Tuesday, February 17, 2009

Bhide, innovation and basic research

I highly recommend this podcast interview with Amar Bhide at Columbia Business School. Bhide studies entrepreneurship and has a very good understanding of how business innovation actually works. (This is quite rare for an academic -- even those in economics departments or business schools.)

The whole podcast is worthwhile, but particularly the last 25 minutes (starting at about minute 40), in which Bhide discusses Schumpeterian vs Hayekian models of innovation, Knightian uncertainty, securitization and the financial crisis.

I would fault Bhide in one area: the catchy point of his recent book is that high level scientific breakthroughs (e.g., Archimedes' Principle of buoyancy) rapidly become public goods, whereas the nitty gritty skills and know-how necessary to create a useful product (e.g., shipbuilding) are more readily localized and the real source of competitive advantage. He focuses on small optimizations of existing technology to solve everyday problems; it's true that this is the more common type of innovation. But he neglects how whole new industries are sometimes created by real technological breakthroughs.

To take a particular example, look at the Fairchild Semiconductor guys. They weren't just average engineers -- they were trained in advanced labs and hired by the guy who actually invented the transistor (Shockley). It's no coincidence that the country that paid for the basic R&D went on to invent and capture the semiconductor industry. Of course, it was also necessary to have venture capital (actually, they sort of invented it), big capital markets and proximity to customers. But Bhide sounds like he wants to leave out the R&D aspect -- that can be done anywhere, he says. Yes, it can be done anywhere, but the commercialization is more likely to happen nearby, as long as the other necessary factors are also available. I could tell a similar story about biotech or internet companies in the bay area.

Basic research tends to be underfunded primarily because the inventor seldom captures the lion's share of future returns. This makes it less appealing to private investors compared to small optimizations (applications of existing technology) which lead more directly to products and profits. Therefore, funding for basic research must come from the public sector. Societies typically spend too little rather than too much, as future returns are diffuse and have no singular advocate.


Anonymous said...

Many years ago, I heard an interview with an advocate for the necessity of government involvement in basic nuclear power R&D, in which he argued his case by observing that "on a discounted cash flow basis, the world isn't worth saving".

When the problems get too hard, private investors tend to look for greener pastures, where the returns are easier to achieve and the path to them is easier to see. Perhaps small-government ideologues will argue that this is merely because they've come to take the supporting role of government and university R&D for granted, and would support long-term investment if they had no alternative. We might well have the opportunity to test that assumption in the coming decade.

Anonymous said...

"Schumpeter-ian, Hayek-ian, Knight-ian" Why does anyone talk this way?

If there were an accounting for basic research, it would be funded privately. How were Bell Labs' profitability and efficiency measured?

Anonymous said...

I listened to the podcast, and have to say that I found it weirdly disconnected from the realities of the current economy.

Also, Bhide seems disproportionally interested in venture-funded companies. Most of the hard blocking-and-tackling in the economy is done by companies that wouldn't be able to get their calls returned by a VC firm, let alone prompt unsolicited interest.

And that's just as well. From Joel Spolsky:

When people ask me if they should seek venture capital for their software startups, I usually say no. At Fog Creek Software, we have never looked for venture capital. Here's why.

The fundamental reason is that VCs do not have goals that are aligned with the goals of the company founders. This creates a built-in source of stress in the relationship. Specifically, founders would prefer reasonable success with high probability, while VCs are looking for fantastic hit-it-out-of-the-ballpark success with low probability. A VC fund will invest in a lot of startups. They expect about seven of them to fail, two of them to trudge along, and one of them to be The Next Netscape ("TNN"). It's OK if seven fail, because the terms of the deal will be structured so that TNN makes them enough money to make up for all the losers.

The fascination with hit-it-out-of-the-ballpark success, and the myopic concerns of investors generally, has set us up for the current disaster. The integrity and reliability of our financial infrastructure is as vital as the integrity of the power grid, of water supplies, and of public health. All of these things are now under threat, given the dire straits of both the private and public sectors (especially state budgets).

Steve Hsu said...

Bhide's specialty is entrepreneurship and innovation, not finance.

Investors in VC funds (should) know what they are getting into and want the high risk high return strategy. It's useful for diversification.

However, entrepreneurs do need to understand that their interests are not necessarily aligned with those of the VCs.

Anonymous said...

"Most of the hard blocking-and-tackling in the economy is done by companies that wouldn't be able to get their calls returned by a VC firm"

Exactly! Clearly someone living in the media world and not in the real world.

Anonymous said...

Equine hoof odor research birthing a generic cancer cure would be felonious negligent discovery.

Do left and right shoes falsify the Equivalence Principle? Nobody has looked. Single crystals of left- and right-handed quartz (opposite parity atomic mass distributions) are otherwise identical test masses in an Eötvös experiment.

A massed sector chiral vacuum background is silly. Yang and Lee seeking Weak interaction chiral asymmetry were silly, for fundamental theory demanded the world and its mirror image were identical. Discovery is insubordination.

Anonymous said...

I haven't read the following book, but it looks quite relevant to this post:

Inside the Black Box: Technology and Economics, by Nathan Rosenberg

(It is referenced in an article on economic growth, by Paul Romer.)

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