Broken Symmetry

Creating My Own Create Your Own Economy

2009-07-13T15:00:24-07:00

On Saturday, I received my hard copy of Tyler Cowen's latest work of popular economics, Create Your Own Economy: The Path To Prosperity in a Disordered World. Although a work of popular nonfiction, which read easily over the course of a few hours this weekend, this book is chock full of creative insights into what might be called an alternative economic vision of social life. I say "alternative" because until recently most academic economists had confined their interests to finance rather than culture, although Cowen is careful to trace the threads of Adam Smith, F.A. Hayek, and Thomas Schelling (among others) from which his unique vision is woven together. In the sense of developing this alternative vision, this book is actually the continuation of his last, Discover Your Inner Economist: Use Incentives to Fall in Love, Survive Your Next Meeting, and Motivate Your Dentist. In both books, Cowen assumes the point of view of individual consumers; his data is drawn from individual stories and experiences; his understanding of group behavior and consumption are correspondingly richer with local and temporary detail than most economic analyses of culture. Read in conjunction with Schelling's Micromotives and Macrobehavior and Robert H. Frank's The Economic Naturalist, one can see how the methodologies of Thomas Schelling are facilitating a gradual evolution in economic thought among his students and (thanks to their attention to the needs of non-economists), the public at large. All are recommended reading.

A central premise in Create Your Own Economy is that technology is fostering a more "autistic" lifestyle. Cowen envisions "autism" as a superior ability to filter out particular bits of information from the barrage of stimuli we experience in everyday life, to absorb those filtered bits, and to imbue those disparate bits with meaning by ordering and re-ordering them into a collage of our own creation. John Milton would be proud. It is part of Cowen's project in this book to encourage a more positive definition of autism, a definition that focuses on the cognitive strengths of people who might otherwise be called autistic only because of their inferior ability to communicate in traditional social settings. We might even call this "positive abnormal psychology." Although this aspect of the book is interesting, and is sure to get attention from both the autistic community and the community of psychologists and clinicians who specialize in working with people diagnosed with autism, my focus as reviewer will be on how this vision of culture could be seen through the lens of science. More specifically, I'm going to explain how Cowen's vision of a more creative economy fits with the systems theory that has been the theme of Broken Symmetry. I think it would give Prof. Cowen pleasure to see somebody using his own work as a source of information to be re-ordered within the particular mental framework I bring to bear on understanding economics and culture -- i.e., to see me creating my own Create Your Own Economy. So here's how this book fits within my interior world.

I see Cowen's book as premised on a particular epistemology of culture. Although that epistemology is not quite laid out systematically, what is clear from his unique vision of autism, Hayek's Sensory Order, and his pyramid diagram is that culture is embedded in the neural networks of individuals. For Cowen, economics and culture emerge organically from a process of filtering, absorbing, and reordering information. This is an appealing vision because it promises the possibility that someday economic theories might be understood in terms of biology. And Cowen mentions neuroeconomics in passing, but again Cowen's focus is on culture.

What is interesting is what Cowen does not say about these neural networks and their process of development. Cowen's emphasis is on the largely individualistic process of ordering information that flows into our neural networks. What he does not emphasize is the activity -- especially the social activity -- required to obtain desired bits of information and (perhaps more importantly) to decide what bits should be given privilege in our internal ordering.

For example, in his Chapter on the contrast between autism and Buddhism, Cowen's vision seems heavily weighted in favor of the autistic approach to interior life. On Cowen's view, educational institutions are mostly about using social influence to encourage non-austistic young people to develop more autistic habits. The trouble with this view is that it does not seem to leave enough room for the possibility that some learning and information processing may occur at the social level -- i.e., that some ordering of information cannot be done autistically.

In that vein, I find another theory of learning interesting. According to psychologist Mihalyi Csikszentmihalyi, learning is an individual process, but one that alternates between modes of openness and closedness to external feedback. There is potentially a deep scientific basis for Csikszentmihalyi's theory, which is drawn from the science of networks and self-organized criticality. Given the right balance of external stimuli and internal constraints, networks can self-organize into structures that optimize the flow of information. Optimal flow through networks was studied by Mandelbrot in connection with Zipf's Law. But today it is known that the same self-organized critical structure can be found in an incredibly diverse array of networks in nature, including neural networks and even our economy. In each case, the network structure emerges from an evolutionary process whereby particular network structures persist over time only so long as they can accommodate the stable or unstable variations in flow through the network.

This theory of flow is complementary with Cowen's vision of autistic culture. In particular, the closed mode of operating corresponds directly with Cowen's vision of autism. What seems to be missing from Cowen's vision is the other phase, the phase of extreme openness to feedback and diverse stimulus. (Is this what zen meditation is designed to facilitate?) Within the theory of autism presented by Cowen, it would seem that such openness would be difficult for autistics. Yet it would seem equally important to the creativity and learning characterized by Csikszentmihalyi as "flow."

But why is it so important to maintain balance between openness and closedness? By the end, what becomes clear is that Cowen envisions a radically different structure for society in which individuals cluster into small units -- perhaps even as small as one. And perhaps Cowen is right that this is where current technology is leading us. But can that kind of culture survive?

Robert H. Frank, also a student of Schelling, provides an answer in a recent NYT editorial titled, "The Invisible Hand, Trumped by Darwin?":

By calling our attention to the conflict between individual and group interest, Darwin has identified the rationale for much of the regulation we observe in modern societies... Ideas have consequences. The uncritical celebration of the invisible hand by Smith’s disciples has undermined regulatory efforts to reconcile conflicts between individual and collective interests in recent decades, causing considerable harm to us all. If, as Darwin suggested, many important aspects of life are graded on the curve, his insights may help us avoid stumbling down that grim path once again... The competitive forces that mold business behavior are like the forces of natural selection that molded elk. In each case, we see instances of socially benign conduct. But in neither can we safely presume that individual and social interests coincide.

Technology has enabled us to take finer and finer control over the flow of information and goods that we access as individuals. But over very long times, the benefits of finer control over flow have tended to accrue to the most well-organized groups rather than the most well-ordered individual minds. So perhaps the most dramatic impact of technology will be in how it enables us to be more social, even as autistics.

Jamming transition in air transportation networks

2009-07-11T09:21:55-07:00

From Lucas Lacasa, Miguel Cea, Massimiliano Zanin:

In this work we present a model of an air transportation traffic system from the complex network modelling viewpoint. In the network, every node corresponds to a given airport, and two nodes are connected by means of flight routes. Each node is weighted according to its load capacity, and links are weighted according to the Euclidean distance that separates each pair of nodes. Local rules describing the behavior of individual nodes in terms of the surrounding flow have been also modelled, and a random network topology has been chosen in a baseline approach. Numerical simulations describing the diffusion of a given number of agents (aircraft) in this network show the onset of a jamming transition that distinguishes an efficient regime with null amount of airport queues and high diffusivity (free phase) and a regime where bottlenecks suddenly take place, leading to a poor aircraft diffusion (congested phase). Fluctuations are maximal around the congestion threshold, suggesting that the transition is critical. We then proceed by exploring the robustness of our results in neutral random topologies by embedding the model in heterogeneous networks. Specifically, we make use of the European air transportation network formed by 858 airports and 11170 flight routes connecting them, which we show to be scale-free. The jamming transition is also observed in this case. These results and methodologies may introduce relevant decision making procedures in order to optimize the air transportation traffic.

The frequency spectrum of the "brownian" states in the middle obey a power law that has been measured in other systems exhibiting flow congestion. Consider the possibility that other behavior modeled as "brownian" is actually the result of self-organized criticality in flow diffusion. Although it's difficult to visualize, it's not entirely unreasonable to consider "brownian" market price signals as flow-limiting nodes in a network of consumption and production. In other words, market price signals are the rate-limiting step in synchronizing flows of cash and goods within an economy.

Very nice, clearly written paper.

Via physics arXiv blog

One Reason Why the Supreme Court Should Reverse Bilski

2009-07-10T11:02:22-07:00

Because if firms could patent business methods -- especially financial engineering -- then these types of disputes would be less costly:

Citadel Investment Group LLC, the $12 billion hedge fund firm founded by Ken Griffin, sued three former executives and the firm they started, Teza Technologies LLC, over claims they violated non-competition agreements.
“This is a case of industrial espionage,” Citadel said in a complaint filed today in Illinois state court in Chicago. The firm seeks a court order barring the individual defendants from conducting any business through Teza or related entities that compete with Citadel, for the duration of the agreements.

Patents are the cheapest way to handle disputes over allocation of the products of human capital.

Click on "Trade Secrets" or "IP Ownership" at right for earlier episodes in this series.

Robust dynamic classes revealed by measuring the response function of a social system

2009-07-09T10:38:15-07:00

From Riley Crane and Didier Sornette:

We find that most videos’ dynamics (≈90%) either do not experience much activity or can be described statistically as a Poisson process (verified using a Chi-Squared test). This large set of data is consistent with the endo-subcritical classification. For the remaining 10% (≈500, 000 videos), we find nontrivial herding behavior that accurately obeys the three power-law relations described above. Characteristic examples of endogenous and exogenous dynamics are shown in Fig. 3.

Via Computational Legal Studies blog.

By what mechanism does traffic transition form Poisson to Power-law statistics? Click on the "syncronization" category at on the right to see some speculations. It seems that spatially dispersed clusters are syncing up. In the exogenous case, that's in response to a driving force -- new information. In the endogenous case, the mechanism is more subtle, and may be an example of self-organization. See the Zanette and Kuperman summary especially.

Updated Blog Roll

2009-07-09T09:03:50-07:00

I just noticed today that my blog roll was cutting off at ten, and I had gone past that limit a while back. Now fixed. I also added a couple of new blogs to the roll because I find myself going back to them over and over again lately.

Non-convexities in Production

2009-07-09T08:40:28-07:00

From The Economics of Non-Convex Ecosystems: Introduction by Partha Dasgupta and Karl-Goran Maler:

The price mechanism is especially problematic in economic systems characterised by positive feedback processes. We now know that in such environments it may prove impossible to decentralise an efficient allocation of resources by means exclusively of prices. Efficient mechanisms would typically involve additional social contrivances, such as (Pigouvian) taxes and subsidies, quantity controls, social norms of behaviour, and so forth. This was proved formally in a justly famous article by Starrett (1972), who showed that for certain types of non-convexities associated with environmental pollution, a competitive price equilibrium simply does not exist: markets for pollution would be unable to equate demands to supplies.

The discussion in Section 4 demonstrates a link between gauge theory in physics and non-convexity theory in economics. Dasgupta and Maler "without rigorous justification" associate investment I with the time-derivative of capital stock K. Using the language of gauge theory, one would say that K is a "conserved current." When local symmetries of the system are broken over time or across space, such currents are no-longer conserved.

"Computational Social Science"

2009-07-08T09:02:37-07:00

From David Lazer, Alex Pentland, Lada Adamic, Sinan Aral, Albert-László Barabási, Devon Brewer, Nicholas Christakis, Noshir Contractor, James Fowler, Myron Gutmann, Tony Jebara, Gary King, Michael Macy, Deb Roy, Marshall Van Alstyne:

To date, research on human interactions has relied mainly on one-time, self-reported data on relationships. New technologies, such as video surveillance (1), e-mail, and “smart” name badges, offer a moment-by-moment picture of interactions over extended periods of time, providing information about both the structure and content of relationships. For example, group interactions could be examined through e-mail data, and questions about the temporal dynamics of human communications could be addressed: Do work groups reach a stasis with little change, or do they dramatically change over time (2)? What interaction patterns predict highly productive groups and individuals? Can the diversity of news and content we receive predict our power or performance (3)? Face-to-face group interactions could be assessed over time with “sociometers.” Such electronic devices could be worn to capture physical proximity, location, movement, and other facets of individual behavior and collective interactions.
The data could raise interesting questions about, for example, patterns of proximity and communication within an organization, and flow patterns associated with high individual and group performance (4). We can also learn what a “macro” social network of society looks like (5), and how it evolves over time. Phone companies have records of call patterns among their customers extending over multiple years, and e- Commerce portals such as Google and Yahoo collect instant messaging data on global communication. Do these data paint a comprehensive picture of societal-level communication patterns? In what ways do these interactions affect economic productivity or public health? It is also increasingly easy to track the movements of people (6). Mobile phones allow the large-scale tracing of people’s movements and physical proximities over time (7). Such data may provide useful epidemiological insights: How might a pathogen, such as influenza, driven by physical proximity, spread through a population?

Available here. To model that data, you need a theory of highly integrated, complex dynamical systems. That set of theory is what I refer to as "systems theory" on this blog.

Computational social science is actually not new. Csikszentmihalyi started collecting such data with pagers decades ago using his "Experience Sampling Method" (ESM).

Via Dan Katz at the Computational Legal Studies blog.

What happened at AIG

2009-07-08T08:42:48-07:00

Michael Lewis reports:

DeSantis turned out to be a friend of a friend. He’d called because he didn’t know anyone else “in the media.” As a type he was instantly recognizable: a “quant,” a numbers guy who was allowed to take financial risks because of his superior math skills, but who had no taste for company politics or public exposure. He’d grown up in the Midwest, the son of schoolteachers, and discovered Wall Street as a scholarship student at M.I.T. The previous seven years he’d spent running A.I.G. F.P.’s profitable stock-market-related trades. He wasn’t looking for me to write about him or about A.I.G. F.P. He just wanted to know why the public perception of what had happened inside his unit, and the larger company, was so different from the private perception of the people inside it, who actually knew what had happened. The idea that the employees of A.I.G. F.P. had conspired to maximize their short-term gains at the company’s longer-term expense, for instance. He and the other traders had been required to defer about half of their pay for years, and intertwine their long-term interests with their firm’s. The people who lost the most when A.I.G. F.P. went down were the employees of A.I.G. F.P.: DeSantis himself had just watched more than half of what he’d made over the previous nine years vanish. The incentive system at A.I.G. F.P., created in the mid-1990s, wasn’t the short-term-oriented racket that helped doom the Wall Street investment bank as we knew it. It was the very system that U.S. Treasury secretary Timothy Geithner, among others, had proposed as a solution to the problem of Wall Street pay.

Via Marginal Revolution.

The Great Synchronization

2009-07-08T08:19:27-07:00

From the Vox blog, a post by Sónia Araújo and Joaquim Oliveira Martins

The current trade crisis is a uniquely synchronised fall. A pattern standing out from Figure 4 is that periods of abrupt decline of total trade flows were not uncommon at the individual country level, but these drops were not occurring simultaneously. The unique feature in the current crisis is the negative growth rates exceeding -10%, from November 2008 onwards for all six countries depicted,3 with the fall increasing to more than 20% as of January 2009.
Figures 4-5 try to uncover this striking synchronisation with an aggregate indicator. The figures display, for exports and imports separately, the percentage of OECD countries that exhibit a monthly year-on-year trade growth rate that is: i) negative, ii) below -5%, and iii) below -10%. To focus on the current decline, the analysis includes all 30 OECD member countries since January 1998.

The remarkable degree of synchronisation emerges rather neatly. There have been episodes of synchronised trade declines, namely following the dot.com crisis and September 11, but by end-2008 suddenly more than 90% of OECD countries exhibit simultaneously a decline in exports and imports exceeding 10%. It is the synchronised and large drop in trade in every OECD country that explains the collapse in international trade.

At this scale, psychology is not the right modeling tool. "Animal spirits" are real, but they do not provide an adequate explanation for how behavior gets correlated across continents. Click on the "Sync" category at the right and explore some of the mathematical models of sync. Markets are global now; market price signals are a mechanism for an all-to-all coupling of trade flows. The Kuramoto Model could provide insight into global sync of trade flows.

Editorial Note: New Categories

2009-07-07T18:47:42-07:00

For some reason I got it in my head that it would be a good idea to go back and redo my categories on this blog. The categories before yesterday were default plus a handful that I added over time. You can see the new list of categories at left, which are a far better fit. I hope this will be useful to readers interesting in learning more about some of the topics covered -- especially symmetry breaking, synchronization, flow, and systems theory.

What Network Structure Provides the Smoothest Flow?

2009-07-07T17:58:45-07:00

From a paper by Zoltan Toroczkai, Balazs Kozma, Kevin E. Bassler, N.W. Hengartner, and G. Korniss:

If the flow received by a node has to be processed, it will happen at a finite rate. For example, a node receiving a packet, has to read off its destination and find out to which neighbor to send it. This is a physical process and takes a non-zero amount of time. Thus, if a node receives too many packets per unit time, they will form a queue, and long queues will generally cause delays in information transmission and thus leads to congestion, or jamming. An important question then arises: Can the topology of the underlying substrate graph influence the level of congestion in the network?
The answer is yes...

Capitalism and Culture

2009-07-07T17:46:50-07:00

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

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

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

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

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

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

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

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

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

Silly Physicist! Bubbles Need Financing

2009-07-05T21:27:53-07:00

From the WSJ:

At the summit of the Group of Eight leading nations in L'Aquila, Italy, next week, Ms. Merkel will urge leaders including U.S. President Barack Obama to rein in ballooning budget deficits as soon as the recovery allows, or risk another debt crisis.
She has also called on central banks to reverse their unorthodox measures to increase borrowing and lending once the paralysis in credit markets eases.

Normal, prudent policies should return once economic activity rebounds to its level before last year's downturn, Ms. Merkel says. "Then it will be important for us to take care that we don't set up the next crisis right away by taking too-high risks," Ms. Merkel said in her airy, modern chancellery office overlooking the Reichstag parliament building.

Hmm... Didn't she learn any economics? What about Keynes?

Ms. Merkel, a 54-year-old former particle physicist who grew up in communist East Germany, is strong favorite to remain in office after German elections on Sept. 27.

Well that explains it. I guess she expects actual data to support her economic theories! Actually, I think the WSJ may have gotten this slightly wrong. She is a Physical Chemist.

Via ThinkMarkets.

Happy Independence Day

2009-07-03T14:25:32-07:00

Before all things I am reminded as I go along, that this day, the birthday of our republic, demands our filial acknowledgments. A day now at length auspicious, since by the establishment of our new constitution we have the fair prospect of enjoying those good things, for which we have had so hard a contest. Indulge, I pray you, the effusion of my heart, which gratulates itself on this occasion. Feel, with me, the transports which I cannot but feel, when every letter from America brings confirmation of the public happiness, and announces some additional cement to our national union, or some useful exhibition of national authority. The opposition sickens with mortal symptoms, and I hope and trust, that our countrymen will have the wisdom to wait, before they attempt amendments, for those lights of experience, which are the only guides that can pretend to infallibility.

From Gouverneur Morris in a letter to William Carmichael on July 4, 1789.

What is the Systems Theory of Economics?

2009-07-02T10:16:43-07:00

Systems theory is an attempt to put Hayek, Coase, Williamson, North, and Ellickson on more quantitatively rigorous foundations. Systems theory is an umbrella term for physics models of networks and dynamical systems that are used to understand how interconnected flows can end up in stable or unstable local equilibria, spontaneously synchronize, and generally evolve over time in feedback loops.

Here are some of the basic hypotheses about human behavior that might be associated with systems theory:

Individuals have preferences for goods that can be measured in units of flow (quantity consumed/produced per unit time).
Individuals seek to optimize the fit between their flow preferences and available flow using available information about past and present available flow.

These together suggest that individuals can be modeled as a nexus of flows of cash and other goods. In turn, the interconnected streams of these flows lead to additional hypotheses about the behavior of the integrated system of flows.

Feedback loops in flow among individuals can result in more spatially and temporally stable preferences by synchronization of flow.
A nexus of synchronized flows may be a firm or a market depending on the structure of interconnections. (I.e., the ability to synchronize flow over time determines what structures will persist.)
Firms that synchronize with higher-bandwidth can operate at lower cost, sell at higher margin, or both.
Firms with scale-free architecture are the most cost-efficient, but also the most susceptible to catastrophic failure.
(Perhaps most surprisingly) Under certain circumstances, individual preferences will spontaneously synchronize through market price signals.

There is an evolutionary mechanism at work here in that the nexus of flows that constitutes a firm is in competition with other nexuses of flows for additional flow. Over time, some network structures will survive better. And the success or failure of a particular network will, of course, have an impact on how the preferences of individuals within it will evolve over time. There are deep connections between systems theory and the evolutionary theory of psychologists like Mihaly Csikszentmihalyi and sociologists like Donald T. Campbell. But the kind of data and scale of the models used by systems theory is more traditionally associated with economics.

Much of systems theory has been anticipated by New Institutional Economics, and in some cases sociology and psychology. The work from Haidt and Ehrenreich on hive psychology and collective joy, for example, is consistent within broad contours of the physics models of self-organized synchronization. Robert H. Frank's work on positional goods can be understood in terms of the sustainability of certain integrated flow structures over long times. In general, Thomas Schelling seems to have had these sorts of models in mind in his writing, although he tended to focus on the potentially destructive outcomes after long periods of repeated interactions.

I'm going to try to turn each of these bullet points into a separate post over the next few weeks or months.

Who has the leverage with VC-backed real-time startups?

2009-07-02T08:59:56-07:00

The new wave of VC investment in Internet-based startups focuses on "real-time" applications.

Long time readers of BS should know that I am quite enthusiastic, overall, about this development.

But on my way in this morning, I was thinking again of Fourier transforms. The goal of thinner and thinner slices toward the present time comes at a cost of wider frequency.

So who will be the biggest winners because of real-time startups?

Of course, if IRR expectations are reasonable, then everything will turnout just fine. Only they can't be with 2x what's coming out going in the last few years running.

I see a few bandwidth owners tenting their fingers and laughing maniacallly at this fortuitous development.

Excellent Sentences from Joff Wild at IAM

2009-06-29T14:42:27-07:00

However, how do you measure value when IP can be so frustratingly intangible - what price that collaborative relationship with a competitor that a piece of IP may enable, for example? One at least partial solution to this conundrum may be to make royalty rates far more transparent. One suggestion was that all licensing deals agreed in the US should be publicly recorded at the USPTO so that people could see the sums involved. This would have to be compulsory as no-one would do it voluntarily.

From the IAM Blog.

Bleg for Economists: Empirical Tests of the Rational Hypothesis

2009-06-29T12:32:33-07:00

Folks, aside from the lab experiments (which I know produced mixed results), what empirical evidence do we have of the validity of the rational hypothesis? As best I can tell, the last work done in this regard were the nonparametric tests of WARP by Varian and Bronars in the 1980s.

Those studies, of course, were of aggregates of household consumption over long time periods. Has anybody tested the rational hypothesis against revealed preferences outside a laboratory by tracking individual consumer behavior?

The question comes to this: Is there a data set for a large population that tracks the time-series of acts of consumption for each individual in the population over some period of time?

If the rational hypothesis is applied to predict how individuals will behave, then it should be based on empirical data about individual behavior, should it not? Where is that data?

Twitter Updates

2009-06-27T10:14:53-07:00

Have now been added to Broken Symmetry on the right. If you're already tweeting, be sure to follow me. I'm riemannzeta. If you tell me you read Broken Symmetry, I'll be more likely to reciprocate.

More Systems Theory from Judge Posner

2009-06-26T12:39:45-07:00

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

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

Highlights from the 2009 IP Business Congress

2009-06-26T11:42:57-07:00

Monday and Tuesday of this week I attended the second annual IP Business Congress, which this year was venued at the Four Seasons Hotel in Chicago. There were almost 400 attendees at the event, which was a good turnout given the economic climate. Attendees represented stakeholders in nearly every part of the IP Market, both primary and secondary. As expected, the panels organized by IAM magazine were excellent and informative, especially the question and answer sessions afterward. This is an event that I expect to put on my calendar annually.

Highlights for me as an attendee to this event included (1) the first panel on Monday on the state of IP rights in China, India, Japan, Europe, and the United States; (2) the panel on patent pools on Monday afternoon; (3) the panel on open innovation on Monday afternoon; and (4) the Gala dinner on Monday night. Tuesday's panels were also excellent, but of less interest to me because of my more direct involvement with many of the issues addressed on Tuesday.

State of IP Rights Internationally

Harvey (expert on China) kicked things off by noting how IP rights had been a strong influence on the development of rule of law more generally in China: IP was the first private property right to be recognized by the Chinese government after the cultural revolution. Harvey also explained that in number of lawsuits, there is more IP litigation in China than in any other nation. The picture he painted was of a thriving IP system in China that was operating decoupled from the rest of the IP world. The coupling of China's IP system into the rest of the world's will produce winners and losers of epic proportion, and now is the time for us to think strategically about how to prepare our clients and customers for this inevitable merge of the Chinese system into the rest of the world.

McGinley (EPO Officer) followed Harvey with sobering statistics on the patent application bubble that is growing inside the US, EPO, and Japanese patent offices: 2 million applications althogether are now pending inside these offices. Given how the rate of examination has not kept up with the rate of growth in filing, McGinley suggested that the system was beginning to resemble a pyramid scheme! This was a brave position for a government official to take, but everybody in the system should appreciate what McGinley is trying to do. Where might we have been had more financial regulatory authorities here in the U.S. pointed out the pyramid-scheme-like growth of the subprime mortgage market? McGinley was short on answers as to how to solve the problem, but he did suggest that Chinese officials were probably at the top in terms of training practices and the reduction of systematic errors in examination. This seemed unsurprising to this listener given the on-the-ground experience of many Chinese with more complex manufacturing workflows!

The presenter from Japan had little of interest to say, and presented some confusing interpretations of statistics on patenting in Japan. For example, he pointed out that the largest number of patents issued in Japan were to computer companies rather than pharma companies. Pharma companies need only one well-drafted and prosecuted patent to protect their products. This is not very surprising, and is true everywhere in the world.

Basheer from India gave in many ways the most interesting presentation. His was mostly a diplomatic presentation of facts about the IP market in India, where the political agenda is driven by the success of generic drug manufacturers. As a few BS readers may know, Basheer is also one of the authors of the consistently excellent (but very detailed!) Spicy IP blog. From listening to Basheer, one could piece together a picture of India in a critical state, in which more or less IP protection could result from a sharp push in either direction. Too difficult to call for the time being. On my view, it seems that Indian biotech and pharma researchers have a regulatory arbitrage over their U.S. counterparts, who have many years of redtape to cut through before carrying out even relatively safe clinical trials! Note that beating heart transplants are now being carried out in Indian hospitals. There are many high-risk, high-reward medical treatments now avaiable in India that may never be available in the United States. Another trend to watch carefully.

The first question/comment for this panel was also notable. It came from Sherry Knowles of GSK, who noted that Chinese generic manufacturers were getting drugs to market before US manufacturers by simply scraping clinical data off the clinicaltrials.gov website on which U.S. manufacturers, such as GSK, have to post their data by law! There's one for the USTR to call to Chinese government attention.

Patent Pooling

The Monday afternoon panel on patent pools included Sisvel founder Dini, Hinman from Verizon, and Michel from the FTC. Dini gave a great pitch for hiring independent administrators (such as Sisvel) for allocating profits among patent pool participants, and for getting such admins involved at as early a stage as possible. Michel gave a presentation of the recent history of FTC regulation of patent pools, including a summary of the federal court holdings relating to Rambus's participation in JEDEC. Hinman talked about the perils of patent pool participation, and noted that even opt-out could be anti-competitive. Referring to one patent pool in particular, he pointed out that all but two industry participants had entered. I saw Michel scribbling notes!

The upshot is that if your company is involved with patent pools, you need to hire experienced outside counsel with knowledge at the interface of IP and Antitrust law to help ensure your business strategy reduces the risk of antitrust liability. Your author knows and works with a few such experts, and is happy to make an intro. Note that most corporate lawyers or IP lawyers will not be aware of the perils of competition law because the Bush and Clinton administrations were relatively lax on this front. All indications are that the Obama administration will be more active in enforcing competition law.

Open Innovation

By now the term "open innovation" has become relatively well-known within the business community. Some IP owners may believe that open innovation represents a form of socialism -- an alternative to a system of property rights. Attendance to this panel would have been the antidote to such misunderstandings of this theory. Panelists Weedman from P&G, Simonton from Exelixis, and Bergelt from the Open Innovation Network (and formerly of Paradox) talked about the dynamic growth that the feedback loops established by open innovation networks facilitate for the companies that take open innovation seriously.

Because the theory of open innovation is a paradigm shift from traditional neoclassical economic theories, only a handful of businesses (including P&G and Exelixis) have been fortunate enough to find leaders willing to foster the organizational commitments necessary to make open innovation work. This business model is the future of every large public corporation in the world. Watching these businesses continue to outgrow their competitors, others will eventually follow.

Gala Dinner

One of the best parts of the event was meeting the attendees. Over drinks before the Gala dinner, I had the chance to catch up with Niels Reimers, who later that evening was inducted into the IP Hall of Fame for his path-breaking work in technology transfer. In this rare moment of opportunity, I had the chance to ask Niels about how he worked at Stanford. By Niels's description, he was practicing the same technique followed by the best founders and managers in Silicon Valley both then and now -- "management by walking around." Dave Packard and Bill Hewlett, Bill Perry at ESL, and Nils at Stanford were all doing management by walking around. Niels's personal accounts of his work connecting Stanford music department (!) professor John Chowning with Hamamatsu corporation engineers were a highlight among highlights for this event.

Later, when Niels cited the Teece Model of innovation in his acceptance speech, I nearly fell out of my chair. The same model was cited by FTC Commissioner Tom Rosch in his speech about new theories in competition law on June 1, 2009. Note that Teece was also cited in the explanation of systems theory provided in your author's letter comment to the FTC on the Evolving IP Marketplace.

Final Thoughts

Another highlight made possible by my attendance to the event, but not directly related thereto, was an invitation to a breakfast with Congressman Bill Foster on Tuesday morning. I am already a fan. Foster is an entrepreneur and physicist who decided (after 22 years of building superconducting magnets to detect subatomic particles) to roll up his sleeves and try to help fix government. I'm pretty sure there's nobody else in Congress who would know what the title of this blog refers to. The discussion of the patent system and innovation at this breakfast was the best I've heard ever anywhere, but it also revealed to me the underlying problem facing patent reform: nobody has a complete view of the whole system. Almost everybody (at least) focuses on the broken incentives and procedures facing them in their subsystem, without stepping back to see how all of the subsystems coalesce into an competitive and innovative ecosystem. Nonetheless, the kinds of questions asked and answers given at this breakfast suggest that already the level of discourse has progressed far beyond the pat answers that were served up last year when patent reform was before Congress. There is more widespread awareness at least of how the public has been manipulated to some extent by the more technologically sophisticated and media-connected subset of stakeholders in the system. Perhaps we will have sensible patent reform after all. Here's to that hope.

Judge Posner on the Systems Theory of the Financial Crisis

2009-06-24T09:28:51-07:00

Yet even if all firms that create systemic risk decided to shrink, or to reduce their interactions with other financial firms, systemic risk would not be eliminated. For such risk is a property of the financial system rather than of individual firms. That is, systemic risk is correlated risk. If the entire banking industry were heavily invested in home mortgages, and a housing bubble caused a drastic fall in the value of those mortgages, it wouldn't matter if the industry consisted of 10,000 banks of equal (and therefore equally small) size that had no dealings with other financial firms. The whole industry would be brought down.

Read the whole post here.

Feedback Loops in the All-to-All Network in which we live

2009-06-23T10:12:20-07:00

Story I heard from Congressman Bill Foster this morning: Last fall, when the Stimulus Bill first went to the House for a vote, Congress members on the floor were watching the markets drop in real time on their blackberries. At the same time, traders in the pits on Wall Street were watching Congress voting on the Bill. Pro voters began berating Con voters as they came to the floor to vote. In effect, traders and their thousands of customers, spread all over the world, were doing the same.

Pause and let that sink in. We live in Robert Musil's world now. If we aren't careful, our decisionmaking can become very tightly correlated very fast.

Consider how many steps the framers of the United States Constitution took to avoid their decisionmaking during the Convention -- or the decisionmaking of actors in different branches of government -- from becoming too correlated.

How to Reduce Systemic Risk: Look at the Rates of Growth and Cross-Correlations

2009-06-20T17:20:06-07:00

The White Paper last week was a disappointment. It was long on generalities and short on specifics of how and why we ended up in this mess. Lots of people are throwing their hands up in the air. A few are saying that the only way to avoid this problem is to go back -- i.e., to keep banks from ever growing so big again. Both of these are counterproductive. We have learned a few things from watching this crisis enfold that may help us avoid similar crises in the future.

One of those lessons is directly relevant to the argument that banks should simply be limited to a particular size. If there is any lesson that we have learned from this crisis, it is that size doesn't matter. Banks big and small all over the world have been brought to their knees by this crisis.

Systemic Risk = Large-Scale Correlations in Risk

What brought the financial industry all over the world to its knees can be attributed to a single mistake in reasoning, which was made by managers at every bank that ended up insolvent. Their mistake was in assuming that their risk of loss would range only within the boundaries set by local and recent events. The Royal Bank of Scotland, Kaupthing Bank in Iceland, Lehman Brothers in the United States, and your local Savings & Loan -- all made the same basic mistake of assuming that even if things got ugly for them, then there would be plenty of other banks around to pick up the slack. So long as I can depend on my counter-parties to behave exactly as we expect by contract, we will survive.

One thing that's worth noting is that this mistake wasn't fatal to the financial industry before the subprime mortgage bubble. The financial industry survived several bubbles before that, including the dot com bubble only ten years before. What changed?

The answer is cross-correlation. Over the past ten years, the financial industry became more interconnected through the financial engineering of derivatives and increased leverage than it has been ever before in history.

When any system becomes cross-linked beyond a certain low threshold, correlations in the dynamics of the system can spread from local to global. And this is exactly what we are living through. Although the system became exponentially more interconnected over the last ten years, the individual decisionmakers within the system (for the most part) kept their horizons relatively local and short-term. Nobody was looking at the large-scale, long-term trends and worrying about how those could ripple out in the event of a single default. Nobody was looking because no such cascade had ever occurred before.

The first role of any systemic risk regulator should thus be to quantify and limit the amount of cross-correlation in risk within the financial industry. We just can't afford to have every financial institution making the same kinds of bets. If a few are taking their cut from poker players, then the others need to take their cut from craps-players or roulette-players.

Regulating at Scale: Measuring Fundamental Limits to Growth

Systemic risk regulators have to be especially careful about the problem of scale. As numerous commentators have pointed out, there were a few people within the SEC that noticed the problems that might be caused by the unregulated sale of over-the-counter derivatives and the explosion in growth of the subprime mortgage market. How is putting a new agency in charge -- even if it has access to more information -- going to avoid such cascades in the future? In general, I don't think that any such agency will be able to prevent such cascades without having unintended negative consequences. And the scope of the authority needed to effect system-wide regulations is worrisome too from the point of view of suceptibility to political influence. A thumb on the scale at that scale is enough to crush entire markets.

To deal with systemic risk, any actual regulation will have to gloss over many of the fine details of what particular parties and counter-parties are doing. Getting too involved in these details simply invites corruption anyway. To deal with systemic risk, regulators need to change focus from the short-term and local, to the long-term and global.

For example, has anybody in government ever tried to figure out the highest rate of growth that has ever been achieved by a legitimate (i.e., non-fraudulent, sustainable) large corporation? If a company is growing faster than a certain rate then risk is being spread through the system. Such a company is either a Ponzi scheme or a gamble that some market exists that has not been demonstrated to exist.

A perfectly legitimate way for a systemic risk regulator to operate would be to set a threshold internal rate of return on cashflow -- say 30% annualized -- and then to demand that anybody with a higher IRR has to report to the systemic risk regulator on from whom and to whom that cash is flowing. Such a policy would have flagged the problem with subprime mortgages immediately. The size of the subprime mortgage market did not suddenly go from a few hundred million to billions in a year or two. At the very least, the government should have been carefully scrutinizing it after the cashflow increased by that number of orders of magnitude.

The Big Picture: A Network of Cashflows

At the end of the day, an economy is a network of cashflows. What makes our economy unique in the history of the world is its degree of interconnectedness. Those interconnections are both a blessing and a curse. They are a blessing in that they lower the costs of lending so that more and more people can get access to financing. (Think of Kiva, which is part of that interconnectedness.) The curse is that they permit for system-wide fluctuations to develop even from relatively small losses when decisionmaking is too tightly correlated.

Our goal should not be to go back to the smaller, less interconnected world. It should be to forge ahead into a fully networked economy, but with awareness of and capabilities to manage these global and long-term patterns of growth and decay in the network.

We need to think bigger.

The Glassy State of the Financial Services Industry

2009-06-19T10:54:10-07:00

How might financial regulators have identified a problem with our market? By looking at cross-correlations like this one:

Again, this is from the paper on synchronized clusters reviewed here.