Broken Symmetry

The Good, the Bad, and the Ugly

From Dan Primack at peHUB:

The secondary market’s stickiest wicket continues to be the gap between buyside and sellside pricing expectations. Rather than trying to bridge the divide, it would appear that both sides are calcifying – believing that the other will cave.

For buyers, that means banking on a theory that increased capital call volume will push some LPs over the line from liquidity-parched to liquidity-desperate. Sellers, on the other hand, counter that an increase in capital calls is likely to be coupled with an increase in distributions, which could help them maintain an even keel.

The detente among LPs, buy-side GPs, and sell-side GPs recalls a classic spaghetti western:

One cannot help observing that the same groups that before the crisis were actively engaged in buying and selling have undergone a sort of phase transition to passive standoffs in which the biggest concern is with being the last man standing.

What will break up this "calicified" state, and get the volume of transactions flowing again? Government interventions seem not to be enough. Only restored trust and confidence will do the job. And these take time.

The Wire and Csikszentmihalyi's Theory of Flow

Last night I finished the last episode of Season 1 of The Wire. If you haven't seen any of this, check it out. The show compares favorably with any film or lit I've consumed in many years.

The show, in fact, provides a good fictional depiction of a complex system, of the kind discussed repeatedly on Broken Symmetry. Of particular note in this regard is the term chosen by characters in the show to describe the complex system of which they are a part -- "the game."

The term naturally calls to mind Csikszentmihalyi's theory of flow, which was discussed in an earlier post, which included this excerpt C.'s book Flow: The Psychology of Optimal Experience at 81:

Cultures are defensive constructions against chaos, designed to reduce the impact of randomness on experience. They are adaptive responses, just as feathers are for birds and fur is for mammals. Cultures prescribe norms, evolve goals, build beliefs that help us tackle the challenges of existence. In so doing they must rule out many alternative goals and beliefs, and thereby limit possibilities; but this channeling of attention to a limited set of goals and means is what allows effortless action within self-created boundaries [i.e., flow]."

It is in this respect that games provide a compelling analogy to cultures. Both consist of more or less arbitrary goals and rules that allow people to become involved in a process and act with a minimum of doubts and distractions. The difference is mainly one of scale. Cultures are all embracing: they specify how a person should be born, how she should grow up, marry, have children, and die. Games fill out the interludes of the cultural script. They enhance action and concentration during "free time," when cultural instructions offer little guidance, and a person's attention threatens to wander into the uncharted realms of chaos.

When a culture succeeds in evolving a set of goals and rules so compelling and so well matched to the skills of the population that its members are able to experience flow with unusual frequency and intensity, the analogy between games and culture is even closer. In such a case we can say that the culture as a whole becomes a "great game." Some of the classical civilizations may have succeeded in reaching this state. Athenian citizens, Romans who shaped their actions by virtus, Chinese intellectuals, or Indian Brahmins moved through life with intricate grace, and derived perhaps the same enjoyment from the challenging harmony of their actions as they would have from an extended dance. The Athenian polis, Roman law, the divinely grounded bureaucratcy of China, and the all-encompassing spiritual order of India were successful and lasting examples of how culture can enhance flow -- at least for those who were lucky enough to be among the principal players.

On my view, this is the most compelling explanation for why the characters are at once enthralled and entrapped by the institution of which they are a part.

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.

What do referees or umpires do?

Consider the analogy drawn by Hayek to illustrate the "pretence of knowledge" in the social sciences:

Consider some ball game played by a few people of approximately equal skill. If we knew a few particular facts in addition to our general knowledge of the ability of the individual players, such as their state of attention, their perceptions and the state of their hearts, lungs, muscles etc. at each moment of the game, we could probably predict the outcome. Indeed, if we were familiar both with the game and the teams we should probably have a fairly shrewd idea on what the outcome will depend. But we shall of course not be able to ascertain those facts and in consequence the result of the game will be outside the range of the scientifically predictable, however well we may know what effects particular events would have on the result of the game. This does not mean that we can make no predictions at all about the course of such a game. If we know the rules of the different games we shall, in watching one, very soon know which game is being played and what kinds of actions we can expect and what kind not. But our capacity to predict will be confined to such general characteristics of the events to be expected and not include the capacity of predicting particular individual events.

Yet we generally agree on the need for referees and umpires, however much we complain about their judgment after "a bad call." What makes for a good umpire or referee?

Having played water polo for a coach, Bruce Watson, who was widely regarded as one of the best refs at the international level in his time, I remember a few principles. One was that a good ref tends to call the game towards a tie. Why? Because it's not as much fun to watch a team get slaughtered. And it's not a good test of the skills of either team.

Bruce was rumored to have made a personal fortune in the market before "retiring" to coach water polo full-time.

I'm indebted to Mario Rizzo for the pointer to Hayek here and in the last post. Hayek is often a tough read -- probably something to do with his native language being Austrian -- but with wonderful gems that bear revisiting.

Netflix Culture

From MG Siegler at Techcruch: (why did he leave Venturebeat for what is turning into a rag?)

The real company values, as opposed to the nice-sounding values, are shown by who gets rewarded, promoted, or let go. Real company values are the behaviors and skills that we particularly value in fellow employees.

PowerPoint here.

The Netflix definition of values is the more coherent, and reminds me of Teece's capabilities models and Nelson and Winter's routines. So how is it that when we think of "company values" we think more of the aspirational statements that seem to have so little impact on how companies operate? Sometimes it seems that the more publicly committed an organization on a particular issue, the less trustworthy its commmitment. Like individuals, organizations that do things don't need to proclaim their ability to do said things.

The Topology of Knowledge

From Joho the blog:

In the Age of Links, we still use credentials and rely on authorities. Those are indispensible ways of scaling knowledge, that is, letting us know more than any one of us could authenticate on our own. But, increasingly, credentials and authority work best for vouchsafing commoditized knowledge, the stuff that’s settled and not worth arguing about. At the edges of knowledge — in the analysis and contextualization that journalists nowadays tell us is their real value — we want, need, can have, and expect transparency. Transparency puts within the report itself a way for us to see what assumptions and values may have shaped it, and lets us see the arguments that the report resolved one way and not another. Transparency — the embedded ability to see through the published draft — often gives us more reason to believe a report than the claim of objectivity did.

Consider the following possibility: Maybe transparency was objectivity all along, but it simply took much, much longer for feedback loops in analog social networks to discredit overreaching authorities than it does in digital social networks.

A corollary is that credentials and authority aren't going anywhere. Their relative importance in the offline world just went up precipitously at the same time that it declined precipitously in the online world.

Capitalism and Culture

A brilliant player wants a referee, for only when the game has appropriate rules can he really show his talents. While the sports of baseball and football haven't changed much in the last century, the economy has -- and American financial regulation hasn't had an overhaul in 70 years. The challenge for the Obama administration, along with the U.S. Congress and our SROs, is to invent a new and better American version of the capitalist game.

-Akerlof and Shiller in the WSJ on April 23, 2009.

Human history has been blighted with dark ages in which our games were little different from the games played by animals in the jungle. Eat or be eaten. Might makes right. During these dark ages, drawing a short straw on health or wealth in the birth lottery meant a life sentence of hunger, ignorance, and fear. A lifetime of hard work was often not enough to guarantee a person her own welfare, much less the welfare of her children.

Civilization writ large can be understood as an effort to redefine the rules of engagement we knew in our ancestral environment. At some moment in time long ago, two competing groups of people either explicitly or implicitly agreed not to kill each other in competing for scarce resources. We will never know exactly what this first agreement looked like, but it is at least plausible that it would have substituted combat for some other form of a competition -- a competitive game. Each group could hold the other accountable to the rules of the new game by the implicit threat of mutually destructive violence should cheating be found. Cheating, and hence violence, did not and have not disappeared as a result of new games being adopted. But as Robert Axelrod demonstrated first with Tit-for-Tat, the individuals or groups that adopt a default strategy of cooperation (or in this context, playing by the rules), reserving punishment only for cheaters, over time outperform other strategies in nearly any local environment. In other words, human civilization evolved to play formal games, games with symbolic rules and procedures agreed in advance.

This shift from chaotic violence to the order of symbolic rules and procedures has had ramifications far beyond mere escape from violence. In the negative space created by the escape from violence, there was room for individuals and groups to develop the knowledge and skills useful to learning and experimenting with strategy in the formal games. Strategies for winning became overlaid on the rules and procedures, and on the commitment to play by the rules and procedures. So long as the agreements that formed the lower layers of this hierarchy of rules remained stable, there was opportunity for individuals to earn reward and recognition from their group by proposing winning strategies. Over time, reward and recognition began to flow to the individuals who were better equipped to learn, analyze, and make strategy rather than the individuals who were more likely to have won in an environment of violent chaos.

This shift in reward and recognition itself was a source of conflict within some groups. It was probably easier for groups to give rewards and recognition to the individuals who came up with winning strategies when those individuals were also the strongest warriors. But over time, as symbolic rules replaced chaotic violence, the coincidence of these traits became less necessary. One choice for the strong bodied but weak minded was to try and impose their own violent order on the group. But when that option failed, it only made it less likely to be attempted in the future. Another was to leave and found another group. This strategy was risky, but more likely to succeed over the long-term should the founding of the competing group be successful. Depending on the fecundity of the new group relative to the old, the new group might overwhelm the old with shear numbers, thereby imposing a violent disorder.

But somewhere over the course of human history, perhaps toward the end of the Dark Ages, it seems that the cooperative groups picked up enough momentum to squeeze the more violent groups into the cracks and crevices of global civilization -- into place like Papua New Guinea, for example. And once the creative power of these cooperative groups was unleashed, it began to transform the face of the earth. Not since Greece and Rome has so much art, music, architecture, law, and technology been developed so fast.

Within this new, non-violent order, the rules of the game themselves have been subject to evolution. Not only are we playing a game rather than killing one another, we are constantly looking for better games to play. Cultural evolution is evolution within evolution. Capitalism is a game that everybody can play, although like any game there will be winners and losers.

[MFM Note: I had most of this post together in April and didn't like it. I circled back around today, made a few edits and am now posting. Comments are welcome. This is a little diffuse even for me.]

More Systems Theory from Judge Posner

My remaining proposals are of measures to improve regulatory performance, as distinct from the organization of financial regulation. First, we need a program that will rotate financial regulatory staff among the different financial regulatory agencies, to broaden the perspectives of regulators, reduce the "stovepiping" of information that may relate to a wide range of companies and financial markets, expose regulators to new ideas, reduce turf warfare based on misunderstandings, and make a career in financial regulation more interesting and challenging.

At his Atlantic Correspondents blog. This is a prescription that could be drawn directly from Ciskszentmihalyi's systems theory as applied to cultural economics.

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 Energy Landscape of Social Balance

From Seth A. Marvel, Steven H. Strogatz, and Jon M. Kleinberg:

Taken together, the above results give us a first look at the energy spectrum of jammed states in completely connected social networks in which opportunities for greater relational consistency and cooperation are the driving forces for change. Since balanced states—the global energy minima—correspond to two mutually antagonistic cliques, they often represent socially undesirable outcomes such as intractable conflict. Viewed in this light, the presence of jammed states at higher energies suggests the possible beginnings of a companion theory of reconciliation and flexibility in the setting of social balance: since these jammed states show less large-scale antagonism, they may provide pathways to steer conflicts into structures where reconciliation can more easily occur.

Available here. For a variety of reasons, I believe these "jammed states" are related to the "twisted states" described in the paper by Kuperman and Zatteo reviewed earlier.

Found via Physics ArXiv blog.

More on Group Selection Theory

From the Independent:

In his study, published in the journal Science, Dr Bowles takes on the proponents of the selfish-gene theory of human evolution by suggesting that natural selection worked on groups of people co-operating together, rather than just individuals.

See also earlier posts from Broken Symmetry relating group selection theory to Tribal Leadership and Executive Compensation.

CEO of Beth Israel Hospital in Boston Blogs

Check out Running a Hospital.

Our President has a blog.

If you're a leader of any kind, blogging is a very good way to communicate your vision, and to receive feedback in real time from people within your organization.

See also this earlier post on the impact that blogging by leaders might have on innovation.

Whom can you trust?

From Clay Shirky:

To describe the world before or after the spread of print was child’s play; those dates were safely distanced from upheaval. But what was happening in 1500? The hard question Eisenstein’s book asks is “How did we get from the world before the printing press to the world after it? What was the revolution itself like?”

Chaotic, as it turns out. The Bible was translated into local languages; was this an educational boon or the work of the devil? Erotic novels appeared, prompting the same set of questions. Copies of Aristotle and Galen circulated widely, but direct encounter with the relevant texts revealed that the two sources clashed, tarnishing faith in the Ancients. As novelty spread, old institutions seemed exhausted while new ones seemed untrustworthy; as a result, people almost literally didn’t know what to think. If you can’t trust Aristotle, who can you trust?

Our notion of credibility and authority is changing in fundamental ways because of the Internet.

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.

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.

Revisiting Robert Ellickson's Critique of Functionalism

An excerpt from Order Without Law:

[E]arly functionalists had a tendencey to consider a human group as a single organizm whose "health" could be examined. It was then easy for them to surmise that Darwinian evolutionary processes would help favor the survival of socially adaptive norms. In the following passage the libertarian scholar Friedrich Hayek lapsed into this sort of analysis:

It is not only in his knowledge, but also in his aims and values, that man is the creature of civilization: in the last resort, it is the relevance of these individual wishes to the perpetuation of the group or the species that will determine whether they will persist or change. It is, of course, a mistake to believe that we can draw conclusions about what our values ought to be simply because we realized that they are a product of evolution. But we cannot reasonably doubt that these values are created and altered by the same evolutionary forces that have produced our intelligence. All that we can know is that the ultimate decision about what is good or bad will be made not by individual human wisdom, but by the decline of the groups that have adhered to the "wrong" beliefs. [The Constitution of Liberty at 36]

(Before nonlibertarian scholars dismiss these thoughts, they should be aware that both Lon Fuller and Thomas Schelling have also harbored suspiciously functionalist sentiments.) [Citing Fuller's "Human Interaction and the Law," and Schelling's Micromotives and Macrobehavior at 124-133].

The difficulty with this sort of organic analysis is that evolutionary processes, as most biologists understand them, select either genes or individual organisms, not groups, for survival. [Citing Dawkins's Selfish Gene and E.O. Wilson's Sociobiology at 106-129; and noting V.C. Wynne-Edwards's dissent.] Assume, for example, that honesty is a functional norm in the sense that, if all the members of a group were consistently honest, they would each be better off than if everyone were consistently dishonest. Would the Darwinian struggle favor the survival of the groups of honest persons? Not necessarily. A dishonest individual living in an environment surrounded by honest people might especially prosper, surrounded by easy marks. As a result, the Darwinian process would tend to select dishonest people for survival. In short, to support a Panglossian scenario of group evolutionary progress, functionalists could not rely simply on the biological theory of natural selection. Instead, they had to develop theories to explain how social-control systems would evolve within groups to prevent successful invasions by deviants who would subvert group welfare.

The punchline is that group selection theory is now enjoying a resurgence among some evolutionary biologists, notably including E.O. Wilson, whom Ellickson cites in support of the proposition that the theory has been rejected by evolutionary biologists. Wilson and Holldobler recently published, The Superorganism, which lays out a group selection theory for how cooperation evolved among insects.

The other objections to functionalism raised by Ellickson are also moot now in view of the improved theoretical tools for being more quantitative about functionalism. In particular, associating a group with a network, and individuals with nodes therein, permits evolution of group behavior to be modeled using mathematical models for network growth and decay. Such models help to eliminate much of the conceptual circularity to which Ellickson objects in this passage.

Why is our System of Executive Compensation so Broken?

Robert H. Frank has an answer:

When the strength of positional concerns differs across domains, the resulting conflict between individual and social welfare is structurally identical to the one inherent in a military arms race. To illustrate, consider rival nations faced with deciding how to apportion available resources between domestic consumption and military armaments. Each country’s valuations are typically more context-dependent in the armaments domain than in the domain of domestic consumption. After all, having lower domestic consumption than one’s rival might entail psychological discomfort, but being less well armed could spell the end of political independence. The familiar result is a mutual escalation of expenditure on armaments that does not enhance security for either nation. Because the extra spending comes at the expense of domestic consumption, its overall effect is to reduce welfare. Note that if each country’s valuations were equally context-sensitive in the two domains, there would be no arms race, for in that case the attraction of having more arms than one’s rival would be exactly offset by the penalties of having lower relative consumption.

So long as CEO pay performance is determined by what other CEOs are getting paid rather than by how much value the company creates during the CEO's tenure, CEO pay will be a positional good in Frank's terms, which draws value away from employees, customers, and investors.

How could CEO pay become less positional? By giving other stakeholders (but especially investors) more transparency into the cash-flows in and out of the firm. Boards and shareholders are forced to compete with other boards and shareholders because those measurements of CEO performance are right now more reliable than more direct measurements of company growth.

Blogging and Scholarship

In general, it seems the academic community is warming up to the idea of blogs as complementary to scholarship. The benefits are obvious enough -- blogs can potentially reach a wider audience and provide feedback on new ideas quicker than the traditional system of private correspondence, conferences, and peer reviewed publication.

There are certain fields -- mathematics, sociology, literature, poetry, philosophy -- for which these benefits seem decisive. Although a scholar in these fields will still want to publish in addition to blogging, once a critical mass of scholars in these fields are publishing their work online, the community within the field will increasingly find the Internet to be a more convenient medium for exchanging ideas. Each scholar has control over their own printing press. Going from expression to wide publication takes zero time rather than months or years.

There are other academic fields, however, for which the benefits seem less decisive. These fields include, for example, experimental physics, engineering, and medicine. These fields, by comparison, are driven more strongly by new empirical results. Empirical studies are time consuming, and take months or years to complete. The time scale of reporting cannot be shorter than the time scale of information gathering.

By the way, neither group of fields is entirely empirical or theoretical. It's just that, on balance, the first group is more theoretical and the second, more empirical. The two groups need each other, and the growth of both fields will be limited by how much information (both data and theory) is shared between them.

In terms of raw numbers, I think the off-line population of the second group is actually much larger than the first group because the second group is generally the group that society calls upon to assist in solving its problems. This is the academic group that has the most direct impact on the rest of society, and its number bears that out. By contrast, the first group (of theorists) probably has a more lasting impact on the way that academia evolves independent of society. The big successes in the first group percolate out of academia through the second group, and eventually change society as a whole. Marx changed the face of the world with his ideas. The Wright Brothers changed the face of transportation. Both theory and practice were necessary to both; but their day to day lives looked quite different, and their influence on society over time reflects those differences.

At the moment, it seems that the first group is going to grow much faster than the second group into the blogosphere. Over the short run, this isn't a big deal. There are still plenty of sources of data available online. The problem is that many of these sources are journalists from newspapers and magazines that are on the verge of bankruptcy. Moreover, very few of these sources of data are put together using the careful methodology that one might find in a typical empirical study by an economist or sociologist, for example. In effect, the Internet is crammed with lots of theorists analyzing a tiny amount of data that is from comparatively unreliable sources. The Internet is a bit like our consciousness in that sense.

What can we do to bring more data online, and keep it organized but accessible? The people who specialize in gathering data now have little incentive to put it onto the Internet when the existing mechanisms for sharing that information are just as good or better, and make it easier to predict whether and how recognition and reward will be distributed tot he gatherers?

People rave about the importance of openness on the Internet. But already I'm beginning to see that the evolution of property rights will be no different on the Internet than it was on any frontier of the past. To encourage people to share valuable goods with others, we have to define and enforce property rights a contracts. Attribution rights to content distributed over the Internet is going to become more and more important as larger and larger portions of the population move online. If we want to make the highest quality content available at the lowest cost to users, then exclusive rights and privately adaptable rules for allocating them are going to be necessary.

Else the owners of the most valuable content are simply going to keep it offline.

Douglass North on What We Don't Understand

"Economics, political science, sociology ... are static disciplines... [that] assume[] away all of the interesting things we want to understand... What's missing? Belief. Time. Culture."

Broken Symmetry readers should take note that "non-ergodicity" is a characteristic of dynamical systems with spontaneously broken symmetries.

You can download a powerpoint presentation in which North makes similar points here.

And here is an academic paper on the same subject.

For more on these topics, see an earlier post on The Three Laws of Performance here.

Would it be fair to call an "open access" state a manifestation of Csikszentmihalyi's flow at the level of organizations and organizations of organizations?

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.

Formal Education and Innovation

Since Mike Speiser stopped blogging, Fred Wilson has provided the best blog connection to the venture capital world. Fred is a thoughtful guy, and has put tons of work into building a wonderful community through his blog. Check out out how many comments he responds to. Unlike so many other bloggers, he's really interested in what his readers think about, and reads and responds to many comments.

Which is why I was a bit disappointed with his latest post. As I see it, he's pandering a bit to his younger readers here. His post is about how you don't need a college degree to be an entrepreneur.

Precocity attracts attention. We all know the stories about how Bill Gates dropped out of college. But for every Bill Gates there are probably thousands of college dropouts whose new businesses never really got off the ground. Many of them would have been better off taking the time to learn what was already known and written down in books. Some young people have a hard time with that. Yet that is what I believe we should encourage young people to do.

The Kauffman Foundation published an interesting study last year that provides some empirial basis to support this view:

Challenging the perception of American technology entrepreneurs as 20-something wunderkinds launching businesses from college dorm rooms, a new study by the Ewing Marion Kauffman Foundation and researchers at Duke and Harvard universities reveals most U.S.-born technology and engineering company founders are middle-aged, well-educated and hold degrees from a wide assortment of universities.

I know it's true that you learn some things from trying to start a business that you cannot learn in school. But you can always start a business after you graduate. It's harder to go back to school.

The larger point is that innovations -- including new businesses -- require the cooperation between a creator and a group of people who recognizes the work of the creator as a contribution. Young people are better creators because of their naivete. But older people are better at listening, watching, and meeting needs.

Tjalling Koopmans on Milton Friedman on Profit Maximization

Here's Milton Friedman:

Let the apparent immediate determinant of business behavior be anything at all -- habitual reaction, random chance, or what not. Whenever this determinant happens to lead to behavior consistent with rational and informed maximization of returns, the business will prosper and acquire resources with which to expand; whenever it does not the business will tend to lose resources and can be kept in existence only by the addtion of resources from outside. The process of natural selection helps to validate the hypothesis [of profit maximization]-- or, rather, given natural selection, acceptance of the hypothesis can be based largely on the judgment that it summarizes appropriately the conditions for survival.

Here's Tjalling Koopmans picking that apart:

Here a postulate about individual behavior is made more plausible by reference to the adverse effects of, and hence the penalty for, departures from the postulated behavior. The reality of the penalty is documented by technological and institutional facts, such as the reproducibility of production processes and the operation of accounting procedures in bankrputcy laws. . . But if this is the basis for our belief in profit maximization, then we should posulate that basis itself and not the profit maximization which it implies in certain circumstances.

Friedman's argument is incomplete for at least two reasons. First, we need an additional explanation as to how or why profit maximization is the relevant selection criterion. There is no a priori reason for this to be true of any institution. Second, we need to know at what level the selection criterion is applied -- i.e., to individual or group performance. The level at which competitive pressure applies will determine the amount of in-group coopearation below that level.

More evidence that collaboration promotes innovation

Via Tim Kane at Growthology:

[F]or every percentage point rise in the share of immigrant college graduates in the U.S. population, the total per capita number of patents for the entire population should increase by an astonishing 6%. Even more important, Hunt and Gauthier-Loiselle found that natives are not crowded out by immigrants, and that "immigrants do have positive spillovers, resulting in an increase in patents per capita of 9%-18% in response to a one-percentage-point increase in immigrant college graduates.

Global Consciousness

Another fascinating excerpt from the Edge symposium, this one by Danny Hillis:

In 1851, Nathaniel Hawthorne wrote, "Is it a fact — or have I dreamt it — that, by means of electricity, the world of matter has become a great nerve, vibrating thousands of miles in a breathless point of time? Rather, the round globe is a vast head, a brain, instinct with intelligence!" He was writing about the telegraph, but today we make essentially the same observation about the Internet.

One might suppose that, with all its zillions of transistors and billions of human minds, the world brain would be thinking some pretty profound thoughts. There is little evidence that this is so. Today's Internet functions mostly as a giant communications and storage system, accessed by individual humans. Although much of human knowledge is represented in some form within the machine, it is not yet represented in a form that is particularly meaningful to the machine. For the most part, the Internet knows no more about the information it handles than the telephone system knows about the conversations that take place over its lines. Most of those zillions of transistors are either doing something very trivial or nothing at all, and most of those billions of human minds are doing their own thing.

If there is such a thing as a world mind today, then its thoughts are primarily about commerce. It is the "invisible hand" of Adam Smith, deciding the prices, allocating the capital. Its brain is composed not only of the human buyers and sellers, but also of the trading programs on Wall Street and of the economic models of the central banks. The wires "vibrating thousands of miles in a breathless point of time" are not just carrying messages between human minds, they are participating in the decisions of the world mind as a whole. This unconscious system is the world's hindbrain.

The whole of this one should be read for the full effect.