Michael Blume recently reminded me of a point I made eleven years ago. At the time it seemed too obvious to be original, but now I’m not so sure. So let me point out an important negative investment externality:
On your point 1, it is exactly like why a monopolist wants to raise prices above the competitive level; he loses marginal customers and gains on all infra-marginal customers.
So, it makes more sense if I think of the long-term rights that solve the problem not as extended patents -- because the problem is the race to be patentable. What you want is a lower barrier to lock up research toward a particular patentable item early on in the dev process. So you could apply for a pre-patent right to deliverable a patentable item in N years. This would then be made public and bid on. Like other patent rights it should be tradeable. What the winner (holder) gets is basically the sole right to patent this item if they produce it within the term. If anyone else wants to beat them out, they have to buy the pre-patent or hope the holder can't produce a patentable product within the term so that it expires.
If this is the kind of right Robin imagines, that would make sense (at least in the patent space). There is still the social cost of the year wait, and while there's no reason to think it's as much as 100 million, it's still significant (probably on the order of 20M if the net benefit over the patent term is 200M).
Plus we haven't considered how much of the extra 100M in spending is dead-weight loss versus mere utility transfers. In your contrived hypothetical, it's easy to imagine dead-weight loss being more than 20%, so that probably represents a net social cost, that some kind of pre-patent right would eliminate or at least drastically reduce.
I'd love to have a real world example to chew on, though. I'm not aware of any races to be first where the cost ratio was that dramatic (10 x cost for 10% time savings). With less extreme numbers and a small percentage of dead-weight loss on the extra spending, a race to be first in innovations could end up being a net social positive, even if it is negative for all the entrants in the race.
The social benefit is less obvious for something like homesteading.
I've thought some more on the interest rate issue, and if there is no economic profit (due to efficient competition), then it makes sense that all investments would earn the market rate plus something the investor brings to the table. But the difference is still just transfers except at the investment margin which, as Jordan Amdahl notes, is an unclear (to me anyway) trade off between delayed now profitable investments (social good) and scrapped no-longer profitable investments (social bad).
This entry appears to presuppose the "first mover" hypothesis made infamous by the dot-com crash.
Of course, another reason people attempt to be first (the attempt to be first being the culprit here) is that the first person with an innovation gets to patent it. But the solution may simply be to abolish patents.
I think the problem is that you didn't use any concrete examples. I have been able to explain a simpler version of the same argument (which does not use interest rates / rates of return) to many people.
Yeah, it is hard to understand without examples, I wouldn't have understood the post if I hadn't already worked through it on my own.
The negative externality is on who would have discovered it second. Consider a drug that can be discovered in 9 years of R&D for $110M, or in 10 years of R&D for $10M. Whoever discovers it first will patent it and get $120M in revenue out of $200M in total social benefit. Obviously it is worth spending $110M (an extra $100M) to be first, to get the drug a year earlier.
There is no reason to think that society values that extra year at $100M. It is just a result of the "first one gets the value" structure. 1/2 of the $200M in social profit is being burned by this structure. Rather than a societal surplus of $200M-$110M = $90M, we could have had a surplus of $200M - $10M = $190M, for only a 1 year delay in getting the drug.
Robin, if I understand you correctly, you suggest, that by delaying a project until technology improves, so that project's rate of return increases, you can increase average rate of return, and thus, growth rate.
But in your model you take that demand schedule moving up is completely exogenous process, having nothing to do with actual projects being run through trial-and-error process. This doesn't seem right. Of course, you mention positive innovation externalities and assert they won't outweight losses due to first-past-the-post race. But it would be nice to provide some evidence for this assertion. Can you point some market where judicious delaying of well-thought-of projects actually provide superior returns and doesn't, at the same time, slow down rate with which demand schedule goes up?
I've been making the same general point - that people burn resources in an attempt to be first, and that this may be a very common situation where individual rationality leads to bad group outcomes - for years, ever since I first encountered it. I hadn't thought of long-term property rights in opportunities as an answer.
Also, I had focused on it in narrower contexts where the problem is more obvious, like patenting drug discoveries, or discovering stock market mispricings. I find that using such narrow contexts helps people understand it. I think of it as a form of rent-seeking, burning most of the value of a windfall or other fixed resource by competing to obtain it. What I am not sure of is how widespread it is in practice.
I'm not convinced that Robin's choosing to neglect us amateurs is necessarily in his interest (though of course, he's free to). When I program, I sometimes explain how my code works to this or that inanimate object, which sits on my desk. I have to say things very carefully and clearly in order for the "stupid" thing to understand me. I tend to find most of my bugs this way.
Maybe some time, when you get the chance, you could try to help make your discussion on this topic more "accessible"? I know I'd enjoy reading it in words I can understand more readily, and if your theory is truly as novel as you claimed it might be in the intro to your article, then you'll probably also benefit from an increased reader-base (assuming that's something that appeals to you). In any case, may help Robin extend his own understanding of the implications by having such a discussion.
This is probably the hippiest free love post I've ever made on a blog. Peace and love all around! ~
I am with the folks who are confused by this post, and probably don't qualify as an amateur. I would suggest breaking this post up into a few separate, more specific arguments.
If we move away from macroeconomic policy, does the argument have anything to say about the following? Private firms often demand new projects to generate returns that far exceed their cost of capital. They tout this under the banner of 'capital rationing' and traditional economists have struggled to understand the policy. Is there a relationship?
Even though I'm one such "amateur," I think I learn a lot from reading this blog, and I've learned much from the occasional replies to my comments from you and others. (Thanks!)
I realize these replies are in essence an act of charity, so in the future (as I did above) I will briefly advertise my "amateur" status at the very beginning, so you and others can choose whether to spend time on my comments or not (no hard feelings if not -- we're all busy people). Maybe we should all do that, which has the side benefit of allowing us amateurs to discern the validity of those comments that receive no reply.
I think the problem with this post is that it apparently claims that raising interest rates is good without reference to the current rate (which everyone who has heard of Zimbabwe knows is wrong) and then defends the thesis using inpenetrable economist tech-talk. That sort of thing is bound to make many readers squirm.
If there wasn't much point in attempting such a project very long after other teams tried...
Firms can't compete in the same technology space if the first-mover secures those rights, but they can compete above that technology space as the tech becomes available. No problem here.
This should happen even if the project returns would be much greater if everyone waited longer.
The returns to using the first tech that satisfied "market return + epsilon" couldn't possibly be greater by waiting and then still using that same tech, so what do you mean here? If one firm lunges after the "market return + epsilon" opportunity, other firms will go after the new tech opportunities as they become available. All opportunities are captured.
Do you mean that firms should collectively ignore the current tech that satisfies "market return + epsilon"? Why? It seems to me that firms that bring a recently profitable opportunity to market satisfy a market demand from consumers who are saying, "I will buy your product even though other firms are bringing new and better technology soon"? Why second-guess their time-preferences?
1. "Poor" investment projects discouraged by artificially higher interest rates is not a good outcome. Investments that are "poor" at the margin still are a net benefit to society. The increased profitability of investments that are delayed is likely to be offset by investments that never happen. While it might be true that these investments are only marginally profitable, a marginal increase in the interest rate will only make the delayed investments marginally more profitable. It is not at all clear to me that there is a net gain to be had.
2. The use of tax policy is problematic because it will lead to many unintended consequences. For example, investments tied to more secure property rights will only be adversely affected. For example, suppose I own a natural resource. I can rationally choose to invest in extraction when the profitability of doing so it at its highest. Even if the maximum profitability occurs after my death, I can wait for the resource to appreciate as technological advances make it more profitable and sell it to someone who will live long enough to invest in it (or, more likely, to a corporation). In such cases, there is no tragedy of the commons where investment is made too early and taxes on investment will only lead to deadweight loss.
A few points: (Is the joke that if you only want responses from non-economists then you would publish your ideas in a gated journal?)
A. It looks like you are largely discounting the investment vs consumption trade off by having time preference being dependent mainly on genes. This doesn't seem right. You might believe that the race to be first has negative externalities that are larger than the foregone investment at all in most cases, but that seems unlikely.
B. How much of the benefit comes from proposal #1 and how much from proposal #2? Proposal #1 alone seems beneficial, proposal #2 alone seems harmful as it will drive people towards even shorter term behavior. #1 and #2 might be better than the status quo, but how much of that is from the #1 and how much from #2?
C. The economy reacts to the price signals of bottlenecks, and perhaps this reaction is slow but raising the rate of return to get around the bottlenecks gives far too much credit to the foresight of actual economic actors, who are more responsive to current price signals than possible future price signals.
D. Short term investments in the stock market are already taxed at a higher rate than medium term investments. Perhaps the term structure of taxes could be a better mechanism to theoretically modify than than the total level of taxes on investment.
On your point 1, it is exactly like why a monopolist wants to raise prices above the competitive level; he loses marginal customers and gains on all infra-marginal customers.
So, it makes more sense if I think of the long-term rights that solve the problem not as extended patents -- because the problem is the race to be patentable. What you want is a lower barrier to lock up research toward a particular patentable item early on in the dev process. So you could apply for a pre-patent right to deliverable a patentable item in N years. This would then be made public and bid on. Like other patent rights it should be tradeable. What the winner (holder) gets is basically the sole right to patent this item if they produce it within the term. If anyone else wants to beat them out, they have to buy the pre-patent or hope the holder can't produce a patentable product within the term so that it expires.
If this is the kind of right Robin imagines, that would make sense (at least in the patent space). There is still the social cost of the year wait, and while there's no reason to think it's as much as 100 million, it's still significant (probably on the order of 20M if the net benefit over the patent term is 200M).
Plus we haven't considered how much of the extra 100M in spending is dead-weight loss versus mere utility transfers. In your contrived hypothetical, it's easy to imagine dead-weight loss being more than 20%, so that probably represents a net social cost, that some kind of pre-patent right would eliminate or at least drastically reduce.
I'd love to have a real world example to chew on, though. I'm not aware of any races to be first where the cost ratio was that dramatic (10 x cost for 10% time savings). With less extreme numbers and a small percentage of dead-weight loss on the extra spending, a race to be first in innovations could end up being a net social positive, even if it is negative for all the entrants in the race.
The social benefit is less obvious for something like homesteading.
I've thought some more on the interest rate issue, and if there is no economic profit (due to efficient competition), then it makes sense that all investments would earn the market rate plus something the investor brings to the table. But the difference is still just transfers except at the investment margin which, as Jordan Amdahl notes, is an unclear (to me anyway) trade off between delayed now profitable investments (social good) and scrapped no-longer profitable investments (social bad).
Yes, that is a more specific example.
This entry appears to presuppose the "first mover" hypothesis made infamous by the dot-com crash.
Of course, another reason people attempt to be first (the attempt to be first being the culprit here) is that the first person with an innovation gets to patent it. But the solution may simply be to abolish patents.
I think the problem is that you didn't use any concrete examples. I have been able to explain a simpler version of the same argument (which does not use interest rates / rates of return) to many people.
Yeah, it is hard to understand without examples, I wouldn't have understood the post if I hadn't already worked through it on my own.
The negative externality is on who would have discovered it second. Consider a drug that can be discovered in 9 years of R&D for $110M, or in 10 years of R&D for $10M. Whoever discovers it first will patent it and get $120M in revenue out of $200M in total social benefit. Obviously it is worth spending $110M (an extra $100M) to be first, to get the drug a year earlier.
There is no reason to think that society values that extra year at $100M. It is just a result of the "first one gets the value" structure. 1/2 of the $200M in social profit is being burned by this structure. Rather than a societal surplus of $200M-$110M = $90M, we could have had a surplus of $200M - $10M = $190M, for only a 1 year delay in getting the drug.
Robin, if I understand you correctly, you suggest, that by delaying a project until technology improves, so that project's rate of return increases, you can increase average rate of return, and thus, growth rate.
But in your model you take that demand schedule moving up is completely exogenous process, having nothing to do with actual projects being run through trial-and-error process. This doesn't seem right. Of course, you mention positive innovation externalities and assert they won't outweight losses due to first-past-the-post race. But it would be nice to provide some evidence for this assertion. Can you point some market where judicious delaying of well-thought-of projects actually provide superior returns and doesn't, at the same time, slow down rate with which demand schedule goes up?
I've been making the same general point - that people burn resources in an attempt to be first, and that this may be a very common situation where individual rationality leads to bad group outcomes - for years, ever since I first encountered it. I hadn't thought of long-term property rights in opportunities as an answer.
Also, I had focused on it in narrower contexts where the problem is more obvious, like patenting drug discoveries, or discovering stock market mispricings. I find that using such narrow contexts helps people understand it. I think of it as a form of rent-seeking, burning most of the value of a windfall or other fixed resource by competing to obtain it. What I am not sure of is how widespread it is in practice.
I'm not convinced that Robin's choosing to neglect us amateurs is necessarily in his interest (though of course, he's free to). When I program, I sometimes explain how my code works to this or that inanimate object, which sits on my desk. I have to say things very carefully and clearly in order for the "stupid" thing to understand me. I tend to find most of my bugs this way.
Maybe some time, when you get the chance, you could try to help make your discussion on this topic more "accessible"? I know I'd enjoy reading it in words I can understand more readily, and if your theory is truly as novel as you claimed it might be in the intro to your article, then you'll probably also benefit from an increased reader-base (assuming that's something that appeals to you). In any case, may help Robin extend his own understanding of the implications by having such a discussion.
This is probably the hippiest free love post I've ever made on a blog. Peace and love all around! ~
I am with the folks who are confused by this post, and probably don't qualify as an amateur. I would suggest breaking this post up into a few separate, more specific arguments.
If we move away from macroeconomic policy, does the argument have anything to say about the following? Private firms often demand new projects to generate returns that far exceed their cost of capital. They tout this under the banner of 'capital rationing' and traditional economists have struggled to understand the policy. Is there a relationship?
Even though I'm one such "amateur," I think I learn a lot from reading this blog, and I've learned much from the occasional replies to my comments from you and others. (Thanks!)
I realize these replies are in essence an act of charity, so in the future (as I did above) I will briefly advertise my "amateur" status at the very beginning, so you and others can choose whether to spend time on my comments or not (no hard feelings if not -- we're all busy people). Maybe we should all do that, which has the side benefit of allowing us amateurs to discern the validity of those comments that receive no reply.
I think the problem with this post is that it apparently claims that raising interest rates is good without reference to the current rate (which everyone who has heard of Zimbabwe knows is wrong) and then defends the thesis using inpenetrable economist tech-talk. That sort of thing is bound to make many readers squirm.
If there wasn't much point in attempting such a project very long after other teams tried...
Firms can't compete in the same technology space if the first-mover secures those rights, but they can compete above that technology space as the tech becomes available. No problem here.
This should happen even if the project returns would be much greater if everyone waited longer.
The returns to using the first tech that satisfied "market return + epsilon" couldn't possibly be greater by waiting and then still using that same tech, so what do you mean here? If one firm lunges after the "market return + epsilon" opportunity, other firms will go after the new tech opportunities as they become available. All opportunities are captured.
Do you mean that firms should collectively ignore the current tech that satisfies "market return + epsilon"? Why? It seems to me that firms that bring a recently profitable opportunity to market satisfy a market demand from consumers who are saying, "I will buy your product even though other firms are bringing new and better technology soon"? Why second-guess their time-preferences?
This reminds me of:
The homesteading problem--inefficiently early settlement in order to establish a claim.
I'm still digesting, but a couple comments:
1. "Poor" investment projects discouraged by artificially higher interest rates is not a good outcome. Investments that are "poor" at the margin still are a net benefit to society. The increased profitability of investments that are delayed is likely to be offset by investments that never happen. While it might be true that these investments are only marginally profitable, a marginal increase in the interest rate will only make the delayed investments marginally more profitable. It is not at all clear to me that there is a net gain to be had.
2. The use of tax policy is problematic because it will lead to many unintended consequences. For example, investments tied to more secure property rights will only be adversely affected. For example, suppose I own a natural resource. I can rationally choose to invest in extraction when the profitability of doing so it at its highest. Even if the maximum profitability occurs after my death, I can wait for the resource to appreciate as technological advances make it more profitable and sell it to someone who will live long enough to invest in it (or, more likely, to a corporation). In such cases, there is no tragedy of the commons where investment is made too early and taxes on investment will only lead to deadweight loss.
A few points: (Is the joke that if you only want responses from non-economists then you would publish your ideas in a gated journal?)
A. It looks like you are largely discounting the investment vs consumption trade off by having time preference being dependent mainly on genes. This doesn't seem right. You might believe that the race to be first has negative externalities that are larger than the foregone investment at all in most cases, but that seems unlikely.
B. How much of the benefit comes from proposal #1 and how much from proposal #2? Proposal #1 alone seems beneficial, proposal #2 alone seems harmful as it will drive people towards even shorter term behavior. #1 and #2 might be better than the status quo, but how much of that is from the #1 and how much from #2?
C. The economy reacts to the price signals of bottlenecks, and perhaps this reaction is slow but raising the rate of return to get around the bottlenecks gives far too much credit to the foresight of actual economic actors, who are more responsive to current price signals than possible future price signals.
D. Short term investments in the stock market are already taxed at a higher rate than medium term investments. Perhaps the term structure of taxes could be a better mechanism to theoretically modify than than the total level of taxes on investment.