even the most hard-bitten capitalists might lazily think in such a way. Even a blogger you know ...

In my last post, for instance, I wrote "Look, if it is in the national interest to save these companies [GM and Chrysler], then taxpayers should have a say in how the money gets spent."

Minutes after publishing the post, it hit me how easily I had fallen into the trap.  Sounds a lot like socialism, doesn't it? 

In socialism's purest form, the government would take outright ownership of firms, manage them, establish wages, and so forth. Few would be so brazen. We instead need to be watchful for the slippery alternative form of socialism wherein the government acts as a "lender" rather than an owner. You might recall this was the approach suggested by Bernanke and Paulson, initially, until numerous voices suggested the taxpayer deserved some upside (e.g. a sliver of ownership) in distressed assets. Or warrants - a fancy way of getting ownership with upside. I'm afraid this mindset may have become a default consensus framework. But it is the next step is where we get into real trouble.

The next logical step following taxpayer's role as lender/owners of distressed firms (or indeed any firms that "voluntarily" accept government rate funds) is this: conditions. It is exactly the logic I followed earlier. Take public money = take public conditions on how your firm is operated.

The trouble hinges entirely on what conditions the government should, could, and will establish. For many people, conditions include limiting executive pay, minimum wages for each occupation (i.e. privatizing Davis-Bacon rules), mandates for health insurance, dental insurance, and so forth. If the federal loans are to banks, one would imagine these conditions would be extended to all small firms borrowing from those banks. FDIC insured lenders?  Sure, them too. How about rules that force firms to buy American components? -- very popular in some Republican as well as Democratic circles.

In the GM case, I think it is pretty clear that the conditions should involve bankruptcy-like realignment of unsustainable contracts with the unions -- including the infamous policy of paying workers to sit around and do nothing. In other words, the conditions I envisioned would lower costs, not raise them. But who is to say what policies will become part of the consensus rescure template?

Who is to say, indeed.

One final thought. You may notice that my initial statement calling for conditional lending included a qualifier. "... if it is in the national interest to save these companies  ..."

That is a very big if.  I will try to make it clearer next time.

American Dreaming

Uh-oh.  Some scientists have determined that the American Dream is actually impossible to achieve. The neuro-science is solid: people cannot achieve happiness through material abundance. Unfortunately, that science is being badly misinterpreted and then further misapplied as policy advice for reforming our economy. The problem is that many otherwise intelligent people don't have a firm grasp of either economics or history, specifically that the "American Dream" is not a culture of greed, but a culture of personal independence that stood in stark contrast to class distinctions in Europe.

This zeitgeist is being generated by Peter Whybrow, head of the Semel Institute for Neuroscience and Behavior at UCLA and author of American Mania: When More Is Not Enough. Whybrow's argument, to the extent not evident in the book's title, is that the American culture is founded on self-satisfaction, and worse, a strain of competitive consumption, fueled by irresponsible credit. WIRED summarizes the Whybrow critique thus:

Our built-in dopamine-reward system makes instant gratification highly desirable, and the future difficult to balance with the present. This worked fine on the savanna, said Whybrow, but not the suburbs: We gorge on fatty foods and use credit cards to buy luxuries we can't actually afford. And then, overworked, underslept and overdrawn, we find ourselves anxious and depressed.

You might agree with Whybrow. I certainly agree, and strongly, with some of his points. But not his conclusions. Whybrow is making a mistake of confusing the effects with causes. The American Dream is not material prosperity, but the system that gives people the opportunity to prosper. Miss that nuance, and you do not understand America. So when Whybrow confuses these two, he is contributing to 21st century cultural amnesia: Americans are forgetting who they are.

Historically, one could point to the Declaration of Independence as the origin of the Dream, which laid out the principles of equality and unalienable Rights, notably the Pursuit of Happiness. But as a phrase, "American Dream" was coined in the 1931 book Epic of America by James Truslow Adams. Adams wrote:

The American Dream is that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position." (emphasis added)

So even at its first muttering, the idea of The American Dream was literally and pointedly not about materialism, but about the means of individual liberty, free of class, caste, and race. People who say otherwise are committing cultural libel. Seriously, if the American Dream is a fiction, somebody better tell my grandfather, because he must have been mistaken when he died happy (and poor) because he lived as a free man in a humble home.

Unfortunately, the wayward thinking doesn't stop there.  It just starts there.

Again, as summarized by WIRED:

The answers aren't easy, Whybrow cautioned — but they do exist. People can think creatively about jumping from the treadmills of bad jobs and unmeetable needs; and even if this isn't always possible, they can teach their children to live modestly and within their means. Urban engineers can design cities that allow people to live and work and shop in the same place. Governments can, at the insistence of their citizens, provide the social safety nets on which social mobility, stagnant for the last 50 years, is based. And we can — however much it hurts — look to Europe for advice.

Look to Europe for advice? Do they mean us to emulate Italy, where women don't want babies anymore or do you mean France where entrepreneurs face extinction because the labor laws are so extreme (and the lower classes riot in the streets because they cannot find jobs)? Europe is a diverse place, and the countries with the most economic freedom are the most prosperous. End of story.

Social mobility is stagnant? This is drivel. If it mean that the same percentage of people are going from rags to riches each decade, that is not stagnation.  It means social mobility is stable. Different adjectives.

Urban engineers? Right now, if people want walkable cities, they can move to them. Supply and Demand. And happily, this is happening -- the free market is already radically reshaping cities.

Bad jobs? Show me the evidence that people do not like their jobs in the U.S.! Sure, I like to mock cubicle culture as much as any Dilbert fan, but I bet mocking salt mine culture, serf/peasant culture, and hunter-gatherer culture were even more hilarious.

Living within their means. I am all for this, and it's where I find myself agreeing with Whybrow. The instinct for short-term gratification is too often indulged. And yet, the solution is not to erode America's long-term growth miracle embedded in property rights, free markets and trade, and democratizing finance. Whybrow seems to think that credit is the evil here, as if taking out loans causes overconsumption. Why not a cash economy?  Because giving poorer people access to credit is one of the great equalizers in U.S. (and world) history. We can all agree that predatory lending is bad, but to conclude that any lending is inherently bad is frankly pretty foolish. Has Whybrow not heard of microfinance?

Whybrow has an interesting interview on his homepage, and I think the most intriguing meme he is pushing is that the American people are not just culturally, but genetically distinct. The immigrants who moved here voluntarily, and those who thrived, were humans on the less risk averse side of the gene pool. He then draws numerous fantastical conclusions from this idea, suggesting that Americans are more prone to stock market bubbles (!), mental sickness, etcetera. I am inclined to agree that our culture is different, but two questions. Isn't cultural diversity a good thing inherently? Is it clear in any empirical research that Americans (or entrepreneurs) are more materialistic/greedy than others?

It just seems like Whybrow is telling Eagles they could be much happier without their feathers. 

Six Faces of Innovation

What is innovation, exactly? There is an unresolved tension whether the source of innovation comes from big firm R&D or small firm entrepreneurship. I'm particularly fascinated with the question whether breakthroughs or incremental innovations matter more to growth. And there are unresolved questions about what policies would enhance technology-based growth: industrial targeting or ecosystem optimization or research subsidies.

A May 2008 research paper (available at SSRN) written by Roger Miller and Marcel Cote titled The Faces of Innovation offers an exciting synthesis of many of the issues, and directly challenges the popular notions of "best practices" for business innovation and centralized public innovation polcies.

To be honest, at first glance this paper struck me as it may strike many of you - another glib mumbo-jumbo framework on innovation with buzzwords and checklists. On the contrary, the six-part framework is both insightful and well-organized. The authors define innovations along two axes: (1) market-creating versus in-market (MC and IM) and (2) the typology of product, process, or platform (my own abbreviations).  Here's a graphic showing the six faces or "games" (as the authors describe them) of innovation from the paper:

I've copied three interesting paragraphs from the paper, adding my own bolding:

[N]ew entrants displacing complacent incumbents and rendering old ways obsolete, is still a central theoretical tenet. There is also an almost mythical belief in the critical role of entrepreneurs as agent of rejuvenation, and by extension, in venture capital supporting them. But as Schumpeter argued late in his life, large firms with R&D are significant innovation agents, as scale matters when it comes to R&D. That view led to a strong association in public policy between R&D and innovation. Indeed, the most popular indicator of national performance on innovation seems to be Business expenditures on R&D as a percentage of GDP, (BERD).

...

A central feature of the synthesis that came out of the MINE survey is thus that innovation has many faces, each representing a distinct logic of innovation, requiring different strategies and practices. This view goes against the widely held belief that there are universal best practices to stimulate innovation. Indeed, the generalization of a unique set of "best practices" could trap entire sectors in negative-sum competition with low innovation, low growth, and low profit.

...

Government innovation strategies tend to focus on a limited number of areas strongly supported by special interests: university and industrial research, university-industry collaboration, intellectual properties, venture capital, etc... Looking at innovation from the perspective of the six games suggests different priorities, and more importantly, a much more parcelled approach.

Very highly recommended.

9/22 .... End of (Summer) Capitalism?

With news that Goldman Sachs and Morgan Stanley are ending the era of investment banking as of today, I could not help but wonder if today's date 9/22 will become a shorthand symbol as did 9/11.

The credit crisis is ongoing, but a new and unprecedented government bailout known as the Paulson Plan is being worked out in Congress. Every hour that ticks by reveals the typcial nasty partisan differences, introduces add-ons, but also allows experts to raise questions about deficiencies and unexplored alternatives.

I remain a skeptic for reasons that don't merit too much attention at a time when renowned financial experts are publishing very valuable insights. Here are four worth your time:

• Jim Hamilton, a seer if there ever was one
• Bob Litan, my colleague and a towering expert on finance
• Paul Krugman, in a welcome essay showing his wit and wisdom, rather than rancor
• Luigi Zingales, UofC professor who explains "Why Paulson is Wrong."

As for me, I would happily repeat what I have told all my econ students and countless people in casual conversation the simplest explanation for confidence: "There will never be another Great Depression." It can't happen for a handful of reasons, but perhaps the most important lesson is that the Great Depression resulted not from Wall Street's collapse, but from numerous wrong-headed responses to the crisis that unfolded over many, many years. At a minimum, the Fed will not fail to provide more liquidity, not less (as it did during the early 1930s).

New Business Cycle Theory

Step aside, RBC, it's time for NBC (New Business Cycle) theory, in a nice article in the WSJ today ...

In theory, output and income should go up and down together. If the economy is still expanding, why are so many households being squeezed?

One answer is that the business cycle itself is changing. Recessions in the past used to follow a predictable script. Business would slow or inventories would go up too much and catch companies flat-footed. As their own productivity dropped, they would belatedly respond by cutting back on workers. Then, as the process fed on itself, everything would go down together -- output, employment, income and productivity.

The 2001 recession changed the script -- productivity held up surprisingly well throughout. Companies cut back ahead of the business slowdown and kept doing it even after demand started rising again. The productivity they managed to squeeze out of existing workers bolstered output, even as it strained households.

The same thing seems to be happening again: To the surprise of many economists, worker productivity is rising, not falling.

Mathematically, a workforce contraction with relatively less GDP contraction gives off a signal of higher productivity. This is different: GDP is expanding while employment is contracting. I understand that the notion of GDP as a lagging indicator seems like the ultimate oxymoron ... because in fact it is. I refuse to believe the U.S. is in recession (and so should you) until it recesses. And yet, I can't get my head around an exploding unemployment rate (+0.4 percent in one month) in the context of a mere slowdown.

Recession or not? Yawn. Much more exciting question: How is the economy evolving?

America in Decline, Again . . . and Again . . . and Again . . .

Once again, the United States economy stands on the brink of historical irrelevance. That, at least, seems to be the consensus emerging from several books, reports, and public statements that have appeared in the last couple of years.

The din of the chorus has grown louder with the current economic turmoil. The latest salvo has come from Byron Wien of Pequot Capital Management, in the Financial Times a few days ago. Wien recounts the decline of American manufacturing, rising deficits, and our seemingly shoddy international performance in math and science. Wien has the facts right: yes, the U.S. has lost manufacturing jobs; yes, our debt and deficits have risen; yes, our students don't compare well to other countries.

The problem is that these are only numbers, and incomplete numbers at that. Declines in manufacturing employment are due in large part to productivity gains: China, remember, has also lost manufacturing jobs as its productivity has risen. Others have pointed to the danger of doing cross-country comparisons in test scores, as well as the possible explanations for discrepancies. In fact, I don't want to dwell on the general idea of decline here--others, too, have adequately covered that. (Here was a good response to Wien's column, and I hear Joel Kotkin is working on a book about persistent declinism in America.)

The most revealing thing about these periodic bouts of anxiety is that the proposed remedies are eerily similar. I offer two short book excerpts:

(1) "The National Innovation Council would be convened and led by the National Innovation Advisor. . . . This would be a 'guiding coalition,' setting direction and overseeing the innovation transformation process for our country. Its responsibilities would include adjudicating competing priorities, making useful exceptions, and orchestrating funding from multiple sources."

(2) "Solving our energy and growth problems demands that government gets more heavilty involved in the economy's major investment decisions. . . . To compete we need the national equivalent of a corporate investment committee. Major investment decisions have become too important to be left to the private market alone, but a way must be found to incorporate private corporate planning into this process in a non-adversary way."

(Wien's FT column echoes these.)

The last period of anxiety over the economic future of the United States was the late 1970s and early 1980s. One of the above excerpts is from 1980, the other from 2007 (answers below).  As Kauffman Foundation president Carl Schramm has chronicled (also explored in Good Capitalism, Bad Capitalism), the American economy in the last 25 years experienced a surge of entrepreneurship and growth driven by the confluence of a number of factors.

In 1967, for example, John Kenneth Galbraith published The New Industrial State. As Carl Schramm has written, "within a year of the first edition of The New Industrial State, Intel was founded out of Fairchild Semiconductor. The 1970s saw the appearance of firms such as FedEx, Microsoft, Apple, and Home Depot, and the expansion of companies such as Target and Wal-Mart, all of which became fast-growing parts of an entrepreneurial economy."

The rise of entrepreneurial capitalism began well before the economic troubles of 1980. By 1985, in fact, Peter Drucker was heralding the arrival of an "entrepreneurial economy." What happened was that far beneath the radar, the economy was transforming in a number of ways. The military, a major engine of the "bureaucratic capitalism" that grew up in the 1950s and 1960s, actually became a source of new discoveries and entrepreneurial opportunities. Thanks in part to deregulation, individuals and firms carved out new pathways of business in financial services and insurance. Some areas of manufacturing, even, enjoyed growth. (Take a look at the Inc. 500 list for 1983.)

It seems likely, in other words, that today the seeds of tomorrow's economic growth are being sown by individuals "out there" forging ahead, forming new firms, innovating, and seeking profit. We won't see them until they move onto the radar screen, but they're there for sure. I love analogies, and I have used this one elsewhere, but maybe we can think of this as the "dark matter" of the economy: we know it's there, expanding the economy, but we can't fully detect or measure it.

A side note: above I mentioned the military's role in in funding the research and development that helped give rise to entrepreneurial capitalism. That's not a new story. But what is often forgotten (or ignored) is the importance of the military in shaping what became Silicon Valley. When urban experts today discuss Silicon Valley and how other cities and regions can imitate it, they default to venture capital, research universities, and start-up firms. Those were all important, of course, but a very strong case can be made that the Pentagon was the sine qua non in creating Silicon Valley. You have to go back to about 1900 to see it fully play out, but the evidence is persuasive. I have yet to see, however, a mayor or urban planner propose the military as a strategic piece of economic development. (Although the Washington D.C. metropolitan area has certainly benefited from government contracting.) Anyway, this is turning into a separate topic--I'll leave it by saying that with thousands of returning veterans all over the country and the skills they are learning in the armed forces today, it is a rich but untapped resource for any city or region seeking a new avenue of growth.

Answer to book excerpts: (1) is from Innovation Nation by John Kao (2007); (2) is from The Zero-Sum Society by Lester Thurow (1980).

Just When You Thought We Were Out of Innovation . . .

Readers are undoubtedly familiar with the debates raging over American competitiveness and whether China or India or both will overtake the United States and consign us all to the dismal service sector tasks of burger-flipping, hair-cutting, and retail cashiering.

I exaggerate. But this is a not-so-subtle subtext running underneath debates over the continued decline in manufacturing jobs, as well as the persistent exhortations from the scientific and policy establishments that we need to train more scientists and engineers.

There often appears to be a disconnect, however, between the public debate and what is going on in the American economy. Such a disconnect is nothing new, but I sometimes think we only dimly grasp the shift beneath our feet.

By sheer coincidence today, I came across this chart on The Big Picture, showing a growing gap between world GDP and oil production, and this Resilience Report from Strategy+Business about "digital oil fields." One way to jointly read these is with the expectation that digital oil fields will help boost oil production. Maybe.

The more interesting tale here is the transformation of the oil industry: facing a labor crunch and spike in demand, it's responding by developing a "new breed of engineer and technician." The oil industry is becoming, or already is, an example of a "service system." Our friend Jim Spohrer over at IBM has been a leader in developing the science of service systems, management, and engineering.

This type of evolutionary transformation is occurring across the economy, as old and new technologies, new knowledge, software platforms, and continuous learning keep coming together to create ever-greater levels of integration that require new approaches (entrepreneurship), new ways of thinking, and new forms of business.

In this sense, the steady drumbeat for 'more scientists and engineers' begins to appear a bit shallow. We need them, of course, but before simply recruiting more students into the existing disciplines, maybe we should think about restructuring those disciplines. In an odd way, the age-old story of specialization, increasing returns, and greater knowledge that continues to shape the economy, may push us toward an educational system that emphasizes integrative, consilient thinking.

More on Inequality

After the last post on inequality and different ways to look at it, I came across this entertaining post by Mark Perry on scoring inequality in the NBA. He also applies this method to Olympic medals and home runs in baseball.

Anyway, all this talk about inequality reminded me of something Hayek once wrote: "From the fact that people are very different it follows that, if we treat them equally, the result must be inequality in their actual position, and that the only way to place them in an equal position would be to treat them differently. Equality before the law and material equality are therefore not only different but are in conflict which each other; and we can achieve either one or the other, but not both at the same time." (From The Constitution of Liberty.)

And that, of course, is reminiscent of Vonnegut's famous short story, "Harrison Bergeron," in Welcome to the Monkey House. (There was a thought-provoking essay on Vonnegut, by the way, in the Winter 2007 issue of the Claremont Review of Books.)

Inequality is not a simple issue conducive to Gordian solutions, and proves at least two things: (1) the once seemingly dead discipline of "political economy" is not dead, and (2) discussions of economics are perhaps inevitably informed by philosophy. Namely, why type of justice should we have?

In Defense of Consumption

Nearly four months ago, two economists at the University of Chicago released a paper purporting to show that much of the ballyhooed rise in income inequality in the United States actually closes when measured by prices and inflation across different classes of goods and services.

This paper has been written up in a few different places (see here and here), so I won't dwell on its counterintuitive yet completely common-sense conclusions, except to say that it (and other work on consumption as a better measure of relative inequality) confirms this observation made long ago by Joseph Schumpeter:

    "The capitalist achievement does not typically consist in providing more silk stockings for queens but     in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort."     (Page 67 of Capitalism, Socialism and Democracy.)

Consumption is often derided as either wasteful or mindless or soul-destroying. (This, by the way, is not a partisan issue: you can locate various criticisms of consumption at any point on the spectrum of American politics.)

Such knocks, however, see only one stage of consumption: the actual purchase of a product or service or its actual use. They usually don't extend (necessarily) to what that consumption gets you. When you "consume" a cell phone, what you're really consuming is connection with other people. When you purchase a better refrigerator, you're consuming the ability to store food for longer periods of time than was available to most humans throughout history, thus raising the ability to improve nutrition. When you buy a drink from Starbucks, you're getting not only the drink itself but also the experience and interaction with others. (One of the original investment bets behind Starbucks, remember, was provision of a "third place" for people to get together.)

In other words, there is a great essay waiting to be written in defense of consumption. I'm not the first to observe this, of course--a couple of years ago Nick Gillespie had a brief but fantastic commentary on Marketplace. I won't venture into that perennial bugaboo of video games--there has been plenty of recent scholarly work on their cognitive and social benefits. See, for example, this interesting story in yesterday's New York Times, on the front of the Arts section no less. Also in the Times is Rob Walker's fantastic weekly column, Consumed, which provides an additional perspective on consumption and all its manifold uses and benefits. Walker has a new book out, too, which I look forward to reading.

Anyway, maybe the research paper with which I began this post will give us a new view of not only relative inequality but also consumption in general and its possible uses in, for example, international development.

(I am indebted to Kauffman Foundation president Carl Schramm for some of the insights and comments in this post.)