Broken Symmetry

Co-opetition by Nalebluff and Brandenburger

A blurb on the jacket to Information Rules by Shapiro and Varian leads me to the website for this book by Nalebluff and Brandenburger:

Q. How does someone put this idea of CO-OPETITION into practice?

A. The key is looking at business as a "game." Once you do, you can much more easily spot both the competitive and cooperative aspects of what's going on. Then, after you have a more complete picture of what's going on, there are some simple concepts from game theory that allow you to change the game so you'll do better.

I came to this view through Csikszentmihalyi's version of systems theory. Game theory has always seemed to static. But I liked Nalebluff's Thinking Strategically. Another book for the reading list...

The New Economics by W. Edwards Deming

Recently, I stumbled upon the work of W. Edwards Deming while doing some reading on the applicaton of stastical control to quality improvement. I'm not sure for whom Deming would today be a recognized name, and after reading The New Economics I have a few guesses as to why his reputation may not have persisted for as long after his death as has the reputation of F.W. Taylor, for example.

Deming, unlike Taylor, was not offering easy solutions to his clients, his clients being managers at for-profit companies, teachers and administrators in schools and universities, and politicians or public servants in government -- really anybody who cared to listen. Rather, he was offering a theory about how organizations could improve their overall performance.

The Systems Theory according to Deming

Of special significance to your author is the fact that Deming chose to call his theory "systems theory." Deming defines a "system" as follows:

A system is a network of interdependent components that work together to try to accomplish the aim of the system. A system must have an aim. Without an aim, there is no system. The aim of the system must be clear to everyone in the system. The aim must include plans for the future. The aim is a value judgment. (We are of course talking here about a man-made system.)

Included in this chapter 3 of The New Economics is Figure 6, which Deming calls a "flow diagram" of "Production viewed as a system":

Figure 6 illustrates the interdependence of the components (most economists would call them agents today) within the system. Deming uses the figure to explain how the product is the result not only of how each agent does his or her job, but of how well the agents cooperate to achieve their mutual goal of a happy consumer.

As Deming sees it, "[a] system must be managed. It will not manage itself. Left to themselves in the Western world, components become selfish, competitive, independent profit centers, and thus destroy the system." By contrast, "[t]he secret is cooperation between components toward the aim of the organization. We cannot afford the destructive effect of competition."

More specifically, Deming places the responsibility with management for studying the market, identifying and selecting goals, and clarifying and facilitating the communication of those goals among agents. In practice, this involves listening to agents more than talking, since it is the agents (especially the agents in contact with people outside the firm) that have the freshest information to guide goal development.

Deming suggests that the ultimate goal should be for every stakeholder in the organization -- stockholders, employees, suppliers, customers, community, the environment -- to benefit over the long term. Contrast this with fiduciary duty to maximize profits for shareholders instituted by Dodge v. Ford..

On my view, Deming was prophetic. This book was published in 1993, when the first of two major financial bubbles were just getting started. But now that the global economy has exploded into a chaotic frenzy of new markets and firms, most of which only roughly fit within traditional geographical or jurisdictional boundaries, it is now obvious that there is no institution in the world powerful enough to guarantee to any stakeholder that it will be favored over all others that contribute to an organization. Until a few decades ago, capital was king. No wonder that the owners of capital, often being the scarcest resource available to a firm, got special protection from government. What is the scarcest resource over the very long haul? As Deming could see even in 1993, the answer is human capital -- people power. The systems theory that Deming espoused is about optimizing firms to make the best use of human capital, and it is completely consistent with the systems theory Broken Symmetry seeks to understand in gory detail. Get in the habit of thinking this way, and life will not be the same.

Let's take one example of Deming's application of systems theory to the problem of optimizing firms. Deming attributes this application to Shewhart, who Deming says:

invented a new way to think about uniformity and nonuniformity. He saw two kinds of variation -- variation from common causes and variation from special causes. Common causes of variation produce points on a control chart that over a long period all fall inside the control limits. Common causes of variation stay the same day to day, lot to lot. A special cause of variation is something special, not part of the system of common causes. It is detected as a point that falls outside of control limits.

According to Shewhart, a lack of knowledge about common and special causes of variation leads to two mistakes:

Mistake 1: To react to an outcome as if it came from a special cause when actually it came from a common cause of variation.

Mistake 2: To treat an outcome as if it came from common causes of variation, when actually it came from a special cause.

The "Common Cause of Variation" is a Martingale

At this point, I can explain to my readers why I believe Deming's representation did not last long beyond his death. These statements, devoid of any experience with statistical or physical theory, must seem completely obvious, even trivial. They are not if one can understand and interpret what Shewhart and Deming (both trained as physicists) are talking about here.

What Deming and Shewhart call a "common cause of variation" is what most engineers, scientists, and even economists and other social scientists would recognize as a normal or Gaussian distribution in outcomes. As wikipedia explains:

By the central limit theorem, the sum of a large number of independent random variables is distributed approximately normally. For this reason, the normal distribution is used throughout statistics, natural science, and social science as a simple model for complex phenomena. For example, the observational error in an experiment is usually assumed to follow a normal distribution, and the propagation of uncertainty is computed using this assumption.

By contrast, when Deming and Shewhart talk about "special causes of variation," they're talking about distributions of outcomes with fat tails -- pareto distributions (a/k/a power laws), Levy distributions, and so on. Deming and Shewhart were studying Martingales and non-convergent stochastic dynamics decades before these became popular in academic fields! Even better, they were teaching managers inside large corporations how to recognize non-Markovian dynamics and correct system design without making the problem worse.

An Application to Financial Regulatory Reform

How might this be applied to the financial system? Fat tails developed, which almost destroyed the system. Lots of folks are jumping in now with reform proposals that promise to make the system more efficient, more stable. What would Deming and Shewhart have to say?

Chapter 9 provides some tantalizing clues. Chapter 9 is called "The Funnel," and describes a process whereby marbles are dropped through a funnel (which is wide enough for each marble to have some clearance) onto a table cloth, with the position at which the marbles come to rest being marked. Without doing the experiment yourself, you can imagine that the actual pattern of marks formed after such an experiment will be a cluster of marks on the table under a target under the funnel -- not one spot right on the target. As Deming explains by successively considering various alternatives, most active efforts to reduce the radius of the cluster of marks will not be successful.

1. If at each drop, the funnel is moved from its last position to a new position to compensate for the last error (for example, by moving northeast to compensate for a mark southwest of the target), then the results are worse -- the pattern of marks has an even wider radius.
2. If at each drop, the funnel is moved from its starting position to a position equal in distance and opposite the direction of the last error, then the results are even worse -- a plot of the radius of marks now shows distinct oscillations.
3. If at each drop, the funnel is moved over the mark where the last marble fell, then the marks will merely drift off "to the Milky Way."

What's going on here and how is this relevant to the financial system? Banks are funnels for cash and other assets -- the marbles flowing through our system. The marks on the table are the marks on the books of each bank -- marks of how each asset is valued at a given moment. The various alternative rules for moving the funnel around represent the effects of mark-to-market rules on the financial system -- rules intended to correct for the default gaussian spread of marks!

1. When corrections are made to book value in each period to account for newest market prices, volatility in asset value is increased. This is equivalent to moving the filter in a direction equal and opposite to the last mark after each drop.
2. Making corrections to book values of cost only makes things worse, increasing volatility in the system even further!
3. Marking assets to exactly the last market price (i.e., without taking into account historical value at all) sets the whole system adrift.

How and why was FAS 157, which implemented these rules, ever put into place? The answer is that the accountants who work on these regulations work for the banks and institutions that wanted to mark up their book value during the Great Moderation that preceded the present financial crisis. And they're not entirely to blame because most of these people do not have a systems-wide view of the consequences of these rules. But it should be clear how important they can be.

I hope this example demonstrates the instrumental value of systems theory to policymakers. Until now, law and economics (the economics being mostly neoclassical) was the only quantitative tool in the toolbox. What this example shows is that systems theory can provide insight. As Deming points out, none of the active efforts to correct the error would have been as helpful as simply moving the funnel closer to the table cloth or using a sticky table cloth (by analogy to the financial system, this could mean better matching the frequency of marks to market to the frequency of transactions or increasing the transactions costs relative to the size of the transaction).

The Problem with American Anti-intellectualism

From W. Edwards Deming's The New Economics at 173:

On arrival [at] Western Electric, following directions, I found my way to Mr. Chester Coulter on the fifth floor. I was to join a group of about two hundred people working in so-called research and development. The head of the organization was a Dr. H. Rossbacher. My esteem for him increased year by year. He had a respect for theory. In a conversation that I overheard one time, somebody complained to him that the way we were starting off was too theoretical. HIs reply was that if we have ever accomplished anything here, it started off with studies that some people complained were too theoretical. He had no use for the word practical.

On that note, I plan to post a review of Deming's New Economics sometime soon. Deming is fuzzy on the distinction between special and common causes of variation in production, and it's no accident why. Statistical models of special variation are very sophisticated.

Renormalization Group in Macroeconomics

Should I be relieved that this was published in 1996?

A friend clued me in to the fact that macroeconomic theorists were applying the Ising Model a long time ago.

But how far have Prof. Aoki and his students and colleagues gotten with this?

Douglas McGregor on Systems Theory

We study characteristics of cells, of organs, of the nervous system as a whole, of the human being as an organism, of groups, and of larger aggregations of human beings. Certain characteristics are common to all these "systems"; others are unique at each level. Water, for example, is composed of atoms of hydrogen and oxygen. Knowledge about these at the level of the atom would not give us knowledge of the properties of water, nor of the fact that water at temperatures below 32 degrees Fahrenheit becomes solid and floats.

Management's insistence that the individual is the unit of organization is as limiting as an engineer's insistence that the atom is the unit of physical systems. The limitations of a physical technology based at one level alone would be great indeed. A molecule is an assembly of atoms, to be sure, but certain relationships among the atoms result in molecules with given properties, whereas other relationships result in entirely different properties. These properties of molecules cannot be predicted solely on the basis of knowledge of the properties of atoms.

That's from The Professional Manager, published in 1967, which I picked up at D.G. Wills in La Jolla while on vacation. I'm still in the first chapter, but have been delighted with what I've discovered so far. McGregor points to Maslow as the foundation for his theory of human behavior, and comes out (in the passage above and its surrounding pages) very strongly in favor of group selection theory. This was just a few years before the new Atheists, especially Dawkins, effectively put the kibosh on multilevel selection theory in evolutionary biology -- a trend that has recently reversed.

A friend tells me that McGregor taught both Warren Bennis and Peter Drucker. It's very intellectually satisfying to find that McGregor shared so many of my personal inclinations. I may have more to say about this book in the future.

If one were to quibble with McGregor's last claim in the quoted passage (that properties of molecules cannot be predicted solely on the basis of properties of atoms), then one would point out that renormalization group methods give us some insights into how relationships at one scale affect dynamics at larger scales.

Music and the Brain

From an interview of Oliver Sacks:

Using loud music as torture draws on these qualities of music, as well as simple sensory overload. I personally find the assault of loud public music—in stores, restaurants, airports–a minor form of torture. One wants to listen to one’s own music, in one’s own way, not to have it force-fed, especially at great volume.

One of the things I found remarkable about Beijing when I visited in 1998 was the ubiquity of public address speakers, which were usually playing some kind of music in the background in between and during public announcements. One had the sense that people there were uncomfortable without these sounds, since one could have observed these speakers installed even in improbable locations. Here's another quote from the interview:

Rhythm, actual or imagined, activates areas of the motor cortex, crucial in synchronizing and energizing movemen... There is a great deal of debate about the relationship between music and language, and speculation about which capacity evolved first. It has often been suggested that music emerged as a by-product of linguistic capacities. But musical rhythm, with its regular pulse, is very unlike the irregular stressed syllables of speech.

Musicophilia may be worth a look.

The Female Brain by Louann Brizendine

This is a useful book for any man who lives or works with women. Among other facts that I learned from reading this book, I was especially amazed at the following:

• Until eight weeks old, both male and female fetal brains look exactly alike. A testosterone surge at eight weeks turns the unisex brain male by killing off cells in the communication centers and growing more cells in the sex and agression centers.
• During the first twenty-four months after birth, female brains marinate in estrogen, and imprint their early social environment.
• Estrogen affects responsivity to light and the daily light-dark cycle.
• During puberty, many new synaptic connections -- including those between the amygdyla and the prefrontal cortex -- remain uninsulated by myelin, making control by the prefrontal cortex slower and less reliable.
• The amygdyla has to shut down before the female brain can experience orgasm.
• The female brain may have more mirror neurons (although I am told that this conjecture has been called into question recently).
• The oxytocin/dopamine response to touching significant others or children (which I knew about from reading The Happiness Hypothesis by Jonathan Haidt, basically drops off dramatically at menopause, with only a modest recurrence when grandmothers come in contact with their grandchildren.

Carol Gilligan should be pleased. Catherine MacKinnon perhaps not so much. (Although I think the work is not technically incompatible with MacKinnon's work.) Highly recommended. I wish I'd had the chance to read this book while still a teenager.

The book greatly benefits also from the wealth of experience that Brizendine has through her psychiatric practice. Some of the stories rang very true for this reader.

Creating My Own Create Your Own Economy

On Saturday, I received my hard copy of Tyler Cowen's latest work of popular economics, Create Your Own Economy: The Path To Prosperity in a Disordered World. Although a work of popular nonfiction, which read easily over the course of a few hours this weekend, this book is chock full of creative insights into what might be called an alternative economic vision of social life. I say "alternative" because until recently most academic economists had confined their interests to finance rather than culture, although Cowen is careful to trace the threads of Adam Smith, F.A. Hayek, and Thomas Schelling (among others) from which his unique vision is woven together. In the sense of developing this alternative vision, this book is actually the continuation of his last, Discover Your Inner Economist: Use Incentives to Fall in Love, Survive Your Next Meeting, and Motivate Your Dentist. In both books, Cowen assumes the point of view of individual consumers; his data is drawn from individual stories and experiences; his understanding of group behavior and consumption are correspondingly richer with local and temporary detail than most economic analyses of culture. Read in conjunction with Schelling's Micromotives and Macrobehavior and Robert H. Frank's The Economic Naturalist, one can see how the methodologies of Thomas Schelling are facilitating a gradual evolution in economic thought among his students and (thanks to their attention to the needs of non-economists), the public at large. All are recommended reading.

A central premise in Create Your Own Economy is that technology is fostering a more "autistic" lifestyle. Cowen envisions "autism" as a superior ability to filter out particular bits of information from the barrage of stimuli we experience in everyday life, to absorb those filtered bits, and to imbue those disparate bits with meaning by ordering and re-ordering them into a collage of our own creation. John Milton would be proud. It is part of Cowen's project in this book to encourage a more positive definition of autism, a definition that focuses on the cognitive strengths of people who might otherwise be called autistic only because of their inferior ability to communicate in traditional social settings. We might even call this "positive abnormal psychology." Although this aspect of the book is interesting, and is sure to get attention from both the autistic community and the community of psychologists and clinicians who specialize in working with people diagnosed with autism, my focus as reviewer will be on how this vision of culture could be seen through the lens of science. More specifically, I'm going to explain how Cowen's vision of a more creative economy fits with the systems theory that has been the theme of Broken Symmetry. I think it would give Prof. Cowen pleasure to see somebody using his own work as a source of information to be re-ordered within the particular mental framework I bring to bear on understanding economics and culture -- i.e., to see me creating my own Create Your Own Economy. So here's how this book fits within my interior world.

I see Cowen's book as premised on a particular epistemology of culture. Although that epistemology is not quite laid out systematically, what is clear from his unique vision of autism, Hayek's Sensory Order, and his pyramid diagram is that culture is embedded in the neural networks of individuals. For Cowen, economics and culture emerge organically from a process of filtering, absorbing, and reordering information. This is an appealing vision because it promises the possibility that someday economic theories might be understood in terms of biology. And Cowen mentions neuroeconomics in passing, but again Cowen's focus is on culture.

What is interesting is what Cowen does not say about these neural networks and their process of development. Cowen's emphasis is on the largely individualistic process of ordering information that flows into our neural networks. What he does not emphasize is the activity -- especially the social activity -- required to obtain desired bits of information and (perhaps more importantly) to decide what bits should be given privilege in our internal ordering.

For example, in his Chapter on the contrast between autism and Buddhism, Cowen's vision seems heavily weighted in favor of the autistic approach to interior life. On Cowen's view, educational institutions are mostly about using social influence to encourage non-austistic young people to develop more autistic habits. The trouble with this view is that it does not seem to leave enough room for the possibility that some learning and information processing may occur at the social level -- i.e., that some ordering of information cannot be done autistically.

In that vein, I find another theory of learning interesting. According to psychologist Mihalyi Csikszentmihalyi, learning is an individual process, but one that alternates between modes of openness and closedness to external feedback. There is potentially a deep scientific basis for Csikszentmihalyi's theory, which is drawn from the science of networks and self-organized criticality. Given the right balance of external stimuli and internal constraints, networks can self-organize into structures that optimize the flow of information. Optimal flow through networks was studied by Mandelbrot in connection with Zipf's Law. But today it is known that the same self-organized critical structure can be found in an incredibly diverse array of networks in nature, including neural networks and even our economy. In each case, the network structure emerges from an evolutionary process whereby particular network structures persist over time only so long as they can accommodate the stable or unstable variations in flow through the network.

This theory of flow is complementary with Cowen's vision of autistic culture. In particular, the closed mode of operating corresponds directly with Cowen's vision of autism. What seems to be missing from Cowen's vision is the other phase, the phase of extreme openness to feedback and diverse stimulus. (Is this what zen meditation is designed to facilitate?) Within the theory of autism presented by Cowen, it would seem that such openness would be difficult for autistics. Yet it would seem equally important to the creativity and learning characterized by Csikszentmihalyi as "flow."

But why is it so important to maintain balance between openness and closedness? By the end, what becomes clear is that Cowen envisions a radically different structure for society in which individuals cluster into small units -- perhaps even as small as one. And perhaps Cowen is right that this is where current technology is leading us. But can that kind of culture survive?

Robert H. Frank, also a student of Schelling, provides an answer in a recent NYT editorial titled, "The Invisible Hand, Trumped by Darwin?":

By calling our attention to the conflict between individual and group interest, Darwin has identified the rationale for much of the regulation we observe in modern societies... Ideas have consequences. The uncritical celebration of the invisible hand by Smith’s disciples has undermined regulatory efforts to reconcile conflicts between individual and collective interests in recent decades, causing considerable harm to us all. If, as Darwin suggested, many important aspects of life are graded on the curve, his insights may help us avoid stumbling down that grim path once again... The competitive forces that mold business behavior are like the forces of natural selection that molded elk. In each case, we see instances of socially benign conduct. But in neither can we safely presume that individual and social interests coincide.

Technology has enabled us to take finer and finer control over the flow of information and goods that we access as individuals. But over very long times, the benefits of finer control over flow have tended to accrue to the most well-organized groups rather than the most well-ordered individual minds. So perhaps the most dramatic impact of technology will be in how it enables us to be more social, even as autistics.

Reward and Recognition within our Educational System

In attending professional school, I felt surrounded by the kind of behavior that Walter Kirn describes of himself:

Early on, Mr. Kirn was a flash-card adept: "Ignoring three-quarters of the text to focus on the dates and numbers . . . this process involved neither reading nor comprehension. It was more like sifting sand for seashells." He tossed off a free-verse poem to win a contest. "I lived for prizes, plaques, citations, stars. . . . Learning was secondary, promotion was primary. No one ever told me what the point was, except to keep on accumulating points."

I note that Mr. Kirn's father was a patent lawyer:

Though his father was a patent lawyer and a Princeton graduate, the senior Kirn also prosecuted a longrunning war with convention; young Walter spent part of his childhood growing up on a subsistence farm in rural Minnesota, "Amish style."

Bill Watterson's Calvin wasn't raised Amish-style, but one can't help wondering if this is what becomes of Calvin after the system is finished with him.

F. Scott Kieff on New Institutional Economics in Patent and Antitrust

Truth on the Market has been posting guest comments on a new treatise on IP & Antitrust from Prof. Michael Carrier this week. As usual, Prof. Kieff brings order to the confusion of proposals for reform of IP and antitrust law:

Indeed, while much is made about the uncertainty of patents – it’s all the rage today – one of the central problems with many of the legal changes that Michael proposes is that these changes inject into the patent system a much greater uncertainty, and an uncertainty of a much more pernicious type. Business can deal well with factual uncertainty – in fact many forms of business thrive on it (think options, futures, insurance, etc) – but the one type of uncertainty that is particularly bad for business overall is the uncertainty caused by having the underlying legal rules of the game enforced as a function of fashion and politics. But this is what you get when the enforcement mechanism (the details of the particular framework of the legal institutional design) are matters of flexible discretion.

For an earlier post on law as a game see here. Regardless of whether you agree with Prof. Kieff's conclusions about what that theory implies, I find no way to disagree with his suggestion that New Institutional Economics provides the best theory for analyzing the effect of changes in the rules of the IP and antitrust game.

The Three Laws of Performance by Zaffron and Logan

Back in October I read and blogged about Tribal Leadership by Logan, King, and Fischer-Wright. The thesis presented in Tribal Leadership is that the health of organizations correlates with growth in the average number of connections between members of the organization over time. If you haven't read Tribal Leadership, then you should check it out. That book, unlike this one, also includes a useful cheatsheet, which summarizes the most important points of the book. It's the better place to start, and should probably be read in conjunction with The Three Laws of Performance.

Both of these books promote what Mihalyi Csikszentmihalyi would call a systems model for explaining individual and group performance. According to the systems model, there is no particular habit or activity that will guarantee an individual who practices it better performance or more creativity. The reason for this is that whereas an individual produces the performance or creative work, the work must then be evaluated and accepted by the field of experts for the symbolic domain of the performance before it can become a part of that domain. In other words, transcendent performances (including creative works and the accomplishment of challenging business goals) require collaboration between individuals and groups. Growth (or decay) results as groups and the individuals who constitute them evolve to tackle successively more complex goals.

The Three Laws of Performance provides a list of rules (and stories explaining how they work in practice) that promise to help individuals in leadership roles facilitate the group coherence and cohesion that are necessary to bring about transcendent performance. The book is based on a wealth of experience from decades of applying the ideas it explains. If you're interested in this kind of theory, the book is worth a read. It was disappointing, however, that the authors didn't make more of an effort to connect their ideas up with similar work done by others in the past. I'll explain with reference to the three laws themselves.

The first law of performance holds that how people perform correlates to how situations "occur" to them. This odd choice of word raises many questions. Fortunately, the authors were merciful enough to address the confusion upfront:

So what exactly does occur mean? We mean something beyond perception and subjective experience. We mean the reality that arises within and from your perspective on the situation. In fact, your perspective is itself part of the way in which the world occurs to you. "How a situation occurs" includes your view of the past (why things are the way they are) and the future (where all this is going)."

Now without a systems model in mind, this is nearly incomprehensible to me. Again, the best way that I have of understanding it is in terms of a systems model that includes feedback loops between individuals, the field that includes those individuals, and the domain of symbolic knowledge that the field operates within. If you want a picture, consider this diagram from Roger Penrose's Road to Reality:

In this diagram we see the feedback loop that connects the physical world, our mental picture of it (our consciousness), and our models of it in a given symbolic domain (such as language or mathematics). We can associate each stage of the loop with different people who work within a particular symbolic domain. For a domain to be cohesive, each individual within the group has to a have a mental picture of the entire domain. For it to be coherent, those pictures have to be consistent with the rules of the domain set by a group of recognized experts. So the bottom left corner would correspond to individuals within the group. The top corner corresponds to the domain as it is defined by the group of people who are considered experts in the domain. Note that although the rules of the domain are determined by the group of experts, the domain exists independent of any one of the experts -- making it possible for individuals in the bottom left corner to contribute, and for the domain to outlive any particular expert.

Finally, in the bottom right corner we have the physical world in which everything is embedded. It is through this corner that new information (including experimental observations or discoveries) enters the loop.

Having a systems model in mind makes the first law more comprehensible, at least to me. With the systems model in mind, we can reinterpret the first law as "how individuals perform correlates to their memory and forecast for how the group and the world itself have and will evolve over time." (Or something pretty close to that.) So far this might seem fascinating, but also useless. So what? Should seeing things this way make any difference in how we act?

The answer is yes because as Werner Erhard knew well, it is possible to change the loop by convincing individuals to change how they understand their past and forecast their future, especially as it relates to others within the group. As the Author's Note makes clear, part of the intellectual history of this book is derived from the knowledge and experience of people who worked with Erhard in the est seminars popular several decades ago. Incidentally, that inheritance might also explain the willingness to leave some terminology inscrutable. Part of the ethics of est seems to have involved challenging the audience to engage with the teaching intellectually -- a practice best exemplified by Socrates and worst exemplified by Heidegger, both of whom might also be considered antecedents to this sort of philosophy.

Back to the book. The remaining two laws basically spell out a prescription for how to implement transformational change within an organization given that the systems model applies. So the second law holds that "how a situation occurs arises in language." This is the Sapir-Whorf hypothesis, which is now an accepted fact at least among cognitive psychologists. The Sapir-Whorf hypothesis explains how corners of the loop are linked.

The third law holds that "[f]uture based language transforms how situations occur to people." In other words, when enough individuals working within a domain decide to change the domain, then the domain and hence the activities of the indviduals and groups that constitute it will shift into a different mode of operating. What is perhaps less intuitive is the fact that such shifts may occur voluntarily when enough individuals agree to make them happen. That's another reason why this book should be read in conjunction with Tribal Leadership.

I like the vision that the authors have in this book, and believe their prescriptions are sound advice for carrying out transformational change within an organization. There is so much theory compacted into a short book, however, that it is a bit difficult to digest, and is probably best used in conjunction with training by somebody familiar with the theory. (The authors are also professional consultants with an impressive track record of helping organizations achieve transformational change.)

As a final note, I was reminded by this book of this post on how Thomas Schelling's concept of focal points is useful in facilitating institutional change, and this book review on how the culture of reformed Protestantism may have influenced the Founding Fathers. There is more to be said about insitutional design than is captured by the static mental models of economic equilibrium taught in law and business schools, and this book is a good contribution to the evolution of these mental models.

UPDATE: If you're interested in systems theory in business, then you might also like some of the books and papers published by Prof. John Sterman at MIT.

FULL DISCLOSURE: Per new FTC rules, I want to disclose that I received a free copy of this book before providing the review here. I guess they found me because of my earlier review of Tribal Leadership and thought I'd be interested. I probably would have written a nice review if I didn't feel myself pulled in that direction by my desire to get more free books in the future!

Introduction for Guest Blogger Michael A. Gollin

As a fun way to kick off 2009 for Broken Symmetry readers, I am welcoming author, patent lawyer, and professor Michael A. Gollin to guest blog on Broken Symmetry. Michael has had a distinguished career, which includes almost ten years of teaching Strategic Management of Intellectual Property at Georgetown.  Recently, he authored Driving Innovation: Intellectual Property Strategies for a Dynamic World, which was released by Cambridge University Press in February 2008.  To give readers a sense of the potential importance of this book to policymakers, the introduction was provided by former Senator Birch Bayh of Bayh-Dole Act fame.  (If only Senator Bayh were still in office!)

Beyond the pleasure of his company, I wanted to invite Michael to guest blog because 2009 marks a pivotal moment in the history of intellectual property.  Patent reform efforts that can only be called misguided were narrowly defeated in 2008.  Many in Congress and in the Obama administration are aware that there are problems with the current patent system, but the proposals for change are all over the map.  If anything, the guiding principle behind most proposals seems to be simple self-interest.  What is needed badly at this moment is a comprehensive economic theory of innovation, and of how the patent system can work to promote innovation.  Mr. Gollin's book should be required reading for anybody involved with patent reform.

The most important reason why Mr. Gollin's book succeeds at explaining how and why the patent system can be an effective means for promoting the progress of science and engineering is dynamics.  Policymakers have understood how economic theory is important to both patent and copyright law for a long time.  But many of the most prominent theorists of law and economics have overlooked how static models of equilibrium (all related in one way or another to the Arrow-Debreu model) fail to accomodate change over time.  Whereas such a failure might have been tolerated in older industries and prior to globalization, it cannot in any industry in which innovation drives growth.  More importantly to present purposes, it cannot adequately explain how and why a patent system can benefit both inventors and society at large.

But rather than summarizing the numerous principles of dynamic economic theory that are explained and applied to intellectual property in his book (read the book!), I want to take this opportunity to engage him in a discussion of patent reform.  What subsantive or procedural changes would be most beneficial (or disadvantageous) to IP and antitrust law?  How does a dynamic theory of IP and competition inform our policy analysis in ways that carry us beyond the standard arguments?

Here are a few areas that I can identify:

• Complete overhaul of patent disclosure requirements: The 19th Century specifications and drawings now filed should be supplanted by full multimedia so that inventors can explain their work in their own words to others in their field using full-color video and graphics.  Let the lawyers worry about claiming.
• Clearinghouse for Ownership and Licensing Information: Any member of the public should be able to determine quickly and easily (for example, through an Internet search) the ownership and market price of a patented technology.  The reason there is not a liquid market for IP rights is because valuations are difficult when price information stays private.
• Complete overhaul of antitrust rules as applied in cases involving IP:  Recent FTC actions suggest a grave misunderstanding of the pro-competitive role of patents.  Patents raise barriers to entry in the markets for patented products and processes, but patents also lower barriers to entry in the markets for R&D.  Because these two competitions take place at different times -- often decades apart -- the net pro-competitive effect of patenting is not grasped by some antitrust decisionmakers.

Michael, am I wrong in thinking that the dynamic theory presented in your book might show favor on these kinds of proposals?  Are there others that you would favor more?

Reading List for 2009

Here's the list of books I'll be working through in early 2009:

• Hidden Order by John H. Holland A survey of complex adaptative systems by a scientist at the Santa Fe Institute.
• Kaizen and the Art of Creative Thinking by Shigeo Shingo. Shingo pioneered what I would call self-organized management systems.
• From Assets to Profits edited by Bruce Berman. A collection of essays on investing in IP.
• Free Riding by Richard Tuck. A philosophical reexamination of the concept of free riding and related market failures.
• Against the Gods: the Remarkable Story of Risk by Peter L. Bernstein. I'll be looking for the seeds of 2008.
• Superorganism: The Beauty, Elegance, and Strangeness of Insect Societies by E.O. Wilson and Bert Holldobler. I'm probably the most excited about this book, which is rich with details that support an extraordinary vision of nature. Readers will probably hear more about this book on Broken Symmetry.

More on the Application of Non-equilibrium Statistical Mechanics to Economics

Edge.org recently published a manifesto on how science can help economists and politicians improve forecasts and regulations:

Instead of being in equilibrium, markets can be understood as self-organized critical systems. This is a theoretical construct that can be usefully applied to real markets. It leads one to expect that in steady states markets are approximately scale invariant. This implies a prediction for how certain quantities will be distributed in an economy, which includes wealth, income, sizes of firms, populations of cities, and total values of currencies. The prediction is that these distributions are power laws and the prediction is observed in the real economy.

Note that the theory is that the entire market displays self-organized criticality, not individual firms within the market.

Time scales matter. Different functional cash to cash cycles have very different time scales. Instabilities can be easily introduced by too strongly coupling processes on different time scales.

What this means is that if in a population of 300 million people, only 3 million or so are going to be eligible to borrow under subprime terms in a given year, then you're going to create a bubble by coupling enough money to fund 30 million a year into the market through things like CDOs and CDO^2s.

Read the whole thing. There's also mention of periodicity in cycles of economic activity.

The Snowball by Alice Schroeder

Like many folks in business, Warren Buffett is a personal hero of mine.  I love reading the annual reports of Berkshire-Hathaway, and pay close attention whenever Mr. Buffett speaks about current events. Thus, it was a pleasure to read this comprehensive, authorized account of Buffett's life, including both his career as an investor and as a father.

There are many lessons that could be learned by vicarious study of Buffett's life. I will mention only one because it ties in with an earlier book review I wrote about Carol Dweck's excellent book Mindset.

Buffett started working at a very young age, selling packs of gum door to door, and even buying stock before he was yet a teenager. And he kept at it, even as he experienced a number of serious, potentially career-limiting setbacks along the way. Carol Dweck would say that Buffett is a primo exemplar of the "growth mindset." While Buffett says that he "tap dances in to work everyday," it is not true, of course, that he does no hard work. In the aggregate, he's probably spent more hours, days, months, and years studying financial statements and meeting with people on the frontlines in a given industry than any other investor alive today. What his attitude reveals, however, is that he probably also enjoys these activities more than any other person alive today. Where most of us hit our point of diminishing marginal utility reading financial statements and stock analysis after a few hours, Buffett had them stacked up in the backseat of his car on his honeymooon.

It takes sacrifices, however, to cultivate an interest so unilaterally. And Buffett's personal life has not been a picnic at times, although he has largely succeeded in the Herculean effort to keep it all together. Would Buffett have diversified more in how he spent his time had he to do it all over again? It's a pure hypothetical, but I wonder how he feels about things now looking back.

How much would you pay for good math?

I was both happy and sad to see Applied Hyperfunction Theory selling used for over $700 on Amazon.  That's a one-volume treatise on hyperfunctions, not an encyclopedia.  Happy because I'm very intrigued by hyperfunctions, and I'm glad to see there's strong demand for a treatise about them.  Sad because how much would it cost a publisher to print another thousand copies and clear the market?  Seems like it shouldn't be so hard to clear the market for highly technical books.

Tribal Leadership and Group Selection Theory

Over the weekend I found Tribal Leadership by Logan, King, and Fischer-Wright. I don't read a lot of management how-to books, but the blurb on the jacket plus the recommendation from Michael Jensen caught my eye.  As readers of Broken Symmetry know, I've come around to the idea that markets and firms are, in an attenuated but nonetheless measurable way, subject to change according to evolutionary theory in a way not dissimilar from smaller groups, such as the cells that make up our bodies, or the genes that make up our chromosomes.

What the authors of Tribal Leadership have discovered through a large-scale study is that the most successful firms have a measurably higher amount of in-group cooperation.  In fact, they actually break the health of "tribal firms" into five stages, and the key metric for defining each stage is the average number of connections between members of the group.  Stage 1 is for individuals who are new or for other reasons have no connections to the firm, and hence have a "life sucks" attitude toward everything.  Stage 2 is for individuals who have noticed that the group is doing things for others, but who have not yet figured out how to benefit personally from the group (and hence to contribute to the group themselves).  Stage 3 is characterized by a set of highly productive individuals within the group, each of whom has a number of "dyadic" (i.e., bilateral) relationships with others within the group.  (Imagine a hub with spokes for each individual.)  Stage 4 emerges as the highly productive individuals begin to build relationships with other hubs both inside and outside the firm in order to achieve a goal that they cannot achieve on their own.  Stage 5 is the worst defined in some ways, but is basically meant to describe the stage in which the group transcends competition with other groups, with goals that are broad enough to potentially require cooperation with competitors under the right circumstances.

The book is concise and includes a very helpful cheat sheet in the Appendix.  In fact, you will get most of the substantive content of the book from the cheat sheet even without reading the rest of the text.  I recommend checking it out.  This is a very useful heuristic for analyzing the culture within a large institution.

Anybody who has read the book might be interested in seeing a post I did a few months back, which I think fits very well with the general theory outlined in Tribal Leadership.  In a post on the importance of focal (a/k/a Schelling) points to cooperation, I wrote that the identification of focal points that would foster in-group cooperation was the most important challenge for leaders.  The post was written in the middle of the Creative Capitalism blog debate over the merit of maintaining a narrow focal point of profit maximization as the goal of the firm.  I was pleased to see today that somebody as venerable as Henry Kravis is now admitting that profit-maximization is too narrow a focal point to keep firms health for the long term on a global scale.

Last, I think it's heartening to see that the authors found a few institutions (including Amgen in the mid-1990s) that seemed to have transcended conflict with out-groups as a mechanism for keeping the firm focused on a common goal.  It's an open question as a philosophical, religious, and political matter as to whether abstract goals can substitute for conflict with flesh-and-blood out-groups.  Perhaps the economic model will carry over into these other domains with salutary consequences.  So no, I don't think that markets are inherently bad for moral character.

Quotes from Sync: The Emerging Science of Spontaneous Order

Thanks to my friend Harish, I recently discovered the applied math and physics that Steven Strogatz, among others, have been doing on the spontaneous synchronization of coupled oscillators.  Back in may, I blogged a little about how these systems could be used to model price bubbles.  See here for a post on the subprime bubble.

For almost 20 years now, Strogatz has been studying biological and physical systems that exhibit spontaneous ordering in time -- i.e., synchronization.  See here for an earlier post on his work with links to articles available on the web.  I'm now working my way through his 2003 book, of the same title of this post.  The book is written for a nontechnical audience, but does an excellent job of summarizing some of the mathematics in the work.

Amazingly, Strogatz does not seem to be aware of Hayek and his work.  Hayek is not mentioned in the index, and does not show up in the last chapter dealing with sociology.  Perhaps he's mentioned in a footnote somewhere, but given the title of the book, this seems rather amazing.

I'll be sharing quotes from the book that stick out to me over the next few days.  The quote for the day deals with the first mathematical model developed by Strogatz and his collaborators to describe how a set of oscillators of fixed frequency (they used an all-to-all network of RC oscillators) will always spontaneously synchronize.  It turns out that the key parameter is leakage -- i.e., each oscillator has to have a charge curve that shows slower increase closer to the threshold for each reset:

If the charging curve had bowed up instead of down -- if the voltage accelerates up to threshold -- our simulations showed the population doesn't necessarily synchronize.  The oscillators can get stuck in a random-looking pattern of disorganized firing.

This delicate point often tripped up other mathematicians when I first gave lectures about our work; before I had the chance to explain it, some heckler (and usually there was one) would interrupt and say the theorem is trivial, that of course the oscillators will synchronize, since they're all identical and coupled equally to one another, and what else did I expect?  But that objection is too facile -- it overlooks the subtle influence of the charging curve's shape.  Only when the curve bends [downward] is sync inevitable.

The way I'm thinking about frequency patterns of consumption, it is entirely predictable (because of diminishing marginal utility) that a population of people will demonstrate downward bending aggregate consumption within a window of time.  In other words, at successively higher aggregate levels of consumption, the additional quantity of goods or services demanded will be smaller.

What this means is that market for goods or services in which the law of diminishing marginal utility applies demonstrate the key characteristic necessary for spontaneous synchronization to occur. (!)  Hayek would be very excited about this research.

But this isn't simple.  Unfortuntaely, in the model I've been working on, I assume that there is a poisson distribution in frequency of consumption, and this in turn gives rise to the shape of the demand curve.  In the model solved in the book (at least in this chapter), the oscillators are assumed to have identical frequencies.

Waddell & Bodek on the End of the Quarter (or Year) Shuffle

During those last few days of the quarter, all the stops are pulled out to make the numbers.  Some of what is done is downright illegal.  Much of it is unethical.  Just about all of it is senseless.  However, management salaries and promotions are driven by numbers.  Plants are closed or kept open based on the numbers.  Work is shifted from America to China and India based on these numbers.  The numbers, unfortunately, are not based on sensible economics or what is good for the long term health of the business and its various stakeholders.  They are based on Wall Street schedules and balance sheet targets

Most plants have been through the drill so many times that the people need very little coaching.  All the way down to the operators on the production floor, the people know how to rig the numbers.

Every machine and every production employee will run all-out if there is anything in the plant for them to work on.  Supervisors who are normally lenient concerning breaks will become frenzied taskmasters.  Of course, there will be no employee safety or quality meetings.  Nothing will keep production people from their machines on the last few days of the quarter.

...

Quality inspection will virtually shut down.  If anything produced is bad, no one wants to know about it until next week -- after the books are closed on this quarter.

This passage does an excellent job of revealing the connection between quality and periodicity.  Smaller fluctuations in frequency are probably correlated positively with quality.  Quality is difficult to measure.  Periodicity not so much.

More Waddell & Bodek and Why Ideas are Cheap

When there is only one part available, the cost of it being defective is enormous -- production slams to a halt.  However, when there is a sizeable heap of parts to choose from, the cost of a defective one is minimal.  Just toss it out, pull another part from the stack and move on.

Could it be that having to sort through a sizeable heap of relatively poor quality ideas is the reason that venture capitalists and entrepreneurs generally believe that "ideas are cheap, execution is everything"?  What if ideas got a little more private proof-of-concept stage funding?

Maybe it's a cultural issue.  There's another interesting quote from the book relating to industry culture.

In Cincinnati, Ohio the place for all of the managers, junior and senior, to buy the appropriate uniform was a chain of men's clothing stores called Burkhardt's.  The fellow who did the buying for Burkhardt's waited to make his big decisions every year until the Proctor and Gamble annual report was released.  Cincinnati is the headquarters location for P&G and Burkhardt's customer base included thousands of P&G managers.  If the senior executives pictured in the report were wearing blue shirts or pinstripe suits, he tilted the stores' inventories to blue and pinstripes.  If the executives wore white shirts or plaid suits, he stocked up on white or plaid.

See here and here for earlier posts on Waddell & Bodek.

Baird on Coase on Knudsen: Revisiting the History of Ford and Venice

A few years ago I listened into a podcast of Douglas Baird sharing his paper, In Coase's Footsteps, via the Chicago Law Faculty Blog.  I was particularly interested in his discussion of how it was human capital that had given Ford its comparative advantage.  Baird traces the Coase Theorem to research that Coase did while an undergraduate on the manufacturing processes at Ford and GM.  Baird pinpoints William Knudsen as the source of know-how at both GM and Ford:

Central to bringing this about was replacing the person in charge of production in the Chevrolet division with “the best production man in the United States,” a man named William Knudsen. Knudsen was empowered to make dramatic changes at Chevrolet, and he did exactly this. Knudsen divided the production of automobiles into two largely separate operations. First there was the manufacturing of the basic components, such as the engine, the transmission, the wheels, and so forth. Second, there was the question of assembling the component parts. Knudsen was convinced that efficient production required a dramatically different approach to each. (page 6)

This history is mostly consistent with the historical discussion in Waddell & Bodek's, Rebirth of American Industry, but it leaves out some facts that may be important.  At least as Waddell & Bodek tell it:

[Knudsen] played no part in the development of the Ford manufacturing process that was exploding at Highland Park while he was at remote plants.  That he was a sound manufacturing man was certain, and he had good business acumen, but he was not an expert in the Ford manufacturing system.  At best, he was an arm's length observer.

In 1920, Knudsen left Ford on friendly enough terms and went to work for Chevrolet.  He did a good job there and eventually rose to senior management at GM, but he in no way implemented the Ford system.  Assembly lines were not the Ford system, they merely looked like Ford.  In fact, just about everyone implemented assembly lines soon enough, and they did not need former Ford people to do it.  Knudsen, Chevrolet and everyone else failed to implement the management system that drove the creation of assembly lines; and that was the system that drove almost zero defects and an intense focus on cycle time.  Assembly lines without quality control and short cycle times were not the Ford system.

Waddell & Bodek don't in this passage give a complete account of how the difference in incentives caused by a focus on both cost and cycle time were key to Ford's success.  But that is the main message of their book.

Consistent with their observations, I thought it was interesting to see that the same independent tracking of time and cost was done in Venice in the 15th and 16th centuries

Commercial ventures entangled people in projects with different time returns, so that a kind of hook-and-eye weave of them all into a common undertaking was the result.  The republic governed all this activity with rules ensuring continuity and conformity of rules.  Weights and measures, value of goods, maintenance of quality, gave deals and products a sameness over the years.  Frederic Lane notes how the extensive use of double-entry bookkeeping made people think in terms of complex equations, holding together separate investments with overlapping periods of completion.  Investment partners of different ages and status made contracts binding them together, and any one merchant normally had a web of such engagements...

Time had a special significance for the city that traded so widely through different cultures and varying customs.  The merchant of Venice had his mind on climates far off, on products being matured in countries widely scattered, on the weather favorable for war on sea or land, on the times for sending precious cargoes upriver or down the Adriatic, on the holy seasons setting calendars elsewhere.  Time was fungible.  The constraint in  this wide spectrum of juggled schedules and calendars was the time of Venice itself, marked by recurring festivals, varying day lengths, unvarying liturgies.  Precisely because Venetian time formed a continuum, ways had to be found for measuring its different aspects.  In the tapestry of Venetian time, bells daily rang the hours for devotion and business, astrological phases marked the months, allegorical figures made vivid the four seasons of the year and the three ages of man, ecclesiastical ceremony haloed special times, and saints' feast jostled each other in the dense stream of passing days.  Edward Muir notes that time itself was elastic in Venice: "Through its power to arrange ritual life, the government attempted to impose its own political concerns on the cosmos by restructuring time, which was still in the Renaissance a comparatively flexible dimension defined by the saints' feast and the office hours of the Church rather than by the inexorable mechanisms of the modern age.  The length of an hour in Renaissance Venice, for example, varied according to the season; so time was truly relative."

From Venice: Lion City, by Garry Wills.

Time is now measured with subatomic granularity.  Should not our institutions be more accountable for how they use time than were the Venetians'?

Waddell & Bodek on the Information Economy

Another quote from Rebirth of American Industry.  See here and here for earlier installments.

To the extent that information technology improves manufacturing, it is valuable to all Americans.  Information disseminated through books, newspapers, television, and the Internet may allow us to grow our knowledge and build our skills.  But unless the greater knowledge and skills are put to productive use, the knowledge gained cannot enhance the long term quality of our life...

This view has been under-appreciated for the past ten years at least.  But like the dream of an information economy, the dream of an agrarian or manufacturing economy can be taken too far.

Some services may, in fact, create value.  This is because demand is not a static function.  Utility functions, and the preference functions beneath them, are time-varying and interdependent.  Services that channel demand into more sustainable directions actually do "create value" in the sense that they free up value that is wasted on less sustainable products.

For example, government servants perform an important service to society by enforcing rules that require manufacturers to accurately represent the performance of their products.  Without that service, many corporations would simply redistribute wealth from customers to shareholders by spiking demand with false advertising, distributing dividends, and then declaring bankruptcy.  Similarly, lawyers perform an important service to society by lubricating negotiations between parties without personal relationships.  We rely on lawyers more and more for these services as cultural norms are replaced by legal norms (for example, in family law).  Similarly, investors and insurers liberate value by smoothing consumption patterns over long time horizons.  Last but not least, inventors liberate value by conceiving and demonstrating to the world that needs can be met better or at lower cost with an improved product or process.

But the Waddell & Bodek point about the importance of mining, agriculture, and manufacturing is under-appreciated in our current "knowledge" economy.

Another Waddell & Bodek Quote

See also the first quote describing how Ford implemented a prediction market at its Highland Park plant.

The philosophical underpinnings of much of this can be found in Sloan's "M Form" concept.  One of the key ideas was to break General Motors into divisions that would operate "independently" -- decentralized, according to Sloan -- but still reporting to and controlled by the corporate headquarters.  Because it was really one company, this decentralization often required the divisions to "buy" and "sell" from each other.  Fisher Body, for example, sold car bodies to the Chevrolet Division and so forth.  This notion of a company buying and selling from itself flowed down to the very details of the company's cost accounting scheme... The idea is that somehow, even though nobody sold anything to anybody, machining made a profit on the deal, and that profit can be used to measure the return on the company's investment in the machining department.

From Rebirth of American Industry, page 67.

Here's an interesting SSRN paper discussing a government-sponsored review of M Form theory in the Netherlands.

Reporting credit and debit flows for each balance sheet account would make it easier to keep track of how capital expenditures were either helping or hurting the ultimate goal of selling higher quality products to customers.

Human Capital Development on Small and Large Scales

I've read two great books in the past few weeks.  One is about management and institutional design.  The other is about personality and social psychology.  I believe that the theories presented in the two books are related.

Charles G. Koch, in The Science of Success: How Market Based Management Built the World's Largest Private Company, describes how his company has grown exponentially by harnessing its human capital through a culture that encourages experimentation, differentiation of individual skills, understanding of opportunity costs and divisions of labor, and transparency.  In a sentence, his view is that successful companies maintain growth by focussing on what and how they produce economic value.  In economists' jargon, "value" here means allocative efficiency.

Carol Dweck, in Mindset: The New Psychology of Success, describes how an individual's attitude toward hardship or adversity has dramatic long-term consequences for personal development (of skills and relationships).  The "fixed mindset" manifests as a need to achieve short-term goals for validation of the individual's self-conception as successful.  The "growth mindset" manifests as a need to be challenged and see improvement over the long-term regardless of whether particular short-term goals are met.

The affinity of these two theories is rather startling.  Individuals demonstrating Dweck's "growth mindset" would flourish in a company implementing market based management.  It would not be unreasonable to say that one way to live the "growth mindset," would be to apply market based management to one's day-to-day decisionmaking.