Capitalistic Musings

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Perhaps because oligopolies are more common in the US than they are
elsewhere. Baumol suggests that oligopolies use their excess rent -
i.e., profits which exceed perfect competition takings - to innovate
and thus to differentiate their products. Still, oligopolistic behavior
does not sit well with another of Baumol's observations: that
innovators tend to maximize their returns by sharing their technology
and licensing it to more efficient and profitable manufacturers. Nor
can one square this propensity to share with the ever more stringent
and expansive intellectual property laws that afflict many rich
countries nowadays.

Very few inventions have forced "established companies from their
dominant market positions" as the "The Economist" put it recently.
Moreover, most novelties are spawned by established companies. The
single, tortured, and misunderstood inventor working on a shoestring
budget in his garage - is a mythical relic of 18th century Romanticism.

More often, innovation is systematically and methodically pursued by
teams of scientists and researchers in the labs of mega-corporations
and endowed academic institutions.

Governments - and, more particularly the defense establishment -
finance most of this brainstorming. the Internet was invented by DARPA
- a Department of Defense agency - and not by libertarian intellectuals.

A recent report compiled by PricewaterhouseCoopers from interviews with
800 CEO's in the UK, France, Germany, Spain, Australia, Japan and the
US and titled "Innovation and Growth: A Global Perspective" included
the following findings:

"High-performing companies - those that generate annual total
shareholder returns in excess of 37 percent and have seen consistent
revenue growth over the last five years - average 61 percent of their
turnover from new products and services. For low performers, only 26
percent of turnover comes from new products and services."

Most of the respondents attributed the need to innovate to increasing
pressures to brand and differentiate exerted by the advent of
e-business and globalization. Yet a full three quarters admitted to
being entirely unprepared for the new challenges.

Two good places to study routine innovation are the design studio and
the financial markets.

Tom Kelly, brother of founder David Kelly, studies, in "The Art of
Innovation", the history of some of the greater inventions to have been
incubated in IDEO, a prominent California-based design firm dubbed
"Innovation U." by Fortune Magazine. These include the computer mouse,
the instant camera, and the PDA. The secret of success seems to consist
of keenly observing what people miss most when they work and play.

Robert Morris, an Amazon reviewer, sums up IDEO's creative process:

- Understand the market, the client, the technology, and the perceived
constraints on the given problem;

- Observe real people in real-life situations;

- Literally visualize new-to-the- world concepts AND the customers who
will use them;

- Evaluate and refine the prototypes in a series of quick iterations;

- And finally, implement the new concept for commercialization.

This methodology is a hybrid between the lone-inventor and the faceless
corporate R&D team. An entirely different process of innovation
characterizes the financial markets. Jacob Goldenberg and David
Mazursky postulated the existence of Creativity Templates. Once
systematically applied to existing products, these lead to innovation.

Financial innovation is methodical and product-centric. The resulting
trade in pioneering products, such as all manner of derivatives, has
expanded 20-fold between 1986 and 1999, when annual trading volume
exceeded 13 trillion dollar.

Swiss Re Economic Research and Consulting had this to say in its study,
Sigma 3/2001:

"Three types of factors drive financial innovation: demand, supply, and
taxes and regulation. Demand driven innovation occurs in response to
the desire of companies to protect themselves from market risks ...
Supply side factors ... include improvements in technology and
heightened competition among financial service firms. Other financial
innovation occurs as a rational response to taxes and regulation, as
firms seek to minimize the cost that these impose."

Financial innovation is closely related to breakthroughs in information
technology. Both markets are founded on the manipulation of symbols and
coded concepts. The dynamic of these markets is self-reinforcing.
Faster computers with more massive storage, speedier data transfer
("pipeline"), and networking capabilities - give rise to all forms of
advances - from math-rich derivatives contracts to distributed
computing. These, in turn, drive software companies, creators of
content, financial engineers, scientists, and inventors to a heightened
complexity of thinking. It is a virtuous cycle in which innovation
generates the very tools that facilitate further innovation.

The eminent American economist Robert Merton - quoted in Sigma 3/2001 -
described in the Winter 1992 issue of the "Journal of Applied Corporate
Finance" the various phases of the market-buttressed spiral of
financial innovation thus:

"1. In the first stage ... there is a proliferation of standardised
securities such as futures. These securities make possible the creation
of custom-designed financial products ...

2. In the second stage, volume in the new market expands as financial
intermediaries trade to hedge their market exposures.

3. The increased trading volume in turn reduces financial transaction
costs and thereby makes further implementation of new products and
trading strategies possible, which leads to still more volume.

4. The success of these trading markets then encourages investments in
creating additional markets, and the financial system spirals towards
the theoretical limit of zero transaction costs and dynamically
complete markets."

Financial innovation is not adjuvant. Innovation is useless without
finance - whether in the form of equity or debt. Schumpeter himself
gave equal weight to new forms of "credit creation" which invariably
accompanied each technological "paradigm shift". In the absence of
stock options and venture capital - there would have been no Microsoft
or Intel.

It would seem that both management gurus and ivory tower academics
agree that innovation - technological and financial - is an inseparable
part of competition. Tom Peters put it succinctly in "The Circle of
Innovation" when he wrote: "Innovate or die." James Morse, a management
consultant, rendered, in the same tome, the same lesson more verbosely:
"The only sustainable competitive advantage comes from out-innovating
the competition."

The OECD has just published a study titled "Productivity and
Innovation". It summarizes the orthodoxy, first formulated by Nobel
prizewinner Robert Solow from MIT almost five decades ago:

"A substantial part of economic growth cannot be explained by increased
utilisation of capital and labour. This part of growth, commonly
labelled "multi-factor productivity, represents improvements in the
efficiency of production. It is usually seen as the result of
innovation by best-practice firms, technological catch-up by other
firms, and reallocation of resources across firms and industries."

The study analyzed the entire OECD area. It concluded, unsurprisingly,
that easing regulatory restrictions enhances productivity and that
policies that favor competition spur innovation. They do so by making
it easier to adjust the factors of production and by facilitating the
entrance of new firms - mainly in rapidly evolving industries.

Pro-competition policies stimulate increases in efficiency and product
diversification. They help shift output to innovative industries. More
unconventionally, as the report diplomatically put it: "The effects on
innovation of easing job protection are complex" and "Excessive
intellectual property rights protection may hinder the development of
new processes and products."

As expected, the study found that productivity performance varies
across countries reflecting their ability to reach and then shift the
technological frontier - a direct outcome of aggregate innovative
effort.

Yet, innovation may be curbed by even more all-pervasive and pernicious
problems. "The Economist" posed a question to its readers in the
December 2001`issue of its Technology Quarterly:

Was "technology losing its knack of being able to invent a host of
solutions for any given problem ... (and) as a corollary, (was)
innovation ... running out of new ideas to exploit."

These worrying trends were attributed to "the soaring cost of
developing high-tech products ... as only one of the reasons why
technological choice is on the wane, as one or two firms emerge as the
sole suppliers. The trend towards globalisation-of markets as much as
manufacturing-was seen as another cause of this loss of engineering
diversity ... (as was the) the widespread use of safety standards that
emphasise detailed design specifications instead of setting minimum
performance requirements for designers to achieve any way they wish.

Then there was the commoditisation of technology brought on largely by
the cross-licensing and patent-trading between rival firms, which more
or less guarantees that many of their products are essentially the same
... (Another innovation-inhibiting problem is that) increasing
knowledge was leading to increasing specialisation - with little or no
cross- communication between experts in different fields ...

... Maturing technology can quickly become de-skilled as automated
tools get developed so designers can harness the technology's power
without having to understand its inner workings.

The more that happens, the more engineers closest to the technology
become incapable of contributing improvements to it. And without such
user input, a technology can quickly ossify."

The readers overwhelmingly rejected these contentions. The rate of
innovation, they asserted, has actually accelerated with wider spread
education and more efficient weeding-out of unfit solutions by the
marketplace. "... Technology in the 21st

century is going to be less about discovering new phenomena and more
about putting known things together with greater imagination and
efficiency."

Many cited the S-curve to illuminate the current respite. Innovation is
followed by selection, improvement of the surviving models, shake-out
among competing suppliers, and convergence on a single solution.
Information technology has matured - but new S-curves are nascent:
nanotechnology, quantum computing, proteomics, neuro-silicates, and
machine intelligence.

Recent innovations have spawned two crucial ethical debates, though
with accentuated pragmatic aspects. The first is "open source-free
access" versus proprietary technology and the second revolves around
the role of technological progress in re-defining relationships between
stakeholders.

Both issues are related to the inadvertent re-engineering of the
corporation. Modern technology helped streamline firms by removing
layers of paper-shuffling management. It placed great power in the
hands of the end-user, be it an executive, a household, or an
individual.

It reversed the trends of centralization and hierarchical
stratification wrought by the Industrial Revolution. From
microprocessor to micropower - an enormous centrifugal shift is
underway. Power percolates back to the people.

Thus, the relationships between user and supplier, customer and
company, shareholder and manager, medium and consumer - are being
radically reshaped. In an intriguing spin on this theme, Michael Cox
and Richard Alm argue in their book "Myths of Rich and Poor - Why We
are Better off than We Think" that income inequality actually engenders
innovation. The rich and corporate clients pay exorbitant prices for
prototypes and new products, thus cross-subsidising development costs
for the poorer majority.

Yet the poor are malcontented. They want equal access to new products.
One way of securing it is by having the poor develop the products and
then disseminate them free of charge. The development effort is done
collectively, by volunteers. The Linux operating system is an example
as is the Open Directory Project which competes with the commercial
Yahoo!

The UNDP's Human Development Report 2001 titled "Making new
technologies work for human development" is unequivocal. Innovation and
access to technologies are the keys to poverty-reduction through
sustained growth. Technology helps reduce mortality rates, disease, and
hunger among the destitute.

"The Economist" carried last December the story of the agricultural
technologist Richard Jefferson who helps "local plant breeders and
growers develop the foods they think best ... CAMBIA (the institute he
founded) has resisted the lure of exclusive licences and shareholder
investment, because it wants its work to be freely available and widely
used." This may well foretell the shape of things to come.

Governments and Growth

By: Dr. Sam Vaknin

Also published by United Press International (UPI)

Also Read:

The Washington Consensus - I. The IMF

It is a maxim of current economic orthodoxy that governments compete
with the private sector on a limited pool of savings. It is considered
equally self-evident that the private sector is better, more competent,
and more efficient at allocating scarce economic resources and thus at
preventing waste. It is therefore thought economically sound to reduce
the size of government - i.e., minimize its tax intake and its public
borrowing - in order to free resources for the private sector to
allocate productively and efficiently.

Yet, both dogmas are far from being universally applicable.

The assumption underlying the first conjecture is that government
obligations and corporate lending are perfect substitutes. In other
words, once deprived of treasury notes, bills, and bonds - a rational
investor is expected to divert her savings to buying stocks or
corporate bonds.

It is further anticipated that financial intermediaries - pension
funds, banks, mutual funds - will tread similarly. If unable to invest
the savings of their depositors in scarce risk-free - i.e., government
- securities - they will likely alter their investment preferences and
buy equity and debt issued by firms.

Yet, this is expressly untrue. Bond buyers and stock investors are two
distinct crowds. Their risk aversion is different. Their investment
preferences are disparate. Some of them - e.g., pension funds - are
constrained by law as to the composition of their investment
portfolios. Once government debt has turned scarce or expensive, bond
investors tend to resort to cash. That cash - not equity or corporate
debt - is the veritable substitute for risk-free securities is a basic
tenet of modern investment portfolio theory.

Moreover, the "perfect substitute" hypothesis assumes the existence of
efficient markets and frictionless transmission mechanisms. But this is
a conveniently idealized picture which has little to do with grubby
reality. Switching from one kind of investment to another incurs -
often prohibitive - transaction costs. In many countries, financial
intermediaries are dysfunctional or corrupt or both. They are unable to
efficiently convert savings to investments - or are wary of doing so.

Furthermore, very few capital and financial markets are closed,
self-contained, or self-sufficient units. Governments can and do borrow
from foreigners. Most rich world countries - with the exception of
Japan - tap "foreign people's money" for their public borrowing needs.
When the US government borrows more, it crowds out the private sector
in Japan - not in the USA.

It is universally agreed that governments have at least two critical
economic roles. The first is to provide a "level playing field" for all
economic players. It is supposed to foster competition, enforce the
rule of law and, in particular, property rights, encourage free trade,
avoid distorting fiscal incentives and disincentives, and so on. Its
second role is to cope with market failures and the provision of public
goods. It is expected to step in when markets fail to deliver goods and
services, when asset bubbles inflate, or when economic resources are
blatantly misallocated.

Yet, there is a third role. In our post-Keynesian world, it is a
heresy. It flies in the face of the "Washington Consensus" propagated
by the Bretton-Woods institutions and by development banks the world
over. It is the government's obligation to foster growth.

In most countries of the world - definitely in Africa, the Middle East,
the bulk of Latin America, central and eastern Europe, and central and
east Asia - savings do not translate to investments, either in the form
of corporate debt or in the form of corporate equity.

In most countries of the world, institutions do not function, the rule
of law and properly rights are not upheld, the banking system is
dysfunctional and clogged by bad debts. Rusty monetary transmission
mechanisms render monetary policy impotent.

In most countries of the world, there is no entrepreneurial and
thriving private sector and the economy is at the mercy of external
shocks and fickle business cycles. Only the state can counter these
economically detrimental vicissitudes.

Often, the sole engine of growth and the exclusive automatic stabilizer
is public spending. Not all types of public expenditures have the
desired effect. Witness Japan's pork barrel spending on "infrastructure
projects". But development-related and consumption-enhancing spending
is usually beneficial.

To say, in most countries of the world, that "public borrowing is
crowding out the private sector" is wrong. It assumes the existence of
a formal private sector which can tap the credit and capital markets
through functioning financial intermediaries, notably banks and stock
exchanges.

Yet, this mental picture is a figment of economic imagination. The bulk
of the private sector in these countries is informal. In many of them,
there are no credit or capital markets to speak of. The government
doesn't borrow from savers through the marketplace - but
internationally, often from multilaterals.

Outlandish default rates result in vertiginously high real interest
rates. Inter-corporate lending, barter, and cash transactions
substitute for bank credit, corporate bonds, or equity flotations. As a
result, the private sector's financial leverage is minuscule. In the
rich West $1 in equity generates $3-5 in debt for a total investment of
$4-6. In the developing world, $1 of tax-evaded equity generates
nothing. The state has to pick up the slack.

Growth and employment are public goods and developing countries are in
a perpetual state of systemic and multiple market failures.

Rather than lend to businesses or households - banks thrive on
arbitrage. Investment horizons are limited. Should the state refrain
from stepping in to fill up the gap - these countries are doomed to
inexorable decline.

The Distributive Justice of the Market

By: Dr. Sam Vaknin

Also published by United Press International (UPI)

Also Read

The Principal-Agent Conundrum

The Green-Eyed Capitalist

The Misconception of Scarcity

The public outcry against executive pay and compensation followed
disclosures of insider trading, double dealing, and outright fraud. But
even honest and productive entrepreneurs often earn more money in one
year than Albert Einstein did in his entire life. This strikes many -
especially academics - as unfair. Surely Einstein's contributions to
human knowledge and welfare far exceed anything ever accomplished by
sundry businessmen? Fortunately, this discrepancy is cause for
constructive jealousy, emulation, and imitation. It can, however, lead
to an orgy of destructive and self-ruinous envy.

Entrepreneurs recombine natural and human resources in novel ways. They
do so to respond to forecasts of future needs, or to observations of
failures and shortcomings of current products or services.
Entrepreneurs are professional - though usually intuitive -
futurologists. This is a valuable service and it is financed by
systematic risk takers, such as venture capitalists. Surely they all
deserve compensation for their efforts and the hazards they assume?

Exclusive ownership is the most ancient type of such remuneration.
First movers, entrepreneurs, risk takers, owners of the wealth they
generated, exploiters of resources - are allowed to exclude others from
owning or exploiting the same things. Mineral concessions, patents,
copyright, trademarks - are all forms of monopoly ownership. What moral
right to exclude others is gained from being the first?

Nozick advanced Locke's Proviso. An exclusive ownership of property is
just only if "enough and as good is left in common for others". If it
does not worsen other people's lot, exclusivity is morally permissible.
It can be argued, though, that all modes of exclusive ownership
aggravate other people's situation. As far as everyone, bar the
entrepreneur, are concerned, exclusivity also prevents a more
advantageous distribution of income and wealth.

Exclusive ownership reflects real-life irreversibility. A first mover
has the advantage of excess information and of irreversibly invested
work, time, and effort.

Economic enterprise is subject to information asymmetry: we know
nothing about the future and everything about the past. This asymmetry
is known as "investment risk". Society compensates the entrepreneur
with one type of asymmetry - exclusive ownership - for assuming
another, the investment risk.

One way of looking at it is that all others are worse off by the amount
of profits and rents accruing to owner-entrepreneurs. Profits and rents
reflect an intrinsic inefficiency. Another is to recall that ownership
is the result of adding value to the world. It is only reasonable to
expect it to yield to the entrepreneur at least this value added now
and in the future.

In a "Theory of Justice" (published 1971, p. 302), John Rawls described
an ideal society thus:

"(1) Each person is to have an equal right to the most extensive total
system of equal basic liberties compatible with a similar system of
liberty for all. (2) Social and economic inequalities are to be
arranged so that they are both: (a) to the greatest benefit of the
least advantaged, consistent with the just savings principle, and (b)
attached to offices and positions open to all under conditions of fair
equality of opportunity. "

It all harks back to scarcity of resources - land, money, raw
materials, manpower, creative brains. Those who can afford to do so,
hoard resources to offset anxiety regarding future uncertainty. Others
wallow in paucity. The distribution of means is thus skewed.

"Distributive justice" deals with the just allocation of scarce
resources.

Yet, even the basic terminology is somewhat fuzzy. What constitutes a
resource? what is meant by allocation? Who should allocate resources -
Adam Smith's "invisible hand", the government, the consumer, or
business? Should it reflect differences in power, in intelligence, in
knowledge, or in heredity? Should resource allocation be subject to a
principle of entitlement? Is it reasonable to demand that it be just -
or merely efficient? Are justice and efficiency antonyms?

Justice is concerned with equal access to opportunities. Equal access
does not guarantee equal outcomes, invariably determined by
idiosyncrasies and differences between people. Access leveraged by the
application of natural or acquired capacities - translates into accrued
wealth. Disparities in these capacities lead to discrepancies in
accrued wealth.

The doctrine of equal access is founded on the equivalence of Men. That
all men are created equal and deserve the same respect and, therefore,
equal treatment is not self evident. European aristocracy well into
this century would have probably found this notion abhorrent. Jose
Ortega Y Gasset, writing in the 1930's, preached that access to
educational and economic opportunities should be premised on one's
lineage, up bringing, wealth, and social responsibilities.

A succession of societies and cultures discriminated against the
ignorant, criminals, atheists, females, homosexuals, members of ethnic,
religious, or racial groups, the old, the immigrant, and the poor.

Communism - ostensibly a strict egalitarian idea - foundered because it
failed to reconcile strict equality with economic and psychological
realities within an impatient timetable.

Philosophers tried to specify a "bundle" or "package" of goods,
services, and intangibles (like information, or skills, or knowledge).
Justice - though not necessarily happiness - is when everyone possesses
an identical bundle. Happiness - though not necessarily justice - is
when each one of us possesses a "bundle" which reflects his or her
preferences, priorities, and predilections. None of us will be too
happy with a standardized bundle, selected by a committee of
philosophers - or bureaucrats, as was the case under communism.

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