Clay Christensen, Jerome Grossman and Jason Hwang on the Three Basic Types of Business Models

In The Innovator’s Prescription, Clay Christensen, Jerome Grossman and Jason Hwang make good use of a typology of business models laid out by C. B. Stabell and Øystein Fjeldstad in their May, 1998 Strategic Management Journal article “Configuring Value for Competitive Advantage: On Chains, Shops and Networks.” Modifying Stabell and Fjeldstad’s terminology a bit for clarity, Clay and his coauthors call the three types of business models solutions shops, value-adding processes, and facilitated networks. Clay, Jerome and Jason argue that these three types of business models are so different that it is difficult to efficiently house them under one roof. They give these definitions for these three types of business models (from about location 360):

Solution Shops

These “shops” are businesses that are structured to diagnose and solve unstructured problems. Consulting firms, advertising agencies, research and development organizations, and certain law firms fall into this category. Solution shops deliver value primarily through the people they employ—experts who draw upon their intuition and analytical and problem-solving skills to diagnose the cause of complicated problems. After diagnosis, these experts recommend solutions. Because diagnosing the cause of complex problems and devising workable solutions has such high subsequent leverage, customers typically are willing to pay very high prices for the services of the professionals in solution shops. 

The diagnostic work performed in general hospitals and in some specialist physicians’ practices are solution shops of sorts. …

Value-Adding Processes

Organizations with value-adding process business models take in incomplete or broken things and then transform them into more complete outputs of higher value. Retailing, restaurants, automobile manufacturing, petroleum refining, and the work of many educational institutions are examples of VAP businesses. Some VAP organizations are highly efficient and consistent, while others are less so.

Many medical procedures that occur after a definitive diagnosis has been made are value-adding process activities….

Facilitated Networks

These are enterprises in which people exchange things with one another. Mutual insurance companies are facilitators of networks: customers deposit their premiums into the pool, and they take claims out of it. Participants in telecommunications networks send and receive calls and data among themselves; eBay and craigslist are network businesses. In this type of business, the companies that make money tend to be those that facilitate the effective operation of the network. They typically make money through membership or user fees.

Networks can also be an effective business model for the care of many chronic illnesses that rely heavily on modifications in patient behavior for successful treatment. Until recently, however, there have been few facilitated network businesses to address this growing portion of the world’s health-care burden. …

Clay, Jerome and Jason’s central idea is that medicine will be more efficient if there is one medical institution designed for inherently expensive “solution shop” activities such as difficult diagnoses, other much more convenient and inexpensive clinics for the routine treatment of well-diagnosed diseases, and online networks for patients to discuss their contribution as patients to disease management with others who have the same disease. What wouldn’t survive would be the current hospital model where the solution shop aspect of what they do confers high expense on many other activities that don’t have to be so expensive. Here is the way Clay, Jerome and Jason say it:

The two dominant provider institutions in health care—general hospitals and physicians’ practices—emerged originally as solution shops. But over time they have mixed in value-adding process and facilitated network activities as well. This has resulted in complex, confused institutions in which much of the cost is spent in overhead activities, rather than in direct patient care. For each to function properly, these business models must be separated in as “pure” a way as possible.

This is not just a matter of static efficiency:

The health-care system has trapped many disruption-enabling technologies in high-cost institutions that have conflated two and often three business models under the same roof. The situation screams for business model innovation. The first wave of innovation must separate different business models into separate institutions whose resources, processes, and profit models are matched to the nature and degree of precision by which the disease is understood. Solution shops need to become focused so they can deliver and price the services of intuitive medicine accurately. Focused value-adding process hospitals need to absorb those procedures that general hospitals have historically performed after definitive diagnosis. And facilitated networks need to be cultivated to manage the care of many behavior-dependent chronic diseases. Solution shops and VAP hospitals can be created as hospitals-within-hospitals if done correctly.

Further Musings: Even apart from this application to health care, I have found the typology of solution shop, value-adding process and facilitated network very interesting to think about for understanding my own work life (as a complement to the kind of analysis I talked about in my post “Prioritization”).  

I work at the University of Michigan. Universities combine research–which is quintessentially a solution shop activity–with teaching, which has a big component of value-adding processes. And of course, Tumblr, Twitter and Facebook, where I put in effort as a blogger, are facilitated networks.

The idea of a value-adding process highlights the gains to be had from routinizing something. It is good to periodically ask oneself if there is anything in my daily activities that I can make more routine and streamlined.  

The idea of a facilitated network highlights the gains to be had by having users do a lot of the work. That in turn is related both to the benefits of laissez faire under a decent system of rules and the idea of delegation, which typically involves giving up some control at the detailed level.  

I find for me, however, that I love the “solution-shop” aspect of life so much that I think I resist routinization. I don’t know if this is what I should be doing, but I would rather keep thinking about how I am doing things than have everything fade into the background of routine. That does cost me extra time, as I do things inefficiently because I am thinking too much about them as I do them.  

Here is a link to a sub-blog of all of my posts tagged as being about Clay Christensen’s work

Matthew O'Brien: The 10 Biggest U.S. Cities by GDP →

In addition to Matthew O'Brien’s article “The 10 Biggest U.S. Cities by GDP,” as a counterpoint, see Richard Florida’s list of US metro areas by GDP per person: “America’s Most Productive Metros.” That list looks very different.

Clay Christensen, Jerome Grossman and Jason Hwang on Intuitive Medicine vs. Precision Medicine

I found the passage below from The Innovator’s Prescription (location 333), by Clay Christensen, Jerome Grossman and Jason Hwang especially insightful. It puts diagnosis at the center of medicine, especially when viewing medicine from a business point of view. Better and better diagnosis opens up the possibility of more cost-efficient treatments for those diseases that are precisely identified. But that possibility must be seized.

Our bodies have a limited vocabulary to draw upon when they need to express that something is wrong. The vocabulary is comprised of physical symptoms, and there aren’t nearly enough symptoms to go around for all of the diseases that exist—so diseases essentially have to share symptoms. When a disease is only diagnosed by physical symptoms, therefore, a rules-based therapy for that diagnosis is typically impossible—because the symptom is typically just an umbrella manifestation of any one of a number of distinctly different disorders.

The technological enablers of disruption in health care are those that provide the ability to precisely diagnose by the cause of a patient’s condition, rather than by physical symptom. These technologies include molecular diagnostics, diagnostic imaging technology, and ubiquitous telecommunication. When precise diagnosis isn’t possible, then treatment must be provided through what we call intuitive medicine, where highly trained and expensive professionals solve medical problems through intuitive experimentation and pattern recognition. As these patterns become clearer, care evolves into the realm of evidence-based medicine, or empirical medicine—where data are amassed to show that certain ways of treating patients are, on average, better than others. Only when diseases are diagnosed precisely, however, can therapy that is predictably effective for each patient be developed and standardized. We term this domain precision medicine.

… disruption-enabling diagnostic technologies long ago shifted the care of most infectious diseases from intuitive medicine (when diseases were given labels such as “consumption”) to the realm of precision medicine (where they can be defined as precisely as different types of infection, different categories of lung disease, and so on). To the extent that we know what type of bacterium, virus, or parasite causes one of these diseases—and when we know the mechanism by which the infection propagates—predictably effective therapies can be developed—therapies that address the cause, not just the symptom. As a result, nurses can now provide care for many infectious diseases, and patients with these diseases rarely require hospitalization. Diagnostics technologies are enabling similar transformations, disease by disease, for families of much more complicated conditions that historically have been lumped into categories we have called cancer, hypertension, Type II diabetes, asthma, and so on.

When I was a kid, we talked about “curing cancer” as the prototypical world-shaking accomplishment. The reason there is no one “cure for cancer” is that cancer is not one disease but hundreds of different diseases involving different genes going awry in the direction of too much growth. A cure needs to be found for each one of those diseases in order for there to be a cure for the amorphous notion of “cancer.” Many of these diseases have been cured and others are well on their way to being cured. But other diseases under the general heading of “cancer” have not even been identified yet (in the sense of carefully distinguishing them from other diseases with similar symptoms). Once they have been identified at the level of the particular gene that goes awry to produce that particular disease, they will be halfway to being cured.

The term “personalized medicine” is sometimes used for what I would call “treating the disease someone actually has instead of some other disease.” A better phrase for that is the phrase Clay, Jerome and Jason use: “precision medicine.”

Quartz 49—>Will Narendra Modi’s Economic Reforms Put India on the Road to Being a Superpower?

Link to the Column on Quartz

Here is the full text of my 49th Quartz column, “Why you really want India to join the US and China as a superpower" now brought home to supplysideliberal.com. It was first published on June 13, 2014. Links to all my other columns can be found here.

I kept my working title as the title of this companion post, since it better reflects the content of the column.

If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Quartz column and the following copyright notice:

© June 13, 2014: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2017. All rights reserved.

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Iraq joined Syria in civil war and Ukraine’s crisis persisted this week. And yet let me argue that this week’s most important geopolitical news is the economic program of India’s new prime minister, Narendra Modi.

Any increase in the chances for a full-scale supply-side transformation of India’s economy is cause to cheer for many reasons. First and foremost, faster economic growth in India would lift hundreds of millions of people out of dire poverty. But its geopolitical significance should not be underestimated. India is the only nation that rivals China in its population–and is on track to surpass China’s population. As I wrote in a previous Quartz piece, “Benjamin Franklin’s strategy to make the US a superpower worked once, why not try it again?”:

The reason China’s economic rise matters for US grand strategy is that China has a much larger population than the United States. … if China has ¼ the per capita GDP, but four times as many people, its total GDP will be the same size. …  Power corrupts. So … it should surprise no one that the US has done some bad things as a superpower. Yet I am convinced that the combination of Chinese nationalism and “Communist” oligarchy—or the combination of Chinese nationalism with some tumultuous future political transition in China—would lead a dominant China to behave much worse than the US has.

I believe a future in which India joins China and the US as a superpower would be a safer world than one in which China and the United States are the only superpowers. News of Chinese saber-rattling over territorial disputes has become a commonplace in the last few years. Here is a recent example. And the 25th anniversary of the Tiananmen Square Massacre is a reminder of the ugliness of China’s politics now and the tough road China has ahead even in the best-case scenario in which it does become more democratic.

Narendra Modi’s own past is a reminder that India has its own political ugliness. He is the only person to ever have been denied a US visa based on a law designed to punish foreign officials for “severe violations of religious freedom,” since as the head of the Indian state of Gujarat, he failed to stop a Hindu vs. Muslim riot that left more than 1,000 people dead.

Yet, India has been a functioning democracy since 1950, with genuine handoffs of power between different political parties since 1977. And both the religious tensions Modi fatally mishandled and the welfare state he now challenges point to the orientation of Indian politics primarily toward domestic issues, rather than territorial disputes with neighboring countries. What ideological gap exists between the Indian electorate and the US electorate would be narrowed further if further economic liberalization in India is successful. So I do not worry about what India might do as a future superpower the way I worry about what China might do.

What does India’s new government plan to do to make the Indian economy as big as possible, as fast as possible? One key element of the policy address by India’s president Pranab Mukherjee earlier this week, reflecting the prime minister’s agenda, is to make making agricultural markets more competitive, so that farmers can get a better price for their crops. The Wall Street Journal explains:

Subsidies and make-work schemes discourage farmers from concentrating on maximizing yields. Under the Agriculture Produce Marketing Committee Act, they are required to sell produce to monopolistic middlemen. As a result, much of India’s harvest rots before it gets to consumers, further driving up food prices.

The policy address outlines the rest of Modi’s agenda:

1. “Minimum government, maximum governance;”
2. “basic infrastructure such as roads, shelter, power and drinking water” in rural areas;
3. helping farmers to farm better in order to raise yields;
4. pursuing irrigation projects;
5. more use of massively open online courses (MOOCs) for education with the most bang for the buck;
6. toilets for everyone;
7. garbage collection;
8. making sure girls receive an education and are protected from violence;
9. encouraging groups of states within India to cooperate on economic development;
10. combating corruption with “transparent systems and timebound delivery of government services;”
11. trying to eliminate “obsolete laws, regulations, administrative structures and practices;”
12. digitization of government records;
13. “Wi-Fi zones in critical public areas” and broad-band in every village;
14. social media as a way of getting feedback about how government is doing;
15. “rationalisation and simplification of the tax regime to make it non-adversarial and conducive to investment, enterprise and growth” including reducing taxation of saving and investment by shifting toward a value added tax;
16. reducing red tape to “enhance the ease of doing business;”
17. providing workers with “access to modern financial services;”
18. creating “dedicated freight corridors and industrial corridors” as attractive destinations for investment;
19. more airports and upgraded seaports;
20. 100 newly developed cities;
21. allowing more foreign investment in making military equipment to make this sector more efficient.

There is always a big gap between government promises and government performance. But this list of initiatives is remarkable for what it doesn’t emphasize. There is not much in the way of direct handouts. By contrast, I learned at a “Cashless Society” workshop, sponsored by New York University’s Urbanization Project, that under the previous Indian government, when government officials came to take the biometric measurements to make it possible to establish identitywithout needing an identity card, people were happy to cooperate because they see government officials coming to town as a sign that some new handout, subsidy, or goody is on the way.

Most of the things Modi’s government is promising are things that, if delivered, will foster the quantity and quality of private economic activity. To give just two examples, more toilets would not only reduce the number of girls who get raped while going out to the fields to relieve themselves, it would save those girls a lot of time every day that they could devote to their schoolwork. And pushing the educational system heavily in the direction of massively open online courses could speed India toward the kind of low-cost, effective education that ace management guru Clay Christensen and his coauthors predict is the future of education everywhere in the world.

The policy address by the new Indian government is also relatively sophisticated in realizing the obstacles to rolling out new policies. It recognizes that, as a practical matter, many things that need to be done for economic development need to be done at the level of Indian states or groups of Indian states, rather than at the national level. If some states are more willing to work with the national government to foster economic development than others, those states can move ahead faster, and hopefully at some point, citizens of the remaining states will insist on policies like the successful policies of neighboring states.

In a previous election, Modi’s Bharatiya Janata Party (BJP) began using the slogan “India Shining.” If the new Indian government is able to implement even half of its policy agenda, and subsequent Indian governments continue to push further along the road of supply-side improvement, it won’t be long before “India Shining” is no longer just a slogan. It will be an accurate description of the world’s newest superpower.

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• Important Note: Thirumaran makes the case in these storified tweets that Narendra Modi has been given a bad rap for his performance during the Gujarat riots in 2002.What I say in my column about that incident is based entirely on the Wall Street Journal article "Why Narendra Modi Was Banned From the U.S.” I would be glad to hear reactions to Thirumaran’s additional perspective. 

Populations of the Most Populous Nations. I found the population figures in Wikipedia’s “World population” for the most populous countries very interesting.

• China: 1,364,970,000
• India: 1,245,280,000
• United States: 318,201,000
• Indonesia: 247,008,052
• Brazil: 201,032,714
• Pakistan: 186,709,000
• Nigeria: 173,615,000
• Bangladesh: 152,518,015
• Russia: 143,657,134
• Japan: 127,180,000

I hadn’t realized that the US was the third most populous nation. All of Europe, including 110,000,000 in the European part of Russia, is only listed at 742,000,000. The reason it makes sense to focus on population figures is that catch-up economic growth up to the cutting-edge level of income per capita is much easier than the economic goal of the US of pushing income per capita to levels the world has never seen before for any large nation.

I was clued into India being headed for beating out China in overall population by Thomas Piketty’s Capital in the 21st Century. It is a fat enough book that I am only partway through. And I am glad I am reading it on a Kindle.

Clay Christensen, Jerome Grossman and Jason Hwang on the Personal Computer Revolution

Link to the Wikipedia article on the Osborne 1–the first portable microcomputer

I saw the personal computer revolution firsthand. It all went down very fast. In December 1973, when I was 13, I got a chance to use a calculator for the first time. I was visiting my brother Christian Kimball (1, 2), who was then an undergraduate at Harvard; there was a calculator in one of the Harvard libraries that allowed me to do conversions between 3-dimensional radial coordinates of nearby stars to xyz coordinates so I could better understand the layout of our interstellar neighborhood. A year and half later, in 1975, I learned a little computer programming at an NSF supported math camp at Utah State University. In 1978 and 1979 I had to get special access to Harvard Business School computers in order to run some regressions. But in August 1983, I convinced my father (1, 2)  to help me buy a used Osborne “portable” computer. It wasn’t easy to learn to use, but I did ultimately write my Harvard Ph.D. program economic history paper “Farmer’s Cooperatives as Behavior Towards Risk” (which was ultimately published in the American Economic Review). In 1986 and 1987, when I wrote my dissertation, I was only able to manage to typeset all of the equations because my wife Gail was an ace scientific secretary with access to the needed computers and software. (After I convinced her to marry me and move to Massachusetts, she found a job working as a secretary first for professors at Harvard Business School and then later for Eric Maskin, Mike Whinston in the Economics Department.) But by Fall of 1987, as a new assistant professor at the University of Michigan, I could typeset equations myself using TeX (not yet LaTeX) on the new desktop computer the University of Michigan had given me.  

In The Innovator’s Prescription (location 316), Clay Christensen, Jerome Grossman and Jason Hwang give this analytical account of the personal computer revolution:

Until the 1970s there were only a few thousand engineers in the world who possessed the expertise required to design mainframe computers, and it took deep expertise to operate them. The business model required to make and market these machines required gross profit margins of 60 percent just to cover the inherent overhead. The personal computer disrupted this industry by making computing so affordable and accessible that hundreds of millions of people could own and use computers.

The technological enabler of this disruption was the microprocessor, which so simplified the problems of computer design and assembly that Steve Wozniak and Steve Jobs could slap together an Apple computer in a garage. And Michael Dell could build them in his dorm room.

However, by itself, the microprocessor was not sufficient. IBM and Digital Equipment Corporation (DEC) both had this technological enabler inside their companies, for example. DEC eschewed business model innovation and tried instead to commercialize the personal computer from within its minicomputer business model, a model that simply could not make money if computers were priced below $50,000. IBM, in contrast, set up an innovative business model in Florida, far from its mainframe and minicomputer business units in New York and Minnesota. In its PC business model, IBM could make money with low margins, low overhead costs, and high unit volumes. By coupling the technological and business model enablers, IBM transformed the computing industry and much of the world with it, while DEC was swept away.

And it wasn’t just the makers of expensive computers that were swept away. The systems of component and software suppliers, and the sales and service channels that had sustained the mainframe and minicomputer industries, were all disrupted by a new supporting cast of companies whose economics, technologies, and competitive rhythms matched those of the personal computer makers. An entire new value network displaced the old network.

The analogy Clay, Jerome and Jason draw to health care is that one need not despair when seeing how the bulk of health care providers are set up to do things in a very expensive way. As long as we don’t let regulations smother new providers, doing things in new, less expensive ways–though perhaps at first in somewhat lower quality ways–there is hope. (See “Clay Christensen, Jerome Grossman and Jason Hwang on the Agenda for the Transformation of Health Care” and “Tyler Cowen: Regulations Hinder Development of Driverless Cars.”)

Clay Christensen, Jerome Grossman and Jason Hwang on How the History of Other Industries Gives Hope for Health Care

Image from The Innovator’s Prescription, location 294

Things start hard and then get easier. This can be true even for health care. Here are the examples that Clay Christensen, Jerome Grossman and Jason Hwang give in The Innovator’s Prescription:

The problems facing the health-care industry actually aren’t unique. The products and services offered in nearly every industry, at their outset, are so complicated and expensive that only people with a lot of money can afford them, and only people with a lot of expertise can provide or use them. Only the wealthy had access to telephones, photography, air travel, and automobiles in the first decades of those industries. Only the rich could own diversified portfolios of stocks and bonds, and paid handsome fees to professionals who had the expertise to buy and sell those securities. Quality higher education was limited to the wealthy who could pay for it and the elite professors who could provide it. And more recently, mainframe computers were so expensive and complicated that only the largest corporations and universities could own them, and only highly trained experts could operate them. (We will come back to this last example, below.)

It’s the same with health care. Today, it’s very expensive to receive care from highly trained professionals. Without the largesse of well-heeled employers and governments that are willing to pay for much of it, most health care would be inaccessible to most of us.

At some point, however, these industries were transformed, making their products and services so much more affordable and accessible that a much larger population of people could purchase them, and people with less training could competently provide them and use them. We have termed this agent of transformation disruptive innovation. It consists of three elements (shown in Figure I.1). Technological enabler. Typically, sophisticated technology whose purpose is to simplify, it routinizes the solution to problems that previously required unstructured processes of intuitive experimentation to resolve. Business model innovation. Can profitably deliver these simplified solutions to customers in ways that make them affordable and conveniently accessible. Value network. A commercial infrastructure whose constituent companies have consistently disruptive, mutually reinforcing economic models.

Using some terminology Clay Christensen uses in all of his books, the key problem with health care is that so much of it is set up on the “solution shop” business model. The “solution shop” business model is familiar to academics in research universities because the kind of research done in academic is almost always done in a solution-shop way, by specialized crafting of ways to get a scientific job done. The only way to make health care significantly cheaper is to routinize and “deskill” or at least “downskill” much of it so that the job for at least the easy cases can be done in a way that is more in the spirit of mass-production: as a “value-added process.”

Against Bullying

Link to the website for the National Association of People Against Bullying

I never got into a fistfight or suffered physical harm from another kid when I was young, other than a kid once randomly slugging me in the solar plexus. But I was afraid of bullies. I felt a little extra vulnerable because of being a bookworm. I tried to at least put some hard edge onto my intellectuality so that I wouldn’t look too much like a pushover and thereby attract unwanted attention from bullies.

During the years my own children were in elementary school, I was delightfully surprised to learn of serious anti-bullying campaigns, and to see how, as a result, my children felt less fear than I had in school. I see anti-bullying campaigns as part of the anti-violence march of civilization that Steven Pinker documents in The Better Angels of Our Nature: Why Violence Has Declined. (See also my post “Things are Getting Better: 3 Videos.”)

Going even further, the spirit of anti-bullying campaigns is being extended to other forms of cruelty that can only be called violence metaphorically. After reading Sumathi Reddy’s Wall Street Journal article “Little Children and Already Acting Mean Children, Especially Girls, Withhold Friendship as a Weapon; Teaching Empathy" I tweeted:

It is wonderful that anti-bullying campaigns are now being extended to fight social exclusion. 

There are certainly many worse things in the world than bullying, but I suspect that many of those worse things are the actions of either those who got practice in bullying when they were young, or whose bad behavior later on was partly revenge on the world for bullying suffered when young. 

To further make the case that bullying is not a trivial matter, in their article in the Proceedings of the National Academy of Science, ”Childhood bullying involvement predicts low-grade systemic inflammation into adulthood,“ William E. Copeland, Dieter Wolkeb, Suzet Tanya Lereya, Lilly Shanahan, Carol Worthman, and E. Jane Costello write:

Bullying is a common childhood experience that affects children at all income levels and racial/ethnic groups. Being a bully victim has long-term adverse consequences on physical and mental health and financial functioning, but bullies themselves display few ill effects. Here, we show that victims suffer from greater increases in low-grade systemic inflammation from childhood to young adulthood than are seen in others. In contrast, bullies showed lower increases in inflammation into adulthood compared with those uninvolved in bullying. Elevated systemic low-grade inflammation is a mechanism by which this common childhood social adversity may get under the skin to affect adult health functioning, even many years later.

(You can see a discussion of this research in the Washington Post here.) One bit of context for this is that inflammation is being seen more and more as a risk factor for heart disease, strokes and other maladies in later life. So inflammation is not innocent. 

A little over a year ago, an overlapping team of researchers reported long-lasting psychological problems resulting from being bullied as a child. Here is the description in an article in Reuters by Genevra Pittman, ”Psychological effects of bullying can last years“:

"It’s obviously very well established how problematic bullying is short-term,” said William Copeland, a clinical psychologist who led the new study at Duke University Medical Center in Durham, North Carolina.

“I was surprised that a decade down the road after they’ve been victimized, when they’ve kind of transitioned to adulthood, we would still see these emotional marks for the victims and also the bullies/victims.”

His team’s research included 1,420 youth from Western North Carolina who were asked about their experiences with bullying at various points between age nine and 16, then were followed and assessed for psychiatric disorders through age 26.

Just over one-quarter of kids and their parents reported they were bullied at least once, and close to one in ten said they had bullied other kids.

After adjusting for the participants’ history of family hardships, the researchers found that, compared to young adults with no history of bullying, former victims were at higher risk for a range of psychiatric conditions.

For example, 6 percent of uninvolved youth went on to have an anxiety disorder, versus 24 percent of former bullying victims and 32 percent of youth who had been both bullies and targets of bullying.

Kids who originally reported both bullying and being bullied were the most likely to be diagnosed with panic disorder or depression as young adults or to consider suicide.

Of course, this does not prove causality; those things that tend to make kids attractive target for bullying might still cause an elevated rate of psychological disorders even if an effective anti-bullying campaign meant that “easy targets” did not in fact suffer from bullying. Most likely there is some of that. But I wouldn’t want to bet on a total lack of causality from being bullied to having psychological problems later on in life. If there are regions of the country where anti-bullying campaigns have not yet begun in earnest, it should be possible to do randomized trials implementing anti-bullying campaigns in half of the schools in a sample.

If metaphorical violence is included, bullies are not absent among adults. The power of adults who are bullies in this broader sense can be reduced if they are clearly labeled as bullies by those around them.

Tyler Cowen: Regulations Hinder Development of Driverless Cars →

Here is a key passage from Tyler Cowen’s 2011 piece on driverless cars that applies to a lot more than driverless cars:

The point is not that such cars could be on the road in large numbers tomorrow, but that we ought to give the cars — and other potential innovations — a fair shot so that a prototype can become a commercial product someday. Michael Mandel, an economist with the Progressive Policy Institute, compares government regulation of innovation to the accumulation of pebbles in a stream. At some point too many pebbles block off the water flow, yet no single pebble is to blame for the slowdown. Right now the pebbles are limiting investment in future innovation.

The lesson here is the one I emphasized in my post yesterday, “Clay Christensen, Jerome Grossman and Jason Hwang on the Agenda for the Transformation of Health Care”: allowing experimentation with innovations that at first seem like lower quality ways to do things (except for their cost and convenience) is crucial to many of the economic transformations that will do the most to improve overall standards of living. Needing a path through what seems at first like lower quality is exactly what Clay Christensen means when he says that an innovation is “disruptive.” Driverless cars provide a wonderful example. Ultimately, driverless cars will be much safer than human-driven cars, since it is unlikely that the overall skill and care of human drivers will dramatically improve from where it is now, while computers and sensors for cars can continue to get better and better and better. But we will get to those driverless cars that dominate human-driven cars in all respects (except for those who find driving recreational) if right now we allow driverless cars on the road that are better than human-driven cars in some respects and worse (within reason) in other respects.

I am saying that, because they are likely to ultimately be much safer that driverless cars should be allowed even if at first they are somewhat less safe, but in fact the relevant situation is more like this. At some point driverless cars will have a good safety performance in small-scale tests, but there will be some uncertainty about how they will do in substantial numbers in real world situations on the road. Even if at that point they would in fact have a better safety record if allowed on the road, opponents will argue that the uncertainty about how they will do means they should be banned. Such a ban–and its counterparts in other domains–are a very effective method to  slow down technological progress.

Clay Christensen, Jerome Grossman and Jason Hwang on the Agenda for the Transformation of Health Care

The Innovator’s Prescription: A Disruptive Solution for Health Care

As I said in my post “Saint Clay," I plan to feature the work of Clay Christensen and his coauthors in a slow, thoroughgoing, methodical way, much as I have featured John Stuart Mill's On Liberty. Because of its urgency in the policy debate, I will start with Clay Christensen, Jerome Grossman and Jason Hwang’s book, "The Innovator’s Prescription.” Here is how they lay out their agenda in the introduction to the book:

1. The growth in health-care spending in the United States regularly outpaces the growth of the overall economy. Over the last 35 years, while the nation’s spending on all goods and services has risen at an average annual rate of 7.2 percent, the amount spent on health care has grown at a rate of 9.8 percent.1 As a consequence, an increasing proportion of Americans simply cannot afford adequate care. Many efforts to contain overall costs have the effect of making care inaccessible on a convenient and timely basis for all of us—even for those who can pay for it.

2. Second, if federal government spending remains a relatively constant percentage of GDP, the rising cost of Medicare within that budget will crowd out all other spending except defense within 20 years.

3. The third factor that engenders fear is that the burden of covering the costs of health care for employees, retirees, and their families is forcing some of America’s most economically important companies to become uncompetitive in world markets. Health-care costs add over $1,500 to the cost of every car our automakers sell, for example.

4. The fourth frightening factor, about which few people are aware, is that if governments were forced to report on their financial statements the liabilities they face resulting from contractual commitments to provide health care for retired employees, nearly every city and town in the United States would be bankrupt. There is no way for them to pay for what they are obligated to pay, except by denying funding for schools, roads, and public safety, or by raising taxes to extreme levels.

What can be done? It isn’t easy:

Those fighting for reform have few weapons for systemic change. Most can only work on improving the cost and efficacy of their piece of the system. There are very few system architects among these forces that have the scope and power of a commanding general to reconfigure the elements of the system.

Perhaps most discouraging of all, however, is that there is no credible map of the terrain ahead that reformers agree upon and trust. They are armed with data about the past, and they have become accustomed to reaching consensus for action when the data are conclusive. But because there are no data about the future, there is no map available to convincingly show these reformers which of the pathways ahead of them lead to a dead end and which constitute a promising road to reform. And few have a sense for the interconnectedness of these pathways. As the prophet of Proverbs said, “Where there is no vision, the people perish.”

So why this book? There is little dispute that we need a system that is competitive, responsive, and consumer-driven, with clear metrics of value per dollar being spent.9 Our hope is that The Innovator’s Prescription can provide a road map for those seeking innovation and reform—an accurate description of the terrain ahead, about which data are not yet available. Much of today’s political dialogue on health-care reform centers on how to pay for the cost of health care in the future. This book offers the other half of the equation: how to innovate to reduce costs and improve the quality and accessibility of care. We don’t simply ask how we can afford health care. We show how to make it affordable—less costly and of better quality.

To preview the main message, the number one policy in order to foster progress in most any area is to make sure that new entrants, who may initially do things worse in some dimensions, but more cheaply or more conveniently than the established incumbents, have a chance to gain a foothold in the market. Then what the new entrants do has a chance to improve in quality until in the end they bring down prices even at high quality, just as personal computers, which initially were not very good, became more powerful–as well as less expensive and more convenient–than the mainframes of old (only to be challenged in turn by smartphones and tablets).

One possible reaction to this would be to object to the idea of having anyone get medical care that is cheaper and more convenient, but is otherwise of somewhat worse quality. But the result of acting as if cost does not matter is the startling fact discussed in "Another Quality Control Failure on the Wall Street Journal Editorial Page?“ that real after-tax, after-transfer income for the poorest 20% of the population has increased by 49% since 1979. As the title of my post suggests, I thought this was a mistake. But it is not. What the Congressional Budget Office did to come up with this number was to count as part of after-tax, after-transfer income the full cost of both medical care paid for by employers and medical care paid for by the government (much of it through Medicaid). If you don’t feel that the poorest 20% of the population is as much better off since 1979 as a 49% increase in income would suggest, it is an indication that all of that money spent on medical care has not gotten the value that one would think it should have been able to purchase.

Our current medical system has too few good paths for finding ways to do things more cheaply and conveniently. If we block all paths that lead even temporarily through a region of lower cost at lower quality and greater convenience, the next 35 years may see another 49% increase in the after-tax, after-transfer income of the bottom 20% of the population that hardly feels like an improvement in living standards at all, as we head toward more and more expensive medicine that is only marginally better in quality. Alternatively, we can allow disruptive innovation that will get much better quality, much lower cost and much greater convenience 35 years from now if we avoid crushing in their infancy ways of doing things that right now are much cheaper and more convenient, but slightly lower in other dimensions of quality.

Right now, many people would gladly choose lower expense and greater convenience for some types of medical care even at slightly lower quality in other dimensions, if they were allowed (by any of half of dozen different possible mechanisms) to get a true signal about the actual tradeoffs that society faces in this regard. Too often, discussion about these tradeoffs only points out the static welfare gains from helping people to incorporate the cost of various types of health care into their decisions. I am persuaded by Clay, Jerome and Jason’s arguments that the dynamic gains are much more important.

Three Revolutions

image source

Today it has been two years since my first post: “What is a Supply-Side Liberal?"  My first anniversary post, ”A Year in the Life of a Supply-Side Liberal,“ provides an introduction to this blog and tells of the exhilarating experience of my first year of blogging. Today, I wanted to talk about some of the pictures in my mind of possible futures that keep me going.  

As for the blog itself, one of my standards of excellence for an independent economics blog is Tyler Cowen and Alex Tabarrok's Marginal Revolution blog. Day after day, Tyler and Alex give people reason to come back and learn more. Their tagline to explain their title "Marginal Revolution” is “Small Steps Toward a Much Better World.” Although there would have to be many small steps along the way to each of these, I tend to think of the revolutions I want to see happen in a more discrete way. Let me talk about three revolutions I hope to see, in order of how fast I think they could happen. 

1. The Electronic Money Revolution. The world’s attempts at economic stabilization since 2008 have left much to be desired. The main reason has been the partial crippling of monetary policy due to the difficulties of making interest rates negative when paper currency guarantees to all an interest rate of at last zero (minus storage costs). This difficulty is called the zero lower bound. Since I published “How Subordinating Paper Currency to Electronic Money Can End Recessions and End Inflation” in November 2012, I have been writing and traveling the world speaking to spread the word that the zero lower bound is a policy choice, not a law of nature. I argue that it is a bad policy choice. The benefits of economic stabilization without needing to have long-run inflation far outweigh the inconveniences of dealing with negative interest rates and an exchange rate between paper currency and electronic money that is sometimes away from 1-for-1.

I have collected links to everything I have written about eliminating the zero lower bound in my post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” On why to eliminate the zero lower bound, let me recommend

• America’s Big Monetary Policy Mistake: How Negative Interest Rates Could Have Stopped the Great Recession in Its Tracks
• Governments Can and Should Beat Bitcoin at Its Own Game
• The Costs and Benefits of Repealing the Zero Lower Bound … and Then Lowering the Long-Run Inflation Target
• Gather ‘round, Children, Here’s How to Heal a Wounded Economy.

On how to eliminate the zero lower bound, let me recommend this presentation that I have given in various versions at the Bank of England, the Bank of Japan, Japan’s Ministry of Finance, Danmarks Nationalbank, the Banque de France, the Federal Reserve Board, and the US Treasury:

• Electronic Money: The Powerpoint File

I have seminars scheduled in July at the ECB, the Bundesbank, the Banca D'Italia and the Swiss National Bank. In addition to the posts above, this presentation relies on what I say in these fairly technical posts:

• A Minimalist Implementation of Electronic Money
• How to Set the Exchange Rate Between Paper Currency and Electronic Money
• Paul Romer and Company on the Cashless Society
• The Path to Electronic Money as a Monetary System
• Going off the Paper Standard

I believe a transition to a monetary system based on electronic money that avoids creating a zero lower bound is almost inevitable. The electronic money revolution will happen. The question is when. The more people there are who understand the principles and reasoning involved, the quicker that day will come. Some countries may lag behind, but some country will lead the way.

2. The Supply-Side Liberal Revolution.  Posts about policies to foster economic growth, while taking care of the poor, are the heart of this blog, as you can see from looking down my list of most popular columns and posts. For economic growth, beyond the basics I wrote about in “The Government and the Mob,” the key policies are those I wrote about with Noah Smith in “One of the Biggest Threats to America’s Future Has the Easiest Fix” (followed up by “Capital Budgeting: The Powerpoint File”), the kind of individual effort Noah and I recommended in “There’s One Key Difference Between Kids Who Excel at Math and Those Who Don’t” and blocking attempts to squash the kind of disruptive innovation that Clay Christensen talks about. (See my post on Monday: “Saint Clay.”)  It also doesn’t hurt to understand the key role that knowledge plays in economic growth, something I talk about in my post “Two Types of Knowledge: Human Capital and Information." 

For taking care of the poor, many of the key issues are political. First, as I argue in "Inequality Aversion Utility Functions: Would $1000 Mean More to a Poorer Family than $4000 to One Twice as Rich?” it is crucial not to be distracted by a fascination with the division of wealth and income between the middle class and the rich from the primary task of taking care of the poor. Besides a safety net focused on helping the poor rather than unsustainably trying to give large amounts of money to the middle class, key policies to help the poor are 1. more open immigration, 2. job freedom, and 3. school reform:

1. The Hunger Games is Hardly Our Future: It’s Already Here
2. When the Government Says “You May Not Have a Job”
3. Magic Ingredient 1: More K-12 School.

One key to sustainably getting resources for helping the poor is to do it in a way that causes the fewest economic distortions. In addition to focusing on the right kinds of taxes, to the extent that there must be taxes, I believe that there is great potential in the kind of public contribution system that I talk about in the links in my post “The Red Banker on Supply-Side Liberalism."  People often hate taxes, so they try to avoid them. Those efforts at tax avoidance are a social waste. So it makes sense to get many of the resources for helping the poor from public contributions that people won’t want to avoid as much as taxes, and that allow those contributing to be creative in making the world a better place. The creativity and flexibility fostered by a public contribution system are also bound to lead to technological progress in ways to help the poor. 

3. The Heroic Revolution. By making the right choices, anyone can be a hero in the sense of making the world of the future a significantly better place than it otherwise would have been. For many, the objective of making the world a better place takes on a religious flavor, as it does for me (though for me in a resolutely non-supernaturalist way). See for example my sermons

• Teleotheism and the Purpose of Life
• The Egocentric Illusion
• UU Visions
• So You Want to Save the World
• Godless Religion
• The Message of Mormonism for Atheists Who Want to Stay Atheists, 

 and see Noah’s wonderful religion guest post

• God and Supergod.

But regardless of one’s views on religion, hope and faith that one can make things better is the key to actually making things better. This is a principle I write about in

• The Unavoidability of Faith.

There are reasons to have hope that one can make the world a better place. The most basic is the argument that all it takes is to durably convince the younger generation that there is a better way:

• That Baby Born in Bethlehem Should Inspire Society to Keep Redeeming Itself.

But there also the power of gratitude, as I write of in

• Human Grace: Gratitude is Not Simple Sentiment; It is the Motivation that Can Save the World.

However, in the end, our success at making the world a better place will depend crucially on our ability to see clearly what is better and what is worse. Whatever its flaws, and despite all the ways it goes astray, religion has something to say about this. But so does the economics of happiness–in particular the work drawing on the intuitions of many people about what "better” means that I write of in

• Judging the Nations: Wealth and Happiness Are Not Enough.

Summing Up. I believe in the potential of the blogosphere to change the world. I hope my view of the good of our noble species and the rest of the universe is clear enough that I am pushing in the right direction rather than in the wrong direction. My gut-level reaction to partisan politics in the United States is that enormous time and effort is wasted by Republicans and Democrats as they cancel each other out in opposition to one another. A key source of this wasted effort is that people are much too quick to assume they know the right direction to go. Many partisans assume they know the right direction to go, despite failing to undertake thoroughgoing discussions according to the principles of open, heated, but respectful discussion laid out by John Stuart Mill. (Those principles are familiar to those of you who follow my every-other-week series of posts on John’s book On Liberty, such as "John Stuart Mill’s Brief for Freedom of Speech.“) The blogosphere can help forward that kind of discussion, and get us a little closer to the truth.

Saint Clay

Wikipedia article on Clayton Christensen. Image source.

Update: Here is a link to my sub-blog of posts about Clay’s work. 

There are many Supply-Side Liberal Heroes (1, 2, 3, 4, 5, 6, and with some additional fortitude, 7), but up until now, there was only one declared Supply-Side Liberal saint: Adam Smith, the Patron Saint of Supply-Side Liberalism. (Since July 30, 2012 no one has ventured a serious devil’s advocate case about Adam Smith.) Today, I want to declare another: Clay Christensen. To be a Supply-Side Liberal Saint, one must be both a Supply-Side Liberal hero and of unimpeachable character.

From conversations, I have found that Clay Christensen is not well known among economists, but he should be. First of all, in our sister field of business, Clay is at the very top. For example, in November 2013, Clay won the award for top management thinker in the world for the second time in a row in the once-every-two-years Thinkers50 award. Andrew Hill described it this way in the Financial Times: 

But the climax was Thinkers50′s “Best Picture” award – for the management thinker judged most influential – which went to Clayton Christensen, author of The Innovator’s Dilemma and perhaps the nicest man ever to lecture at Harvard Business School.

Second, Clay’s theory of disruptive innovation counts as powerful economic theory that explains much about the world we live in. There is a rigor to it that goes far beyond all the other bits of management theory I have encountered. But it is reading his books that will convince you. Here is not only great insight, but also helpful approaches to many of our most pressing problems. In the last few months I have devoured this much of his body of work:

• The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail
• The Innovator’s Solution: Creating and Sustaining Successful Growth
• The Innovator’s DNA: Mastering the Five Skills of Disruptive Innovators
• Disrupting Class, Expanded Edition: How Disruptive Innovation Will Change the Way the World Learns
• The Innovative University: Changing the DNA of Higher Education from the Inside Out
• The Innovator’s Prescription: A Disruptive Solution for Health Care

All of that is enough to make Clay a hero, but how does Clay pass the devil’s advocate’s gauntlet to be made a saint? That is, how can I be so confident I won’t be embarrassed by a future revelation about some skeleton in Clay’s closet? First, as you can see from the quotation above, many people think Clay is one of the nicest men they have ever met. I am among them. Back in 1977, when I was headed to Harvard as a freshman, and Clay was headed to the first year of his MBA program,  I carpooled across the country from Utah with him, and then stayed with him for a week or so until I could get into my new dorm room. That time with Clay made an unforgettable impression on me. I had no idea how eminent he would become, but I knew how good he was. I have hardly seen Clay since then, and haven’t had any serious conversations with Clay since 1977, but other observers (including my daughter, Diana, who was a student in his class in the second year of her MBA program) still attest to his goodness. And I have the advantage of the vetting he has undergone for relatively high office in the Mormon church, which screens for many types (though not all types) of sins.

In the coming months (which may stretch into years given the volume of his work) I plan to feature the work of Clay and his coauthors in a slow, thoroughgoing, methodical way, much as I have featured John Stuart Mill's On Liberty. Like On Liberty, Clay’s work is worth cutting to pieces–blog-post-sized morsels, ready for delectation.

Schumpeter: Digital Disruption on the Farm | The Economist →

It is always good to see real-world examples of technology shocks. Here are some key excerpts from this article:

Farmers can be among the most hidebound of managers, so it is no surprise that they are nervous about a new idea called prescriptive planting, which is set to disrupt their business. In essence, it is a system that tells them with great precision which seeds to plant and how to cultivate them in each patch of land. …

Prescriptive planting is catching on fast. …

The benefits are clear. Farmers who have tried Monsanto’s system say it has pushed up yields by roughly 5% over two years, a feat no other single intervention could match. The seed companies think providing more data to farmers could increase America’s maize yield from 160 bushels an acre (10 tonnes a hectare) to 200 bushels—giving a terrific boost to growers’ meagre margins. …

Farmers might be expected to have mixed feelings about the technology anyway: although it boosts yields, it reduces the role of discretion and skill in farming—their core competence. However, the bigger problem is that farmers distrust the companies peddling this new method. They fear that the stream of detailed data they are providing on their harvests might be misused. Their commercial secrets could be sold, or leak to rival farmers; the prescriptive-planting firms might even use the data to buy underperforming farms and run them in competition with the farmers; or the companies could use the highly sensitive data on harvests to trade on the commodity markets, to the detriment of farmers who sell into those markets.

I view aggregate technology shocks as primarily representing the steep part of an S-shaped adoption curve for a technology. As such, most aggregate technology shocks should be predictable in advance if the natural logarithms of [(market share/ (1 - market share)]  for promising techniques are graphed against time. (Such graphs are something Clay Christensen and coauthors recommend to predict the future course of disruptive innovations. Watch for my post on Clay Christensen, tomorrow morning, at half-past midnight EDT.)

Wei Zhu: The Sharing Economy

Link to Wei Zhu’s economics blog

My Winter 2014 “Monetary and Financial Theory” class is over, but I read a flurry of excellent posts toward the end of the semester that I plan to publish as guest posts here in the coming Saturdays. Wei Zhu is one of several students in the class who have set up their own public blogs to continue blogging even now that the class is over. I think you will like his post about the Sharing Economy. (Catherine Rampell objects to calling it “sharing” in her Washington Post essay “What preschoolers can teach Silicon Valley about ‘sharing’”. I am very sympathetic to Catherine’s argument that the word “sharing” is being bent out of shape when applied to new, more convenient forms of rental, but I suspect that that moniker “sharing economy” is here to stay–at least for a few years, until it is old hat.)

---

What do

• Bitcoin, 
• Groupon, 
• Airbnb, 
• Waze, 
• Meshnet, 
• Kickstarter
• Wikipedia

have in common? They are all billion-dollar ideas based on one concept: the Sharing Economy.

Like the name suggests, the Sharing Economy is “a socio-economic system built around the sharing of human and physical assets”(Wikipedia). The system sees the excess capacity in goods and services as a problem and solves it with collaborative consumption. Simply put, the Sharing Economy wants to lower your cost of living by letting you borrow a bike from you neighbor and make your trip in Puerto Rico much more enjoyable while cheaper by renting you a house in San Juan.

Jeremy Rifkin’s comments on Airbnb’s success explains a lot about the Sharing Economy:

“Airbnb owes its meteoric rise to a new phenomenon — near zero marginal cost — which is disrupting entire sectors of the global economy and giving rise to a new economic system riding alongside the conventional market. Marginal cost is the cost of producing an additional unit of a good or service once a business has its fixed costs in place, and for businesses like Airbnb, that cost is extremely low.”

The extremely low marginal cost is one of the greatest benefits of Sharing Economics. By efficiently redistributing resources among the crowd, this economy system significantly decreases the pressure of purchasing for individuals. For example, if you want to buy a vacuum machine, in the conventional market, you have to pay $200. That’s $200 per person. But with the sharing model, although the nominal price of the vacuum machine is the same, since you can share the purchase with your neighbor, the real cost becomes $200 divided by n. The more you share, the less you actually pay.

The concept is simple, but the impact can be huge.

Since the beginning of the Great Recession, most households’ real income has been decreasing.

This forces average households to spend a greater portion of their income on food and other basic living expenses. People are scared of big purchases because of the financial pressure. Shared purchases, however, remove this pressure. The real expense on shareable goods is divided among several– and sometimes many–people therefore becomes much lower. With the shareable goods looking cheaper, people will be willing to pay for access to more goods.

The Sharing Economy can help people feel they have abundance despite scarce resources in a world that, despite falling birth rates, will have more people in the future than it does now. (The UN projects that, by the year of 2050, there will be 9.3 billion people in the world.) A world without resource-sharing would be relatively impoverished in that future.

One thing that may hold back the Sharing Economy, at least in the short run, is regulatory uncertainty. The Sharing Economy’s model suggests that everybody can be a service provider or property lender. This will surely introduce problems when it comes to security, licensing and the tax treatment of the Sharing Economy. But the success of Airbnb and Uber in their respective industries suggests that these regulatory issues can ultimately be overcome.

Capital Budgeting: The Powerpoint File

Writing “One of the Biggest Threats to America’s Future Has the Easiest Fix” with Noah Smith about capital budgeting inspired the seminar presentation I am giving today at the Congressional Budget Office, Here is a link to my Powerpoint file for the presentation:

The Applied Theory of Capital Budgeting

It is quite technical, and is a work in progress. If you do want to brave it, I recommend that you first read "One of the Biggest Threats to America’s Future Has the Easiest Fix.“

Update: I learned today that the Congressional Budget Office put out a document on "Capital Budgeting” in 2008. I hope they now put out a new document on capital budgeting!

John Stuart Mill on China's Technological Lost Centuries

Image source: an article on “Characteristics of Ancient Chinese Science And Technology”

One of the greatest of all questions in the study of economic growth is why China, which for a long time was the technological leader of humanity, fell behind Europe and its offshoots technologically.

In On Liberty, Chapter III: “Of Individuality, as One of the Elements of Well-Being,“ paragraph 17, John Stuart Mill points to the ascendance of "Custom” in the centuries immediately before he wrote as a key factor, and draws cautionary lessons about the dangers of letting Custom rule too thoroughly: 

The greater part of the world has, properly speaking, no history, because the despotism of Custom is complete. This is the case over the whole East. Custom is there, in all things, the final appeal; justice and right mean conformity to custom; the argument of custom no one, unless some tyrant intoxicated with power, thinks of resisting. And we see the result. Those nations must once have had originality; they did not start out of the ground populous, lettered, and versed in many of the arts of life; they made themselves all this, and were then the greatest and most powerful nations of the world. What are they now? The subjects or dependents of tribes whose forefathers wandered in the forests when theirs had magnificent palaces and gorgeous temples, but over whom custom exercised only a divided rule with liberty and progress. A people, it appears, may be progressive for a certain length of time, and then stop: when does it stop? When it ceases to possess individuality.

We have a warning example in China—a nation of much talent, and, in some respects, even wisdom, owing to the rare good fortune of having been provided at an early period with a particularly good set of customs, the work, in some measure, of men to whom even the most enlightened European must accord, under certain limitations, the title of sages and philosophers. They are remarkable, too, in the excellence of their apparatus for impressing, as far as possible, the best wisdom they possess upon every mind in the community, and securing that those who have appropriated most of it shall occupy the posts of honour and power. Surely the people who did this have discovered the secret of human progressiveness, and must have kept themselves steadily at the head of the movement of the world. On the contrary, they have become stationary—have remained so for thousands of years; and if they are ever to be farther improved, it must be by foreigners. They have succeeded beyond all hope in what English philanthropists are so industriously working at—in making a people all alike, all governing their thoughts and conduct by the same maxims and rules; and these are the fruits. The modern régime of public opinion is, in an unorganized form, what the Chinese educational and political systems are in an organized; and unless individuality shall be able successfully to assert itself against this yoke, Europe, notwithstanding its noble antecedents and its professed Christianity, will tend to become another China.

I have often gotten in minor trouble from not following Custom. Maybe that isn’t all bad.

“This can be the inflection point for the new Africa, a time and place where Africans bend the arc of history towards reform, and not retribution; towards peace and prosperity, not revenge and resentment.”

– John Kerry, May 3, 2014 as reported in “John Kerry Says Violence Threatens Africa’s Prosperity,” by Heidi Vogt in the Wall Street Journal

Italy's Supply-Side Troubles

Italy’s immediate crisis is a demand-side crisis. The financial crisis in late 2008 and insufficiently stimulative monetary policy on the part of the European Central Bank since then have led to lower output and bigger budget deficits.

But Italy has longer run problems as well. The graph above shows the natural logarithm of real GDP in Italy relative to its value in mid-2004. When people talk about “bending the curve” of medical costs, they are talking about the kind of falling growth rate that this graph shows for Italy’s GDP, long before the Great Recession.

I am always on the lookout for articles that give a bit more vivid picture of what can go wrong on the supply side of an economy. “Can Italy Find Its Way? Resistance to Change Means Slow Recovery” by Marcus Walker and Deborah Ball in the April 29, 2014 Wall Street Journal is an excellent example of just such an article. All quotations below are from Marcus and Deborah. 

Taxes

Sometimes people think of the supply side as primarily a matter of taxes. In Italy, there are high taxes, but they are high partly because other taxes are not paid:

Taxes on labor are particularly high. One reason is that taxes that would normally help spread the burden—including on the incomes of small businesses and the self-employed—are widely dodged.

Italian entrepreneurs evade over 50% of the income taxes they owe, while people living off investment income skip over 80%, the country’s central bank estimates. The heavy taxes on payrolls deter companies from hiring and weaken consumers’ spending power, economists say.

Slow Permits

A big factor in Italy’s supply-side malaise is the difficulty of establish any new shop. This issue is sprinkled throughout Marcus’s and Deborah’s article:

1. Bernardo Caprotti was a 45-year-old entrepreneur when he agreed to buy a suburban plot of land for a new supermarket.

Building permits recently came through. He’s now 88.

2. Red tape is one factor that deters businesses from growing. …

In 2012 British Gas PLC threw in the towel on a €500 million gas import terminal in southern Italy after struggling for over a decade to get the necessary permits.

It is a problem familiar to Mr. Caprotti. “If we start something today, it could take 15 years to finish,” he says. “Then you’re lost because you find that the size or the location doesn’t work anymore.”

Impaired Property Rights Because of Slow Courts

Property rights are crucial for economic efficiency, but property rights are created by law. A slow legal system impairs property rights:

Italy’s court system also spooks businesses: Routine contract disputes take more than three years on average to resolve in court—and much longer if there are appeals. Italy’s lawyers, who outnumber their French brethren fourfold, have resisted efforts to streamline a judicial system that offers rich opportunities for lengthy proceedings. At the end of 2012, there was a backlog of 9.7 million cases, according to the International Monetary Fund.

General Resistance to Change

Marcus and Deborah make the case that tolerance change is necessary for economic growth:  

In societies whose populations aren’t growing, sustainable growth comes from improving productivity, or the efficiency of the economy’s supply side. And that requires constant change: Europe’s Achilles’ heel.

But the status quo is powerful in Europe, and in Italy particularly:

Entrenched interests and hardened habits have accumulated in Europe over decades, slowing once-dynamic economies to a crawl, and are now proving difficult to overcome. From bureaucrats to businesses, unions to pensioners, interest groups vigorously defend the status quo, even when it leaves no one satisfied. …

The roots of the problem, say many Italians, lie in how vested interests in the private and public sectors gum up the economy, preventing change that replaces old practices with new, more efficient ones, and repeatedly frustrating political attempts to shake up the country.

It adds up to “deep-seated cultural obstacles to growth,” says Tito Boeri, a professor at Milan’s Bocconi University who is one of Italy’s top economists. “In Italy you define your identity in terms of your membership of some specific interest group,” he says, making it hard to rally support for any notion of the common good. 

Regulated professions such as lawyers and pharmacists consistently beat back efforts to break their cartels. Powerful bureaucrats bog down the implementation of new laws for years. And Rome’s political class is so quarrelsome that governments last little more than a year on average.

It used to matter less. Italy’s economy grew rapidly in the postwar era despite a stonewalling bureaucracy, legions of tiny companies and a fragmented, often corrupt political system. But growing was easier then: Relatively poor Southern European countries mainly had to copy technology from more-developed economies such as the U.S., and use it to churn out goods cheaply.

Making the wheels turn in an advanced economy requires the efficient rule of law, reliable public administration and more capital and expertise than many mom-and-pop businesses can muster, says Fabiano Schivardi, an economist at Rome’s Luiss University who has studied the stagnation of swaths of Italy’s business sector.

“Our institutions were good enough for an economy that was catching up, but they’re not good enough any more,” he says.

Family Businesses Resistant to Change

Not all resistance to change in Italy is at the collective decision-making level. Individual families running businesses also are often resistant to change at a level far beyond what is seen in the US: 

Many family business owners prefer to stay small, sticking to the staff and customers they already know and trust, says Matteo Bugamelli, senior analyst at the Bank of Italy. “Often, all of the family wealth is in the firm, and there isn’t the risk appetite that you need to invest and grow,” he says. …

“The culture here is be the padrone in your own house,” he says, using the Italian for “boss.” Many family entrepreneurs “don’t trust outsiders and prefer to bring in their own son, even if he’s not well qualified,” he says.

Institutional Resistance to Change

Organized groups resist change in many ways. 

Italian unions have also often dug in their heels to resist change. For years, union battles held up efforts to save the national airline, Alitalia, which struggled to get its labor costs down. Last fall, as the carrier faced imminent bankruptcy, unions agreed to pay cuts and more-flexible working terms.

Fear often lies behind unions’ defense of the status quo. Redundant blue-collar workers might never find jobs again in Italy’s sclerotic jobs market.

Some foreign entrepreneurs are discovering just how tough it remains to penetrate the Italian market.

Uber, the app-based car service that launched in Italy last year, says traditional taxi drivers have verbally abused its drivers, who respond to customers’ orders sent by smartphone. The taxi union denies any aggression, and says its members have paid a fortune for their taxi licenses, which now trade at about €170,000, and offer a public service that needs to be protected.

“During a period of change, there are some whose jobs are under threat and a sense of protectionism sets in,” says Benedetta Arese Lucini, general manager of Uber in Italy. “Unfortunately, Italy is afraid of changing.”

Low Government Capability

Finally, in Italy, the national government often seems powerless in relation to the ability of local vested interests to resist change: 

Even when leaders pass reforms into law, change doesn’t necessarily follow. Bureaucrats who must implement laws by issuing administrative decrees often stall, dilute them or render them incomprehensible, say reform-minded officials. When the government of Enrico Letta fell in February, about 500 laws had been passed but not implemented. Among them: a measure to reduce the number of permits required for companies to do business and a law to digitize certain processes to simplify dealing with the government.

“There is a great deal of difficulty in moving the bureaucracy and the whole machinery of the state,” said Graziano Delrio, undersecretary to the prime minister, in an interview. “There has been this approach of making modest changes, but we need to make a leap in how it all works.”

Former Premier Mario Monti tried to inject more free-market competition in service sectors where regulation protects incumbents’ profits. Striking taxi and truck drivers, railway workers, pharmacists, lawyers and gas-station owners protested his overhaul attempts and lobbied parliament to water them down. Even the weakened measures that passed into law have often made little difference, because the public administration hasn’t acted on them, Mr. Monti says. 

Final Thoughts

It is not that easy to think of good solutions for Italy’s supply-side problems. I think I would start with

1. Reforming the courts. This is a precondition for item 2.
2. Firmly establishing the legal supremacy of the national government over local governments, especially when the national government is giving more freedom to entrepreneurs.

Jennifer Breheny Wallace—The Upside of Envy: Envy Can Lower "Life Satisfaction," but at Its Best, Can Provide Motivation and Inspiration →

As an economist heavily invested in studying happiness and life satisfaction, I was very interested in the essay by Jennifer Breheny Wallace linked above. Here is the key passage:

A study published last August by the journal Plos One, led by researchers at the University of Michigan, found that the more people used Facebook, the less satisfied they were with their lives. In another study last year involving almost 600 Facebook users, German researchers say they witnessed the “rampant nature of envy” on social-networking websites.

So modern envy seems to be bad—but it doesn’t have to be. Researchers are finding that, if approached the right way, there can actually be an upside to this deadly sin.

Psychologists classify envy in two ways: malicious and benign. With benign envy, you are motivated by another person’s success and strive to emulate it. With malicious envy, you want to cut the advantaged person down so you look better by comparison. Let’s say you feel pangs of envy after your rival at another firm gets promoted. Malicious envy might drive you to undermine his success, but benign envy would inspire you to work harder and get promoted, too.

Studies show benign envy can be a great motivator. In a 2011 study published in the Personality and Social Psychology Bulletin, researchers in the Netherlands conducted a series of experiments with more than 200 university students. Researchers found that when they triggered feelings of benign envy—as opposed to admiration or malicious envy—in the students, it drove them to want to study more and perform better on a test measuring creativity and intelligence. While admiration may feel better, the researchers found, it doesn’t motivate performance like the pain and frustration of envy.

The research mentioned is not mine–the University of Michigan is a hotbed for research on happiness and life satisfaction in general. I’d be glad for the reference.  

Matt Ridley on the Debate Between Economists and Ecologists →

The piece linked above is an excellent essay by Matt Ridley in the Wall Street Journal this morning. Here are some key passages that provide a taste, followed by my own views:

1. What frustrates [economists] about ecologists is the latter’s tendency to think in terms of static limits. Ecologists can’t seem to see that when whale oil starts to run out, petroleum is discovered, or that when farm yields flatten, fertilizer comes along, or that when glass fiber is invented, demand for copper falls.

That frustration is heartily reciprocated. Ecologists think that economists espouse a sort of superstitious magic called “markets” or “prices” to avoid confronting the reality of limits to growth. The easiest way to raise a cheer in a conference of ecologists is to make a rude joke about economists.

I have lived among both tribes. I studied various forms of ecology in an academic setting for seven years and then worked at the Economist magazine for eight years. When I was an ecologist (in the academic sense of the word, not the political one, though I also had antinuclear stickers on my car), I very much espoused the carrying-capacity viewpoint—that there were limits to growth. I nowadays lean to the view that there are no limits because we can invent new ways of doing more with less. …

2. The best-selling book “Limits to Growth,” published in 1972 by the Club of Rome (an influential global think tank), argued that we would have bumped our heads against all sorts of ceilings by now, running short of various metals, fuels, minerals and space. Why did it not happen? In a word, technology: better mining techniques, more frugal use of materials, and if scarcity causes price increases, substitution by cheaper material. We use 100 times thinner gold plating on computer connectors than we did 40 years ago. The steel content of cars and buildings keeps on falling.

3. …  thanks to fracking and the shale revolution, peak oil and gas have been postponed. They will run out one day, but only in the sense that you will run out of Atlantic Ocean one day if you take a rowboat west out of a harbor in Ireland. Just as you are likely to stop rowing long before you bump into Newfoundland, so we may well find cheap substitutes for fossil fuels long before they run out.

4. In 1972, the ecologist Paul Ehrlich of Stanford University came up with a simple formula called IPAT, which stated that the impact of humankind was equal to population multiplied by affluence multiplied again by technology. In other words, the damage done to Earth increases the more people there are, the richer they get and the more technology they have.

Many ecologists still subscribe to this doctrine, which has attained the status of holy writ in ecology. But the past 40 years haven’t been kind to it. In many respects, greater affluence and new technology have led to less human impact on the planet, not more. Richer people with new technologies tend not to collect firewood and bushmeat from natural forests; instead, they use electricity and farmed chicken—both of which need much less land. In 2006, Mr. Ausubel calculated that no country with a GDP per head greater than $4,600 has a falling stock of forest (in density as well as in acreage).

Haiti is 98% deforested and literally brown on satellite images, compared with its green, well-forested neighbor, the Dominican Republic. The difference stems from Haiti’s poverty, which causes it to rely on charcoal for domestic and industrial energy, whereas the Dominican Republic is wealthy enough to use fossil fuels, subsidizing propane gas for cooking fuel specifically so that people won’t cut down forests.

As for my own views, for the kinds of reasons Matt Ridley gives, I am definitely not worried about the world running out of resources. I do worry more than Matt seems to about the possibility that fossil fuels are so abundant that we might fry the planet. You can see my views about how to deal with that danger in my column “Actually, There Was Some Real Policy in Obama’s Speech” and in my repeated Twitter refrain “Kill coal!” I think environmental activists can be most effectively heroic in saving the planet at this point in history

• by singling out coal for demonization among all fossil fuels and
• by pushing for more support for solar power research.