My journey back to school has made me realize the skill school forbade me from learning is the single most important one I use in my job: delegation.

I have been running a research company I founded for 5 years now, and no single skill I have learned matters to my leadership abilities more than delegation. The only reason our company thrives is that other people do things I could never do myself, and it would be self-destructive and short-sighted to even try to hog the work on any task.

However, I returned to law school to finish my degree, and felt the limitations of my student life fall again squarely on my shoulders. Every assignment, every class felt uncomfortably heavy almost immediately, not because they were meaningless or useless, but because I could not treat them like a problem seeking a solution. Like an obstacle for me to overcome with my greatest asset–my team.

This simple rule, that I must turn in only my own work, makes sense only in the sterile world of the bean counting metric junkies, who worry not about whether I build great things but whether I built them alone. No client has ever peered suspiciously over my work, suggesting that perhaps I may have gotten outside, illicit assistance. Or worse, Googled and found someone else’s solution.

I’m not saying that all schools must immediately revise their grading systems to teach leadership or fit my needs. Far from it–I am telling anyone else struggling under the burdens of leadership, your school simply cannot help you. Recognize that there is no way to prepare for real challenges by getting high grades on fake ones. And learn to value the skills of others, lest you drown in your own inbox and incompetence.

Game theory in the wild

09/05/202009/05/2020 Kevin Kallmes Liberty entrepreneurship, game theory, heuristics, iteration, Nassim Taleb, nuclear deterrence, Power Laws, uncertainty, Von Neumann

Game theory is an amazing way to simulate reality, and I strongly recommend any business leader to educate herself on underlying concepts. However, I have found that the way that it is constructed in economic and political science papers has limited connection to the real world–apart from nuclear weapons strategies, of course.

If you are not a mathematician or economist, you don’t really have time to assign exact payoffs to outcomes or calculate an optimal strategy. Instead, you can either guess, or you can use the framework of game theory–but none of the math–to make rapid decisions that cohere to its principles, and thus avoid being a sucker (at least some of the time).

As Yogi Berra didn’t say, “In theory, there is no difference between practice and theory. In practice, there is.” As a daily practitioner of game theory, here are some of its assumptions that I literally had to throw out to make it actually work:

Established/certain boundaries on utility: Lots of games bound utility (often from 0 to 1, or -1 to 1, etc. for each individual). Throw away those games, as they preferenced easier math over representation of random, infinite realities, where the outcomes are always more uncertain and tend to be unbounded.
Equating participants: Similar to the above, most games have the same utility boundaries for all participants, when in reality it literally always varies. I honestly think that game theorists would model out the benefits of technology based on the assumption that a Sumerian peasant in 3000 BC and an American member of the service economy in 2020 can have equivalent utility. That is dumb.
Unchanging calculations: In part because of the uncertainty and asymmetries mentioned above, no exact representation of a game sticks around–instead, the equation constantly shifts as participants change, and utility boundaries move (up with new tech, down with new regs, etc). That is why the math is subordinate to structure: if you are right about the participants, the pathways, and have an OK gut estimate of the payoff magnitudes, you can decide rapidly and then shift your equation as the world changes.
Minimal feedback/second order effects: Some games have signal-response, but it is hard to abstract the concept that all decisions enter a complex milieu of interacting causes and effects where the direction arrow is hard to map. Since you can’t model them, just try to guess–what with the response to the game outcome be? Focus on feedback loops–they hold secrets to unbounded long-term utilities.
The game ends: Obviously, since games are abstractions, it makes sense to tie them up nicely in one set of inputs and then a final set of outputs. In reality, there is really only one game, and each little representation is a snapshot of life. That means that many games forget that the real goal of the game is to stay in it.

These examples–good rules of thumb to practitioners, certain to be subject to quibbling by any academic reader–remind me of how wrong even the history of game theory is. As with many oversights by historians of science, the attribution of game theory’s invention credits the first theoretician (John von Neumann, who was smart enough to both practice and theorize), not the first practitioner (probably lost to history–but certainly by the 1600’s, as Pascal’s Wager actually lines up better with “game theory in the wild” in that he used infinite payoffs and actually did become religious). Practitioners, I would ignore the conventional history, theory, actual math, and long papers. Focus on easily used principles and heuristics that capture uncertainty, unboundedness, and asymmetries. Some examples:

Principle: Prediction is hard. Don’t do it if you can help it.
Heuristic: Bounded vs. Unbounded. Magnitude is easier to measure (or at least cap) than likelihood is.

Principle: Every variable introduces more complexity and uncertainty.
Heuristic: Make decisions for one really good reason. If your best reason is not enough, don’t depend on accumulation.

Principle: One-time experiments don’t optimize.
Heuristic: If you actually want to find useful methods, iterate.

Principle: Anything that matters (power, utility, etc.) tends to be unequally distributed.
Heuristic: Ignore the middle. Either make one very rich person very happy (preferred) or make most people at least a little happier. Or pull a barbell strategy if you can.

The Academic Certainty Principle: Mere observation of reality by academics inevitably means they don’t get it. (Actually a riff on observer effects, not Hiesenberg, but the name is catchier this way).
Heuristic: In game theory as in all academic ideas, if you think an academic stumbled upon a good practice, try it–but assume you will need trial and error to get it right.

Principle: Since any action has costs, ‘infinite’ payoffs, in reality, come from dividing by zero.
The via negativa: Your base assumption should be inaction, followed by action to eliminate cost. Be very skeptical of “why not” arguments.

So, in summary, most specific game theories are broken because they preference math (finite, tidy, linear) over practice (interconnected, guess-based, asymmetric). That does not mean you can’t use game theory in the wild, it just means that you should focus on structure over math, unbounded/infinite payoffs over solvable games, feedback loops over causal arrows, inaction over action, extremes over moderates, and rules of thumb over quibbles.

Good luck!

The Blind Entrepreneur

08/25/202008/26/2020 Kevin Kallmes Books, Culture, Economics, History, Liberty anti-fragility, Auftragstaktik, entrepreneurship, evolution, risk, The Blind Watchmaker, The Red Queen, The Selfish Gene

Entrepreneurs usually make decisions with incomplete information, in disciplines where we lack expertise, and where time is vital. How, then, can we be expected to make decisions that lead to our success, and how can other people judge our startups on our potential value? And even if there are heuristics for startup value, how can they cross fields?

The answer, to me, comes from a generalizable system for improvement and growth that has proven itself– the blind watchmaker of evolution. In this, the crucial method by which genes promulgate themselves is not by predicting their environments, but by promiscuity and opportunism in a random, dog-eat-dog-world. By this, I mean that successful genes free-ride on or resonate with other genes that promote reproductive success (promiscuity) and select winning strategies by experimenting in the environment and letting reality be the determinant of what gene-pairings to try more often (opportunism). Strategies that are either robust or anti-fragile usually outperform fragile and deleterious strategies, and strategies that exist within an evolutionary framework that enables rapid testing, learning, mixing, and sharing (such as sexual reproduction or lateral gene transfer paired with fast generations) outperform those that do not (such as cloning), as shown by the Red Queen hypothesis.

OK, so startups are survival/reproductive vehicles and startup traits/methods are genes (or memes, in the Selfish Gene paradigm). With analogies, we should throw out what is different and keep what is useful, so what do we need from evolution?

First, one quick note: we can’t borrow the payout calculator exactly. Reproductive success is where a gene makes more of itself, but startups dont make more of themselves. For startups the best metric is probably money. Other than that, what adaptations are best to adopt? Or, in the evolutionary frame, what memes should we imbue in our survival vehicles?

Traits to borrow:

Short lives: long generations mean the time between trial and error is too long. Short projects, short-term goals, and concrete exits.
Laziness: energy efficiency is far more important than #5 on your priority list.
Optionality: when all things are equal, more choices = more chances at success.
Evolutionarily Stable Strategies: also called “don’t be a sucker.”
React, don’t plan: prediction is difficult or even impossible, but being quick to jump into the breach has the same outcome. Could also be called “prepare, but don’t predict.”
Small and many: big investments take a lot of energy and effectively become walking targets. Make small and many bets on try-outs and then feed those that get traction. Note– this is also how to run a military!
Auftragstaktik: should be obvious, central planning never works. Entrepreneurs should probably not make any more decisions than they have to.
Resonance: I used to call this “endogenous positive feedback loops,” but that doesn’t roll off the tongue. In short, pick traits that make your other traits more powerful–and even better if all of your central traits magnify your other actions.
Taking is better than inventing: Its not a better startup if its all yours. Its a better startup if you ruthlessly pick the best idea.
Pareto distributions (or really, power laws): Most things don’t really matter. Things that matter, matter a lot.
Finite downside, infinite upside: Taleb calls this “convexity”. Whenever presented with a choice that has one finite and one infinite potential, forget about predicting what will happen– focus on the impact’s upper bound in both directions. It goes without saying– avoid infinite downsides!
Don’t fall behind (debt): The economy is a Red Queen, anyone carrying anything heavy will continually fall behind. Debt is also the most likely way companies die.
Pay it forward to your future self: squirrels bury nuts; you should build generic resources as well.
Don’t change things: Intervening takes energy and hurts diversity.
Survive: You can’t win if you’re not in the game. More important than being successful is being not-dead.

When following these guidelines, there are two other differences between entrepreneurs and genes: One, genes largely exist in an amoral state, whereas your business is vital to your own life, and if you picked a worthwhile idea, society. Two, unlike evolution, you actually have goals and are trying to achieve something beyond replication, beyond even money. Therefore, you do not need to take your values from evolution. However, if you ignore its lessons, you close your eyes to reality and are truly blind.

Our “blind” entrepreneur, then, can still pick goals and construct what she sees as her utility. But to achieve the highest utility, once defined, she will create unknowable and unpredictable risk of her idea’s demise if she does not learn to grow the way that the blind watchmaker does.

Crisis, governments and the micro-macro conundrum

04/02/202004/02/2020 Aris Trantidis Current Events, Economics Austrian Economics, crisis, entrepreneurship, Greece, Hilton Root, instability, macroeconomics, microeconomics

Layoffs and salary cuts are individual firm responses to a crisis that may make sense from a micro perspective- it is about saving money – but they will have dire consequences on the macro level.

I lived through this in Greece. Ten years ago, every firm was expecting the worst to come from the memorandum. They started making people redundant, pulling out from planned investment and cutting salaries. Unemployment went up, demand collapsed, public revenue went down, more austerity measures were needed and the downward spiral deepened. The country ended up losing one third of its economy in just four years.

Will it now be Greece on steroids everywhere?

The side effects of myriads of micro adaptations appear on the macro level. This is a key problem for economics and is particularly challenging for Austrian economics. Entrepreneurs creatively respond to a crisis by adopting a cautious and defensive approach long before some of them could spot new opportunities for investment and take positive action to exploit them. But if they all choose to first play ‘defense’, they shape the macro-environment in patterns that keeps telling most of them “keep on protecting yourself”, “there are more risks than opportunities out there”. Both supply and demand are on a continuous downward spiral. While some discerning entrepreneurs will spot some opportunities even in the direst of the circumstances, their plans need time to materialise and some may never come to fruition. In the meantime, most economic actors are not well positioned to start what they know to do well, and many have already lost their money in activities that went downhill.

On the other hand, the side effects of a large top down intervention such as the global lock down confirms the Austrian critique that central planning is also a risky endeavour. In an effort to control a complex reality, radical top-down interventions can divert investment to the specific activities they prop up, which appear sustainable for as long as this diversion lasts. Restrictive measures can also backfire, such as Greece’s shock austerity that was intended to balance the budget in Greece, or can prolong a precarious environment, such as the debt-fuelled bailouts elsewhere to save the banking system.

The problem is that policymakers do not have the tools to gain a full grasp of any potential unintended or undesired consequences from their actions. When they focus on one range of analysis, such as preventing a spike of deaths during the epidemic, the measures they take can generate a cascade of negative side effects in areas off their alarmed radar which they may have no idea how to arrest or fix.

I don’t see this micro-macro antithesis as an automatic validation of post Keynesianism in the sense that capitalism is always inherently unstable. It is unstable in periods of crisis when the micro and the macro can become a contradiction.

Exogenous shocks periodically happen. But it is worth studying what post Keynesians state: a crisis can emerge endogenously as in the financial markets.

The way out may be to think in terms of resilience rather than stability. I am inspired by Hilton Root’s forthcoming book Network Origins of the Global Economy. Resilience is the capacity of a system to accommodate turbulences and absorb shocks in recurrent episodes of instability. The system is unstable but can withstand the stresses.

Are multiple adjustments by adaptive agents able to bring about resilience in a system? Or do we need a central node to gain control and bring about order? Is a centrally-induced order a structure of relations that can be resilient over time, given that it depends on the health of the central node and knowing that the capacity of governments to understand and predict is limited?

Eco’s ‘How to eat ice cream’

03/27/202003/27/2020 Mary Lucia Darst Culture, Liberty Carl Schramm, consumerism, entrepreneurship, Keynesianism, literature, privilege, Umberto Eco

A friend recently gifted me a vintage copy of some of Umberto Eco’s essays translated to English. One of the essays, titled “How to eat ice cream,” opened with an anecdote Eco said was based on his childhood. In the story, there was an ice cream vendor who sold regular cones for two cents and ice cream pie cones for four cents. Eco said his parents and grandmother would buy him which ever type he requested, but there was a limit. Young Eco envied the neighbor children who would parade down the street carrying a regular cone in each hand. But whenever he asked for four cents to buy two cones, the adults would flatly refuse and tell him that he could have a pie cone instead. As an adult, he mused:

[…] I realize that those dear and now departed elders were right. Two two-cent cones instead of one at four cents did not signify squandering, economically speaking, but symbolically they surely did. It was for this precise reason that I yearned for them: because two ice creams suggested excess. And this was precisely why they were denied me: because they looked indecent, an insult to poverty, a display of fictitious privilege, a boast of wealth. […] And parents who encouraged this weakness, appropriate to little parvenus, were bringing up their children in the foolish theatre of “I’d like to but I can’t.” They were preparing them to turn up at tourist-class check-in with a fake Gucci bag bought from a street peddler on the beach at Rimini.

The parenting method must have worked because he became Umberto Eco. What Eco recognized was that his parents had inoculated him against false consumerist behavior. The preventative measures were not against the so-called consumerist society but ostentatious display, the process of “keeping up with the Joneses.”

Around January 2018, there was a meme floating around social media. It said something along the lines of “Entrepreneur: someone who lives a few years the way most people won’t so that they can spend the rest of their lives living the way most people can’t.” I very belatedly discovered Carl Schramm’s 2004 book The Entrepreneurial Imperative. Schramm identified the 1950s as the time when American society ceased valorizing business ownership and virtuous risk in favor of material security. As part of the “security first” mentality, children and young people were openly discouraged from seeking independence or from being different in a positive way. The world was one of ossification and stagnation, even as the federal government and media pushed a strong Keynesian message of “consume to grow.” On a side note, now that I think about it, Keynesian economics resemble the children’s video game Snake: one guides the snake to food so that it will grow but eventually it becomes so big that it bites itself – Game over.

Even given the massive propaganda effort put into promoting Keynesian theories, scapegoating “consumerism” or “consumerist society” is a form of escapist thought, a dodging of responsibility. Eco spotted the cause and effect nature of being a parvenu. The desire for “fictitious privilege” creates a set of priorities that cause one to spend his wherewithal thoughtlessly. In turn a “boast of wealth” strategy leads to “’I’d like to but I can’t’” through ensuring that there is no money when real opportunity arrives. The world becomes one of abundant middle as the effort to possess everything spirals.

True heroes of capitalism

11/29/201911/29/2019 Edwin van de Haar Culture, Liberty capitalism, entrepreneurship, failure, knowledge problem, risk

Steve Jobs, Elon Musk, Bill Gates, John D. Rockefeller, and so forth and so forth. The list of successful entrepreneurs who have become household names is long. To an extent they are the heroes of capitalism, they succeeded, often against all odds, though often with crucial help of far more unknown others, yet they did it and changed whole industries, if not the lives of all people on the globe.

Capitalism is about freedom, to have the liberty to start a business, to start selling a new product or new service. Or if you’re a big company: the freedom to buy somebody’s else’s idea, or to invest huge amounts into research, development, and/or (re)design. It is one of the most important pillars of our civilization, this process built on economic freedom, trade, specialization, barter, openness for odd things or tolerance for people who venture into new directions. Despite many setbacks, opposing ideas and much room for improvement, all around the globe, it still all adds up to what we are now: the richest and most healthy people in the world of all times. And this is not meant teleological, it is certainly not the end of the development, there is more to come, of course.

However, capitalism is built on failure. It is only in a limited number about the success stories, in far more cases it is about hard failure. For every success there are many more failures, people who went bust, companies that did not make it. In the US this is a fact more known and far more accepted than in Europe. Here, if you went broke, you would be indebted for the rest of your life and seen as a social failure as well. Happily, that stigma is not as strong as it used to be, but it is sure not out of existence either.

Therefore, the true heroes of capitalism are those who fail. The men and women who put in their life savings, or take a big loan, to start a business, or take over a franchise, or what have you. Working their ass off, taking risks, without any sight on a certain reward. Also, at least here in The Netherlands and surely elsewhere too, without the social security that employees may count on.

Still, they go for it, they chase their dream, to remain independent, because they hate to work for a boss or manager, because they believe in their great idea, because they want to get rich, or a combination of these elements. And then they fail, have to fire their personnel who depend on them, they can’t pay the bills anymore, file for bankruptcy, and have to accept that their dream is over.

That is hard. I want to congratulate them though. Because without them, our capitalist system would remain static, since no new ideas would drip into the economy. In short: capitalism would grind to a hold. So thank you, all you failed entrepreneurs, for putting in the effort, for trying and working hard. You are true heroes.

Discovery Processes

11/25/201911/25/2019 Federico Sosa Valle Economics, Philosophy competition, cosmopolitanism, entrepreneurship, F.A. Hayek, incentives, innovation, James Jay Carafano

A good friend of mine encouraged me to read this note published by James Jay Carafano, Vice President of The Heritage Foundation.

Despite being as compelling as it is well intentioned, the article misses to mention one of the main arguments for free markets: what once Friedrich Hayek described as “the competition as a discovery process.”

Indeed, the concept is insinuated in Carafano’s piece of writing: “He decided to make a splash in the sports car market by jumping into the race car racket. Initially, he planned to do it by buying the world’s premier race car manufacturer, Ferrari. But that plan fell flat. So Ford moved to Plan B: to field his own, all-American team.”

Businessmen, like any other kind of people, are rational: initially, they try to maximize their profits by avoiding competition. They are not heroes and nobody can ask them to be so. People, businessmen included, respond to incentives.

When there is not any other choice than competition, then innovation, ingenuity, and creativity arise. Not because of a change in the mind of certain businessmen, but for new innovative entrepreneurs outperform the non competitive ones.

The free market capitalist system James Jay Carafano praises is mostly an institutional arrangement named -once again- by Hayek as “competitive order.” Nevertheless, the most interesting question for our times is not about the virtues of the said free market capitalist system -which seem to be out of discussion- but whether competition under the rule of law deserves to have a Kantian “Cosmopolitan Purpose.”

My Startup Experience

11/06/2019 Kevin Kallmes Economics, Liberty data, entrepreneurship, innovation, medicine, Minnesota, Rochester, software, technology

Over the past 4 years, I have had a huge transition in my life–from history student to law student to serial medical entrepreneur. Essentially, I have learned a great deal from my academic work that taught me the value that we can create if we find an unmet need in the world, create an idea that fills that need, and then use technology, personal networks, and hard work to create novelties. While startups obviously tackle any new problem under the sun, to me, they are the mechanism to bring about a positive change–and, along the way, get the resources to scale that change across the globe.

I am still very far from reaching that goal, but my family and cofounders have several visions of how to improve not only how patients are treated but also how we build the knowledge base that physicians, patients, and researchers can use to inform care and innovation. My brother/cofounder and I were recently on an entrepreneurship-focused podcast, and we got the chance to discuss our experience, our vision, and our companies. I hope this can be a springboard for more discussions about how companies are a unique agent of advancing human flourishing, and about the history and philosophy of entrepreneurship, technology, and knowledge.

You can listen here: http://rochesterrising.org/podcast/episode-151-talking-medical-startups-with-keith-and-kevin-kallmes. Heartfelt thanks to Amanda Leightner and Rochester Rising for a great conversation!

Thank you!

Kevin Kallmes

Three Lessons on Institutions and Incentives (Part 7): Breaking the mold

03/28/201903/24/2019 Federico Sosa Valle Economics complementarity, creative destruction, Daron Acemoglu, economic development, entrepreneurship, incentives, institutions, James Robinson, knowledge problem, polarization, public policy, William Easterly

This role of entrepreneurs also depends on an abstract characteristic of technological knowledge: it works in a manner contrary to that of most goods, since it is more productive to the extent that it is more widespread in the population. This characteristic of the abstract nature of technological knowledge is related to the phenomenon of the combination of skills (matching of skills): the negative side of creative destruction lies in substitution phenomena (a computer program of inventory management increases the productivity of work saving the salaries of the army of employees who used to carry them with pencil and paper), but the positive side comes from the phenomena of complementarity.

As William Easterly exemplifies, the cardiac surgeon will be more productive in a first world hospital, where he will have specialized nurses, other qualified doctors like him, a sophisticated system of hospital administration, and so on, being the only cardiac surgeon in a hospital. city of the third world, where it does not have professionalized nurses, nor the help of other medical colleagues, working in a hospital in which he himself has to deal with administrative issues. If there were only substitution relations, it would be convenient for a doctor to practice his profession in the most remote place possible. However, as relations of complementarity of knowledge exponentially increase the productivity of the professionals involved, the doctor will find it more convenient to practice in a health center that has the largest number of doctors and paramedics possible.

The latter does lead to the phenomenon of “traps”: any rational agent, who maximizes the utility of their choices will be discouraged to deepen their studies if they perceive that they can not give any use to their education. There are the cases in which a person discovers that in his country there is no technology or the necessary number of professionals to develop a specific activity, or that, existing, you will find prohibited the exercise of their profession based on restrictions regarding their race, caste, social class, sex, etc. Since, rationally, a person who is included in a particular group under which he will be found forbidden or will be hindered the exercise of his profession, he will find as the most rational of their alternatives to abandon their studies, so that their chances of progress will no longer be limited only by legal or social barriers, but because of their lack of suitability for high-paying functions. Such are the so-called “poverty traps.”

There are also wealth traps. There are those cases in which the individual knows that he is within a favored group or in which he knows a large number of professionals and, therefore, invests time and money in his education because he knows that he has high chances of success, which will then be confirmed. Obviously, such phenomena of divergence generates another problem, addressed both by Easterly and by Daron Acemoglu & James Robinson, which is that of polarized societies.

Easterly affirms that it is the exchange of goods and services, through the mutual benefits that they report to the parties that participate in it, the main source of wealth generation. Where individuals are allowed to exchange, in a stable institutional framework with a stable currency, is where prosperity flourishes. However, Easterly recognizes that bad luck can devastate nations, as are the cases of geological and climatic phenomena such as earthquakes, tsunamis or mudslides, as well as recognizing that the situations of individuals involved in a poverty trap can only be resolved through an active public policy that not only provides education, but also establishes the conditions so that the recipients of that educational system can count on certain expectations that they will be able to apply that knowledge acquired through education and that, consequently, it is reasonable to study.

Just as the bad star can affect the economic performance of the countries, so can a favorable conjuncture, such as the case of a transitory improvement in terms of exchange of a given country. But this favorable circumstance can become a counter-march. Easterly explains that, for a simple statistical matter, it is very difficult for both a nation and an individual to always remain on the crest of the wave, over the years everything tends to return to the average. The problem occurs when a country -or a person, too- got used to a certain level of spending in the boom years and intends to maintain it through debt or emisionism. We come to the cases in which, according to Easterly, the government can “kill the growth.” Public debt and inflation generate capital consumption and, consequently, poverty.

Another way that governments have to discourage growth is through corruption. Not only because it means a transfer of resources from productive activities to unproductive activities, but because it also means a bad signal for citizens. However, in cases of corruption, as noted above, wealth at least changes hands. There is another case, even more pernicious, in which the government’s actions, whether motivated by corruption or inspired by good intentions, destroy wealth, without even redistributing it: this is the case of inconsistent public policies derived from highly polarized societies.

Public policies that aim to favor a given industry, but at the same time need to agree on measures with other sectors of the economy, whose purpose is to compensate for the losses generated by those policies, can lead to a tangle of inconsistent regulations that, instead of transfer riches from one sector to another, directly destroy them. For example: exchange controls harm the export sector, since they generate black markets. The exporters will have costs that will be partly quoted according to the black market prices (which are higher) and they will have to liquidate the value of their exports at the official exchange rate, which will be lower. Regulations of this kind may not involve acts of corruption, but they do destroy wealth, which there is no way to recover.

Easterly lists numerous examples of everything that needs to be done to destroy growth. However, there is something that deserves to be especially highlighted: the progress or stagnation of nations does not depend on educational, cultural or geographic factors, but rather on the incentive framework that predominates. This incentive framework will always be abstract, that is, it can be applied at any time and place.

[Editor’s note: Here is Part 6, and here is the entire, Longform Essay.]

Three Lessons on Institutions and Incentives (Part 3): Innovation means creative destruction

03/24/201903/24/2019 Federico Sosa Valle Economics creative destruction, entrepreneurship, equilibrium, incentives, innovation, institutions, Israel Kirzner, Joseph Schumpeter, Kaldor-Hicks

The concept of creative destruction was popularised by Joseph Schumpeter and assumes that the economy is in a equilibrium. The “entrepreneur,” therefore, is an unbalancing factor that, through innovation, displaces the winners of the prevailing situation until then, generating a new equilibrium. This notion was criticized by other economists such as Friedrich Hayek and Israel Kirzner, who saw that the entrepreneur, far from being a disequilibrating factor, obtained its benefits by identifying the points of disequilibrium of a system and arbitrating between them.

The concept of “creative destruction,” on the other hand, focuses on businesses that go to waste from the irruption of the entrepreneur. This emphasis allows us to understand why there will be those who see with fear or disgust the very idea of innovation. In contrast, Hayek and Kirzner emphasize the benefits of the new equilibrium: greater efficiency in the allocation of resources and, consequently, a greater generation of wealth. The notion of Schumpeter allows us to explain why many oppose innovation, that of Hayek and Kirzner gives us reasons to move forward with it. Strictly speaking, in order for innovation not to cause damage at the aggregate level, it must satisfy the Kaldor-Hicks criterion, that is, the gains from innovation must be so high as to allow a hypothetical compensation to the ones who lost the new distribution of resources.

In short, the notion of creative destruction that both William Easterly and Acemoglu & Robinson use, although it might differs from Schumpeter’s, meets the said Kaldor-Hicks criterion. In these cases, innovation does not represent a social disvalue, but on the contrary it generates a benefit for the whole. Therefore, it goes without saying that any brake on an innovation of this nature generates social loss. At this point, if innovation -also called “creative destruction”- is systematically curtailed, in order to seek to protect activities that would otherwise be displaced, society may encounter the following scenarios: a relative delay (regarding its potential) of its development, or a stagnation, or setback. In all three scenarios, inequality in wealth and income increases, or society sees its standard of living delayed or diminished in a homogenous way. In this last case, the protected sectors are also harmed by the brakes imposed on innovation.

[Editor’s note: Here is Part 2; Here is the entire Longform Essay.]

Innovation and the Failure of the Great Man Theory

11/27/201811/27/2018 Joakim Book Economics entrepreneurship, Great Man Theory, innovation, Mariana Mazzucato, Matt Ridley, prices

We tend to think about innovation as inventions and particularly about the inventors associated with them: Newton, Edison, Jobs, Archimedes, Watt, Arkwright. This Great Man Theory of incredible technical innovation is mostly implicitly held by quite a few of us, celebrating these great men and their deeds.

Matt Ridley, the author of The Rational Optimist and The Evolution of Everything among other credentials, has spent a lot of time and effort in recent years arguing against this theory. In his recent Hayek Lecture to the British Institute of Economic Affairs he convincingly outlines his case: so many independent innovations take place roughly at the same time by different people. The Great Man Theory leads us to believe that hadn’t it been for Edison, we’ll all be in the dark and humanity deprived ofall the benefits that came with the innovation.

Not so. There were a great number of contemporary inventors who came upon versions of the lightbulb (Ridley cites 21 or 23 or them, depending on whom you include) around the same time as Edison. The story can be repeated for most other great inventions we know of: laws of thermodynamics, calculus, most metals, typewriting machines, jet engines, the ATM, Oxygen. Indeed, the phenomenon is so common that it has its own term: simultaneous invention.

It seems, in complete contrast to the Great Man Theory, that history provided a certain problem, a sufficient number of people working on solving it at a certain time, and eventually similar inventions taking place around the same time. The process is, Ridley concludes, “gradual, incremental, collective yet inescapable inevitable […] it was bound to happen when it did”.

Interestingly enough for those of us schooled and fascinated by spontaneous orders and bottom-up social and economic phenomena, the Great Man Theory is remarkably similar to other beliefs about the world. It is a symptom of the same reasoned short-comings that makes us humans susceptible to believing in zero-sum thinking, top-down organizing and “design-implies-a-designer”. Instead of grasping the deep insights of gains from trade, spontaneous order or evolution, we are tempted by the militaristically directed organizations that we believe we understand rather than the emergent order of many independently acting individuals’ trials and errors.

Precisely this bias makes us susceptible to the mistake Mariana Mazzucato has become famous for wholeheartedly embracing: the idea that, whatever the innovation, government probably did it. That government innovation is productive – or at least more productive than is commonly presumed – and indeed societies can greatly benefit from ramping up government R&D spending. Nevermind incentives, track records or statistical robustness.

Indeed, what Ridley points to is precisely that valuable and life-changing innovation cannot be directed. Admittedly, some innovation does occur in labs, but only a vanishingly small part. Mazzucato and other top-downers could have benefited greatly from listening to Ridley (or reading his book The Rational Optimist; or reading Demsetz’ devastating 1969 article ‘Information and Efficiency’).

Coming full circle and espousing the Hayekian insights, Ridley notes that the price is everything. Specifically the reduction in prices is what matters for innovations to be spread and adopted rather than the ideas themselves. Very little happens in terms of adoption and transmission until prices start to fall dramatically (hint, hint, Bitcoin… or nuclear energy, or renewable energy…). Like the printing press and the steam engine, interesting things start to happen when prices fall – not because an innovation is particularly cool in some subsection of society.

Innovation is a deeply decentralized yet deeply collective process. We face similar challenges that occassionally come to similar conclusions – and history would in all likelihood have progress exactly the same had we not had a Newton or Edison or Jobs.