Growthology

Growing Pains

My inaugural column for Forbes.com, "Avoiding the Coming Growth Slowdown," is now up.  Here's a teaser:

Consider this puzzle. Compare economic performance in two periods: 1973-1990 versus 1990-2007. Both periods are 17 years in length; both begin and end with the last year of an economic expansion. In the earlier period, the U.S. economy weathered oil shocks, stagflation, and a punishing recession in the early ’80s, and growth in labor productivity in the nonfarm business sector limped along at a dismal 1.33 percent a year. In the latter period, prosperity was interrupted only by a pair of brief, mild recessions, and the IT revolution led a dazzling rebound in productivity growth up to 2.33 percent a year. Yet in 1973-1990, real gross domestic product per capita rose at an average annual rate of 1.93 percent – better than the 1.85 percent average annual growth rate during 1990-2007. How could that have happened?

Check out the whole thing.

Entrepreneurs Are Natural Hayekians

In the airport on the way back from this conference, I picked up a copy of the current issue of Inc. magazine for the cover story on "How Great Entrepreneurs Think." The article relates the results of a study by UVA Darden School professor Saras Sarsvathy of 45 top entrepreneurs. All were presented with a case study of a hypothetical start-up and then quizzed about how they would run it. Interestingly, she later conducted the same exercise with managers at large corporations. The differences in thinking and decsion-making style are instructive:

Sarasvathy likes to compare expert entrepreneurs to Iron Chefs: at their best when presented with an assortment of motley ingredients and challenged to whip up whatever dish expediency and imagination suggest. Corporate leaders, by contrast, decide they are going to make Swedish meatballs. They then proceed to shop, measure, mix, and cook Swedish meatballs in the most efficient, cost-effective manner possible.

So, for example, when one entrepreneur was asked about what market research would be needed, he replied:

"I don't believe in market research. Somebody once told me that the only thing you need is a customer. Instead of asking all the questions, I'd try and make some sales. I'd learn a lot, you know: which people, what were the obstacles, what were the questions, which prices work better."

Here's another quote along similar lines:

"I always live by the motto of 'Ready, fire, aim.' I think if you spend too much time doing 'Ready, aim, aim, aim,' you're never going to see all the good things that would happen if you actually started doing it. I think business plans are interesting, but they have no real meaning, because you can't put in all the positive things that will occur...."

Generalizing from these kinds of attitudes, Sarasvathy concludes that entrepreneurs

do not believe in predictions of any kind. "If you give them data that has to do with the future, they just dismiss it," she says. "They don't believe the future is predictable ... or they don't want to be in a space that is very predictable."

Which means -- segueing now from practice to theory -- that entrepreneurs grasp intuitively the central insight of the great economist F. A. Hayek: that capitalism is a process of discovery. Hayek saw that socialist central planning, then at the height of intellectual fashion, was doomed to founder on the unpredictability of the future. Capitalism, at the time derided for its chaotic duplicativeness, worked precisely because of its messiness: its decentralized process of trial-and-error experimentation is the only viable response to the ineradicable uncertainties of economic life. 

Entrpreneurs are Hayekians at the micro level. They don't want to sit back and plan, they want to dive in and discover and learn. They want to experiment: to see what works and what doesn't, to build on the successes and leave the failures behind. Which is exactly what how the larger market order works at the macro level.

None of this is to say that planning is unnecessary. On the contrary, it's vital -- after you've discovered a good idea. To take that idea to scale and execute it efficiently -- in other words, to pump out those Swedish meatballs -- you need planning and lots of it. Which is why successful start-ups turn into big corporations run by professional managers.

Here's Sarasvathy's full case study. 

Some Puzzles about Entrepreneurship and Entrepreneurial Capitalism

The standard narrative about the American economy in the late twentieth century typically runs as follows: after four decades of quasi-statist capitalism (the 1940s through the 1970s) that brought the United States to the brink of economic ruin, the economy experienced an entrepreneurial explosion around 1980. The economy moved from the dull bureaucratic capitalism of the "Organization Man" to the exciting entrepreneurial capitalism of high-technology and, accordingly, more robust growth and productivity. Without questioning the importance of entrepreneurship to economic growth, I'm beginning to wonder about this.

For starters, let's take recent technological history. The information technology revolution that is associated with the 1980s and 1990s was born in the 1950s and 1960s, emerging out of government-funded research performed at universities and large company laboratories. We could probably mark the start of the IT revolution at the founding of Fairchild Semiconductor 1957 or, perhaps, the founding of Intel in 1968; Microsoft and Apple followed in the mid-1970s. Other companies typically associated with this entrepreneurial rebirth include FedEx and Southwest Airlines, which were also started in the late 1960s and early 1970s. Even within the confines of the conventional narrative outlined above, we can trace the roots of entrepreneurial capitalism to the final stages of bureaucratic capitalism, a pattern that aligns with other models of technological revolutions and transitions. In his wonderful book, The Age of Abundance, Brink Lindsey (who is now a Senior Fellow at the Kauffman Foundation), connects the counter-cultural ethos of the 1960s with the subsequent entrepreneurial revolution in business.

The typical narrative of entrepreneurial capitalism is also usually supported by reference to either changing rates of overall entrepreneurship or the high number of initial public offerings (IPOs) in the 1980s and 1990s, as well as the explosion of alternative forms of financing, from junk bonds to venture capital. And, indeed, according to at least one strand of Census Bureau data, the absolute number of new incorporations did increase dramatically from the 1960s to the 1970s and again to the 1980s and 1990s. New company listings, moreover, rose from an average of 156 per year from 1973 to 1979, to 549 per year from 1980 to 2001. From 1980 to 2001, in fact, newly listed firms comprised 10 percent of all listed firms in any given year. Venture capital, too, increased by several factors from the end of the 1970s and despite reverting from its astronomical heights in the late 1990s, VC remains at historically elevated levels.

Over the last several months, however, I happened to come across several pieces of evidence--some new, some older--that would appear to contradict the typical narrative. (I am not claiming any particular insight here, nor do I intend to mean that the U.S. economy was somehow "better" in the 1960 and 1970s than today. I heartily endorse Brink's arguments in "Nostalgianomics" on this point.)

Let's start with the most basic empirical information: the number and rate of new business formation. When the Census data cited above are expressed in per capita terms, the apparent doubling of firm formation disappears: the population doubled, bringing new business creation along with it without a corresponding increase in the rate. Indeed, we have published two papers on the puzzle of relatively steady levels of entrepreneurship in the United States, both across the past thirty years (the purported period of extreme entrepreneurship) and, potentially, across the entire twentieth century. In fact, firm formation fell from the 1980s to the 1990s and then flattened, neither falling nor rising. Per capita rates of new business formation today are actually quite similar--and certainly no higher--to those in the 1940s and 1950s, the ostensible high tide of bureaucratic capitalism.

What about IPOs? Using historical data from Gompers and Lerner and more recent data from Fama and French, here are the average annual IPOs for various time periods back to 1935 (the groupings are dependent on the authors' work, not my own manipulations): 

1935-1949:    11

1950-1959:    45

1960-1972:    233

1973-1979:    37

1980-1989:    328

1990-2001:    413

The averages obviously mask variability, but it is generally true that after 1980 the United States saw sustained levels of historically high numbers of IPOs. But it is certainly not true that the era of bureaucratic capitalism was without entrepreneurial excitement. From 1959 to 1962, the average number of IPOs per year was 224. From 1968 to 1972 it was 388, a number much closer to the supposedly go-go 1990s than even the 1980s.

At the same time, the IPO explosion after 1980 brought its own issues. Fama and French found that the "decline in the cost of equity capital for new lists" meant that weaker firms could now go public. In particular, in the 1980s and 1990s the distribution of revenue growth across newly-listed firms skews to the right, meaning higher growth. Meanwhile, the distribution of profitability skewed left, meaning lower rates of profitability. Survival rates of newly listed firms also fell over this time period. As they stated: "Basically, the evidence says that weaker firms and firms whose expected payoffs are further in the future become viable candidates for public equity financing." This echoes other research finding, since the late 1970s, a dramatic rise in growth rate volatility among publicly-traded companies but a fall in the volatility of privately-held firms--nearly to the point of convergence, in fact. It is true as well that volatility among our largest companies, the Fortune 500, has risen and not quite one-fifth of today's Fortune 500 companies have been founded since 1980. But this is more an indication of turnover among existing companies, including mergers and acquisitions, rather than new firm entry. And even if more companies fall off the list, it doesn't mean they fail; it just as likely reflects the relative rise of other companies.

(Some of this also calls into question the role of high-growth firms. As the above comments indicate, rapid revenue growth does not necessarily mean profitability. This corroborates other work that examines the Inc. lists of fast-growing companies. I am a huge fan of the Inc. data and I think much more can be done with it, but we shouldn't imagine that high growth in revenues tells us anything about economic impact or long-term success. Presumably it should, but it apparently does not. I have written elsewhere that high-growth firms are neither as interesting nor important as they are typically thought to be. If the underlying dynamics of firm formation and competition are reasonably healthy, we should expect to see high-growth firms as epiphenomena of those, not necessarily drivers in themselves.)

In any case, what does any of this mean? Let's review. During the period of entrepreneurial capitalism, we have seen no increase (yet no significant decrease either) in levels of firm formation, but a larger number of IPOs and greater volatility among publicly-traded firms, indicated particularly by dispersed growth rates and profitability. This dimension in the public markets is, in part, an effect of greater availability of financing. Is what we call entrepreneurial capitalism really just a reflection of public-market volatility, itself a reflection of the rising role of finance in the American economy over the past thirty years? 

I should point out, again, that none of this is meant to imply that the last thirty years were somehow worse than the middle part of the twentieth century. Nor is it meant to exclude the dramatic changes in technology over the past three decades. Indeed, high-tech companies likely account for much of the public-market volatility. At the broader level of aggregate firm formation, sectors such as food service, administrative services, health care, and professional services (in particular lawyers) tend to predominate, particularly among high-growth firms. My points here are not a value judgment on the types of companies that are formed. But it appears that there is still quite a bit about entrepreneurship--its trends, its composition, its impact--that we do not understand. And, should we be on the cusp of an entrepreneurship boom--whether because of technology, changing economic factors, demographic factors, whatever--it remains to be seen whether, in the context of existing structural factors, this will shift us to a different neutral state. And, again, we have not even touched the impact of new companies yet; a much more extensive treatment than I have given here will also layer on technological change. So much goes on beneath the surface of aggregate entrepreneurship levels, of IPO activity, of growth and profitability, that it is difficult to make blanket claims about capitalist typology.

I could, of course, be wrong.

Thermodynamics and Economics

This is a terrific article by Timothy Garrett at the University of Utah, published in October: "On the coupled evolution of inflation, wealth, and atmospheric concentrations of carbon dioxide." Garrett devises a thermodynamic model of economic growth and energy use and his article is far deeper than what typically passes for energy economics analysis. Looking for a reason to stay awake at night? Look no further:

What remains is only to rapidly decouple civilization growth from CO2 emitting sources of energy. There is an important caveat however, which is that such decarbonization does not slow accumulation by as much as might be anticipated. Decarbonizing civilization promotes society [sic] wealth by alleviating the rise in atmospheric CO2 levels. But growing wealth is tied to energy consumption rates, and therefore to CO2 emissions themselves. Only a combination of extremely rapid decarbonization and civilization collapse keeps CO2 concentrations below 500 ppmv within this century. 

The Accumulation of Firms and the Predominance of New and Young Companies

This is a sequel to last week's post about moving from Paul's drunkard's walk to the accumulation of firms over time. Basically, the message of those two posts is that the internal dynamics of the American economy--lots of new companies founded each year, the exit of firms at all ages, the persistent predominance of young firms as the economy moves through time--make it highly probable that job creation will come from new and young companies rather than older, more established companies. (In these data that we're using, a firm is no longer classified as "young" once it reaches age 6, so the term "older," perhaps imprecisely, includes firms ages 6 and up.) Thus, when we say that new and young firms account for most net job creation in the U.S. economy, we are partly describing the reality of these firm dynamics.

This doesn't diminish the importance of these companies or the jobs they create. After all, the reality of these dynamics is premised on four things: a more or less steady inflow of startups; more or less consistent survival rates from year to year; comparable gross job creation and gross job destruction in older companies; and a higher number of jobs created at young firms (4 versus 1). These are not functions of what might be perceived as mathematical inevitability--they are the reasons behind the mathematical probabilities we are describing. If the level of firm formation were more volatile, if older companies created more jobs than they destroyed, if young firms were somehow suppressed in their hiring (through, perhaps, bailouts of larger, older companies; just speculating here)--if these variables changed, the dynamics of firm age through time, and subsequent job creation, would be different.

But, in recent history, these variables have all held and together they have created a picture that does, in fact, resemble something like mathematical inevitability, but which is probably more accurately described as a likelihood, or something of higher probability. In any given year over the past three decades, young firms (startups [age 0] and firms ages 1-5) have constituted the largest demographic of firms in the United States. Starting an economy at t=0, going out 25 years, the influx of new firms and the survival rates of firms over time generate this outcome. And, we might expect (provided the other variables are true) that the largest demographic sector will create the largest number of new jobs. This says nothing, of course, of innovation or productivity, subjects for another day.

Here, I want to supplement last week's post, which used average figures calculated from the Business Dynamics Statistics data, with the actual numbers from that dataset, which covers 1977-2005. That is, did reality conform to the stylized numbers we used last week? (The charts will not follow precisely the same format because last week's charts extrapolated out beyond 5 years on an annual basis, while the actual data aggregates firms into 5-year age categories after the fifth year: 6-10, 11-15, and so on.) We'll start, first, with the U.S. economy starting de novo in 1977, with only firms that came into existence that year. How, over the next 28 years, did the composition of firms by age change?

Here, startups (age 0, new firms founded each year) are broken out separately while all other firms are combined into 5-year categories. The data generally track the accumulation pattern revealed in last week's post: in any given year, young firms (ages 1-5) will quite naturally comprise the largest sector in terms of firm demographics. Note how few firms in 2005 are included in the 26-28 age category--these firms were founded in 1977-1979. By 2005, 19% of the firms founded in these three years remained. That may be more than expected, but using the survival line for firms founded for 1977 we can trace a slowly declining line of survival out two decades. If we imagine that the line continues on that downward slope for the next two decades, it appears as if very few firms in the economy survive more than four decades. Either those firms we all delight in describing as "dinosaurs" should properly be seen as remarkable achievements, or firm failure (over time) is a much more dominant force in the economy than we perhaps imagined. Probably both, and I'm probably simplifying here.

The advantage of using the real data from BDS is that we can include the "left censored" firms in our calculations, those companies founded prior to 1977 but for which we don't have age information. In 1977, then, these firms could be anywhere from age 1 to age 100. But we can track their survival after 1977 against all firms founded after that year. How long do these companies persist?

I included a brief explanation within the chart itself, but you can clearly see how these pre-1977 firms gradually decline in number over time, while new and young firms in any given year gradually get bigger in comparison. By 1988 (the circle), the pre-1977 firm group has shrunk such that it is now smaller each subsequent year compared to cohorts of new and young companies. By 2005, these firms still number 1.5 million, accounting for about one-fifth of all firms in the economy. This is a lot, but is an aggregate of every year before 1977, so there are probably a good number from the 1970s, a proportionately smaller number from the 1960s, and so on. 

Now, we can include these pre-1977 firms in our overall chart of firm demographics over time and compare firms of all ages:

This is actually an incredibly interesting chart, as the text insert fleshes out, but I'll repeat it here so you don't have to open the image itself. It shows two different ways in which firm composition changes and in which new and young firms consistently account for the bulk of firms in the economy. In 1977, the t=0 moment here, the economy is composed  of a class of startups (age 0) and all other firms existing that were founded before 1977. As the economy moves through time, you see four things happen. First, age 0 firms and age 1-5 firms account for a steady slice. Second, the overall number of firms accumulates. Third, the pre-1977 firms gradually decline in number. Fourth, post-1977 firms that age through time also diminish in terms of their numbers as fewer survive in subsequent years. So new and young firms dominate the economy (numerically) by two mechanisms: gradual disappearance of older firms and gradual disappearance of firms as they age. Same thing, different pathways (on this time scale).

Finally, we'll move to the percentage shares of each firm demographic (excluding pre-1977 firms here):

Once we get to a point where we have firms older than age 6 (and remember, the pre-1977 firms account for the missing shares here) in 1983, new and young companies account for between 30 and 40 percent of all firms in the economy. This percentage naturally falls over time, albeit slowly, as the overall number of firms grows, but this demographic of firms nonetheless comprises the largest demographic slice--a plurality, if you will--in each year, and this would persist over time.

So what, if anything, does this all mean? It means that new and young companies account for most new jobs in the economy in part because they are the largest demographic category of companies. It also means that job creation may actually be a secondary story here because this reality is a reflection of underlying dynamics that have been remarkably persistent over the past three decades. The United States has enjoyed a more or less steady level (and rate) of firm formation and survival rates for those firms have also been rather steady. Older companies, moreover, experience roughly equal levels of gross job creation and destruction, meaning their net job creation approaches zero.

It is entirely possible that these are transitory phenomena. As far as I can tell from the desultory data and research on firm formation prior to the 1970s, entrepreneurship (and subsequent survival rates) across the entire twentieth century have been remarkably consistent (I mention this, with an accompanying citation, in a forthcoming paper, so I'm not simply making this up). According to some Census data, for example, the number of new business created each year doubled from the 1940s to the 1990s--yet the country's population also doubled so the per capita rate of firm formation remained steady. Over the past thirty years, moreover, entrepreneurship rates have been remarkably steady, not declining as some have alleged. 

Yet we surely can't assume that the dynamics beneath such factors are immutable. The preponderance of research concerning firm demographics in many European countries, for example, holds that firm exit is a much smaller factor and that, consequently, unproductive firms simply continue to exist and new firms are dissuaded from entering. Large companies enjoy favorable policy and so the above charts might look quite different for other countries and clearly indicate that the dynamics can change. Even if part of what the above charts do is describe a mathematical reality, it could be considered progress if policymakers in Washington and elsewhere spoke in terms of this reality rather than giving undue attention to the largest companies in the economy (which, incidentally, often seek regulation as a means of protection from competition from startups). What this all means is that startups and young companies are no less important than we thought before--they are a robust and enduring dimension of the U.S. economy. It would be foolish, however, to assume that this is somehow a natural or permanent state of affairs--policy could easily be made to alter these dynamics for the worse.

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.

Defending Thomas Friedman on Job Creation and Startups

In his column yesterday, New York Times columnist Thomas Friedman quoted Kauffman's Bob Litan about the importance of new and young firms to job creation and emphasized the importance of immigrants to firm formation. It was a trademark Friedman column: factoid, examples, quotations from experts, and concise policy lessons. I'm biased because Friedman used Kauffman data, but it was a good column.

Not everyone, however, wants to hear about the economic change that new firms and immigrants visit upon the U.S. economy. At Beat the Press, Dean Baker took issue with Friedman's column and Kauffman's data. With a layer of snark that is by now wearily standard in the blogosphere, Baker writes: "Friedman's conclusion about the special importance of new firms is utter nonsense." His logic:

The claim that most net new jobs came from new firms conceals the fact that existing firms added tens of millions of jobs in this 25-year period. Of course existing firms also lost tens of millions of jobs. We can say that the net job creation for existing firms was zero, but if we did not have an environment that was conducive for the job adders to grow (how many jobs did Microsoft, Apple, and Intel create after their first 5 years of existence?), then existing firms would have lost tens of millions more jobs.

Well, yes, that's true--and that's precisely the point. There are basically two ways to look at job creation in the economy: gross and net. On gross terms, large existing companies hire thousands of people each year, but they also see thousands of people leave, voluntarily or involuntarily. Gross job inflows and outflows in the American economy are enormous, an indicator of the ongoing and dynamic reallocation of resources that drives economic growth.

At the end of the day, however, if we want to keep pace with an expanding labor force (new entrants) and changing economy (the rise and fall of sectors and companies), what matters is net job creation. We have fifteen million people unemployed in the United States right now, and over the next several years net job creation has to proceed at a remarkable pace to not only provide jobs for this population but also create jobs for the millions of new people who will enter the labor force in the coming years. The last two years have seen the two biggest matriculating classes ever in American higher education, which means that in four or five years we will see a large influx of new graduates searching for jobs. How does Baker propose we keep pace with such growth?

From a macro perspective, for keeping pace with this growth, the only thing that matters is net job creation. It would be little consolation if we had 100 people looking for jobs, and large company ABC hired those 100 people but also fired 100 different people. For Baker, this is a good thing. And it is--for the 100 people who were hired. But what does Baker do with the 100 newly unemployed folks? Relate to them the wonders of big companies and their gross hiring?

Big, established companies are indisputably important--the symbiosis between new and old, small and large is a key strength of the U.S. economy. But we only get net job creation--a positive increment of new jobs to keep pace with labor force growth--from new and young companies. True, this population is highly dynamic, equally adept at creating jobs as eliminating them. Whereas this dynamic process works out to a net gain of zero in big companies, the net result among new and young companies is positive. If you subtract startups from the American economy over the past thirty years, there is only a handful of years in which the economy would have created a positive net number of new jobs. This makes sense as a brand new company can only create, not destroy jobs, but from the perspective of adding new jobs--for those 100 people above--this doesn't change the fact that new jobs come from new and young companies.

Baker also neglects to mention that once a company survives to a certain age (at age six a company is no longer classified in the data as "young") it becomes not an organic generator of jobs but an acquirer of new jobs via other companies, which are largely young and small. Baker asks, seemingly rhetorically, how many jobs Microsoft added over the age of five, but companies like Microsoft and Intel and eBay and others can generally only add a positive increment of net new jobs by acquiring young companies. So even the appearance of net job creation in our largest companies reflects the contribution of new and young firms. None of this, moreover, even begins to approach the role of new and young companies in innovation and economic expansion--not monolithic growth but the evolution of sectors and firms into new and unknown territory.

Baker also appears to cast cold water on Friedman's emphasis on the importance of immigrants, but doesn't dwell on it. There is, however, a faintly palpable nativist tinge in the comments to Baker's post. Why bring in "foreigners" to start companies? Don't we trust Americans? Nowhere, however, does Friedman (or Kauffman) claim that Americans are insufficient for entrepreneurship. In fact, immigrants who start companies in the United States create thousands of jobs for Americans--who could argue against that? For a country made great on a history of immigration, the United States risks falling prey to nativist sentiment from both the right and the left, which will inevitably stifle economic dynamism.

In criticizing Friedman (and Kauffman), Baker tries to cover his tracks with snark, wishing someone would revoke Friedman's license to discuss economics. In an altogether brilliant post last week, Michael Pettis observed, "Snarkiness is always a sign of intellectual insecurity or confusion, and never an indication of insight." Rather than snark, Baker should consider how his vision of a big-companies-only economy would lead to stultified job growth, harming the people he claims to want to protect.

Field of Dreams is an Awesome Baseball Movie, not an Economic Development Strategy

By some estimates, the United States currently has vacant office space running into the hundreds of millions of square feet: law offices, Fortune 500 companies, cookie-cutter glass boxes constructed on sandpiles of debt, etc. And, as discussed previously, commercial real estate (CRE) could very well be the next economic shoe to drop, dragging down whatever economic recovery is materializing. 

At the same time, it's increasingly clear to more and more people that recovery and expansion simply won't happen without entrepreneurs: new companies that bring innovations to market. Entrepreneurs are not the silver bullet solution, yet growth will not occur without them. 

So let's see: how could we possibly address a looming CRE problem as well as encouraging incipient and potential entrepreneurs? Got it! Construct completely new science parks! Ignore both problems and travel a well-trod path that, if not inspired by Field of Dreams, at least follows the same blueprint: Build it and they will come. 

Oh, wait, hold on a second, I'm being told that this idea is already being pursued--it seems that Congress has taken time from its time-consuming BCS debates to pass legislation that will ostensibly "spur innovation [and] economic with development" by building science parks. And wouldn't you know it, the bill miraculously finds empirical support from the Association of University Research Parks. This is a page right out of the NVCA's playbook.

Not that science parks are necessarily bad, but evidence on their effectiveness appears mixed and, in any case, the concept would seem to contradict, you know, the entire history of innovation.

The bill's title is "The Building a Stronger America Act," which should not be confused with Build a Stronger America, an entrepreneurs' movement that seeks, inter alia, to expand the popular notions of entrepreneurship and innovation beyond science parks and venture capital, beyond the idea of walling off our "innovators" from the huddled masses of ordinary humans.

One of the absolute best pieces to read on how innovation happens is J. Rogers Hollingsworth's chapter on "High Cognitive Complexity." Synthesis, not separation, is the key.

Update: Kedrosky has written a wonderfully scathing post focused on the CRE part of this issue.

Bill Easterly on Specialization and the Aid Industry

Guest post by Charles C. Johnson

Unveiled in 2000 by the United Nations, the Millennium Development goals have consistently unmet despite pledges from much of the industrialized world. 

On his blog, Bill Easterly of NYU explains why, "Each aid organization tries to meet all MDGs and each fails to specialize. Therefore some aid agencies are forced to supply things they are bad at ... for which there is no demand."

Easterly explains in further detail:

UNICEF is working on swine flu, the traditional province of WHO, who is distracted by trying to do development research, which is the traditional specialty of the World Bank, who is in turn distracted by a new emphasis on children, which is the strength of – just to complete the circle – UNICEF.

Even very small aid agencies fail to specialize – Luxembourg’s $141 million aid budget was divided among 30 different sectors (out of a possible 37). The tiny Luxembourg budget also went to 87 different countries.

With high overhead costs for each separate activity for each country, the ratio of overhead costs to funds for the activity gets extremely high, sometimes over 100 percent. UNDP has one of the very LEAST specialized aid budgets by country and by sector, and it actually does have a ratio of overhead costs to aid disbursed of 129%.

One suspects overhead costs devoured even more of program costs for the $20,000 Greece spent on worldwide post-secondary education, the $30,000 the Netherlands spent on promoting worldwide tourism to developing countries, the $5,000 Denmark spent on worldwide emergency food aid, or the $30,000 Luxembourg spent on conflict, peace, and security. (Remember, these small sums may have been split even further among country recipients.)

One could think of many political economy reasons why aid agencies resist specialization. From my casual experience in a large bureaucracy (the World Bank), the primeval bureaucratic instinct is to give a tiny piece of the pie to every possible lobby group (internal or external). But what’s most clear is that it shows aid agencies lack of accountability, because it is such a wasteful practice that also drives the aid recipients crazy with duplication of efforts by every aid agency in every sector in every country.

I suspect that this problem is even more pronounced than Easterly recognizes. Part of the reason groups specialize, in accordance with Adam Smith, is that they receive a market signal such as a price rise to specialize and thereby innovate, but what evidence is there that there is any such signal in aid agencies? Remember, nobody loses his job for failing to stop poverty. 

 

The Israeli Dream: George Gilder Explains How Israel Become the World's Leading Entrepreneurial Economy

Guest post by Charles C. Johnson

There are some fascinating facts in a City Journal piece by technology guru, Geoge Gilder that warrant careful attention for anyone seeking to explain why it is that Israel, in Carl Schramm’s phrase, has become the world’s leading entrepreneurial economy. The entire article is worth reading, but some points stand out.

On how Israel’s economy used to be run.

In a general enthusiasm for public ownership of the means of production and finance, the government through the 1990s owned four major banks, 200 corporations, and much of the land. Israel’s taxes rose to a confiscatory 56 percent of total earnings, close to the highest in the world, stifling even those private initiatives that managed to pass through the country’s sieves of socialism. Erecting barriers of bureaucracy, sentiment, and culture, Israeli leaders balked the entrepreneurs and inventors who gathered there, creating a country inhospitable to Jewish genius.

On how Israel’s policy vis a vis immigration paid dividends and changed the culture.

The influx of Soviet Jews into Israel represented a 25 percent population increase in ten years, a tsunami of new arrivals that would be equivalent to the entire population of France being accepted into the United States. Largely barred in the USSR from owning land or businesses, many of these Jews had honed their minds into keen instruments of algorithmic science, engineering, and mathematics. Most had wanted to come to America but were diverted to Israel by an agreement between Israel and the United States. Few knew Hebrew or saw a need for it. At best, they were ambivalent Zionists. But many were ferociously smart, fervently anti-Communist, and disdainful of their new country’s bizarre commitment to a socialist ethos that punished achievement.

On the successes of Israel’s reforms:

In under 25 years—starting from those first modest tax reforms of the mid-1980s—Israel has accomplished the most overwhelming transformation in the history of economics, from a nondescript laggard in the industrial world to a luminous first. Today, on a per-capita basis, Israel far leads the world in research and technological creativity. Between 1991 and 2000, even before the big reform of 2005, Israel’s annual venture-capital outlays, nearly all private, rose nearly 60-fold, from $58 million to $3.3 billion; companies launched by Israeli venture funds rose from 100 to 800; and Israel’s information-technology revenues rose from $1.6 billion to $12.5 billion. By 1999, Israel ranked second only to the United States in invested private-equity capital as a share of GDP. And it led the world in the share of its growth attributable to high-tech ventures: 70 percent.

On the growth of Israel’s economy

Germany, ten times larger, roughly tied Israel. In 2008, Israel produced 483 venture-backed companies with just over $2 billion invested; Germany produces approximately 100 venture-backed companies annually. The rankings registered absolute performance, but adjusted for its population, Israel comes in far ahead of all other countries, including the United States.

Wired Looks Into Craigslist's Refusal to Innovate

Guest post by Charles C. Johnson

In the latest issue of Wired, Gary Wolf takes Craigslist to task for failing to iterate upon its 1999 website design. In an age of apps, why doesn't Craigslist make itself more user-friendly? Wired investigates. [Emphasis is mine.]

 Each of these sites, of course, is merely one of the many sections of craigslist, which dominates the market in facilitating face-to-face transactions, whether people are connecting to buy and sell, give something away, rent an apartment, or have some sex. With more than 47 million unique users every month in the US alone—nearly a fifth of the nation's adult population—it is the most important community site going and yet the most underdeveloped. Think of any Web feature that has become popular in the past 10 years: Chances are craigslist has considered it and rejected it. If you try to build a third-party application designed to make craigslist work better, the management will almost certainly throw up technical roadblocks to shut you down.

Most baffling about the article was just how lightly Craigslist is staffed, reflecting, no doubt, founder Craig Newmark’s fascination with creating online public goods.

Craigslist gets more traffic than either eBay or Amazon .com. eBay has more than 16,000 employees. Amazon has more than 20,000. Craigslist has 30. Craigslist may have little to teach us about how to make decisions, but that's not the aspect of democracy that concerns Newmark most. He cares about the details, about executing all the little obvious things we'd like government to do. "I'm not interested in politics, I'm interested in governance," he says. "Customer service is public service."

Craigslist, though, might be onto something in its refusal to innovate.

. . .  craigslist is old-fashioned in any number of ways. It relies on email and the telephone in an era of SMS and social networks. It sticks to traceless transactions in an industry that makes its living collecting data from every touch. And just as people who run technical companies are reaching an apex of confidence in their ability to invent new forms of community based on sharing everything, craigslist still treats social life as dangerously complex, deserving the most jaded caution. Corporate isolation, user anonymity, refusal of excessive profit, glacial adoption of new features: These all signal Newmark and Buckmaster's wariness about what humans, including themselves, might do if given the chance. There may be a peace sign on every page, but the implicit political philosophy of craigslist has a deeply conservative, even a tragic cast. Every day the choristers of the social web chirp their advice about openness and trust; craigslist follows none of it, and every day it grows.

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."

How and Why Apple and AT&T Killed Google Voice

Guest post by Charles Johnson

Hedge fund manager Andy Kessler has written an excellent op-ed explaining why and how Apple and AT&T killed the new iPhone application, Google Voice, while it was still in the craddle. He writes, 

Apple has an exclusive deal with AT&T in the U.S., stirring up rumors that AT&T was the one behind Apple rejecting Google Voice. How could AT&T not object? AT&T clings to the old business of charging for voice calls in minutes. It takes not much more than 10 kilobits per second of data to handle voice. In a world of megabit per-second connections, that's nothing—hence Google's proposal to offer voice calls for no cost and heap on features galore. 

What this episode really uncovers is that AT&T is dying. AT&T is dragging down the rest of us by overcharging us for voice calls and stifling innovation in a mobile data market critical to the U.S. economy. 

For the latest quarter, AT&T reported local voice revenue down 12%, long distance down 15%. With customers unplugging home phones and using flat-rate Internet services for long-distance calls (again, voice is just data), AT&T's wireline operating income is down 36%. Even in the wireless segment, which grew 10% overall, per-customer voice revenue is down 7%.

(Any takers on bets for when AT&T will ask for its own bailout?)

The kerfuffle over the Google Voice application is a great example of how awful monopolies can wind up being for consumer choice and innovation.

When the iPhone was released exclusively with AT&T, I promised that for that very reason I would never buy another Apple product. Kessler rightly argues that locking technology retards innovation. Just how many other potentially societally beneficial applications are out there that won't see the light of day due to the stranglehold that Apple exploits on its own pipeline: the Apple Store? 

And fortunately, there's a way around those who would lock us out from using our own products to their fullest extent. One of the first things a friend and I did when he got his iPhone was figured out a way to put SkypeOut on the phone and to unlock it from AT&T. (Skype Out allows you to call any landline, mobile, or Skype in the world for about 12.95 a month. You get 10,000 minutes and can call from any computer in which its installed.) 

Cell phone plans really need to start to reflect the law of the one price, if only to ensure that innovations affect all segments of the market. According to a recently released report by the OECD, the U.S. lags behind most of the world when it comes to a mobile usage pricing. For high cell phone users, it costs nearly 6 times as much in the United States as Denmark. 

Until we get some real competition in the cell phone plans, I'll see you on Skype. 

Do We Really Need Daily Doses of News?

There must be an ongoing tally somewhere of the number of stories in newspapers about the future of newspapers. In the grand scheme of things, the number is no doubt tiny, but there is an aura of self-pity (inflated by self-importance) about it.

I don't mean to suggest newspapers aren't important or interesting; compared to my peers, I might be characterized as a dinosaur for still having--what?!--print subscriptions. But the demise of news in general (many individual newspapers will survive) might actually be a good thing for us in terms of perspective. Let's start, first, with the present and future of newspapers: media aren't going away, but everyone seems to have a singular concern about newspapers. Why? The usual course of things is that if an industry can't give people what they want (and the desperation move by many mid-size city newspapers to have lots of short stories with three-inch headlines is pretty ridiculous), it will either adapt or die. 

Such a fate is unthinkable to many regarding newspapers, however, because newspapers--we're told--have a special place in democratic self-rule. It's the Fourth Estate, after all. This would indeed be the overarching concern if it were the case that the government itself was shutting down newspapers. It has before, and newspapers quite literally died. But not this time. This time it's the market. And yet it's also not the case that the demise of newspapers means the demise of news and information. Quite the contrary--it's sufficient to say here that the future of news and information is quite bright. 

OK, fine--most blog readers will agree up to this point, but note that I haven't adequately addressed the question of newspapers and democracy--aren't we losing an essential piece of democratic self-rule? Is the ruthless market destroying democracy? Not really. The nature of daily news is probably more corrosive of democracy than it is supportive. I'm not suggesting that daily news coverage is totally corrosive and totally non-supportive of democracy, simply that it's probably a little more of the former. 

How can I say this? What about Watergate? The Pentagon Papers? What about the ties that bind us together as democratic citizens? The main reason daily news, as manifested by newspapers but also by other sources, might corrode democracy is that it telescopes our gaze almost completely on the here and now. The media has long been obsessed with exploring the present-centered weltanschauung of modern life--a state of affairs that the media, including newspapers, largely helped create. If newspapers are to be believed, each day is simply worse than the day before. Daily helpings of news distort one's perspective because they focus your eyes and brain on the moment, largely composed of detritus that will in time wash away and mean nothing to your life or to history writ large.

There is little room for reflection in the daily news, notwithstanding the superficial weekly attempt in the Sunday editions to reflect on the prior week's event and what they might mean for the future. The daily news is, by and large, superficial. This doesn't mean journalists are superficial--it's the nature of the subject matter, not the interlocutors. And there are exceptions, of course: in-depth stories, long features, etc, are all more helpful and more interesting than the daily news.

A democracy doesn't depend on constant, up-to-the-minute news any more than it depends on 100 percent voter participation. But don't we need newspapers to hold our elected officials accountable? If that's the primary raison d'etre of newspapers, then it's (a) a thin reed, and (b) they've done a pretty poor job of it during the Bush and Obama (so far) administrations. But what would we talk about at cocktail parties and conferences if not for newspapers? Maybe the demise of newspapers will prevent people from thinking they're smart simply because they read that day's Times or Journal. In fact, they might be smarter for having ignored them. And look, if something really big happens, you'll find about it.

Oddly, for all these reasons, blogging might offer a much better epistemology in terms of the flow and digestion of news. (I'm speaking generally here, about blogs qua genre--not all individual blogs will fall into these generalizations.) Bloggers often take the daily or weekly news and piece it all together in a larger narrative that is much more informative and useful than newspaper coverage. Because blogs can focus solely on a niche, they can offer much deeper analysis, which is the true stuff of democracy, not the story itself. Again, I'm speaking generally here, and a quick glance at my Google Reader demonstrates innumberable items that passionately dissect the minutiae of what Speaker Pelosi or Rep. Boehner said this morning. Still, on a possibly frivolous level, I have little doubt that sites like Fangraphs and Baseball Analysts are far more helpful for baseball fans than SportsCenter or the daily sports page. The same principle applies for more serious news.

Anyway, I probably sound pretty curmudgeonly here, and I'm certainly not the first one to make these points. Nassim Taleb reserves a special place in his diatribes for newspapers. The point is that life will go on even when newspapers as we know them are gone. And life and democracy would still go on if the daily news disappeared or was greatly reduced in size. (But keep the op-ed pages--they're the best part.)

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.)

A Few Thoughts on Tyler Cowen's New Book

[Another guest post from Charles Johnson, one of our summer interns.]

Tyler Cowen's new book, Create Your Own Economy: The Path to Prosperity in a Disordered World is one of the more engaging books I've read recently. It rests comfortably in the niche between books about behavorial economics and social technology. Careful readers of this blog will note that Tyler Cowen was a participant in the Kauffman Economic Bloggers Forum in February. We prepared videos of the participants. You can see him on video discussing blogging here. Cowen is a seasoned blogger at his blog, Marginal Revolution. 

The thesis for Cowen's new book is that technology is allowing many of us to become autistic-like in our processing of information and consumption of entertainment and culture. We've moved into a "bits" culture where we can constantly be orienting and re-orienting our culture. This remix culture is evident in everything from iPods, to blogs, to delicious, and to Facebook. In a way, I took this part of the book as a kind of demonstration that we can all become renaissance men because the costs of such renaissance have plummeted. We don't need Jefferson's library when we have a worldwide web with easy information at our fingertips. 

Cowen's book can be read as an appeal, that, for the sake of society at large and the individuals in particular, we should embrace neurodiversity, or the different ways in which our brain is wired. (You can hear him discuss the book in an interview with John J. Miller of National Review here.)

I was struck by this paragraph about autism and the foundation of companies. We know that dyslexics tend to have high rates of firm creation. (See here for more details). But what about autistics? 

Here Cowen points to the work of Simon Baron-Cohen, who is a researcher of autism at the University of Cambridge. (Simon Baron-Cohen created an AQ test -- or autism quotient -- that you can take here to see if you might have autistic-like tendencies.) Cowen recounts that Baron-Cohen believes that there may be a lot more autistic high achievers than most people realize. On p. 24-25, Cowen writes about some of these high achievers. [The bolding is mine.] 

Craig Newmark, founder of the web forum Craigslist, has written on his blog that his history as a "recovering nerd" is connected to Asperger's. It is perhaps no accident that autistics are known for their attachment to lists as a means of processing, recording, and ordering knowledge. Bram Cohen, creator and former CEO of BitTorrent, also describes himself in terms of Asperger's syndrome. He founded the company at age twenty-nine and BitTorrent has been a pioneer in exchanging digital information over the web; one of his key insights was how BitTorrent could break up files into smaller bits and send through the bits rather than the whole file at once. Cohen mastered three programming languages by the age of sixteen and his work on BitTorrent is regarded as brilliant. The best-known example of an autistic high achiever is Temple Grandin, a woman who has pioneered commonly used improvements in animal treatment and slaughterhouses; her unique cognitive perspective has helped her understand when animals are afraid and how they can be made to feel more secure. 

I've yet to see a scientific paper or serious clinical discussion of the autistics who hold political office, work in Hollywood, start web 2.0 companies, or run major U.S. corporations or hedge funds.

If Baron-Cohen is right that there is the huge reserve of highly successful autistic achievers, I wonder why there hasn't been some kind of online, Craigslist-type sorting website that seeks to place autistic people with the things in which they specialize or some kind of wider texting that seeks to identify and help autistic people find their niches.  

I came upon this idea when I was spending time with my next door neighbor, who has Asperger's. He has an obsession with clocks and with taking them apart and putting them back together. Imagine the societal benefit if he could be placed with a clock making company. 

Indeed, if I could fault Cowen's book for one thing, it's that it doesn't take the ideas he's advocated and move towards policy. Still, perhaps policy is not one of those things for which Dr. Cowen is wired and I ought to respect his neurodiversity. 

Is Journalism Dead?

That was the question heading one of our Kauffman Econ Blogger Forum discussions.  The panel spent most of the time discussing whether newspapers are dead (Scott Jagow's summary is here), which to me seems probable, if not obvious. That they are dying, no one can deny. Is it sad? Yes. Is the end of seeking truth in current events? Hardly.

What is likely to happen is that newspapers will evolve, perhaps so swiftly and completely that it will be hard to believe that the future species is related to the gray-paper-o-saurus. But will journalism die? That was a trick question. The answer in my mind is that bloggers are the new journalists. Or at least, some are. (Is Rushbo a journo?). In fact, it seems more accurate to critique the growing bias in newspapers than decry the savages in pajamas.

Insofar as we agree that journalism is the reporting of news in pursuit of objective truth, my belief is that this is a fundamental human motivation, the same spirit driving scientific curiosity. The day journalism dies is the day humanity is extinguished, and I'm still on the optimistic side of projecting neither of those events will occur, present recessions notwithstanding. That schools of journalism have downplayed objective truth exists, and some newspapers have abandoned ancient principles of objectivity, they have hastened the downfall of the daily printed word. But those are quibbles, really.

What's ultimately driving the evolution of journalism is the business model. A grimy gray broadsheet has some tactile appeal, about the same way that riding a horse has its appeal. But compared to the alternatives of jet planes and automobiles, the appeal is nostalgic. But the economics of newspapers (and maybe local news television) is eroding. The recession will accelerate the erosion, perhaps completely. The alternative is what exactly? Free content on YouTube and RealClear? Maybe. Or maybe the spectrum of news is much broader than what you imagine.

Maybe we should think about an infinitely long tail where people will pay, handsomely, for news about interests they deeply care about. The President will probably pay dearly for news about Iranian nukes, and the health of dear leaders in North Korea, Cuba, and Venezuela. My friend Luis will subscribe to feeds about Star Wars action figures no doubt (and who wouldn't?).

This is all to say, Luis wonders if the business model for journalism won't look a lot like iTunes.

Kindle versus Schumpeter

Spend a little time reading about entrepreneurship, and you soon tire of the phrase "creative destruction." Yes, Schumpeter had a brilliant idea and phrase to describe it, but it can seem like nothing new under the sun has happened since. No wonder entrepreneurship studies are not as prominent as macro stabilization!  Surely, that's not a fair summary, but it's fair enough to make one appreciate analyses of technology that tickle at the notion of non-destructive creation (Amar Bhide's phrase, I believe). 

So David Pogue in the New York Times writes about Kindle 2,

The point everyone is missing is that in Technoland, nothing ever replaces anything. E-book readers won’t replace books. The iPhone won’t replace e-book readers. Everything just splinters. They will all thrive, serving their respective audiences.

So is he right?  Or am was I write to view this as a classic phenomenon of creative destruction, when I predicted the book will be dead in 7 years? I'll admit that paper books will still exist, per se, but that within 15 years the market will be under 10% of current sales, and that this collapse will be halfway along (and universally acknowledged) in 2016.  Anybody want to take that bet?

Kindle is a case study of Creative Destruction

I think I can speak for Bob and Dane in that we are all huge fans of the Kindle 1. I doubt any of us will buy the Kindle 2 just yet, but its launch this week is garnering a great deal of attention and some controversy. The fact is that e-books in general have succeeded, and Kindle's success in particular, is now going to cause real frictions in the market. This is a case study in creative destruction.

A very big, very old (and quite wonderful) industry called book publishing is evolving incrementally, and along comes a breakthrough innovation that will concievably supplant it. The market is sliced in half in a way that was beyond imagination years ago: the whole concept of readership demand has been cleaved away from the physical page. The phenomenon creates a co-joined market in which the older form cannot fight back. Classic.

How will it play out? Perhaps book stores, not publishers, are the new dinosaurs. Perhaps libraries will flourish (readers will still like to browse). Perhaps Amazon will open the largest book store in the world ... like the Mall of America for the printed word. Will the physical/digital book markets co-exist and complement (as Stephen King articulated at the launch event)? Yes ... for a while. But the Kindle is hardly done evolving. As it becomes faster and more flexible (and especially cheaper), it is hard to imagine real books will be supplied for much more than high-end afficianados. Given a world of conspicuous consumption, maybe. But in the regular sense of the word, I give the book 7 years to live.

The newness of the new technology may obscure its importance. A touch pad screen for a book, along with the capacity to assemble scribbled notes and highlights, has only begun to unfold in application to learning (check out the iRex ILiad, a competitor). What strikes me most is the new reader technology in Kindle 2, which caught me by surprise. I dreamt of innovating a synth reader 15 years ago, and my hunch is that this will be as important a technology as the e-ink. Can you imagine having your spouse's voice reading the news to you? Or President Kennedy? (For me, that would be cool).

Other reactions to the new Kindle are collected below:

Engadget covered the launch event live-blogging.

"It's reading! It actually sounds fairly good -- still very computer-voicey, but totally listenable."

"0.36-inches thick... the iPhone is 0.48!"

TechCrunch compares 1 to 2

NYTimes: "For publishers, Amazon’s e-book efforts could represent a bright future, as the book industry struggles to sell traditional formats. But some worry that Amazon may be assuming too much control over pricing, similar to the influence Apple has established in the music business."

Lance Ulanoff at PC Mag has 10 count review, and concludes strongly positive. Best critique: "Why no touch screen? As I held the Amazon Kindle 2, I had to fight the impulse to touch the screen and navigate and turn pages with gestures. This, too, is something the Sony Reader offers, as does, as noted, the iPod touch and iPhone."

BusinessWeek says "But Amazon is in something of a catch-22. Lowering Kindle's price too much might threaten Amazon's print book business." Already, e-books represent 10 percent of Amazon.com sales.

Final thought: My vision of the near future imagines highly personalized education for all students, and I very much see something like a Kindle in the hands of every child -- replacing heavy textbooks and bookbags, making reading much more expansize and interactive. If you've read Neal Stephenson's The Diamond Age, you know.  I'll end on this, one of my favorite passages:

"The little story went on to include an Excited Elf who was Nibbling Noisily on some Nuts. Then the picture of the Raven came back, with the letters beneath. "Raven. Can you spell raven, Nell?" A hand materialized on the page and pointed to the first letter.

"R," Nell said.

"Very good!  You are a clever girl, Nell, and good with letters," the book said. "What is this letter?" and it pointed to the second one. This one Nell had forgotten. But the book told her a story about and Ape named Albert.

* * *

Update: Some friends and commentor O argue the paperback will never be replaced by the e-book. To me, that is an appealing argument, but on reflection it sounds a lot like a record executive saying the LP will always be with us. Any content - music or writing - is going from a standalone business model to a "razr-blade" or "printer" model. You buy the holding device for a moderate fixed cost, then buy cartridges (blades, laserjet ink, 99 cent iTunes, novels) for a low marginal cost.  When a mini-Kindle costs $30 in ten years ... or are given away as promo devices by RandomHouse ... the cost economics of publishing on paper will have evaporated. It's not that novels will disappear, or authors (they will likely flourish). Just the dead trees.

 

No Creative Destruction in Detroit

President Bush announced a rescue plan for General Motors and Chrysler LLC Friday morning that will make $13.4 billion in federal loans available almost immediately.

What a shame. What a lost opportunity. In the immortal words of Dr. (Garett) Jones: "Creative Destruction, it was fun while it lasted." If you can't count on a lame duck president to do the right thing, what's left?

The bailout has some severe strings attached to it, its defenders will say.  But it is not bankruptcy, so the depth of restructuring will pale next to what is needed to revitalize the American auto industry. That means the answer is, no, I'm not buying it.

UPDATE: This also seems to be a blatant violation of the TARP, which weeks ago the administration was saying would not (and I thought legally could not) be used for industrial policy. So is it Constitutional? It was once fashionable to re-interpret the intent of laws written decades or centuries ago. Now it seems the time horizon for creative interpretation of the law has converged to months.