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.

Are Corporate R&D Labs Close Enough to Universities?

I have only one comment on the excellent New Yorker piece recently published about Stanford, whose title asks whether Stanford has become too influenced by commercial concerns.

As a culture, why shouldn't we be equally concerned with answering a related question -- i.e., have corporations, and especially their R&D groups, gotten close enough to Universities? I take it nobody would have any concern if corporate R&D groups were to become more open in publishing their results, disseminating their knowledge, and even teaching new engineers and scientists.

The poorly kept secret is that there aren't anymore corporate R&D labs like that. Bell Labs is gone. IBM labs are not what they used to be. So Stanford has stepped in to fill the gap. Should we be mourning the loss of its pure curiosity-driven culture -- a culture that probably never existed at Stanford anyway? No there are other universities that do that better. Note that Gerhard Casper, quoted in a few places in the article, hails from Chicago.

It's not wise to pass judgement on Stanford's culture without considering how it fits within the larger ecosystem.

This Day in History: University Research and the Internet

From the Computer History Museum:

March 16, 1990

Internet Extends Beyond U.S. to Europe

The National Science Foundation announces it will extend its network with a high-speed data link to Europe. Five years earlier, the Internet in its modern form had started to develop rapidly thanks to the formation of the NSFNET, which linked five supercomputer centers in the United States. Later in 1990, Europe contributed to the growth of the Internet when CERN's Tim Berners-Lee developed HTML, the language used for the World Wide Web.

Has any technological development done more to change the world in the same period of time? Why do some folks seem to have forgotten how the Internet got started? There were lots of venture capital funds around in 1990. How many were ponying up to fund a transatlantic link between NSFNET and Europe?

Intellectual Property, Venture Capital, and Startups

To borrow a phrase from Prof. Bainbridge, here are a few things that I think I think about the topics above:

1. Talented engineers and scientists want to earn as much money and recognition for their work as possible.
2. All companies, large or small, require talented engineers and scientists to assign their intellectual property to the company in exchange for their pay.
3. Having assigned away intellectual property rights, talented engineers and scientists must rely on contract rights to earn a slice of the profit from their work.
4. Startup companies write contracts that give talented engineers a slice of equity, which is derived from the value of their work.
5. Larger companies with established products or services write contracts that give talented engineers a salary for so long as the established products or services continue to sell.
6. Larger companies will be most interested in buying or imitating startups that develop substantial improvements to established products or services.
7. Venture capitalists will be most interested in investing in startups that larger companies will be most interested in acquiring.
8. As a result of 1 through 7, talented engineers and scientists will be channeled into working on improvements to already established products or services.

If you agree with all of that thinking, and you agree that our most talented engineers and scientists should be working both on established products and services and on new products and services, then you might also agree with the conclusion that all of this thinking seems to lead:

Both Either a strong IPO market and or strong intellectual property rights for individuals and startups are necessary to encourage talented engineers and scientists to build new products and services.

Is there a flaw in this logic? Consider also the fact that many talented engineers and scientists work at universities, which will never IPO.

UPDATE 12/27/9: Switched the conjunction of IPO market and strong IP rights to disjunction. In principle at least, IP rights could be licensed into large companies from individuals or startups -- if they were mutually respected.

We are most free when we are most bound to others

Robert Jensen makes the case:

When bonds are created under conditions of mutual respect and shared power, our freedom is deepened by such interdependence. Our strength is not sapped by these bonds but is enhanced by the emergent properties of collective human action. The individual efforts of numerous people cannot simply be added together and plugged into an equation to predict the outcome, but rather their simple actions come together in a collective result that is novel and irreducible. The most creative force does not come from a power, centralized either in one person or one institution and its bureaucracy, which imposes its will on others and treats people as inputs whose energy can be plugged into a formula for production. The most creative force comes from distributed power that channels the contributions of many into ends that people define collectively.

Via the Omnivore at Bookforum -- the same that I have failed to cite on numerous occasions in the past because of the way I open and close tabs going through the links to those posts. Get yourself on the Omnivore feed!

Paul Graham on "The Founder Visa"

When did Paul Graham finally add RSS to his Essays page? I know I've checked several times in the past 18 months or so. Quick, go add it to your feed reader immediately. Here's a link. Paul is what venture capitalists should aspire to become. I don't consider him a VC. He's transcended VC. Anyway, here's his policy proposal for promoting innovation in the U.S.

The single biggest thing the government could do to increase the number of startups in this country is a policy that would cost nothing: establish a new class of visa for startup founders.

Paul's proposal is even sharper than the suggestion I laid out (in an earlier post on Revitalizing our Culture of Innovation) of granting visas to foreigners who obtain graduate degrees in the U.S. Maybe we can't keep everybody who earns a Ph.D. But at least we can keep those who can create jobs!

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.

If you can't go to them, bring them to you

From Tech Transfer Tactics:

A new seven-story, $127-million building devoted to commercialization of school technologies at the University of California at Berkeley was formally opened last Friday, and its features provide a model for other campuses looking for best practices in designing facilities to encourage tech transfer. The 141,000-square-foot building, designed by SmithGroup, mixes research space with collaboration areas, offices, and conference rooms. In addition, the building houses two 15,000-square-foot “clean rooms” for manufacturing microchips “at resolutions 100,000 times smaller than the diameter of a human hair,” the university says.

Stephen Quake calls for Change in Technology Transfer

This op-ed by successful academic, inventor, and entrepreneur Stephen Quake is a landmark piece. The current system of technology transfer must evolve for the United States to maintain its competitive advantage as a producer of new technology:

Licensing is often a protracted process, and licensing officers so paralyzed with fear about making a mistake and not maximizing licensing revenues that they discourage all but the most persistent licensees. Because universities are non-profit institutions, the true measurement of technology transfer success should not be the total amount of licensing revenue, but rather the successes in helping faculty members patent inventions, in forming new ventures that create jobs, and in facilitating the commercialization of technologies that in many cases will help improve our society.

The best way for universities to achieve this would be to make the same decision the federal government did, and relinquish their control over licensing. Since in most cases faculty know the context of their invention and how it can be best commercialized, they should drive the licensing process, and the OTL should play a supporting role. The university deserves to receive some compensation, but this should be fixed by a simple formula and limited — bearing in mind that the vast majority of research funding that leads to inventions has been obtained by the faculty through grants, and that the university has already taxed a fair bit of that to support its facilities.

Please read the whole thing. There is almost nobody with more first-hand experience than Quake. He's telling us what's wrong with the system.

Commercial entities (from venture capital funds to public corporations) and universities face a prisoner's dilemma when it comes to IP rights. Cooperation offers benefits to both; but the incentive in individual transactions is to defect. Quake is calling for inventors to have more control over the process, and that will help. But even better would be for technology transfer offices to recognize a bigger role for private equity funds in assisting with the process. An intermediary with equity incentives will outperform even the best organized and well-meaning of in-house technology transfer offices.

Read the comments on the NYT page too. See how many in industry are frustrated with the technology transfer offices?

Models of How Social Network Structure Fosters Innovation

Here's a link to a paper by Arbesmand, Kleinberg, and Strogatz with a model of some relevance to the data correlating immigration with patents linked earlier this month.

Their model seems to confirm Granovetter's "weak ties" hypothesis because cities have a higher per capita number of such weak ties.

Feedback Loops in the Innovation Pipeline

Check out the many feedback loops in this Figure. Notice in particular how the loops connect both adjacent and non-adjacent stages in the cycle, wrapping the pipeline back on itself several times:

Now guess when the Figure in this article was published. Leave your answer in the comments below, and click through here to see if you're right.

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.

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.

Quote of the Day

The rest of the country is walking around like stunned raccoons. Silicon Valley understands failure. That’s why we succeed. Silicon Valley has always been in danger of drowning in the waste products of its own success. This gives us breathing room. We live and die by change in this valley. The absence of change is death. I’m not trying to minimize the pain. It is precisely in times like this when you think long term. Focusing on the short term will turn out badly. Panic is not a financial strategy. The market is an efficient mechanism of wealth transfer from the impatient to the patient.

-Paul Saffo

Quoted in an interview with VentureBeat.

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.

Cooperation is the Source of Economic Growth and Intellectual Property is the Next Evolutionary Step

In a submission published on the Creative Capitalism blog, I cited Adam Smith as a source for the claim that cooperation is the source of growth from within an economy.  Strictly speaking, Adam Smith doesn't make this claim.  What he does observe is that successively finer divisions of labor are a source of growth:

And that voluntary exchanges give rise to incentives for the division of labor:

But Smith leaves mysterious the answer to the next obvious followup question (i.e., "from whence does the desire for exchange arise?"), saying only that it has something to do with "the faculties of reason and speech":

It's important to try and answer this question because what the question is really asking is why do people choose to cooperate with each other.  Anybody is qualified to speculate on this question, but if we want to do so with the aid of scientific theory, today we might turn to evolutionary biology for answers.  (Actually, even in Smith's day animal behavior was a source of inspiration to economic thinkers as Mandeville's Fable of the Bees demonstrates.)  Why do humans cooperate?

Humans are not, in fact, the only species characterized by individual cooperation.  In The Happiness Hypothesis by Jonathon Haidt, Haidt identifies hymenoptera (ants, bees, wasps, &c.), termites, and naked mole rats as other independent examples of where cooperation has evolved in the animal kingdom.  Interestingly, however, in each of these other examples the animals are cooperating only with their kin.  In each case, the reproductive mechanism ensures that only kin are part of the social circle of cooperation.  Obviously, the line of evolution that led to human cooperation isn't characterized by only kinship cooperation (although kinship bonds are obviously still an important part of that cooperation).

We probably won't ever know the answer to the question of why humans choose to cooperate, although I find some religious ideas to be compelling.  But at a social level, answering the question is less important than realizing that it is the important question -- i.e., that cooperation is ultimately the source of growth within an economy.

Recognizing cooperation as the most important metric for growth permits us to reanalyze the traditional arguments for and against various forms of government, for example.  Traditionally, the argument in favor of democracy has been that it promotes "freedom," which is implicitly understood to be constitutive of individual happiness.  Conversely, collectivist forms of government promote "equality," which is similarly understood to be constitutive of individual happiness.  Traditional arguments cannot be resolved so long as each side adheres to its view of how individual happiness is best promoted.

But consider how happiness might be measured after a conceptual ascent from individual to group happiness.  Instead of the traditional arguments over whether "freedom" or "equality" is the more important to promoting happiness, we might agree that group happiness will always be some function of the amount of cooperation within a society.

On my view, this is a very useful way to rank different forms of institutions within society, and one that does not split up along traditional democratic vs. collectivist lines.  Instead it offers a rather compelling account of how authoritarian, democratic, collectivist, and ultimately (classically) liberal forms of government are best in different social environments.  Authoritarianism and democracy work best in smaller kinship circles, collectivism works best within groups with shared and sharply contrasted ideologies.  Classical liberal government ultimately is the best form of government because it permits the most widely dispersed and diverse forms of cooperation (for example, through market mechanisms) to flourish.

Last but not least, if cooperation is the source of economic growth, and classical liberal institutional designs are the best way to foster large-scale, long-term cooperation among diverse and widely dispersed people, then strong property rights are the best means for encouraging cooperation when the costs of identifying and transacting for a resource are small compared to the gains from trade.

As I have argued several times on this blog, the advent of the Internet, search algorithms, and online databases of patents means that inventions are now in this category of resources for which strong property rights make sense as a means for encouraging cooperation.  Abraham Lincoln was only a 150 years ahead of his time when he predicted that the patent system would usher in the next major stage of human progress.  

Mark Sanders explains the Lincoln Conjecture

Via Dane Stangler at Growthology, I found this article connecting Kuhnian paradigm shifts with Schumpeterian creative destruction.  It's a connection with intuitive appeal.  Author Mark Sanders distinguishes "fundamental" from "instrumental" knowledge as sources of new opportunities for entrepreneurs.  "Fundamental" knowledge is knowledge of why things work (e.g., fire is a chemical reaction that requires oxygen and hydrocarbons).  "Instrumental" knowledge is knowledge of how things work (e.g., adding fuel and blowing on fire makes it burn hotter).

There are several interesting insights offered by Prof. Sanders.  But here's the one that caught my eye this morning:

[S]cience and fundamental knowledge are quickly replacing learning by doing and instrumental knowledge as the main source of opportunity for commercial innovation.

He doesn't speculate on why this is so (that's not the point of his article), but it seems easy enough to see that improvements in communication and transportation technology basically eliminated the competitive advantage of instrumental knowledge for entrepreneurs.  Trade secrets could be kept safely for decades in an era before wireless communication and cheap and easy travel.

Could this be part of the explanation for why Abraham Lincoln identified the patent system as the next major stage of human progress?  Despite the transactions costs, we need property rights to extend to intangibles in order to permit decentralized coordination of entrepreneurial activities in an era in which trade secrets no longer provide decent returns on investment.

As an aside, the comparison between Schumpeter and Kuhn is interesting when considered in conjunction with a working paper I have posted on SSRN on how certain doctrines of antitrust and IP (namely, the essential facilities, reverse doctrine of equivalents, and Feist originality doctrines) can be used to switch from property rules to liability rules when dealing with natural monopolies.  I hadn't considered it before, but the more I think about it, the more I like the idea that Schumpeter and Kuhn are both concerned with fundamental ideas that create natural monopolies for a product or idea over the time period between when that product or idea is pioneered and when the next pioneering product or idea comes along.

In general, it strikes me that Schumpeter and Arrow are really describing the same sort of competition, but with Schumpeter emphasizing its temporal aspects and Arrow its spatial.  Put the two together and you get an evolutionary model of competition, messier to model but more accurate as a description.

How firms can grow faster by optimizing profit and time independently

My contribution to the Creative Capitalism blog described how Schelling revealed that profit maximization is only one focal point among many that can be used to achieve cooperation among, and suggested that time optimization is another, which could have an equally large impact on long-term growth within economies. There wasn't room to elaborate there, so I thought I'd followup here with a quick explanation for how this might work within a corporation.  Later I might provide similar explanations for how other institutions (including families, churches, or non-profits) are already better optimizing their use of constituents' time.

A good starting point is the time-series of revenue into a firm.  On financial statements, this time series shows up as a time-integrated sum of the revenue for the period.  Right there we have an instance of how financial statements could be improved.  Why not show the entire time series instead of just the sum?  I'd like to know if there were major fluctuations, wouldn't you?

As Sean Macnew does a good job explaining here, an excellent management accounting technique is to break the revenue stream up into units of goods sold multiplied by price.  (Revenue = Price * Quantity).  Notice that the traditional supply and demand curves from introductory economics are plotted in terms of price and quantity.  Notice that only the point on these X curves where the curves cross is relevant, however.  The plots of supply and demand from introductory economics are not plots of supply or demand as a function of time.  Rather, they are cumulative distribution functions that show the frequency of consumption and production within a given market.

Sean explains how parametrizing the revenue time-series into key independent variables within the firm can help in identifying bottlenecks in production, thereby reducing costs or increasing quality (and hence price).  In the comments to his posts, I suggested the Fourier transforms of the time-series might be useful as well.  Why should that be?

Because in many cases, the time-series will not be a smooth, monotonic function.  Rather, it will oscillate downward as costs of sales are booked as expenses and upward as sales are booked as revenue.  Within any given window of time (say 1 month or 1 week) the frequency of these oscillations can be determined by doing a discrete Fourier transform (such as an FFT).  By comparing that frequency with the frequency determined for a different period, managers can determine whether activities within the firm are speeding up or slowing down.

Why is that useful?  Managers are constantly trying to determine where additional time and money should be spent to increase revenue.  The comparative frequency of different activities within the firm gives a fairly direct insight into whether a point of diminishing marginal returns has been hit already, or whether additional resources are unnecessary since the frequency of some activity is still increasing from period to period.

My dream is for all firms to implement more sophisticated internal controls over both time-averaged costs (such as sales and costs of sales) and frequency-averaged measures of activities relating to revenue and expenses.  I'm confident that most firms would operate more efficiently over longer periods of time and more widely dispersed scales by implementing these types of measurements.

Martin Wolf is a Genius

I've been too busy investing time in my favorite new venture.  But for those hungry for more discussion of institutional design, go read Martin Wolf's penultimate post on the Creative Capitalism blog.

[A] company is viewed in the Anglo-American world as a bundle of contracts. But companies are also social organisms created by a highly gregarious mammalian species with a unique capacity for large-scale co-operation over time and space. Companies have cultures and histories. For many of those most closely associated with them, they also have (and offer) a certain meaning. Committed workers in successful companies do not work in order to maximize shareholder value or even to earn the largest possible living. Indeed, it is impossible to direct most companies solely by the goal of profit-maximization. (Goldman Sachs may be an exception.) They have to be aimed at the intermediate goal of producing and developing goods and services that people want to buy and are worth more in the market than they cost to produce.

Mr. Wolf's post basically maps out a new research agenda for academics interested in corporate governance and organizational theory.  Regular readers will appreciate how Broken Symmetry has been scratching at the surface on some of these issues for a while.  But Mr. Wolf deserves our kudos for tying things together in less than 1,000 words.  Only a handful of people in the world have a broad enough view of the history of culture and law to be able to make such pronouncements.

Dane Stangler at Growthology

I've been a regular reader of the Growthology blog since its launch.  In terms of interests, there probably isn't a better match to my own in the blogosphere.  But I was skeptical when regular bloggers Tim and Bob suggested that guest blogger Dane Stangler might steal their show.  But he's been on fire!  Check out this post on consumption for a taste:

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

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

Creative Capitalism at Work?

HP, Intel, and Yahoo have formed a partnership with academic researchers in Asia to research cloud computing:

Founding members of the consortium said they aim to create a level playing field for individual researchers and organizations of all sizes to conduct research on software, network management and the hardware needed to deliver Web-wide services as billions of computer and phone users come online.

   

"No one institution or company is going to figure this out," said Prabhakar Raghavan, the head of Yahoo Research who is also a consulting professor of computer science at nearby Stanford University.

Nonpersonal Focal Points Promote Peace

From Giuliano Amato, professor of constitutional law at the University of Rome:

I believe that Carl Schmitt was right in saying that in politics there has to be an enemy. But does this enemy necessarily have to be the ‘other’, hence a political opponent or someone who is diverse? Could the enemy instead be hatred, intolerance and such issues, so that with such matters at stake the message sent through the media would be very different? One could say that this does not attract attention. This is not true. Political leaders have an undisputed advantage compared to anyone else. If they have something significant to say they obtain attention and visibility. Ordinary people can preach wonderful things without anyone paying any attention, while statements by national, regional and local political leaders become news, and not necessarily bad news.

Does human culture evolve the way our genes do?

from Paul Ehrlich at Seed.

Despite the great difficulties of building a comprehensive theory of cultural change deserving of the label of "evolution," progress in that direction has begun. We are finally starting to understand the patterns of culture change and the role of natural selection in shaping them.

What is it that progresses as culture evolves?  How about our instinct to cooperate?

Creative Capitalism = Sustainable Capitalism

I've been enjoying the commentary posted at the new Creative Capitalism blog.  I love it when people at the very top of their game get together and talk in open-ended terms about how things could be improved.  Being able to listen in -- and even participate through comments -- is a totally earthshaking technological change.

I'm on Peter Drucker's side of the discussion about creative capitalism, and whether it has any instrumental value to investors and managers of large institutions.  Here's what Mr. Drucker wrote in Management: Tasks, Responsibilities, Practices:

In modern society there is no other leadership group but managers. If the managers of our major institutions, and especially of business, do not take responsibility for the common good, no one else can or will.

Drucker knew that the managers of private institutions would have to take more responsibility for the common good because he understood the limits of centrally planned institutional design.  Decentralized control through sponatenous ordering is the only sustainable form of institution over long time periods and large geographical areas.  The administrative agencies of the Executive branch of federal government in the United States are an example of how central planning cannot keep up with markets (just look at how well the Federal Reserve and SEC have kept up with the markets).

But how can we improve on the model of management and investing followed in the United States?  We have to go back to the fundamentals, and rearticulate why it is that we're measuring and reporting the things we do.  In particular, I believe we need to make some important adjustments to how we report things on financial statements.  If we were all measuring growth in the same way, then cooperation among the various stakeholders in corporations would be much easier.  And competition among various corporations would be more efficient.

So here's my suggestion:

For every balance sheet account, let's include a measure of the average debit flow and the average credit flow in/out of the various accounts on a daily basis over the time period of the financial statement.

Thoughtful managers and investors may recognize how this additional measure of liquidity would help us to distinguish between a healthy corporation that is on track to grow sustainably during the next period, and a sick corporation that is being unwound slowly to generate as much cash as possible before dissolving.

Consider who within our economy is now best trained at measuring and reporting the average frequency of different economic events.  With that answer in mind, is it any wonder that some of the best investors in the world generate new liquidity through insurance float?

Here are a few links to other posts I've made about how we could do accounting and management differently:

• Inventors are customers
• Markets and firms maximize profit by synchronizing the flow of supply to demand.
  • The neuroscientific mechanism for synchronized flow.
  • Relationship to Coase, Alchian & Demsetz, and Williamson.
• Could Bear Sterns have avoided disaster were debit and credit flows reported to its management?
• Cost accounting and lean accounting are both needed as views of firm financial health.
• Why Wall Street ignores balance sheets
• Response to Summers on Regulatory System Design