Broken Symmetry

What's the New Exit for Patents?

I'm intrigued by the way crowdsourced funding is upsetting the balance of power in financing new films, and companies. The basic trend is toward less and less friction (or what Coase calls "transaction costs") in obtaining financing. At the limit, we have perfectly efficient financing in which ideas receive funding up to the opportunity cost of capital (i.e., up to the next best startup or film that could have been funded). Five years ago, things looked grim thanks to the costs of SOX and the resulting shift of new listings overseas. Technology to the rescue! Gives warm fuzzies to those who tend to be more pessimistic.

But is there less friction for inventors and patentees? Maybe a little, but not the dramatic shift we've seen in private equity financing. And why not? Here things get murky. Looking at equity financing, we can see that at least part of the reason crowdsourced financing has taken off is because of the new "exit" opportunities it offers. At least in relative terms, people prefer what they get from contributing on kickstarter to watching their money go down the tubes in a Facebook IPO. Are there new exit opportunities for inventors and patentees? Nope. It's the same exit opportunities that have always been there. So is there less friction? Maybe a little less. But without the new exit opportunities, it's unclear whether what appears to be reduced friction for inventors and patentees is, in fact, improved allocative efficiency, or whether instead it's an opportunistic redistribution of wealth. We shall see.

Regardless, it's worth asking: if we could dramatically reduce the friction for inventors and patentees, would the public at large view the patent system as more effective or less effective at its goal of promoting innovation? The answer, I think, depends not on whether friction is reduced, but how. It seems to me that there is simply no (lasting) benefit to any stakeholder in the patent system to reducing the friction in reallocations of ownership until the friction in exits can be reduced even further. Universities avoid the problem by limiting the intake to their pipeline, which is wiser than clogging it up with inventory that goes stale. What's the new exit? That's the billion dollar question to be answered by anybody with an interest in seeing the patent system evolve.

Andy Grove on the Human Capital Needed for Scaling

This is easily the most insightful analysis of the most important issue the United States now faces that I have read this month:

Since the early days of Silicon Valley, the money invested in companies has increased dramatically, only to produce fewer jobs. Simply put, the U.S. has become wildly inefficient at creating American tech jobs. We may be less aware of this growing inefficiency, however, because our history of creating jobs over the past few decades has been spectacular -- masking our greater and greater spending to create each position.

My hope is that the loosening of the currency peg will help reverse some of these trends over the coming decades.

Corporate Control as Tragedy of the Commons

Brian Cheffins and Steven Bank provide some interesting facts about how fast corporate ownership diversified at the turn of the 20th Century:

Data on shareholder numbers also suggest that there was a trend in favor of dispersion of share ownership at the beginning of the twentieth century. The National Civic Federation’s Distribution of Ownership in Investments Subcommittee compiled shareholder statistics for seventy-five large corporations from 1901 to 1913, and its unpublished research showed that the aggregate number of shareholders in these firms rose from 141,000 to 415,000 during this period. These findings revealed, according to law professor Lawrence Mitchell, “a signifi cant spread in share ownership across the population[,] . . . both directly, in holdings of less than one hundred shares, and indirectly in the form of increased stock ownership by insurance companies and savings banks.”37

The authors are interested in responding to another historian's arguments about how and when the divergence of ownership and control emerged in the United States. Don't let their argument distract you from the facts the two apparently agree on: The Great Depression was preceded by a big increase in the diversity of ownership.

Without seeing similar figures, it's hard to say for sure. But based on the average number of shares outstanding in many publicly traded companies and the daily volume in trades, I'd be very suprised if the numbers aren't at least 10x what they were in 1913. Moreover, I'd be surprised if the biggest increase in those numbers hasn't come over the period between 1990 and 2008. The emergence of the bond market in the 1980s concentrated ownership; the emergence of mutual funds and hedge funds diffused it.

For me at least, the question of what scale of diversification in ownership is sustainable is an open one. A compelling argument can be made that the current scale does not provide a sustainable mechanism for maintaining alignment between managers and shareholders. This was implied also in Richard Posner's article in the Journal of Institutional Economics.

There is a fundamental tension between the need for liquidity and the need for stability and consistency. Achieving the right balance requires dynamic, market-based mechanisms to be set against each other. Without a market-based mechanism for concentrating corporate ownership (such as the good LBO funds), managers will tend to increase diversity by issuing equity until there is less constraint upon their autonomy.

Incidentally, this is one of the most important reasons why owner-operated companies (including especially founder-owned and operated companies) tend to outperform over long periods. Larry Ellison may be sharp in his dealings with competitors; but so long as he holds 30% of Oracle's stock, you're safe from him as a coinvestor. On the other hand, should Larry start selling, it would be wise for you to follow suit!

Via the Legal History Blog

See here for a not-unrelated discussion of the tension between complexity and resilience on the Clay Shirky blog.

The Internet Operating System

From Tim O'Reilly:

Might an operating system of the future manage when and how data is collected about individuals, what applications can access it, and how they might use it? Might it not automatically synchronize data between devices and applications? Might it do automatic translation, and automatic format conversion between different media types? Might such an operating system do predictive analytics to collect or locally cache data that it expects an individual user or device to need? Might such an operating system do "garbage collection" not of memory pointers but of outdated data or spam? Might it not perform credit checks before issuing payments and suspend activity for those who violate terms of service?

Tim probably inadvertently sent a lot of traffic my way thanks to link through to a Google search of windows "bag of device drivers" andreessen.

Scalability is ultimately the key determinant to what Internet "operating system" will dominate. Google has the "unfair" advantage at this point. Microsoft also has a big cost disadvantage because of its need to support legacy revenue streams. Apple doesn't seem to have the capabilities now to code scalable server-side apps. iTunes is a nightmare. Cisco's products are complements to the operating system market.

Maybe there is still room for a new competitor to Google. Yahoo has more of an opportunity here than many people realize.

What would Gene Fama say?

Since the last post happened to relate to Buffett's purchase of Burlington Northern, I couldn't help mentioning an investment opportunity that's had my attention of late:

A train ferry is a ship designed to carry railway vehicles. Typically, one level of the ship is fitted with railway tracks, and the vessel has a door at the front and/or rear to give access to the wharves. In the United States, train ferries are referred to as "car ferries". The wharf (sometimes called a "slip") has a ramp, linkspan or "apron", balanced by weights, that connects the railway proper to the ship, allowing for the water level to rise and fall with the tides. For an example of a specialized slip to receive railcars see ferry slip.

While railway vehicles can be and are shipped on the decks or in the holds of ordinary ships, purpose-built train ferries are much quicker to load and unload, especially as several vehicles can be loaded or unloaded at once. A train ferry that is a barge is called a car float.

Burlington Northern might or might not own a few of these. But given the investment Buffett is putting into railways, one can't help wondering why some rail ferry owners are selling at a discount.

What's next for Larry Ellison?

Sailing is so last week:

"We've already beaten IBM in software, now ... we will beat IBM in hardware," Ellison boasted last fall at a gathering in Silicon Valley. "That is our goal."

As it integrates its new hardware business, Oracle's pitch is pretty straightforward. Corporations pay billions of dollars to companies such as IBM to hire consultants who stitch together disparate servers, software applications, databases and other IT infrastructure, all of it more often than not bought from various vendors. Why not create an offering that is designed to work together from the get-go, eliminating the need for IT services altogether?

"You can do a better job by having all the pieces designed by a team of engineers that talk to each other," Ellison said when the deal closed.

Phil Weiser on the Topology of Innovation Networks

From a speech by Deputy Assistant AG to the Antitrust Division Phil Weiser on 31 January 2010:

One fascinating dynamic in today's entrepreneurial economy is that the world is simultaneously more locally driven and more interlinked. It is more local because clusters of business start-up and expansion activity can create local symbiotic relationships that fuel further growth and innovation; it is more interlinked because ongoing technological development and races to innovate have created internationally interconnected networks for product development, production, and distribution. A key challenge, recognized and engaged by the Obama Administration's Strategy for American Innovation is understanding how best to balance these local and global forces. For countries, it creates an awkward dynamic insofar as modern economic forces are making both local geography and global connections more important. Thus, to be economically successful, countries must both support local economic clusters to spur entrepreneurship and innovation as well as participate and compete in global markets.

I like almost everything Weiser has to say here, although he is as optimistic about the accuracy of antitrust regulation as you would expect for a government agent. To take the Microsoft case, for example, I have previously blogged that the best result might have been for Microsoft to license in browser technology from Netscape.

Weiser's ultimate suggestion is an excellent one. The government would do well to leverage the comparative advantage of private institutions, such as standards-making bodies, in balancing exclusivity and access in order to achieve the right balance between competition and innovation. See here for a few additional thoughts along these lines.

Weiser and I also share the view that natural monopolies ought to be subject to compulsory licensing -- a fact I discovered on reading a post he did on SSOs for the Truth on the Market blog a few months ago. Where we may disagree more is over the question of who and how natural monopolies are to be identified.

Do animals cooperate with non-kin?

From Nature:

Since Robert Trivers' seminal paper on reciprocal altruism in 1971, models of reciprocity and the Prisoner's Dilemma resource-sharing game have provided the dominant theoretical framework for explaining cooperation between unrelated individuals. Yet there is little evidence that, under natural conditions, animals other than man commonly exchange either resources or services. In a Review, Tim Clutton-Brock examines the case for reciprocal altruism in natural populations of non-human animals. The evidence is thin, he concludes, and many examples of apparent cooperation between non-kin are probably cases of mutualism or manipulation.

Thanks to Tyler Cowen for pointing out both this and the last post. We seem to be tuned into a similar wavelength today!

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...

Rolfe Winkler Looks Like a Major New Blogging Talent

From his post "Markets need rules":

Anyone in business knows how much trust matters on both sides of any transaction. When trust disappears, transactions stop. The market breaks down and individuals are forced to rely on themselves. In a perfectly free market, where economic Darwinism means competition always trumps cooperation, trade quickly grinds to a halt.

No one wants this. As economist Russell Roberts has argued, “self-sufficiency is the road to poverty.”

Laws align incentives so that cooperation can be more profitable than competition. So that individuals in the free market don’t have to worry about the market eating them alive.

Winkler's take is slightly different than mine. What I would (and did) say is this:

What Adam Smith taught us is that cooperation is the source of endogenous growth within an economy. Voluntary exchanges and divisions of labor literally create wealth within society. When it's money rather than goods or services that are exchanged, residual income (i.e., profit) is an excellent proxy for cooperation and endogenous growth. In fact, it's the best the world has ever known.

Crucially, the argument is that cooperation creates wealth, and that laws (or social norms) promote wealth creation to the extent that they facilitate and encourage cooperation. This claim may be quite counterintuitive to competition regulatory authorities, in particular, because much of competition regulatory theory is premised on the notion that competition is the engine of growth, with a few recognizing exceptions for temporary and otherwise limited monopolies (for example, for intellectual property). Winkler falls into the same trap by treating cooperation and competition as dichotomous. Competitions are simply one way to get people to cooperate.

Consider the facts of the American Needle case, for example. An unfettered market for NFL souvenirs is one form of private cooperation. The NFL IP licensing group is another. Both are procompetitive and anti-competitive, but among different stakeholders. NFL IP Licensing group promotes competition among professional leagues (MLB, NHL, etc.). A free market among manufacturers and distributors promotes competition among NFL teams, and probably lower prices and lower average quality in souvenirs overall. The question, which I think the Seventh Circuit got right, is what kind of cooperation/competiton we want to promote. The institution of market competition merely pushes people to differentiate or operate with more efficiency. When the market is already operating at peak technological efficiency and peak diversity, competition will be degrading and wasteful.

More fundamentally, the divisons of labor and voluntary exchanges that create wealth are acts of cooperation. In some cases, competiton is necessary to close the gap between bids and asks. In others, there are enough levers on the transaction such that competition isn't necessary to get overlap. In cases where transactions are occurring despite lack of competition, government should be careful not to destroy social capital -- often hard won over generations. That was Ellickson's central insight.

The Flipside to the Commensurability Problem?

From Roman Werpachowski, interviewed by Chad Orzel:

The fact that people in finance are mostly money-driven turns out to be a gift, not a curse -- it's easier to coexist peacefully by dividing cash than by dividing prestige and political influence.

See also the earlier post on Capitalism and Culture.

Highlights from the 2009 IP Business Congress

Monday and Tuesday of this week I attended the second annual IP Business Congress, which this year was venued at the Four Seasons Hotel in Chicago. There were almost 400 attendees at the event, which was a good turnout given the economic climate. Attendees represented stakeholders in nearly every part of the IP Market, both primary and secondary. As expected, the panels organized by IAM magazine were excellent and informative, especially the question and answer sessions afterward. This is an event that I expect to put on my calendar annually.

Highlights for me as an attendee to this event included (1) the first panel on Monday on the state of IP rights in China, India, Japan, Europe, and the United States; (2) the panel on patent pools on Monday afternoon; (3) the panel on open innovation on Monday afternoon; and (4) the Gala dinner on Monday night. Tuesday's panels were also excellent, but of less interest to me because of my more direct involvement with many of the issues addressed on Tuesday.

State of IP Rights Internationally

Harvey (expert on China) kicked things off by noting how IP rights had been a strong influence on the development of rule of law more generally in China: IP was the first private property right to be recognized by the Chinese government after the cultural revolution. Harvey also explained that in number of lawsuits, there is more IP litigation in China than in any other nation. The picture he painted was of a thriving IP system in China that was operating decoupled from the rest of the IP world. The coupling of China's IP system into the rest of the world's will produce winners and losers of epic proportion, and now is the time for us to think strategically about how to prepare our clients and customers for this inevitable merge of the Chinese system into the rest of the world.

McGinley (EPO Officer) followed Harvey with sobering statistics on the patent application bubble that is growing inside the US, EPO, and Japanese patent offices: 2 million applications althogether are now pending inside these offices. Given how the rate of examination has not kept up with the rate of growth in filing, McGinley suggested that the system was beginning to resemble a pyramid scheme! This was a brave position for a government official to take, but everybody in the system should appreciate what McGinley is trying to do. Where might we have been had more financial regulatory authorities here in the U.S. pointed out the pyramid-scheme-like growth of the subprime mortgage market? McGinley was short on answers as to how to solve the problem, but he did suggest that Chinese officials were probably at the top in terms of training practices and the reduction of systematic errors in examination. This seemed unsurprising to this listener given the on-the-ground experience of many Chinese with more complex manufacturing workflows!

The presenter from Japan had little of interest to say, and presented some confusing interpretations of statistics on patenting in Japan. For example, he pointed out that the largest number of patents issued in Japan were to computer companies rather than pharma companies. Pharma companies need only one well-drafted and prosecuted patent to protect their products. This is not very surprising, and is true everywhere in the world.

Basheer from India gave in many ways the most interesting presentation. His was mostly a diplomatic presentation of facts about the IP market in India, where the political agenda is driven by the success of generic drug manufacturers. As a few BS readers may know, Basheer is also one of the authors of the consistently excellent (but very detailed!) Spicy IP blog. From listening to Basheer, one could piece together a picture of India in a critical state, in which more or less IP protection could result from a sharp push in either direction. Too difficult to call for the time being. On my view, it seems that Indian biotech and pharma researchers have a regulatory arbitrage over their U.S. counterparts, who have many years of redtape to cut through before carrying out even relatively safe clinical trials! Note that beating heart transplants are now being carried out in Indian hospitals. There are many high-risk, high-reward medical treatments now avaiable in India that may never be available in the United States. Another trend to watch carefully.

The first question/comment for this panel was also notable. It came from Sherry Knowles of GSK, who noted that Chinese generic manufacturers were getting drugs to market before US manufacturers by simply scraping clinical data off the clinicaltrials.gov website on which U.S. manufacturers, such as GSK, have to post their data by law! There's one for the USTR to call to Chinese government attention.

Patent Pooling

The Monday afternoon panel on patent pools included Sisvel founder Dini, Hinman from Verizon, and Michel from the FTC. Dini gave a great pitch for hiring independent administrators (such as Sisvel) for allocating profits among patent pool participants, and for getting such admins involved at as early a stage as possible. Michel gave a presentation of the recent history of FTC regulation of patent pools, including a summary of the federal court holdings relating to Rambus's participation in JEDEC. Hinman talked about the perils of patent pool participation, and noted that even opt-out could be anti-competitive. Referring to one patent pool in particular, he pointed out that all but two industry participants had entered. I saw Michel scribbling notes!

The upshot is that if your company is involved with patent pools, you need to hire experienced outside counsel with knowledge at the interface of IP and Antitrust law to help ensure your business strategy reduces the risk of antitrust liability. Your author knows and works with a few such experts, and is happy to make an intro. Note that most corporate lawyers or IP lawyers will not be aware of the perils of competition law because the Bush and Clinton administrations were relatively lax on this front. All indications are that the Obama administration will be more active in enforcing competition law.

Open Innovation

By now the term "open innovation" has become relatively well-known within the business community. Some IP owners may believe that open innovation represents a form of socialism -- an alternative to a system of property rights. Attendance to this panel would have been the antidote to such misunderstandings of this theory. Panelists Weedman from P&G, Simonton from Exelixis, and Bergelt from the Open Innovation Network (and formerly of Paradox) talked about the dynamic growth that the feedback loops established by open innovation networks facilitate for the companies that take open innovation seriously.

Because the theory of open innovation is a paradigm shift from traditional neoclassical economic theories, only a handful of businesses (including P&G and Exelixis) have been fortunate enough to find leaders willing to foster the organizational commitments necessary to make open innovation work. This business model is the future of every large public corporation in the world. Watching these businesses continue to outgrow their competitors, others will eventually follow.

Gala Dinner

One of the best parts of the event was meeting the attendees. Over drinks before the Gala dinner, I had the chance to catch up with Niels Reimers, who later that evening was inducted into the IP Hall of Fame for his path-breaking work in technology transfer. In this rare moment of opportunity, I had the chance to ask Niels about how he worked at Stanford. By Niels's description, he was practicing the same technique followed by the best founders and managers in Silicon Valley both then and now -- "management by walking around." Dave Packard and Bill Hewlett, Bill Perry at ESL, and Nils at Stanford were all doing management by walking around. Niels's personal accounts of his work connecting Stanford music department (!) professor John Chowning with Hamamatsu corporation engineers were a highlight among highlights for this event.

Later, when Niels cited the Teece Model of innovation in his acceptance speech, I nearly fell out of my chair. The same model was cited by FTC Commissioner Tom Rosch in his speech about new theories in competition law on June 1, 2009. Note that Teece was also cited in the explanation of systems theory provided in your author's letter comment to the FTC on the Evolving IP Marketplace.

Final Thoughts

Another highlight made possible by my attendance to the event, but not directly related thereto, was an invitation to a breakfast with Congressman Bill Foster on Tuesday morning. I am already a fan. Foster is an entrepreneur and physicist who decided (after 22 years of building superconducting magnets to detect subatomic particles) to roll up his sleeves and try to help fix government. I'm pretty sure there's nobody else in Congress who would know what the title of this blog refers to. The discussion of the patent system and innovation at this breakfast was the best I've heard ever anywhere, but it also revealed to me the underlying problem facing patent reform: nobody has a complete view of the whole system. Almost everybody (at least) focuses on the broken incentives and procedures facing them in their subsystem, without stepping back to see how all of the subsystems coalesce into an competitive and innovative ecosystem. Nonetheless, the kinds of questions asked and answers given at this breakfast suggest that already the level of discourse has progressed far beyond the pat answers that were served up last year when patent reform was before Congress. There is more widespread awareness at least of how the public has been manipulated to some extent by the more technologically sophisticated and media-connected subset of stakeholders in the system. Perhaps we will have sensible patent reform after all. Here's to that hope.

The Rights of Employers to Employee's Inventions

One of the more popular posts on this blog is this overview of patent ownership law. In a nutshell, what the overview explains is that in most states, the rights of employers to their employee-inventors' inventions is limited to what was recognized at common law.

California is no exception to that rule. My lovely wife today called my attention to a recent case decided by Judge Ware in the Northern District of California holding an employment agreement that "presumed" to retain ownership in all inventions conceived by an employee prior to termination for up to 1 year after leaving the company. Not enforceable! As the Court explains:

[T]he scope of the Assignment Clause at issue here is not limited to inventions that are based on Plaintiff’s confidential information. Rather, the Assignment Clause broadly targets any inventions “relate[d] to” former employees’ “work” with Plaintiff. Such a sweeping provision conceivably encompasses both inventions based on confidential employer information and inventions relating to former Applied employees’ work in the broad field of semiconductor research and manufacturing. Indeed, despite the fact that the Employment Agreements specifically define “confidential information,” the Assignment Clause of those Agreements is in no way limited to situations in which former employee inventions are the product of Plaintiff’s confidential information. (See Kuwayti Decl., Ex. J.) The Court also finds that the Assignment Clause is deficient in that it is not limited to inventions conceived by former Applied employees while employed at Applied. Instead, the scope of the Assignment Clause includes any invention disclosed by former employees, regardless of when or where they were conceived. As such, the Court finds that the Clause “encompasses not only the dishonest employee . . . but also the honest employee who legitimately conceives an idea or improvement following . . . termination.” Armorlite, 340 F. Supp. at 275. Ultimately, the Court finds that the Assignment Clause is overly broad with respect to both subject matter and temporal scope. Since the Court finds that the Assignment Clause touches postemployment inventions, regardless of when they were conceived or whether they were based on Applied’s confidential information, the Clause necessarily operates as a restriction on employee mobility. Accordingly, the Court finds that the Assignment Clause is a post-employment penalty that violates California public policy as codified in Business & Professions Code § 16600.

Some people are going to complain that this makes Silicon Valley less competitive. Nonsense. Inventors have rights too, and the health of Silicon Valley depends in part on companies not overrearching their rights to former employees' inventions.

The case is N.D. Cal. 5:07-cv-05248-JW, styled Applied Materials, Inc., v. Advanced Micro-Fabrication Equipment (Shanghai) Co., et al.

Feel free to contact me if you have questions.

Unethical Competition

From the NYT:

I am in full favor of competition. My message is: Compete ethically. Sadly, there is a lot of unethical competition that goes on in science. This year alone, I have heard of cases that are the scientific equivalent of insider trading, where reviewers of important papers exploit their access to privileged data to gain unfair advantages in the “race” to the next big discovery. I have heard of researchers being ignored when they request published materials from scientists.

Any institutional design that lets unethical behavior go unpunished invites unethical norms to be established, and a general decline in morals over time.

What Kind of Competition Promotes Innovation?

Charlie Munger offers his view here:

Over the years, we've tried to figure out why the competition in some markets gets sort of rational from the investor's point of view so that the shareholders do well, and in other markets, there's destructive competition that destroys shareholder wealth.

If it's a pure commodity like airline seats, you can understand why no one makes any money. As we sit here, just think of what airlines have given to the world safe travel, greater experience, time with your loved ones, you name it. Yet, the net amount of money that's been made by the shareholders of airlines since Kitty Hawk, is now a negative figure -- a substantial negative figure. Competition was so intense that, once it was unleashed by deregulation, it ravaged shareholder wealth in the airline business.

Yet, in other fields like cereals, for example almost all the big boys make out. If you're some kind of a medium grade cereal maker, you might make 15% on your capital. And if you're really good, you might make 40%. But why are cereals so profitable despite the fact that it looks to me like they're competing like crazy with promotions, coupons and everything else? I don't fully understand it.

Obviously, there's a brand identity factor in cereals that doesn't exist in airlines. That must be the main factor that accounts for it.

Here's my question: When an industry ends up in price competition alone, shouldn't we expect competition regulatory authorities to do something just as much as we would expect the same competition regulatory authorities to do something if the industry ended up with too little competition? Why don't we have both protrust and antitrust law?

We do. This is exactly the problem that intellectual property law is setup to solve. Granting temporary monopolies forces competitors to differentiate rather than competing on price alone. A properly tuned system of intellectual property rights transforms competition into an engine for discovery of new information about the market. Crescat scientia; vita excolatur.

Quote from Creativity by Csikszentmihalyi: Hayek and Evolutionary Culture

Chapter 13 of this extraordinary book is titled, "The Making of Culture." In it, C. presents prescriptions for how to foster a more creative culture. Within the systems theory of creativity that he promotes in this and others of his books, part of the cycle of creativity involves evaluating new work for its worthiness as an addition to an existing domain of symbolic knowledge.

One of the useful observations C. makes in this context is that the impact of a new discovery may extend beyond the domain in which it is made. An obvious example is the discovery of a self-sustained nuclear chain reaction by Enrico Fermi. A less obvious example, perhaps, is the emergence of cosmetic dentistry after the fluoridation of the water supply. As C. puts it: "Left with carte blanche, every field naturally wants to control as many of the resources of society as possible, and more."

At bottom, C. refuses a laissez faire attitude to competition among fields because, however sensible a new discovery might appear to the experts in a given domain, there is no guarantee that the same discovery will be well-received in the culture that comprises all domains. For C., new discoveries should be evaluated both by the experts of a domain and by experts on culture as a whole. His specific suggestion is the most benign of the many similar suggestions that have been made along these lines in the past. Specifically, he envisions:

[A] civil service above party politics and disciplinary fashions, composed of those who aspire to be 'good ancestors,' as Jonas Salk called them, and who would be willing to represent the claims of evolution when assessing whether scientific advances should receive social support. Inevitably such a group would be composed mainly of older individuals, and therefore it would be open to criticism from younger colleagues who are more concerned with advancing their own scientific careers. On the other hand, the probability for dispassionate wisdom is greater among those who have had more, and more varied, experience and who can see their expertise in a broader context -- and those in turn are likely to be older persons. Yet our society expects very little from its elders. This might be one important contribution of seniors that will benefit everyone.

A gerontocracy. Well this is certainly less menacing than the cultural revolution envisioned by Mao, at least at first. Mormons should be pleased.

Alas, C. has faltered here. For after having spent hundreds of pages analyzing and explaining his evolutionary theory of culture and psychology, he fails to follow it through to its logical conclusion: If individuals are happiest when in a psychological state most conducive to evolution of self, then why should not society be happiest under a government most conducive to evolution of culture?

The thinker most often associated with this notion of evolutionary culture is F.A. Hayek. Hayek is also well-known for promoting markets as an efficient mechanism for allocating resources within society.

But C. dismisses the suggestion that the invisible hand can serve effectively to arbitrate the demands of competing fields on cultural resources. First, he points out that no markets are in fact, free. In effect, this is a nod to public choice theory, which acknowledges how well-organized or rich minorities can manipulate government into distorting markets. That's true, of course. Yet it's more an indictment of government than of markets. C. does not thereby prove (and I would say he cannot prove) that because markets can be manipulated they should be supplanted with a gerontocracy.

Second, he points out that market decisions tend to be short-sighted in various ways, such as being oriented too much toward the present. In effect, this is a nod to bounded rationality and behavioral economics. As our present predicament demonstrates quite clearly, markets can and do blow up when too few participants are capable of valuing what is exchanged -- a valuation that gets more difficult the larger and longer the scales of exchange. But again this proves merely that markets have problems, not that a gerontocracy should be preferred to markets.

C. nonetheless for these reasons dismisses the market as a sufficient mechanism for arbitrating the competing claims of new discoveries from different domains. Oddly, however, he writes the following immediately thereafter:

The greatest art, East or West, was not produced when the artists set the agenda, but when patrons insisted on certain standards that benefited them. Patrons wanted primarily to be admired by the public, so the art they demanded had to appeal to and impress the entire community. In this sense, medieval and Renaissance art, commissioned by popes and princes, was in reality more democratic than it has become since the art world gained the power to separate itself from the rest of society -- as a field with its own peculiar tastes and criteria of selection.

This is fishy. Having dismissed the market as a mechanism for arbitrating taste, C. now appeals to the wisdom of patrons who sought approval from... the market of public opinion. If C. is correct in his assertion, then it might follow that the greatest art resulted when patrons were best able to constrain artists to produce what the market demanded. Yet this is exactly the benefit of markets that people like Milton Friedman and F.A. Hayek have cited in their support! Almost no advocate of free markets (and certainly neither Friedman nor Hayek) has promoted an unmediated free-for-all of exchange. There is always a legitimate role for government to serve -- like good patrons or popes -- in constituting and mediating transactions. The point is that spontaneous ordering is the best way to match the standards placed upon artists to the constantly evolving tastes of society. As Hayek explained, this is because of the "knowledge problem" faced by any individuals who might otherwise seek to match the supply of new discoveries to the demand of cultural desires. A gerontocracy is no match for spontaneous ordering -- an ordering that might even be conceived as cultural flow.

This is not to say, of course, that there is no room for improvement in how markets are regulated. Public choice theory and behavioral economics should be incorporated into regulatory systems design -- along with any and all new discoveries that can improve the stability and growth of our system. But we should not discard our system, the best the world has ever seen, in favor of rule by faculty committee. That experiment was tried one too many times in the 20th Century, and with nasty results.

Revitalizing a Culture of Innovation in the United States

Innovation flows in cycles. Ideas are generated by individuals, evaluated by a field recognized as experts in a domain, and either accepted or rejected as creative contributions. Over many cycles, the domain evolves with the consensus of its experts.

Perhaps because of our cultural history of rugged individualism -- a culture that rightly praises the lone artist, inventor, or poet --, our thinking about innovation tends to start and end with individuals. We have come far enough in our understanding that it is clear that a formula for individual creativity, if one exists, is so complex a mix of nature and nurture -- of genetic endowments and family, cultural, and social influences -- that there cannot be enough certainty to justify political intervention at this level of social life.

We should not conclude from this, however, that there is nothing that can be done to promote innovation. New and useful ideas may be generated at apparently random intervals by creative individuals, but the field entrusted with defining a domain of knowledge may be more or less receptive to those ideas. Somewhat paradoxically (since a field of experts is nothing more than a group of creative individuals, which I have denied we understand well enough to regulate), we do understand enough about what makes a field more or less receptive to new and useful ideas to justify a few political interventions. The reason for this is simple: We have not (at least not until recently) had the technological capacity to store and process enough information about individuals to have certainty about them. The same is not true of groups. We have retold, recorded, and revisited histories of various groups of people for thousands of years.

What are the lessons of that history? Painted in broad brush strokes, they are summarized by Csikszentmihalyi in his work on Creativity:

Better training, higher expectations, more accurate recognition, a greater availability of opportunities, and stronger rewards are among the conditions that facilitate the production and the assimilation of potentially useful new ideas.

These characteristics have been found in every great civilization, be it Greece, Rome, Florence, Venice, Victorian England, or the Silicon Valley and New York of today. Our civilization is now in crisis, and innovation offers it its best hopes for the future. We must save ourselves from this crisis by learning new and useful ways of living. To that end, we could do worse than to make our many fields of endeavor more receptive to the new and useful ideas of individual artists, authors, and inventors.

Here is a sketch of how reform might be accomplished:

• Training: We have the best universities in the world. Lately, they have stayed that way because they have been fed by a stream of immigrants who are eager to learn and have been raised in cultures that place a high value on formal education. Art, mathematics, music, and science are hardly valued in our culture the way they were many years ago. When budget cuts are needed, some of these are first to go. Math and science are not cool to American kids. Why not?
• Expectations: The answer is expectations. Adults in this country place too little value on learning for the sake of learning. There is something beautiful and good about having an understanding that brings order to the universe, be it artistic, musical, or mathematical. But our expectations for the next generation are only that it will be more practical and prosperous in solving whatever problem is immediately before us. The rational hypothesis has been accepted and become a reality for all too many of us. A more humane hypothesis that recognizes and encourages the enjoyment of learning and discovery must take the side of rational self-interest before our posterity seeks training and rises above our expectations.
• Opportunities: We excel at least in this respect as a nation since indeed opportunities to join a field and contribute to a domain of knowledge are open in the United States even to many beyond our borders. But we should not rest on our laurels, and would do even better by making those opportunities available to even larger groups, especially when it can be done at low cost. Why not let students who graduate with Ph.D.s from U.S. universities remain in the U.S. if they so choose? At least we should not use money to make fewer opportunities available!
• Recognition: If we are lucky, our culture will evolve to more widely value creativity. In the mean time, the recognition sought by many creative individuals will be not (or not only) the recognition of experts in a given domain, but the recognition of the managers and investors who decide what new and useful ideas are accepted for development, marketing, and distribution to the whole of society. Those managers and investors should be held to the standards of public service commensurate with their level of responsibility to society as a whole. Although government regulation has failed again and again to keep up with changes in a given domain, the web of knowledge that is being spun with new technology offers us all a chance to hold these leaders responsible when their decisions are too short-term or provincial. We should expect these leaders to establish a public presence on the Internet, and to have at least some channel for receiving feedback from people other than the ones they see and talk to on a day to day basis.
• Rewards: For the truly creative individual, seeing a new and useful idea accepted into the domain is its own reward. Yet material and psychological needs remain. Material needs are often met in this country -- although it certainly harder for the average artist and author now than it was before digital performances were available to everyone. But psychological needs for reward and recognition remain. Without some reward or recognition, there is no game to be played, no competition to be won. If competition is an engine of creativity, then rewards should be set commensurate with the importance of the creative contribution. Our patent and antitrust systems are perhaps the most sophisticated means for maintaining such competitions that the world has ever known. We should beware of cutting back at the rewards of patenting when we are so in need of new and useful ideas.

Putting Competition to Work in Risk Modelling

The Vox EU blog carries an article summary of how the collective use of inappropriate market information and flawed models led to systemic financial problems.

Among the authors' prescriptions for improvement to existing risk models is an increased diversity of methodologies for estimating risk. The authors note, however, that such diversity is difficult so long as the data is relatively inaccessible.

Besides its disciplining effect on attempted fraud, transparency into government or market activity has this added bonus -- it permits a diversity of experiments.

Favoring Dynamic Over Static Competition: Implications for Antitrust Analysis and Policy by David Teece

An evolutionary approach underscores the importance of maintaining variety in the economic system. Competition policy authorities as well as other agencies must be concerned with protecting economic diversity and meaningful variety in organizational forms. The focus need not be a particular market - - - it should be broader as what’s outside the market tends to be amongst the best candidates for Schumpeterian entry and radical innovation.

...

More generally, the presumption that more competitors is always better is overturned - - - once the goal is not just lowering price but also protecting innovation. Barriers to entry may need to be examined over a longer time period and must be examined at the firm level.

The role of supporting structures and government funding for research also affect entry conditions. They may purely reflect capabilities that incumbents have developed that newcomers shouldn’t expect to possess. Capabilities are likely to reflect the search for unique advantages. Their possession drives competition.

...

Subsequent research has established that firms exhibit more stability in their capabilities than in their products. In this sense, capabilities are easier to analyze than products. Capabilities are a proxy for those interrelated and interdependent aspects of the enterprise that govern its competitive significance. They are arguably a better proxy for competitive position than (downstream) market share.

Here's the paper. And here's the website for the Law & Economics of Innovation Conference at George Mason University, where the paper was presented last year.

Patents and Guilds

Part of the ancient history of patent law is that guildsmen who had received patents on their work in Venice helped spread the idea of patenting throughout Europe. Via Peter Klein at the Organizations and Markets blog, I found this interesting book review by patent historian Christine MacLeod of a new book on the influence of guilds on innovation in medieval Europe.

Until recently, Adam Smith’s condemnation of craft guilds as “a conspiracy against the public” has implied that the juxtaposition of “guilds” and “innovation” is an oxymoron. That this no longer so is thanks to three decades of lively revisionist scholarship, which has seen guilds rehabilitated as significant political and cultural institutions, especially by historians of pre-revolutionary France.

Because guilds are a historical antecedent to a diverse set of modern institutions (including labor unions, startups, standards-setting organizations, and R&D labs) this is a review worth reading. 

Consider this tidbit, which suggests that priority disputes were being decided in France long before the first Interference proceeding in the United States.

For, while most contributors offer examples of guilds passively accepting product innovations and even new processes provided they were labor- or skill-intensive, Pérez shows the Grande Fabrique (Lyon’s powerful silk guild) taking great pains to actively promote and disseminate them. French guilds generally were in tune with the “enlightened” state’s policy of promoting innovation through offering financial incentives. Yet, Lyon was demonstrably “the most technologically innovative city in France” (p. 242). In its quest to forestall secrecy and private appropriations of knowledge, the Grande Fabrique mobilized various local institutions to validate inventions and assess appropriate levels of reward; it instituted a public repository of models; and it paid bonuses in proportion to the number of new devices sold to Lyon weavers. Ultimately, however, such interventionism proved not merely unnecessary but possibly counter-productive: Pérez points to the bitter contests over priority and “unfair” reward that erupted.

Patent Ownership: Can state law contracts trump federal property laws?

Last week I attended the University of Texas Advanced Patent Law Institute held at the Santa Clara Hyatt. For those curious at to why UT would be holding a CLE event in Santa Clara, note that program co-chair Mark Lemeley started his teaching career at UT, when he took over the teaching job of former Assistant Commissioner of Patents Larry Goffney.

There were many good panels at this event. Note that an earlier post here on the Quanta decision has been updated with some comments from Prof. Merges on the same. I was also appreciative of the balanced view of the secondary market presented by in-house counsel from Yahoo and Google. Their suggestion was that the bias should be toward settlement except, perhaps, with those parties whose business model is based on the asymmetry in the cost of litigation. If they were to carry through with this suggestion, then their clients should be more amenable to settling cases brought by failed startups that have invested significant time and money into developing new and patented technology. Another presentation by a practicing antitrust lawyer highlighted the aggressive and unmitigated bias of the FTC against non-practicing patent owner Rambus. A friend of Broken Symmetry pointed out that the FTC has established a similar track record in its handling of Schering Plough and Unocal recently.

But the presentation that raised the most interesting legal issue for me was the one given by a panel including John Amster, Co-CEO of RPX Corporation, on developments in IP monetisation strategy. John pointed out in answer to a question about chain of title that it was not sufficient merely to confirm that title had been properly executed and recorded by each successor in chain of title in order to clear title to a patent. In some cases, such as the one described in the article linked, the patents may constitute substantially all of the assets held by a corporation at the time of sale. In such cases, the law of corporations in many states (including Delaware) may require a shareholder vote to authorize the sale of the assets.

Mr. Amster's advice was to get a good corporate lawyer or bankruptcy lawyer involved when a corporation in or near insolvency is the seller of the patents. There are a variety of state laws designed to protect shareholders and creditors that may put a cloud on title to an otherwise properly assigned and recorded patent portfolio. That advice could not be more timely given current market conditions.

The subtitle to this post is meant to point out the somewhat unseemly fact that the willingness of at least some Delaware judges to undo the effect of an otherwise proper assignment and recordation for consideration represents a preemption of federal property law by the state law of corporations. An avoidance of transfer in bankruptcy, because grounded in federal law, does not raise the same problems. But I wonder whether a ruling of the Delaware chancery that an assignment was ineffective because not properly authorized under Delaware corporate law would survive a collateral attack in federal court on the grounds that the federal recording act for patents effectively preempts any question of title. Patent law, because of its monarchical pedigree, has its vestigial limbs of jurisdiction.

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.

The Future of Economic Theory: Emergent Order from Multilevel Selection

David Sloan Wilson on the New Fable of the Bees:

Darwin’s theory of natural selection, which explains how individual organisms can become exquisitely adapted to their environments, does not explain the evolution of adaptive societies with equal ease. To understand the nature of the problem, imagine a mutant individual who behaves in a way that increases the survival of everyone in her society, including herself, to an equal degree. Such a “no-cost public good” might not appear very feasible (and will soon be amended), but is useful for illustrative purposes. By increasing the fitness of everyone, the mutant trait will not increase in frequency within the society (other than by drift, which can equally cause a decrease in frequency). This example illustrates the elementary fact that natural selection is based on relative fitness. It’s not enough for a mutant trait to increase its own survival and reproduction; it must do so more than alternative traits in the population. The relative nature of fitness makes the evolutionary forces within a population insensitive to the welfare of the population as a whole. If providing a public good requires a private cost, which seems reasonable, then the prognosis for the evolution of adaptive societies becomes even worse. The public benefits count for nothing, no matter how great, while the private cost, no matter how small, causes the mutant type to constitute a smaller fraction of the population. The final outcome is a population devoid of public goods providers, whose members demonically strive to widen their slice of the pie while remaining oblivious to the size of the pie. I have called this the fundamental problem of social life (Wilson, 2002).

Darwin was aware of this problem and proposed a solution. Suppose that a population consists of not one but many social groups. In this case, our mutant no-cost public good provider does not increase her relative fitness within her group, but she does increase the fitness of her group, relative to other groups in the total population. The mutant trait can spread through the total population on the strength of among-group selection, even if it is selectively neutral within groups. If there is a cost of providing the public good, then the fate of the mutant trait will depend upon the relative strength of the opposing forces of within- and among-group selection.

Profitability, Accounting Rules, and the Evolution of Corporations

I'm in the middle of reading Evolution for Everyone by David Sloan Wilson, an excellent summary of his teaching on evolutionary theory, which claims to show, among other things, "that evolution and religion, those old enemies who currently occupy opposite corners of human thought, can be brought harmoniously together."  That's a subject for another post (or several).  Readers interested in that claim should see a few posts I've done on another blog here and here.

An important fact presented by Wilson is that the traits of individuals evolve very differently when selective pressure acts at the level of groups (that include individuals) rather than on individuals directly.  That's a little abstract, so here's an example taken right out of his book:

Chickens have always lived in groups, and in the modern egg production industry they are crammed inhumanely into cages usually containing nine to twelve hens.  [Biologist William Muir] wanted to increase egg production by selective breeding, and he tried to do it in two ways.  The first method involved selecting the most productive hen from each of a number of cages to breed the next generation of hens.  The second method involved selecting all the hens from the most productive cages to breed the next generation of hens.  You might think that the difference between the two methods is slight and that the first method should work better.  After all, it is individuals who lay eggs, so selecting the best individuals directly should be more efficient than selecting the best groups, which might include some individual duds.  The results told a completely different story.

When Bill presented his results at a scientific conference that I attended several years ago, he showed a slide of hens selected by the first method after six generations.The audience gasped.  Inside the cage were only three hens, not nine, because the other six hens had been murdered.  The three survivors had plucked each other during their incessant attacks and were now nearly featherless... What happened?  The most productive individuals had achieved their success by suppressing the productivity of their cagemates.

By contrast, the second method resulted in higher production, and a cage that looked almost happy.  If group selection could have such a dramatic impact on egg production, what impact might they have on the characteristics of individuals and groups in other situations in which group selection criteria are at work?

Consider the ecosystem of publicly traded corporations.  There are obviously many selection criteria at work here.  But by some measure, it seems safe to say that the profitability of a corporation compared with other corporations in its industry group is one of the most important in determining long-term survival.

At first glance, one might think that we've (quite by chance) landed on the best selection criteria from the point of view of promoting good social norms in business.  Upon reflection there are several difficulties in reaching that conclusion, and even casual observations of differences in industry norms might suggest another.

The problem is that there are many different ways of measuring profitability.  At least under current practice, most public information about profitability is reported by the corporations themselves.  In other words, profitability is not measured by the public, but rather by the agents of the corporations who are responsible for profitability.  Anyone can see how this could transform what should be a group selection criterion into an individual selection criterion, and in turn how that might have some very bad results both in individual cases and for the industry as a whole.

How to remedy this?  Seems like the easiest way to do this is to require corporations to report all raw data to the public in addition to their summary of that raw data in the form of financial statements and notes.  Why would this work?  Most people won't bother with the raw data.  But a few will review it and confirm that the summaries are accurate.  There are more than enough investors out there now for that processing function to be performed.  And the result will be that strategic behavior by individuals in the form of "creative accounting" will be dramatically reduced by the increased scrutiny of their actions. 

Google's unprecedented access to information about demand

...is now more open to the public.  I'm going to play around with the site a little and see if I can't use it to illustrate how demand synchronizes in different markets over a certain length of time.