When markets fail
Ingenuism Weekly 31
“The greatest obstacle to discovery is not ignorance - it is the illusion of knowledge.” –Daniel J. Boorstin
Predicting the future – Silicon Valley Examined 20
In this episode of Silicon Valley Examined, Robert Hendershott and Don Watkins discuss how the stock market supports innovation by conveying the best available estimate of a company’s future prospects.
When markets fail
Markets tell us what is valuable to the world at large and empower ingenuity to create that value by facilitating collaboration and providing critical feedback for learning.
Tesla’s success both selling cars and in the stock market (Tesla’s trillion-dollar market value is powerful feedback about how much the business is expected to improve in the future) is the foundation of the broader boom in electric vehicles and autonomous transportation. Electric truck company Rivian was able to easily raise $12 billion in its IPO and sports a $145 billion valuation a week after going public (in 2010 Tesla went public at $1.7b).
Investor appetite for electric transportation companies seems insatiable. Electric cars currently have a roughly 10% market share (spread across both new and legacy manufacturers) but electric-only vehicle specialists account for the majority of the total market value of global automakers! Conversely, Toyota’s failure to successfully commercialize hydrogen cars is at the root of the relative dearth of investment in this alternative. Market signals are lighting the way to a new transportation future.
So that’s the case for markets. But what about market failures?
Market failures are not when market participants get things wrong. Markets and market signals are not perfect oracles. Despite their current success, Tesla or Rivian could someday end up bankrupt. EVs may never make up more than a sliver of the auto market. Collaboration and learning are messy, emergent phenomenon that often surprise and disappoint. None of that would make the current valuation of EV companies a market failure.
Market failures, in the standard economic framework, are when market participants get things right, but it doesn’t produce the best outcome. Pollution is a classic example of what economists call “externalities.” Polluters typically don’t bear the entire cost of their activity, so there ends up being too much pollution. This is a negative externality.
In the positive category are “public goods”: activities where the people picking up the bill for something receive a relatively small part of the benefit. A standard example is basic research. Basic research supplies the foundation for future innovation but much of the value isn’t captured by its creators. Just like there may be too much pollution, there may be too little basic research.
Market failures are not a given. The Coase Theorem states that market failures fall with the transaction costs associated with negotiating a better outcome but are likely given incomplete information and less than fully competitive markets.
So, what does Ingenuism have to say about market failures?
It’s a lot like our view of the precautionary principle: it is crucial to look at both sides of the scale. Yes, technology has risks, sometimes significant, and market failures in areas like pollution can cause real problems. And at the same time, well-functioning markets critically enable the two key factors creating progress: connecting people and empowering exploration and discovery. Dealing with market imperfections and failures by restricting and interfering with markets is very tricky: it would be a terrible outcome to throw the proverbial baby out with the bathwater.
So, it is useful to set two guardrails: no action taken to offset market failure should limit 1) connection or 2) the opportunity for exploration and discovery. With those guardrails in mind, we start to see distinctions between Ingenuism-friendly and -unfriendly approaches to market failure; approaches that could make the world a better place and approaches with opportunity costs that swamp the potential benefit.
Consider, for example, mandates and bans. A mandate is a directive for a specific pathway or outcome. A ban prohibits a single pathway or outcome. A mandate requires you to use compact florescent lightbulbs. A ban requires you to stop using incandescent lightbulbs. In 2007 (when Congress passed the law phasing out incandescent) the two actions would initially produce the same result—everyone is forced to switch to compact florescent. Ugh. But a ban leaves open the opportunity to discover and switch to LED bulbs while a mandate does not. Today, as a result, we are not stuck with compact florescent. So, an Ingenuist would generally favor banning over mandating.
This does not mean that Ingenuism endorses banning things! There are plenty of bans that close off connection, exploration, and discovery, at least within a vital category. Banning nuclear power, banning embryonic stem cell research, banning blockchain technology applications closes off important avenues for progress. The point is that an Ingenuist always chooses the path that best protects connection and the opportunity for exploration and discovery.
If there are legitimate grounds for interfering in the market, then it should be done in the most pro-progress way possible. What is unacceptable is to point at a market outcome you don’t like and use cries of “market failure” to justify a corrective policy you hope will produce a better outcome. Stymying markets disrupts our most powerful system for uncovering opportunities to make the world a better place.
So, what about pollution? An Ingenuist favors approaches that incorporate experimentation and learning. This will typically mean market-based solutions: a classic example is capping the total amount of a pollutant and allowing permits to pollute to be traded among polluters. Everyone has an incentive to find ingenious ways to reduce pollution and emitters who are good at reducing emissions are encouraged to continue exploring new ways to cut, even if they have already eliminated their proportional share of the pollutant.
Further, while pollution markets might seem like a good solution, who is to say that there isn’t a superior approach waiting to be discovered? If we are going to “correct” a market failure, it’s best to do it as effectively and efficiently as possible. And ingenuity can not only create solutions in a particular market—it is also a powerful tool to discover better markets. As we are seeing in real time in crypto and decentralized finance, with experimentation and rapid learning products and markets can together quickly evolve in illuminating and valuable ways.
But this freedom to explore in not guaranteed: by classifying Initial Coin Offerings as securities, the SEC essentially banned them and the associated experimentation with utility tokens. We will never know what innovations were preempted in the process.
Markets create connection and provide the feedback for learning from exploration. If markets fail, the answer isn’t to retreat from connection and experimentation. It is to double down to harness the power of ingenuity to mitigate the failure while supercharging the success.
Defending the totally defensible
Defending progress should be like defending feeding hungry babies: the value should be so obvious that it doesn’t need defending. But progress—the thing that feeds babies as well as the rest of us—is on the defense in many quarters, with influential thinkers (I’m using the term generously) openly embracing Luddism and “degrowth.”
Adam Thierer is having none of it. He’s launching a new monthly column at Discourse Magazine to “explain why advances in technology and other areas are essential for our future.”
Growth and innovation are worth defending because they allow us to pursue lives of our own choosing, enrich us culturally, expand the horizons of our humanity, and provide a check on the power of governments over us. This column will endeavor to prove as much.
He takes particular aim at the precautionary principle—one of the main anti-progress tools we’ve discussed in the past. Writes Thierer:
My rationale for rejecting the precautionary principle rests on the belief that living in constant fear of worst-case scenarios—and premising public policy on them—means that best-case scenarios will never come about. When public policy is shaped by the precautionary principle, it poses a serious threat to technological progress, economic entrepreneurialism, social adaptation and long-run prosperity.
Meanwhile, economist Noah Smith shatters one of the major arguments from no-growthers: the alleged impossiblity of infinite growth.
Big Technology makes the case that LinkedIn “is the one good social network.”
LinkedIn’s built a friendly, productive, and scaled network by developing the right incentives and taking genuine action when things go wrong. It’s not perfect, of course. But given that the network’s peers seem to live in perpetual scandal, there’s a lot we can learn from it.
I think the piece is too negative on competing platforms. (Curate your Twitter feed intelligently and it can be as positive and friendly as LinkedIn.) But what I think is that there are a lot of people who aren’t happy with their social media experience.
Rather than engage in lazy denunciations of social media, what we should be doing is striving to identify the features that make social media a net positive experience, and use (or build!) platforms that provide those features.
The 4004 is dead, long live the 4004
Andy Kessler wishes a happy 50th birthday to the microprocessor that started it all: the Intel 4004. Here’s my favorite tidbit:
Now that everyone has a computer in his pocket, one of my favorite movie scenes isn’t quite so funny. In “Take the Money and Run” (1969), Woody Allen’s character interviews for a job at an insurance company and his interviewer asks, “Have you ever had any experience running a high-speed digital electronic computer?” “Yes, I have.” “Where?” “My aunt has one.”
Silicon processors are little engines of human ingenuity that run clever code scaled to billions of devices. They get smaller, faster, cheaper and use less power every year as they spread like Johnny’s apple seeds through society. These days, everyone’s aunt has at least one.
Fifty years of exponential improvement. That’s easy to take for granted. Thankfully, not everyone does.
The cure to the cure
In the black comedy The Death of Stalin, Stalin collapses from a cerebral hemorrhage. Khrushchev says, “I propose we call a doctor.” Kaganovich answers, “All the best doctors are dead.”
Because, you know…Stalin.
In totally unrelated news, the government wants to take credit for Moderna’s COVID vaccine patent. According to the Wall Street Journal:
Democrats nonetheless claim that NIH deserves credit for Moderna’s gene sequence and should be named on the principal patent application because government researchers picked the coronavirus spike protein as the vaccine target. But virtually all Covid vaccines target the spike protein, including those made by the Chinese. Moderna’s significant contribution was choosing the particular gene sequence to reverse engineer the spike.
Government has long financed basic scientific research, but Moderna has spent billions of dollars over many years developing the technology that made its Covid vaccine a success. Liberals now want Americans to believe that government invented Moderna’s vaccine because its success undermines two of their big political goals: Weakening intellectual property protections and imposing drug price controls. If government created the vaccine, then it has a stronger claim to control its price and distribution. Both policies would reduce the incentives and rewards for innovation.
A while back I wondered why it was we weren’t holding parades for the companies that created the COVID-19 vaccines. In my wildest dreams I couldn’t have imagined we’d shake them down and turn them into villains.
I just hope that when the next pandemic comes, we won’t be telling Comrade President, “All the best drug companies are dead.”
Until next time,
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