Posts Tagged ‘economic growth’
What is economic growth? We all think we know the answer to this question. It’s when GDP (Gross Domestic Product) is growing or positive, would be a typical answer. That is an abstract answer for most of us. We tend to focus more on the likely results of a growing economy, such as there are more high paying, high quality jobs; you are more likely to receive a raise above the inflation rate; you are more likely to have more money in your bank account; your access to education, health care, quality of food, etc. generally increase. But if population growth is 5% and GDP growth is only 2% then none of these good things happen. What we are interested in is real per capita increases in wealth.
But what is wealth? Is it the number of digits in your bank account, how many dollars you have in your pocket, how many dollars your 401K is worth? The people in Venezuela have seen a huge increase in the number of digits in their bank accounts, and the number of dollars (Bolivars) in their pockets have increased, however they are getting poorer. So did the people in the Weirmar Republic in the early 1920s, many of whom were billionaires (in Marks). Wealth cannot be confused with the amount of currency (Dollars, Bolivars, Marks) one has.
Using currencies to denote wealth often causes confusion. Let’s look at some examples separate from currency. Image a farmer, we’ll call him Tony. Tony has two cows, a dirt house with a thatch roof and no running water or electricity. A year later Tony has ten cows and running water. Clearly Tony is now wealthier than he was a year ago. In fact, the quantity of livestock one owns has been a traditional indicator of wealth in many societies. Wealth means having more of the things necessary to sustain one’s life. But people in the US and the West are not like Tony, most of these people have more than they could possible need to sustain their life –right? Actually, no. A rational person, let’s call him Randy, does not just worry about whether they have enough food for today. Randy’s a fisherman and just because he catches enough fish to feed his family today, does not mean he should stop fishing. What if the fish are not biting tomorrow? What if there is a storm tomorrow and he cannot fish? What if his boat needs repairs and he cannot fish for a week? Because Randy is rational he keeps fishing even after he has caught enough fish to feed his family that day, if there are fish to be caught and the day is not over.
But the average American, call him Sam, is not like Tony or Randy. Sam has so much to eat he is overweight. He is wealthy beyond the wildest dreams of Tony or Randy. He lives in a nice house, has running water, electricity, three televisions, five cell phones, why should Sam care about being wealthier? Well what if Sam gets sick and can’t work, what if he loses his job, what if his car breaks down, what if his child gets accepted to Harvard? Only the uber wealthy have enough wealth to meet all their needs for the rest of their lives. When you consider that a prolonged hospital stay can cost over million dollars, it would require a net worth in today’s economy of around ten million dollars or more. All except the uber wealthy have a rational desire for economic growth (i.e., increasing wealth) and even the uber wealthy benefit from the new technologies and opportunities provided by economic growth.
It has been two year since I published my book The Decline and Fall of the American Entrepreneur: How Little Know Laws and Regulations are Killing Innovation. The book explains that the only way to increase real per capita income is by increasing our level of technology. This can be accomplished by capital equipment purchases, which upgrade plant and equipment with newer technologies or by creation of inventions. Since the United States is a leader in technology, we do not have the choice of just upgrading to new technologies produced in another country. So we must create new technologies if we want our economy to grow. There are two ways to encourage the creation of new technologies; government funding or private investment in inventions. Government spending on research and development is not nearly as effective as private spending – see Solyndra. A study by the Small Business Administration shows that most emerging technologies are invented by small entrepreneurial start-ups. Unfortunately, since 2000 the U.S. has undermined the three foundations on which technology start-ups are based. Those three foundations are intellectual capital, financial capital, and human capital. We weakened the intellectual capital foundation by weakening our patent system, we weakened the financial capital foundation with the passage of Sarbanes Oxley, and the human capital foundation was weakened by the accounting rules that required the expensing of stock options.
Since my book was published the intellectual capital foundation has been undermined this year by the passage of the America Invents Act and the financial capital foundation has been undermined by the passage of the financial reform bill (Dodd Frank). There has been no change on the human capital front. There is mixed news on the intellectual capital front.
These problems are being exacerbated by the budgetary issues associated with aging baby boomers. The Obama and Bush administrations compounded these problems by expanding Medicare to prescription drugs and the passage of Obama Care. In 2010, Medicare/Medicaid and the Children’s Health Insurance Program (CHIP) represent 21 percent of the federal budget. Social Security represents about 20 percent of the federal budget and interest payments represent about 8 percent of the federal budget. It is estimated that about 10,000 baby boomers will go on Medicare per day for the next twenty years. However, about 5000 seniors are dying per day. Each Medicare recipient costs about $10,500, so Medicare costs will expand by $185 billion dollars (today’s dollars) or another 5% of the federal budget. Roughly, the same calculation applies to social security. So Medicare and Social Security will consume approximately 50% of the U.S. federal budget by 2020. In addition, the interest payments are likely to consume around 30% of the U.S. federal budget. This means that 80% of the federal budget will be spoken for. This does not include any additional costs for Obama Care. It is unlikely that the federal budget as a percentage of the economy can grow, since the U.S. had to borrow one third of the federal budget in 2010.
Here are my predictions for the next decade based on this background. I provide an optimistic, most likely, and pessimistic scenarios. Note these scenarios are based on what I believe is most likely to occur, not what I believe is the best that could be done or the worst that could be done to the U.S. economy.
Predictions Common to all Scenarios
Properties rights of all kinds will continue to be weakened. It appears that you can get a PhD. in economics (or even win the Nobel Prize) without understanding even the most basic ideas of property rights and how they affect a free economy. Even so called free market economists forget that Reagan not only cut tax rates, he strengthened property rights. Particularly he strengthened patent rights – for more information click here. He also strengthened property rights by weakening regulations and weakening the power of unions. A number of so-called free market economists do not understand that property rights are based on productive activity. As a result, they have joined in an all attack on property rights for inventions – patents. For more information see Scarcity Does it Prove Intellectual Property is Unjustified.
One change from last year is that all the Republican candidates have come out for repealing or curtailing Sarbanes Oxley and the Financial Reform Bill. There may be hope that entrepreneurial companies will no longer be starved for financial capital if the Republican’s win the presidency. It appears unlikely we will strengthen property rights for inventions or property rights generally or signficantly strengthen our capital markets so they work for start-up companies, the most optimist scenario is limited to subpar growth.
The growth of the Internet will result in a continued decline in commercial real estate values under all scenarios. Commodity prices are likely to increase, inflation adjusted, under all circumstance. Growth in China and inflation will drive this increase in commodity prices.
Optimistic Scenario (This is Unchanged from 2010)
This scenario assumes that the U.S. faces up to its budgetary problems, repeals Obama Care, and rationalizes it tax structure. This scenario assumes that Obama is not elected for a second term. Government spending will grow slightly as a percentage of GDP. Supply Side economists would probably consider this enough to create vigorous economic growth. However, it does nothing to really encourage investment in new technologies. As a result, real inflation adjusted GDP growth over the decade will probably be around 2%. Median household family income after taxes will be stagnant. This will be two decades during which median household income has not grown in the U.S. I believe that will be the first time in the history of the U.S. this has occurred.
The housing market is likely to be stagnant since family incomes will be stagnant. Inflation is likely to run 4-6% (Note that it appears that government is determined to lie about the inflation numbers, so it will be hard to determine the real inflation rate), but this will not be enough to cause appreciation in housing prices. In fact, inflation adjusted housing prices will likely decline.
The best economic opportunities will be in government related jobs or businesses. Commodity based business will also prosper. Technology entrepreneurs will be few and far between. Unemployment numbers will hover between 7-9% throughout the whole decade – this will be the new normal. The U.S. will no longer be the largest economy in the world and based on per capita income among large countries the U.S. may fall below the top ten in the world. The U.S. will also be one among many equals in technological and scientific leadership. All social ills will increase slowly including crime, number of welfare dependents, and black market transactions.
Most Likely Scenario
This scenario assumes that the U.S. will not face up to its budgetary problems and Obama Care will not be repealed completely. Under this scenario, the U.S. will go from financial crisis to financial crisis. Each financial crisis will be meet with a short term band-aid solutions. Federal government spending will grow to at least 30% of GDP and total government spending will be 50-60% of GDP. Inflation will grow to 10-14% by the end of the decade. Despite this, housing prices will not keep up with inflation. Median household family income after taxes will decline by 2-7%. Official GDP numbers will show slightly negative growth, but this will over state the actual growth rate.
The best economic opportunities will be in government related jobs or businesses. Commodity based business will also prosper. The financial differences between those who are in the government’s favor and those who are not will be huge. Technology entrepreneurs will be almost nonexistent. The brain drain from the U.S. will be apparent and a cause for anxiety. Unemployment numbers will hover between 9-15% throughout the whole decade. The U.S. will no longer be the largest economy in the world and based on per capita income among large countries the U.S. will fall well below the top ten in the world. The U.S. will also be a declining power in technology and science. All social ills will increase moderately including crime, number of welfare dependents, and black market transactions. The chance of a major war in the world will be moderate.
The U.S. will not face up to its budgetary issues even to get through a crisis. The U.S. will either literally default on its debt or inflation will be over 20% or both. Multiple states will go bankrupt and be bailed out by the federal government. Tax burdens will skyrocket as will the black market. Housing prices will decrease significantly except in extremely exclusively neighborhoods. Social order will collapse. The pretense that the U.S. is a nation of laws or that the Constitution has any meaning will be completely destroyed. There is a possibility (15%) that there will be a military coup. Alternatively or in combination there is a possibility that the U.S. will break up into a number of separate countries. Many parts of the U.S. will decide that it no longer makes sense to support Washington, Wall Street and parts of California that have become use to crony capitalism and government handouts. The brain drain from the U.S. will be well known and huge. This may be the driver for politicians and voters to demand real reform. China and India will dominate the world economy. Unfortunately, neither will likely fill the U.S.’s shoes and become a technological and scientific leader. Singapore will likely be the richest country in the world on a per capita basis by a large margin. They will be the major center of technological and scientific research. The chance of a major war in the world will be probably.
The best reason to be more optimistic is that the U.S. has never had two bad decades in a row. In the late 1930s and late 1970s there was no reason to suppose that the U.S. would right itself economically. We pulled out the 1930s because Roosevelt realized that he had to adopt pro-business policies if the U.S. was to have any chance of winning World War II and so did the voters. In the 70s, there was little hope that the U.S., let alone England, would pull out of the inflationary spiral, increasing unionization, increased regulation, increasing government spending and entitlements. However, there was the glimmer of Ronald Reagan and a surge of free market economists such as Milton Friedman, who still understood property rights. Unfortunately, I do not see a Ronald Reagan on the horizon and many of today’s free market economists are overly focused on the detrimental effects of Federal Reserve and high marginal tax rates. Very few seem to understand the importance of strengthening property rights, particularly for inventions or the need to free up our capital markets from regulation. I hope I am wrong and there is a politician who understands property rights, particularly for inventions, and the need to free up our capital markets, while having the strength to stand up to government unions and special interests.
I cannot decide if we are seeing the collapse of Western Civilization under the weight of the welfare state (socialism) or if we are seeing the last hurrah of the welfare state.
This is a multi-part post on the science of economic growth. Standard economic theory has failed miserably to define the source of economic growth, which means it is impossible for it to provide rational policies to restore economic growth. This series of posts defines a scientific theory of the source of economic growth.
Homo sapiens also consume food and create shelter to overcome the effects of entropy. Unlike other living organisms, homo sapiens organize their environment to minimize the effects of biological entropy. For instance, humans have invented agriculture to increase their supply of food (energy). Humans also harnessed the physical strength of animals, created internal combustion machines, electric lights, electricity, washing machines, tractors, computers, the internet, email, lasers, fiber optics, etc. All of these are inventions. Humans alter their environment by creating inventions. This is different from every other animal. For instance, our bison standing on coal will never be able to harness the potential energy in that coal unless the species evolves to eat the coal.
The distinguishing characteristic of homo sapiens is their ability to reason. Man is a rational animal according to Aristotle’s classical definition. Man uses his reason to alter his environment (invent) and increase the energy available to him. Note that I am not limiting myself to the arcane definition of invention provided by the law. Anything that man creates to solve an objective problem is an invention. If a device/service is not found in nature separate from man then it is an invention. For example, the ability to create fire or harness it is an invention of man. No other animal has the ability to create or harness fire. Man did not have some sort of inherent knowledge of how to create or harness fire.
If humans did not invent, then studying economics would be the same thing as studying the evolution of humans. While trade is also unique to humans, trade is not the fundamental basis of economics. Trade is an invention of man. If everyone produces the same thing, then there is no reason to trade. For instance, if we all produce wheat, then there is no reason or ability to trade. It is only because someone has invented a new product that trade becomes a rational choice. For instance, one group of people may have invented a process for skinning animals and using them as clothing. They may have traded this with people who had access to flint and invented a system for making simple axes. Invention has to proceed production, which has to proceed trade logically. Of course, without trade the value of invention and production is severely diminished.
Diminishing Returns: Sustainability Isn’t Sustainable
Biological entropy implies diminishing returns. For all species of life there is a limited supply of the resources (free energy) and conditions necessary to sustain a particular form of life at any point in time. The concentration or ease of extracting these resources varies as a result of the non-homogenous nature of the universe. A species of life thrives where it has a high concentration of resources (low biological entropy for the species) and as its population expands it has to expand to areas of low concentration of resources (high biological entropy), which results in diminishing returns. The species are then constrained by the Malthusian Trap.
The way this is expressed in economics is that the use of any one resource results in diminishing returns for that resource. The question of limited human resources has been the subject of Economics since Malthus and David Ricardo. I will explore the idea of diminishing returns and its relationship to invention, by examining the idea of sustainability. Sustainability is an attempt to overcome or at least manage diminishing returns. There are numerous and conflicting definitions of what sustainability means. However, most sources point to the World Commission on Environment and Development (WCED), also known as the Brundtland Report. According to the 1987 Brundtland Report, sustainability is: “Meeting the needs of the present generation without compromising the ability of future generations to meet their needs.“ This definition is not testable and is incredibly vague. What are the “needs” of the present generation? Do we need the Internet, satellites, SUVs, etc.? How do we know if this will compromise future generations ability to meet their needs?
Since this is not a productive path of inquiry, let’s take the word “sustainable” literally. A sustainable technology would be one that can be used indefinitely by humans without side effects and without any diminution in its effectiveness. This definition violates the laws of physics. According to the second law of thermodynamics, entropy always increases in a closed system. As a result, any use of technology at least produces waste heat – a side effect. Sustainability taken literally is an attempt to create a perpetual motion machine. Even the Sun’s energy will not last forever and it is not infinite. This is true whether we are talking about absolute entropy or biological entropy. Is the sustainability movement unrealistically optimistic?
A key issue for the sustainability movement is the use of so called non-renewable resources, such as the use of fossil fuels and the using up of other natural resources (diminishing returns). The way this is often phrased today is Peak Oil, Peak Water, Peak _____ (Pick Your Favorite Resource). Peak Oil (natural resource) occurs when the amount of oil that can be extracted reaches its maximum or the point at which we reach the maximum net energy output from oil. The alternative definition takes into account that even if we can extract more oil, this is irrelevant if it takes more energy to extract the oil than we receive from the oil. The supposed solution for our Peak Oil problem is to develop renewable energy resources. The Clean Energy website provides the following definition “Renewable energy is natural energy which does not have a limited supply. Renewable energy can be used over and over again, and will never run out.” What is a natural energy? Either all energy is natural, comes from nature, or only animal muscle power is natural. The natural qualification is complete nonsense – unless they really want us to go back to animal muscle only. The “never run out” qualification violates entropy. All energy resources will run out. All energy sources, fossil fuels, solar, hydroelectric, tidal, biomass, hydrothermal, fission, fusion, etc are solar or at least stellar. For instance, hydroelectric energy is the result of the Sun heating the oceans or other large bodies of water. As the water evaporates and then condenses in the form of rain or snow on land masses it is collected in dams. The dams convert the gravitation force of the water into electric energy. Fossil fuels are created by plants converting sunlight into biomass (including animals). The biomass is trapped underground by sea sediment and the pressure and heat converts the biomass into oil, coal, natural gas, etc. Fission is the process whereby heavy elements, generally Uranium, are split into lighter elements and energy is released. These heavy elements were created in a star that has long since expired. Thus, all energy is Solar or at least stellar. The Sun will not last forever and does not provide unlimited energy. The concept of renewable energy that “will never run out” and “can be used over and over again” is false. So was Malthus correct? Are humans doomed by entropy to eventually return to the Malthusian Trap or worse? Is the defining characteristic of economics that diminishing returns (entropy) will always force humans back to the point that we are on the edge of starvation? If so, will evolution pass humans by and humans will become extinct?
This concept of peak resources is not new. You can find numerous examples of “Peak Oil” historically. For instance, the fertilizer crisis of the 19th century. In 1830 it was discovered that bat guano was an excellent fertilizer. Population exploded, as guano was used in Europe because of the additional food (energy) produced as a result of this excellent fertilizer and mechanization. The best sources of guano began to run out fairly quickly. People predicted the equivalent of “Peak Guano.” The question was not whether we would have “Peak Guano,” but Peak Fertilizer. In other words, we did not have a guano problem we had an invention problem. The Haber-Bosch process was invented in 1909, which allowed fixing nitrogen in air and solved the “Peak Guano” problem.
Reason magazine in the article Peak Everything? discussed how logical, scientific projections showed we would run out of lithium, neodymium, and phosphorus. Peak lithium was going to limit the batteries necessary for electric cars. In fact, we would run out of lithium faster than we would run out of oil. The solution is a new invention that replaces lithium with zinc air batteries. Note the solution was not a better way to extract lithium, but to make the supply of lithium irrelevant. New invention creates a paradigm shift. Peak neodymium is going to limit our ability to build the electric motors of hybrid cars as well as other products. Interestingly, neodymium magnets were invented to overcome the problem of peak cobalt. In the area of permanent magnets, it appears that a new induction motor will eliminate the need for permanent magnets. Peak phosphorus is a repeat of Peak Guano. Peak phosphorous threatens our ability to provide enough fertilizer for our agricultural needs. One solution is to expoit human waste. Phosphorous is a byproduct of human urine. The phosphorous can be recycled using a no mix toilet.
Paul Romer has observed, “Every generation has perceived the limits to growth that finite resources and undesirable side effects would pose if no new recipes or ideas were discovered. And every generation has underestimated the potential for finding new recipes and ideas. We consistently fail to grasp how many ideas remain to be discovered. The difficulty is the same one we have with compounding: possibilities do not merely add up; they multiply.”
The computer industry has also been beset by predictions of impending doom, when it could no longer achieve Moore’s law of doubling the number of transistors every eighteen months. Ray Kurzweil has shown that if you restate Moore’s law as computational power, every time a technology reaches its limit to improve computational power a new technology takes over. Using this he shows that computational power has been growing exponentially since 1900. The first computational devices were electromechanical. When these devices reached their limit, they were replaced with relay devices; these were replaced with vacuum tubes, then transistors, and finally integrated circuits. However, if you trace the speed of machines beginning with the invention of the steam engine, it peaks at around supersonic flight. It is hard to determine if this is an economic/technological limitation or political limitation.
Diminishing returns for a given natural resource in a technology static scenario occurs because high order areas of the natural resource are exploited first. It takes more energy to extract lower order areas (high biological entropy). For instance, man first exploited gold nuggets picked up from the ground. Eventually, man dug for the gold or panned, which required more energy because it was less ordered. Note that even this change required new (additional) technologies – a shovel and pick or a tin pan. Modern techniques of gold mining, e.g., cyanide leaching, have allowed formerly unprofitable mines to be reopened. This is because the new technology allows us to exploit even lower order areas of gold. Diminishing returns only apply in a technology static environment. These diminishing returns can be modeled as a decaying exponential.
Are Inventions Subject to Diminishing Returns?
Every invention is a combination of known elements – you cannot create something from nothing. This follows from the natural law conservation of matter and energy. As a result, every invention opens up the possibility of more inventions by building on earlier inventions. Creating these inventions takes energy, but the number of potential inventions we can conceive of increases with every invention we create. As a result, the number of potential inventions grows factorially. There are four ways in which inventions could be subject to diminishing returns: 1) the number of inventions are limited, 2) the inventions in a narrow area of technology are limited 3) the returns on devoting more resources, as a percentage of total resources, to inventing declines, and 4) the cost of creating the next invention in any technology could increase.
The number of potential inventions, however, is not subject to diminishing returns. In fact, the opposite is true. The number of potential inventions grows factorially as new inventions are created.
Inventions in a narrow area of technology are subject to diminishing returns. Early inventions would appear to provide the greatest return and latter inventions appear to provide more limited returns. Ray Kurzweil has studied this and found that new technologies appear to follow an S-curve with the greatest return in the middle of the S and eventually declining in return. Cross pollination between the primary area of technology and other areas of technology appears to prevent diminishing returns in a narrow area of technology, similar to how substitute resources prevents diminishing returns for natural resources.
Would it logically follow, if a greater and greater percentage of a country’s or the world’s resources were devoted to discovering inventions you would hit a point of diminishing returns? The answer is no country has ever come close to testing this hypothesis. Countries throughout history have under invested in inventions and provided little or no incentive for inventors. Those countries that have devoted the most resources to inventing, have seen the greatest economic returns. The U.S. has historically devoted the most resources to invention. It has historically had the strongest laws protecting the rights to inventions, which has resulted in greater resources being devoted to invention. England had some of the strongest laws protecting inventors at the beginning of the Industrial Revolution and it was the hotbed of invention at that time. The Italian city states of the 15th and 16th centuries had some of the first laws protecting inventors and they had a much higher standard of living. Among their inventions were modern glass making techniques and a modern banking system. There is a minimum amount of resources that must be devoted in a country to agriculture and maintenance just to keep up with the decline due to human biological entropy. If inventive activity were so large as to crowd out those activities necessary to overcome biological entropy, you would have to assume that there are diminishing returns at that point.
The idea that the cost per invention could increase to the point of diminishing returns, seems to have credence if we look at a narrow technological area. For instance, the cost of improving the aerodynamics of airplanes is extraordinarily expensive. However, modern electronics allow us to improve the aerodynamics of planes by putting in control systems that allow a plane to be unstable aerodynamically. Commercial supersonic flight was not feasible economically in the 1970s because of aerodynamic drag. This problem can be solved today fairly inexpensively with electronic control systems. The cost of inventing in electronics grew tremendously with the advent of the integrated circuit. The advent of personal computers and software have driven down the cost of inventing in electronics and a wide variety of other areas. There is evidence that the cost of inventing is decreasing over time, if we do not limit inventing to a narrow area of technology.
Diminishing returns can be modeled as a decaying exponential. Inventions across all areas of technology are not subject to diminishing returns. Potential inventions grow factorially, which is much faster than diminishing returns shrink. Thus, it is entirely possible to grow our technology faster than the limitations of diminishing returns. However, it is not foreordained that humans will invent. Humans are volitional beings and they can choose not to invent. There is plenty of evidence that when humans choose not to invent then they become subject to diminishing returns and their society declines or becomes extinct. For example, Jared Diamond’s book Collapse argues that many societies collapsed because of environmental problems.
In a technologically stagnant society, entropy and diminishing returns will prevail and that society will become extinct.
It appears that the sustainability movement is overly optimistic, in a technologically stagnant society. However, if humans choose to invent in broad technological areas, then they can escape this fate. Invention is the key to escaping the Malthusian Trap and growing real per capita income. This is consistent with Robert Solow’s paper “Technical Change and the Aggregate Production Function” paper and the subsequent work in this area of economics which shows all real increases in per capita income are due to increases in technology. It is also consistent with groundbreaking econometric studies of Jacob Schmookler, in chapter V, “Productivity Advance: A Case of Supply and Demand” of his book Invention and Economic Growth.
In a technologically dynamic society, inventions will result in growth that outstrips entropy and diminishing returns. People will escape Malthusian Trap and their per capita income will grow.
The question about whether humans are doomed to a Malthusian existence, where economic growth cannot keep up with population growth, has been one of the most vexing questions since the beginning of economics. Malthus was clearly correct for all of human history other than the last 200 years. Even since then he has been correct for the majority of humans until the last 40 years or so. On the other hand, critics of Malthusian theories have pointed to the West’s ability to overcome all predicted population bombs and resource limitations during the last 200 years. Critics often point to the famous bet between Paul Ehrlich and Julian Simon over the price of commodities. The reason this debate has been so contentious and has not been resolved is clear. There is no predetermined answer. It depends on whether large groups of people decide to invent fast enough. I say large groups because Matt Ridley has shown in his book, The Rational Optimist, that small population groups cannot even sustain their initial level of technology. The book provides numerous examples of how various groups of humans regressed technologically because of inadequate population densities to support specialization, such as Tanzania. The book summarizes the lessons by quoting economist Julian Simon “population leading to diminishing returns is fiction: the induced increase in productivity is scientific fact.”
 Some animal trade like items across time. If I have extra wheat, I give it to someone who does not have enough and they return the favor later. Usually this only occurs between family members in other species.
 Brundtland Commision, Wikipedia, http://en.wikipedia.org/wiki/Brundtland_Commission, 11/7/10.
 Note that have been some alternative explanations proposed for how oil is produced that does not involve this biomass conversion
 Mark Ridley had numerous “Peak Oil” examples in his book The Rational Optimist: How Prosperity Evolves, Harper Collins, 2010, New York, pp 121 -156.
 Bailey, Ronald, Reason.com, Peak Everything?, April 27, 2010, http://reason.com/archives/2010/04/27/peak-everything, 10/16/10.
 Bailey, Ronald, Reason.com, Peak Everything?, April 27, 2010, http://reason.com/archives/2010/04/27/peak-everything, 10/16/10.
 Kurzwiel, Ray, The Singularity is Near: When Humans Transcend Human Biology, Penguin Books, 2005, p 67.
 If there is a limited amount of matter and energy in the Universe, which is open to debate, there may be a limitation to the number of potential inventions. However, this limitation would be so large as to be meaningless for all practical purposes.
 Kurzweil, Ray, The Singularity is Near: When Humans Transcend Human Biology, Penguin Books, 2005, p 44.
 Kurzweil, Ray, The Singularity is Near: When Humans Transcend Human Biology, Penguin Books, 2005, p 44.
 Diamond, Jared, Collapse: How Societies Choose to Fail or Succeed, Penguin Group,New York, 2005.
 Solow, Robert M, Technical Change and the Aggregate Production Function, The Review of Economics and Statistics, Vol. 39, No. 3 (Aug., 1957), pp. 312-320
 Schmookler, Jacob, Inventions and Economic Growth, Harvard Press, 1966, pp 86-103.
 Matt Ridley in his book The Rational Optimist shows that self sufficiency is an economic dead end. Only large groups of humans can afford to have people specialize so some or all their time is devoted to inventing.
 Ridley, Matt, The Rational Optimist: How Prosperity Evolves,Haper Collins,New York, 2010,p. 83.
This is a multi-part post on the science of economic growth. Standard economic theory has failed miserably to define the source of economic growth, which means it is impossible for it to provide rational policies to restore economic growth. This series of posts defines a scientific theory of the source of economic growth.
Since economics is the study of how man meets his needs, the paper will first examine the nature of man. Man is like other life forms in that he is subject to laws of evolution. Evolution is the result of entropy. However, it is not absolute entropy but what is defined herein as biological entropy that controls life forms. The paper starts with an examination of biological entropy.
Every species has unique features that allow it to compete in its evolutionary struggle. Homo Sapiens ’ unique feature is their ability to use their rational mind to alter their environment or invent. If humans did not invent, then the study of economics would be the study of human evolution.
The defining condition of most life is that it exists in the Malthusian Trap, which is the forcing function of evolution. An important question is whether humans can escape the Malthusian Trap. The Malthusian Trap is the result of biological entropy, which implies diminishing returns. Escaping the Malthusian Trap requires humans to overcome diminishing returns. Whether humans can invent their way out of diminishing returns is explored.
The paper shows that the answer to this question is that it depends. If large groups of humans invent quickly enough, then humans can permanently escape the Malthusian Trap. However, it is clear that in a technological stagnant environment, humans will eventually fall back into the Malthusian Trap. This leads to more mainstream economic questions, such as whether inventing is endogenous or exogenous? The paper shows that it is clear that inventing is endogenous. Another more mainstream economic question that is examined is whether dissemination of new technologies is inhibited by property rights in inventions? This question logically leads to the question of whether perfect competition or monopolistic competition encourages economic growth? The paper shows that incentives are not only necessary for the creation of new technologies, but for the dissemination of new technologies and that perfect competition destroys technology creation.
These ideas are then applied to an understanding of the Industrial Revolution, which was the first time that large groups of humans escaped the Malthusian Trap. It is shown that the Industrial Revolution, which was really a constant invention machine, occurred because of specific incentives for ordinary people to invent.
Finally, given the central role of invention to economics the paper examines whether there are any natural laws that apply to inventions. Six natural laws of invention are presented.
How Does Entropy Apply to Life?
Life requires energy to exist because of entropy. Otherwise a living organism could just not expend energy and it would live forever. This setups a struggle between organisms and between species for energy sources, which forms the basis of evolution. According to Peter A. Corning in “Thermoeconomics:
Beyond The Second Law” the idea that evolution and entropy are related has been long recognized. This connection has been espoused by Jean Baptiste de Lamarck, Herbert Spencer, Ludwig Boltzmann, Alfred Lotka, and Erwin Schrödinger, in his book What is Life? However, Corning warns us about confusing energy entropy, information entropy, and physical order. Keeping this in mind, we need to define entropy in a consistent manner. As used herein entropy does not mean information entropy or physical order or strictly energy entropy, which I will call absolute entropy. Entropy means biologic entropy or the ability of an organism or a species to extract useful energy from their surroundings. While this is related to absolute entropy in that it is about extracting useful energy, what matters in biology is the organism’s ability to extract energy from its environment to sustain its life not the absolute amount of useful energy available. For instance, a buffalo (Bison) standing on a vein of coal in an open pit mine is surrounded by useful energy or low absolute entropy. However, the buffalo cannot turn the coal into useful energy for itself and if there is not any grass or sage around, it is an area of high biological entropy for a buffalo. Let’s explore this idea of biological entropy in more detail. When a bison dies it has not reached a point of maximum absolute entropy, its carcass may still provide useful energy for vultures, mountain lions, and people. Despite this, the bison’s biological entropy has reached a maximum, meaning its biological entropy has increased to a level that it no longer is alive.
On an individual organism level I define maximum biological entropy as the point at which the organism dies. Many things can cause the entropy of an individual organism to reach it maximum and organisms use a variety of mechanisms to overcome biological entropy. Plants create useful energy by photosynthesis. They convert carbon dioxide into sugars (energy) using light. They use this energy to reduce their biological entropy. Animals eat plants or other animals and use the energy to reduce their biological entropy. Note that when animals eat plants or other animals, they are increasing the biological entropy of the plants and animals they eat. Thus, there are two general mechanisms that increase the biological entropy of life forms: internal and external. Internal mechanisms are those that result from the failure to consume enough calories (energy) and aging. Animals require oxygen, water, and food, in that order, to survive. Without oxygen, the animal cannot oxidize enough sugar (fat, protein) to survive – overcome biological entropy. Without water, the animal’s cells are unable to absorb energy and expel wastes. Aging is a process of increasing biological entropy. This is caused at least in part by disorder in genetic information. This genetic disorder results in the organism not being able to create enough useful energy to survive or increasing the amount of energy necessary to survive. External mechanisms include being eaten or attacked by other living organisms, diseases, accidents (for animals), and the elements.
In general, living organisms use energy to overcome biological entropy first and then to increase their size. However, some animals also create simple shelters or seek shelter to ward off the biological entropy increasing effects of the elements and predators. Rain, sun, hail, snow, heat, and cold all contribute to the increase in biological entropy of living organisms. Life has two main methods of overcoming the effects of the biological entropy: 1) food (energy) consumption and 2) shelter creation (inhabitation).
A species of life becomes extinct when the species as a whole reaches a certain level of biological entropy either because it cannot consume enough energy or because external mechanisms increase its biological entropy to reach the extinction level. The biological entropy level at which a species becomes extinct is the maximum biological entropy for the species. A species reaches the Malthusian Trap when increases in population of the species results in the total required energy (food) to support the population being greater than the supply of food. Most life forms exist in the Malthusian Trap, most of the time, including humans until the Industrial Revolution.
It is widely known that Malthus’s Essay on the Principles of Population influenced Charles Darwin and shaped his ideas on evolution. Darwin himself recorded in his 1876 autobiography the following:
In October 1838, that is, fifteen months after I had begun my systematic enquiry, I happened to read for amusement ‘Malthus on Population’, and being well prepared to appreciate the struggle for existence which everywhere goes on from long-continued observation of the habits of animals and plants, it at once struck me that under these circumstances favourable variations would tend to be preserved, and unfavourable ones to be destroyed. The results of this would be the formation of a new species. Here, then I had at last got a theory by which to work.
Evolution is then a way of selecting species or variations on species that have low biological entropy and causing those species with high biological entropy to go extinct. The limited amount of food (energy) for each species ensures that evolution is a dynamic ongoing process. The variations are the result of sexual recombination of the parent’s genes and mutations in the organism’s genes. The unique feature of humans is that they alter their environment to fit their needs, they do not just rely on genetic variations that allow them to better adapt to their environment. The way humans do this is by inventing, which will discuss more in the next section.
 Corning, Peter A., Thermoeconomics:
Beyond The Second Law, Journal of Bioeconomics, Journal of Bioeconomics, Vol. 4, No. 1. (1 January 2002), pp. 57-88, p. 58.
 There are few exotic life forms that do not need oxygen, but all require energy to overcome entropy.
 BNET, Physiological Effects of Dehydration: Cure Pain and Prevent Cancer, http://findarticles.com/p/articles/mi_m0ISW/is_2001_August/ai_78177228/, 10/6/10.
 Hayflick, Leonard, Entropy Explains Aging, Genetic Determinism Explains Longevity, and Undefined Terminology Explains Misunderstanding Both, PLoS Genetics, http://www.plosgenetics.org/article/info:doi/10.1371/journal.pgen.0030220, 10/7/10.
 The Autobiography of Charles Darwin, location 680-686, by Charles Darwin (Mar 17, 2006) – Kindle eBook
Two Singapore professor show patents result in significant economic growth. Their paper, Patent Rights and Economic Growth: Evidence from Cross-Country Panels of Manufacturing Industries concludes “the effect of strengthening patent rights on economic growth was substantial in economic terms.” P. 16
Our results have important implications for public policy. One is that patent laws and their enforcement matter for economic growth. However, our findings also suggest that patent rights vary by country and industry. We show that patent rights have a smaller impact on economic growth in poorer countries and in less patent-intensive industries. Since patent intensive industries account for a smaller share of the economies of the poorer countries, our results imply that the welfare gain in terms of economic growth for these countries is more likely to be outweighed by the welfare loss due to lower end-usage, and hence, tip the balance towards weaker rights being socially optimal. Abstract
The paper’s conclusion with respect to “poorer” countries being better off with a weak patent system is pure conjecture and was not part of their study. The reason that poor countries do not see a big boost by having stronger patent laws is: 1) poor countries are technologically backward and can advance economically by copying (purchasing) existing non-patented technologies, and 2) poor countries have poor property rights systems diminishing the effectiveness of their patent systems. A poor country is poor because of its low level of technology. Just raising a poor countries level of technology to the same level as the United States twenty years ago would result in huge economic gains. The reason poor countries have a lower level of technology is because they have weak property right systems that results in under investment in technology (Capital Spending). The paper hints at this point:
Our patent rights index depended on an assumption that enforcement of patent rights was correlated with enforcement of property rights in general, as measured by the Fraser index (The Fraser Institute does a study of economic freedom for all countries once a year). P. 10
In Figure 1, we plotted the Fraser index against the GP index (Patent Strength) scaled up by a factor of two. The two indices were highly correlated. P. 10
In other words, there is a strong correlation between the strength of property rights in general with the strength of a patent system in a country. This should not be surprising since patents are property rights in inventions. If you did a study of arbitrary government grants or monopolies versus the strength of patents in countries, you would find they are highly uncorrelated. Despite the nonsense that suggests that patents are monopolies.
Another interesting point in the paper:
Among 15 Western countries over several centuries, enactment of patent law was associated with higher rates of scientific discoveries, inventions, and innovations.
Hu , Albert G.Z. and Png , I.P.L., Patent Rights and Economic Growth: Evidence from Cross-Country Panels of Manufacturing Industries, August, 2010.
The study of economics would be the same thing as the study of evolution of humans if humans did not invent. Without invention there is no reason for trade. Why would we trade my berries for your berries if they are essentially the same berries? If we both eat the same dead animals, what would the purpose of trade be? Without trade, production is limited to the immediate needs of the person. Perhaps you might store up some nuts, but everything else will spoil. Note that shelter is an invention, unless it only involves taking over a cave or a hole in a tree. The unique feature of man is that he is a rational animal and in the economic realm this means that he invents. No other animal invents. Only humans change their environment to meet their needs.
The driving function of evolution is the Malthusian Trap. In the Malthusian Trap, food (things need to survive) is limited and population growth in any species is always greater than the growth of the food supply, except humans very recently. This puts species into competition for food and selects for the species that are most successful in a given area. The only reason that humans (some) were able to escape the Malthusian Trap was that they invented faster than their population grew. Meaning the rate at which technology changed provided greater productivity growth than the expansion in the population. Why after 20,000 to 100,000 years of human existence did people in England, the United States, and the West suddenly escape the Malthusian Trap? Clearly, the rate of invention accelerated in these places so that productivity outstripped population growth. But why there and why then? There is extensive evidence that the introduction of property rights (individual – there is no such thing as group property rights) always provides a strong incentive to maximize return on an asset. England and then the U.S. at the beginning of the Industrial Revolution were the first large groups of people to introduce property rights in inventions. This provided the necessary impetus to invent new technologies and diffuse them widely. Clearly, patents cannot provide this incredible benefit outside of a system of individual rights and property rights. However, it was the linchpin that launched large groups of humans outside of the Malthusian Trap and the constraints of biological evolution.
For more information see:
A great video from the Economic Freedom blog shows how the U.S. has wiped out two decade of progress toward economic freedom in a nine years. According to the video government spending and regulation take up 65% of the GDP. Regulation by itself takes up 19% of GDP. This means that the average goods and services in the U.S. have to be 23.4% higher in price just to pay for regulations. Imagine how much “demand” would be opened up if the average price of goods and services were lowered by this amount. To understand why the price of the average goods and services is 23.4% higher because of regulations see Austerity: Why it is Key for Both Short Term and Long Term Economic Growth.
The Myth of the Sole Inventor, By Mark A. Lemley, Stanford Law School http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1856610
Professor Mark A Lemley has written a paper suggesting that sole inventors and individual genius does not exist. Mr. Lemley teaches patent law and intellectual property law at Stanford University. However, Mr. Lemley is not a patent attorney, does not have a technical background and as his paper proves does not understand of technology. Mr. Lemley’s idea of collectivist invention ignores three basic facts:
1) Groups of people are made up of individuals.
2) Every individual has to think for themselves – you cannot think for someone else, which is a source of frustration for every parent (child).
3) Throughout history the rate of invention was very slow until we introduced property rights for inventions (patents).
Lemley purposely downplays Edison’s achievement. The fact is that Edison created the first high resistance, long lasting, incandescent light bulb. This was a huge achievement that made electrical lighting commercially feasible. Many “experts” with Ph.D.s from the most prestigious universities at the time said electrical lighting was impossible commercially. Lemley also has his history wrong. Swan was the most important inventor of the light bulb, before Edison. He mentions Man and Sawyer, who I find no reference to in any history of the incandescent light bulb. Lemley appears to have no regard for facts. His analysis of the Wright brother’s achievements is similarly sloppy and just plain wrong.
Lemley’s argument that great inventions are created by multiple people simultaneously has been examined by numerous scholars and found to be incorrect. For instance, see Jacob Schmookler and his ground breaking book, Invention and Economic Growth, which examined this issue. People like Lemley attempt to smear together multiple inventions as being the same invention. For instance, they see Swan’s light bulb and Edison’s light bulb as simultaneous inventions of the light bulb. Lemley may have made this mistake because he does not have the technical background necessary to understand the issues surrounding the invention of the light bulb. However, I suspect that Lemley is not interested in the truth, he is interested in pushing a political theory of collectivist invention. If Lemley’s ideas held any water at all, then you would expect either: 1) the USSR/North Korea should have been one of the greatest sources of inventions in the history of the World, and/or 2) the greatest population centers would be the biggest creators of new technology. The facts are that neither are true. The first is self evident. The second appears to be true until the creation of property rights for inventions. When England and the U.S. create an effective property rights system for inventors almost all significant inventions for the Industrial Revolution are invented in the U.S. and England, even though their populations are much smaller than France, China, India, etc.
Lemley is pushing an old worn out socialist idea that individuals do not matter only the collective. This paper is not novel and its thesis has been proven false over and over again. But socialists do not believe in an objective reality.
The paper is an example of the intellectual and moral bankruptcy of many of our academic institutions.
The Myth of the Sole Inventor, By Mark A. Lemley, Stanford Law School http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1856610
Keynesians believe that you can create economic growth by spending government money. The goal of government spending is to increase aggregate demand. If just increasing demand was the way to increase economic growth, then stealing would also create economic growth. Now you make object that government spending is not like theft. The recipient of the government money did not break any laws when receiving government money, but from an economic point of view the recipient did not provide any economic value for the goods or services they received from the government money and the same is true of the thief. The thief may have expended effort to obtain the money to buy various goods and services, but they did not exchange anything of economic value. Thus, neither the thief nor the recipient of government money provide any economic value for the items they receive because of their theft/welfare. As a result, theft should provide the same economic benefits as government stimulus programs. Since increasing aggregate demand is the goal, thieves perform this function admirably. Most thieves do not save their money and they do not invest, they spend their money – this is part of what makes them thieves. This ensures that the stolen wealth is immediately converted into demand (spent), which is good according to Keynesians. Money that is saved or invested does not immediately increase aggregate demand, which is the cause of economic slowdowns according to Keynesians.
Economic growth or wealth is not created by spending, but by increasing the technological level of the country. If spending (consumption) created wealth, then a farmer could get rich by eating their seed corn. This is complete non-sense. Only by creating inventions or by investing in other people’s inventions can a country increase its per capita wealth.
There are three ways that the government can take money from productive people and give it to non-producers to spend. The most straight forward is to (immediately) tax it from producers. In this case, it is clear that the government is taking money (productive effort) from productive people and giving it to non-producers of the wealth. This is exactly what a thief does. We know that this is not a 100% efficient process, since there is the cost of collecting (stealing) the wealth of the productive people and giving it to non-producers. This requires numerous government bureaucrats and effort on the part of honest taxpayers. However, this is not the only loss in the transfer of wealth. The government has substituted its judgment or worse the judgment of non-producers for producers in how to allocate wealth (productive energy). This means we are substituting the judgment of people who have not proven the ability to create wealth for wealth producers. We know that most of the recipients will not invest in creating new technologies or diffusing new technologies, as result we know that this money will not result in an increase in economic growth. Note that government statistics will not show the whole result of this decrease of economic output, since government statistics of economic output measure consumption, not production. The Gross Domestic Product is calculated as GDP = private consumption + gross investment + government spending + (exports − imports). At first this formula would appear to balance out government spending and gross investment, but the government can only measure spending, even for gross investment. As a result, when government steals from producers this does not show up as a decrease in gross investment if the producers do not believe that the present climate is not conducive to investment. This is like the government forcing a farmer to eat or give away their seed corn, it does not show up as a net reduction in planting (investment) until later, but it does show up as private consumption. As a result, government stimulus numbers inflate the GDP incorrectly during a stimulus program and under estimate the GDP in times of private sector growth.
The government may borrow or use inflation to fund its stimulus programs. When the government borrows money or causes inflation the overall result is the same, but the mechanism is different. If the government borrows in order to pay for its stimulus program, then this reduces the amount of investment capital available and reduces private sector investment by crowding out investment dollars. It also increases the cost of labor, goods, and services by creating artificial demand. In addition, it results in higher tax rates than would otherwise be necessary in order to pay back the money borrowed reducing long term growth. Inflation is just a way of taxing (stealing) from everyone’s paycheck, savings, and investment. The net result is to transfer money from productive people to unproductive people. Since inflation does not immediately show up in the Consumer Price Index, it artificially inflates the GDP during stimulus programs at the expense of future economic growth. Inflation does not immediately show up in the CPI because the government measures the CPI at distinct intervals and because the CPI does not distinguish between changes in demand and inflation (an increase in the amount of money). Much like the way the government measures GDP, the CPI understates the inflation during times of economic contraction and overestimates the CPI in time of economic growth. Increased demand for products and services during a time of economic growth shows up as inflation in the CPI numbers, while decreases in demand during recessionary periods shows up as deflation or low inflation in the CPI numbers.
Now some people may complain that the people being taxed are not (necessarily) producers. For instance, the banks that were bailed out by TARP or the carry trades created by the Federal Reserve, or other corporations (GM, Chrysler, GE, etc.) bailed out by the government. However, the government cannot fund itself except by taking money (wealth, productive effort) from producers ultimately. Taxing government leaches results in a circular system that is negative sum game that would collapse very quickly, but for producers. Taxing non-productive entities does not change the basic analysis above.
Now other people may complain that Keynes actual theory was for the government to store reserves during times of economic prosperity and then spend the reserves during economic downturns. While this may be preferable to a spendthrift government, such as the U.S. presently, it does not change the overall analysis. It just means that during times of economic prosperity, government is overcharging, has a higher tax rate than necessary. This results in underinvestment in technological, which means a lower rate of economic growth rate in the future. In economic downturns, Keynes still advocated spending on things that created immediate demand, not on investing in inventions. Such as paying people to dig holes and then filling them up. Thus, this also lowers long term economic growth. Finally, Keynes did not take into account the large overhead (entropy) necessary to take this money away from productive citizens.
Stimulus programs overinflate the GDP while the stimulus money is being spent, by ignoring the decrease in investment capital. This decrease in investment capital results in lower long term economic growth, since it means there is less money (wealth) to invest in new technologies in the future.
Not surprisingly, this also results in higher unemployment rates. There was a recent study by Timothy Conley from the University of Western Ontario, Canada Economics Department and Bill Dupor of Ohio State University which showed that the U.S.’s recent stimulus program killed two private sector jobs for every job saved or created. This is just one of many examples that shows Keynesian economic theory is truly VODOO ECONOMICS
IF KEYNESIAN THEORY WORKED, THEN THEFT WOULD INCREASE GDP AND WEALTH.
 For those engineers and people with a mathematical background saving is like a capacitor (integrator), draining the capacitor increases the short term current, but reducing the current in the future.
 Even if the money is borrowed from foreign investors, it reduces the amount of investment capital. It also reduces the willingness of foreign investors to invest inU.S. companies.
 A carry trade is when the Federal Reserve allows banks to borrow money at a lower interest rate than they can loan it out at (risk free). The most egregious example is when political powerful banks (corporations) can borrow from the Federal Reserve at a lower rate than short term Treasury Bills are yielding. This takes absolutely no intelligence to make huge amounts of money, as long as the Federal Reserve will loan out money. This is how the TARP banks have been able to pay back their TARP loans. However, it is just a fraud and the cost of this fraud is being paid for by the American taxpayer/worker.
Henry R. Nothhaft author of the book Great Again was interviewed on the Dylan Ratigan show on MSNBC and the Harvard Business Review blog radio. The Dylan Ratigan show focused on job creation and how all new jobs are created by startups not by small business or large corporations. Mr. Nothhaft argues thatWashington is forcing a once size fits all government on American businesses. He wants an immediate freeze on new regulations on startup business and a carve out from Sarbanes Oxley and Dodd Frank for companies with a market capitalization less than $500M. He explains that multinational companies have choices to create jobs in theUS or outside the US and suggests that large companies have decided to create jobs outside the US. While I think it is important to point out the current business climate in the US is causing companies to move overseas, the reality is that large corporations never produce large numbers of net new jobs and they are not the engine of innovation. The host attempts to argue that labor rates are the only reason that companies are relocating outside the US. Mr. Nothhaft explains that for high technology companies labor costs only represent 3% of their total expenses and it is the US tax and regulatory structure that are killing startups.
One of the panel members suggests that Google, Facebook, Twitter, etc show thatSilicon Valleyand innovation in the US are doing just fine. First of all, Google was started in the late 1990s before SOX, other regulatory burdens and before the patent system in this country was undermined. SOX and the changes to our patent system have destroyed the venture capital market in theUS. Second, social media companies have not driven the entire economy like the Internet did in the 1990s and the personal computer did in the 1980s. These companies and the social media industry are isolated islands of success that have little significance to the broader economy. If the panel member had any insight to the US economy he would known that the number of technology startups has declined precipitously. The Information Technology and Innovation Foundation index ranked the US dead last among 40 countries in the change in our rate of innovation last decade and many other indicators show the US is falling behind technologically.
The host of the show and the panel seemed to have no idea what Mr. Nothhaft was talking about. My guess is that the host and panel are all Wall Street experts who believe finance is the American economy. They believe in Keynesian economics in which manipulating the money supply and increasing demand by increasing government spending are all that matters. They have no idea what affects technology startups and they do not really believe they are important. They do not understand that technology startups create the inventions that increase our real per capita income.
The Harvard Business Review interview again focused on how startups create jobs. Mr. Nothhaft again argues for a two-tiered approach to SOX and other financial regulations. He argues that technology startups do not use leverage and do not pose a threat to the financial system of the US. He also points out that Lehman Brothers, AIG, Goldman Sacs, etc. were all SOX compliant going into the current financial crisis.
He later explains that the patent system has been undermined by the theft of user fees from the Patent Office by Congress to the tune of over $1B in the last two decades. Congress just stole another $100M from the Patent Office in the continuing resolution bill – See Stealing From Inventors.
The HBR interviewer is also ignorant of the US’s lack of innovation in the last decade. She does not understand that increases in technology are the only way to increase real per capita income. The host ends the interview with the condescending comment that it’s clearly a very complex issue. It is not complex! When the government interferes with property rights (particularly patents) and imposes absurd regulatory burdens (SOX, Dodd Frank) and the US has the highest corporate tax rate in the World it is straight forward that the result will be fewer businesses, fewer jobs, and a lower standard of living for all.
I respectfully disagree with Mr. Nothhaft’s two-tier approach to SOX and other financial regulation. First of all, Mr. Nothhaft points out that SOX failed to stop financial fraud and the 2008 financial meltdown. He points out that the companies he believes should be subject to SOX were all SOX compliant, but they were also the ones that caused the financial meltdown. So if SOX does not work, why have a two-tiered approach? SOX should be repealed – period. Second, laws that only apply to certain people or businesses are the essence of tyranny. A good law should apply to all people equally, much like a law of physics/nature. When Congress exempts itself from certain laws (e.g., antidiscrimination, Social Security, Obama Care, etc) and makes convoluted tax laws to help the politically connected at the expense of the rest of the country, you know that you are on the path to tyranny. Adding another law that only applies to certain businesses will only accelerate the US’s decline into despotism.
The excellent book Great Again by Henry R. Nothhaft with David Kline, points out that 2000 was the year in which the tax and regulatory burden in theUS reached a tipping point compared to other OECD (First World) countries. 2000 was also the year in which average corporate tax rates of OECD countries fell below theUS’s. TheUS now has highest marginal corporate tax rate in the world (in most states) and our effective tax rate is 50% higher than the European Union average. Is there any wonder why the US is losing high quality jobs to other countries?
The book’s identification of the year 2000 as the tipping point is ironic since this is also the year that I identified in my book as the tipping point for anti-technology startup regulations. The book Great Again calls the decade from 2000-2010 the lost decade, let’s hope it is only a single lost decade. Besides the negative effects of the US corporate and capital gains tax rates, the US has also significantly weakened our patent system and made it extremely difficult for startups to raise capital because of Sarbanes Oxley (although Dodd Frank only makes this worse). The major asset of startups is their patents – legal title to their inventions. Weakening our patent system has undermined this asset.
Some other interesting points made by the book include that a SBA (Small Business Administration) study showed that 1% cut in the corporate tax rate increases the number of start-ups by 1.5% and decreases the rate of failure by 8%. A World Bank study showed that 10% increase in the effective tax rate results in 2.2% reduction in investment to GDP.
The policies necessary to grow high quality jobs and get our economy growing are clear. The only conclusion is that the US is not interested in growing the economy, it is only interested in growing government power.
Great Again: Revitalizing America’s Entrepreneurial Leadership, by Henry R. Nothhaft with David Kline
Hear is an excellent article, IT’S OFFICIAL: The IPO Market Is Crippled — And It’s Hurting Our Country in the Business Insider, on the damage we have done to our capital markets. The article starts out by showing that many of our biggest companies went public when they were very small. At the time there were numerous underwriters and often the main inventors were individual investors. For instance, the article explains:
As recently as 1986 Adobe had an IPO raising $6M. None of these companies could have gone public in today’s environment even adjusting for inflation. Virtually all the buyers at the time were individuals and there was a robust “over the counter” after market for young companies.
The article then explains that a company has to have a market valuation of $250M or more to be viable in today’s market. My estimates are higher. The article points out that a major reason for this change in the market is because of Sarbanes Oxley or SOX, which imposes onerous accounting requirements on companies. The article then discusses some attempted solutions to this problem. (I have suggested an alternative in my post Circumventing Sarbox and the IPO drought)
This has been a disaster for the venture capital industry. As a result, VCs are looking for companies that can exit by M&A at earlier states. VCs are also not investing in capital intensive companies.
Unfortunately, the article calls for half measures of curtailing but not eliminating SOX. They suggest this course of action despite the fact that they do not single benefit provided by SOX. The authors point out that:
The number of annualU.S.issuers listing IPOs onU.S.exchanges has declined since 1996 from 756 to a low of 36 in 2008 and 50 in 2009 and 120 last year according to Dealogic. By contrast, there have been 346 Chinese issued IPOs listed onChinaexchanges in 2010 even though the U. S. GDP is 3x larger thanChina’s.
This is just one more example of how were are exporting our innovation and jobs overseas.
The insane thing about our securities laws is that in the U.S. you have to hire a lawyer to invest in a non-public company, but you can blow your money in Vegas, Atlantic City, etc freely. One activity creates jobs and wealth and creates value. The other is a less than zero sum that destroys wealth.
This is a guest post by David Boundy directed to fellow patent attorneys.
The bill tilts the playing field in favor of multinational corporations and market incumbents. The bill shifts from today’s emphasis on disclosure and disruptive innovation to favor trade secret and market incumbency, in the following ways.
- The § 102(a) grace period is totally repealed. Every inventor will be in a race against all other possible disclosures—no inventor will have the time to perfect and test an invention before filing. All companies will be forced to file before an invention is fully understood or tested. That will be expensive for your clients and trouble for you as an attorney, and reduce patent quality.
- Inventors, entrepreneurs, and startups use the grace period of § 102(a) to meet with investors, do the trial-and-error of R&D, and test their inventions. Under today’s law, the implied obligations of confidentiality in conversations with investors and early-stage partners give sufficient protection to permit these ordinary business activities. The bill repeals all these protections, and replaces them with a flimsy grace period that creates unacceptable risk of loss of patent rights, that no business can rely on—though adds strong protections for large companies that can raise all their financing, and do all their manufacturing and testing in-house. Inventors won’t be able to talk to investors without a patent, and won’t be able to file an application without an investor.
- The bill states that an inventor can recover patent rights if he can prove that all other disclosures originated with the inventor—but the bill neglects to create a procedural forum for showing derivation in cases where the leak is not embodied in a patent application, or where the leak neglects to attribute the original inventor. As a practical business matter, the bill leaves no commercially-feasible grace period, an integral part of U.S. patent law since 1839.—you will have to file every application as soon as possible, often long before the invention is ready.
- Today’s law gives Americans several advantages over foreign inventors (under the “Hilmer rule”). The bill removes these advantages, and instead places American inventors at a disadvantage to foreign inventors. Consider this fact pattern:
- A German inventor files a patent application in Europe, and later in the U.S. under a bilateral treaty
- Shortly after the German’s first filing, an American files a patent application in the U.S. on a similar (not identically the same) invention, and then under the same treaty in Europe
Under the proposed legislation, the German’s patent application will be prior art that blocks the American in the U.S. If we switch them around, so that the American files first, then the American does not block the German in Europe. The bill does not “harmonize” the law, and the difference disfavors Americans.
- The bill provides that all disclosures within and by a single company do not create bars. This is great for multinational companies, with large in-house staffs, but totally useless for a startup or small company that has to partner with outsiders. Startups use and need the options and protections of current law, but the new bill cuts them away.
- A single offer for sale or public demonstration one day before filing a patent application will irretrievably destroy patent rights, if the poorly-drafted language is interpreted literally.
- The § 102(b) grace period is cut back—it no longer protects against activities by third parties, but only the inventor’s own activities.
- A new “post grant review” procedure allows a competitor, at a time of his own choosing, to start a half‑million dollar proceeding against a patent holder that has threatened no one. Existing, more modest versions of this procedure have already put companies out of business.
- As a patent attorney, you will no longer have time to do a good job preparing a patent application, you’ll be “forced to file” prematurely. This will expose you to risks and destroy your weekends. Poor initial applications will drive up post-filing prosecution costs. The stricter and earlier filing deadlines will place you at a blocking point for many of your clients’ business activities, harming your client relationships. Where good patent attorneys are allies in creating value for businesses today, the bill will move you to being a cost—at a much lower billing rate.
The bill destroys commercial certainty and corrupts the incentives in the system:
- Various statutory requirements that an applicant act “without deceptive intention” are repealed—in the future, applicants will have incentive to act with deceptive intent.
- Key terms of art are redefined—you’ve spent a career learning the meaning of “on sale” and “public use,” but the legislative history fundamentally redefines these terms. It will take decades for courts to establish new precedent to provide any meaningful commercial certainty.
- The Metallizing Engineering “secret commercial use” bar is repealed—a company will be able to use an invention as a trade secret, and then spring a patent on the public years later. That favors market incumbents, but makes innovation harder for everyone else.
- The “best mode” requirement is reduced to a sham: a patentee will be permitted to disclose only a fictitious embodiment, while holding the best as a trade secret.
- The bill gives companies the right to patent and repatent inventions for years, to keep them locked up, neither using them nor permitting them to be used, for far longer than 20 years.
- Several aspects of the “first-inventor-to-file” provision—the ones that give patents to second inventors, and to companies that kept inventions in secret for years before filing patent applications—violate constitutional limits on Congress’ authority—years more litigation and commercial uncertainty.
- The Act allows Wall Street banks to attack “business method” patents that they are infringing. This doesn’t extend to any other industry, only business methods—another Wall Street giveaway.
The bill is out of committee—further amendments are unlikely. It is literally impossible to alter the bill to meet the needs of startups through an amendment strategy at this late date. The multinationals and their congressional allies smell victory. They see no reason to allow any weakening of their preferred bill through amendments favoring small businesses. The only option at this point is to vote it down.
Typical inventor activities that no longer “work”
Most startups, and many inventions at established companies, go through at least one of two “stories.” They’re reasonable commercial practice under today’s law, but not under the bill:
- An entrepreneur with nothing but an idea typically has to present his idea to dozens of venture capitalists and potential manufacturing or marketing partners, without formal confidentiality agreements, to get a company started. (VC’s never sign confidentiality agreements for first meetings.) This works under today’s law, because of the implied obligation of confidentiality and the protection of § 102(a), but under the bill, these conversations will create commercially-unacceptable risks to the investor and partner. U.S. inventors will be under the same “Catch-22” as European inventors—unable to talk to potential investors until a patent application is filed, but unable to file a patent application without an investor. Startups will die before being born.
- Companies that need a long “invention incubation” period—trial and error, conceive, test and discard, until finding the “magic combination” of techniques—use the § 102(a) grace period to do their R&D in confidence, and file patent applications only when it’s clear which inventions are valuable, and how they work. Under the bill, a company will have to file a continuous stream of patent applications, many directed to inventions that are dumped under current law. This will increase patent costs remarkably.
Almost every startup goes through one of these two, many through both, as new companies create new wealth and new jobs under today’s law. Inventors wait to file quality patent applications until they have quality inventions. America’s unique and strong right to file in the future, after the inventor and investor know whether the invention is valuable, makes business easy, and prevents wasted costs for inventions that prove worthless.
The “America Invents Act” revokes this historic right. Property rights turn on non-business legal technicalities created to satisfy bureaucrats, technicalities that will cost $1 billion annually. The bill requires a company to file premature, hasty, and expensive patent applications on every baby-step idea to preserve rights against third parties who are dabbling in the field without intent to develop a commercial product. The America Invents Act makes these two stories nonviable for startups—because the authors “didn’t think” about them, or didn’t want to.
In 2010, the Kauffman Foundation and Census Bureau released two studies on job creation. Both found that “net job growth occurs in the U.S. economy only through start up firms.” If creating new jobs is Congress’s Job One, then killing the America Invents Act is a good place to start.
The proponents’ arguments do not survive scrutiny
Proponents suggest that the bill does away with complex and costly interferences. That’s true, but irrelevant. Under 100 applications per year end up in interferences. In contrast, the change to today’s “§ 102(a)” grace period affects commercial decisions and raises costs for hundreds of thousands of inventions per year, during the time before filing, by giving inventors and patent attorneys time to get it right the first time. Because the Patent Office has no insight into the pre-filing process of invention, it simply hasn’t taken into account the realities of invention incubation and the costs of its proposal. Further, the proposed replacement, “derivation proceedings,” are the most costly disputes in patent law in those jurisdictions where they exist.
Second, proponents argue that provisional applications will be a cheap way to preserve rights. But that isn’t true under the new law. Under current law, a cheap provisional is useful to show conception and diligence. But under Patent Reform, a provisional application only provides legal benefit if prepared with full § 112 ¶ 1 care and completeness. For a typical startup invention, the cost in attorney fees and inventor time for a provisional application is $10,000 or more—a formidable barrier to an entrepreneur’s first conversation with an investor.
Third, proponents argue, “The bill locks in rights if you publish a disclosure of the invention.” But all companies rely on secrecy for their future plans. No company publishes its most sensitive and advanced technology years before introduction. This argument ignores business reality.
This intriguing question and its implications for US economic policy are tackled in the groundbreaking book Great Again, by Henry R. Nothhaft with David Kline. They answer the above query with a series of questions:
Could a twenty-year-old college dropout, just back from six months in an ashram somewhere, attract funding for a capital-intensive venture based on the manufacture (yes, the manufacture) and sale of a $2,500 consumer product unlike any that had ever been bought by consumers before? One whose potential uses were at best unknown, and possibly nonexistent? And one for which the total current market size was exactly zero?
Not only could Apple not get funded today, it probably could not go public. Nor would Apple have received its first patent (USPN 4,136,359) in only 20 months. The book asks “how many of today’s Apples are not getting a chance?”
The authors use the above example to make a broader point that theUSis failing economically and technologically because of the policies we are pursuing. They show that all net new jobs created in theUSsince 1977 (and possibly longer) were created by startups like Apple. All increases in real per capita income are due to new technologies and most revolutionary/disruptive technologies are created by startups and individual inventors. So what are the policies that have undermined our economy, by undermining technology startups?
The book examines five areas:
1.Role of regulations. The Authors show that our tax policies, Sarbanes Oxley and our indifferent (some might say arrogant) regulators’ application of well meaning regulations to startups is driving them either overseas or out of business.
2. Underfunding the patent office. This is costing theUS millions of jobs and billions in GDP. According to the authors, each issued patent is worth 3-5 jobs on average, particularly patents issued to startups.
3. Manufacturing policies in the US. Manufacturing is key, particularly in a world that does not respect property rights in inventions, to ensuring that theUS profits fromUS innovation and not other countries. TheUS is also losing the global battle for human talent.
4. Battle for global talent. Our restrictive immigration policies are depriving theUS of talented entrepreneurs such as Andy Grove, founder of Intel.
5. Funding for research. The book shows that our spending on basic science and engineering is not only declining as a percentage of GDP, but the system has become short-term oriented and bureaucratic.
While this book tackles complex issues, it is a quick easy read. It is full of interviews from entrepreneurs, venture capitalists, and technologists who built America’s technology startups over the last three decades. Great Again provides numerous real life examples to illustrate its points.
This pioneering book shows how the US can create jobs and increase per capita income. The policy prescriptions are based on solid science. Just cutting government spending (balancing the budget) will not cause theUSeconomy to grow vigorously, we need pro-growth policies. The authors are some of the few people that understand what policies are needed for the US to be GREAT AGAIN.
Great Again: Revitalizing America’s Entrepreneurial Leadership, by Henry R. Nothhaft and David Kline
I was confronted with the statement that there are “Hugh transaction costs related to patents.” This statement implies the assumption that these transaction costs are unjustified. I disagree with the premise, but since all systems can be improved I will provide a number of specific proposals to reduce the transaction costs.
The alternative proposed by the author of this statement, was to shorten the length of patents and increase government funding of R&D. The proposed system of government funding for research is not effective substitute for patents. The history of government funding for research is mixed at best and much more expensive than patents. The US patent system is completely funded by user fees (in fact Congress has been stealing user fees to pay for their pet projects). The patent system has been significantly more effective at stimulating innovation than government funded projects – see Zorina Khan’s work including her book The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920 (NBER Series on Long-Term Factors in Economic Development) also see The Most Powerful Idea in the World: A Story of Steam, Industry, and Invention, by William Rosen.
Litigation Costs: There has been a very effective propaganda campaign to suggest that the patent litigation is out of control. The implication is that there is an explosion in patent litigation. This is just not true.
“The real facts of the so called litigation crisis are that for the past two decades the number of patent lawsuits commenced annually has been about 1.5 percent of all patents granted. In 2006, it was 1.47 percent. This is business as usual. Most patent lawsuits, moreover, settle before trial. In 1979, some 79 percent of patent cases settled before trial, while in 2004 almost 86 percent did. Matters are actually improving.
Also, the U.S. has few patent trials. For instance, in 2001 only 76 patent lawsuits were tried and only 102 went to trial in 2006. By no measure can 102 patent trials be considered a national litigation crisis. The annual report of Federal Judicial Caseload Statistics, which is on the Internet, provides the factual antidote to false claims of a litigation crisis (www.uscourts.gov/ caseload2006/contents.html).” see http://www.manufacturingnews.com/news/07/0629/art2.html
Even though this data is a little old nothing has changed in the last several years. In a $14.4 trillion economy built on technology this is anything but a litigation crisis.
There is also a myth that there is a patent quality issue in the US. This is not supported by the facts.
“As to the massive numbers of “unworthy patents” argument, the real-world test is how many patents are challenged and the outcome of those challenges. Between 1981 and 2006 the USPTO issued more than 3.1 million patents. In that period, 8,600 were challenged at the Patent Office through inter partes and ex parte reexaminations. The number challenged amounts to less than three-tenths of one percent. Of those challenged, about 74 percent resulted in claims narrowed or cancelled. In addition, almost 60 percent of the relatively few patents challenged in a court trial are sustained.
My point is that the USPTO’s work is certainly not perfect, but the Patent Office is also not pouring out a stream of bad patents.” http://www.manufacturingnews.com/news/07/0629/art2.html
By every objective measure: R&D per patent, GDP per patent, and number of citations per patent patent quality is increasing. See http://hallingblog.com/2010/01/07/patent-quality-nonsense/ and http://hallingblog.com/2009/08/18/patent-quality-myth/.
Cost and Time to Obtain a Patent: When Edison applied for his light bulb, he received a patent in 3 months. The reason it takes so long to obtain a patent today is because Congress has been stealing money from the Patent Office.
I have an angel investor friend who was a highly successful entrepreneur who complained that when he invested in a company he did not know about hidden prior art and this created a large amount of uncertainty. He supported the idea of publication of patents. However, the answer was not publication of patents, which breaks the social contract, but fully funding the patent office – as the Edison example above proves.
Disingenuousness of Libertarian Argument about Costs of Patents: All property rights systems have some costs involved in them. GE employs 600 attorneys to comply with tax laws, it probably employs another 600 to comply with SOX, discrimination laws, environmental laws, health and benefit laws. However, it probably employs less 100 patent attorneys. Their patent costs are a drop in the bucket compared to dealing with tax and other regulatory laws. The Libertarian attack on patents in light of all the other burdens imposed on business is disingenuous.
Patents are property rights and companies’ purposeful infringement of other people’s property rights is not a regulatory burden, it is the result of purposeful belief that they can get away with the theft. It is called efficient infringement. See “Technology Theft as a Business Strategy” http://hallingblog.com/2010/03/24/pat-choate-technology-theft-as-a-business-strategy/
Patent Litigation: While patent litigation costs are similar to litigation costs generally, there are a number of things that can be done to make the system more efficient. Some are changes to government and some are private sector initiatives.
Secondary Market/Title Insurance for patents. Before the advent of title insurance it was very expensive to buy a piece of land. You had to pay an attorney for a title report that did not come with any insurance. Lawsuits over the boundaries of real property were epidemic before the advent of modern survey tools. Patents are in the same position where no title insurance has been created. Unfortunately, antitrust law undermined the first efforts to create a title insurance/secondary market for patents. Patent pools were a way to determine the validity of patents, enforce patents, and widely license the patents in a cost efficient manner. But the antitrust idiots said that they were illegal. Today, Luddites are using the rallying cry of “patent troll” to kill off the beginning of a secondary market – see http://hallingblog.com/2009/09/18/in-defense-of-patent-trolls/ For more information see Jump Starting a Secondary Market for Patents http://hallingblog.com/2009/11/16/jump-starting-a-secondary-market-for-patents/.
Accelerated Patent Court: A new court similar to the ITC that has expertise in patents and accelerates the patent litigation process is needed. The court should be sufficiently funded and have procedures that allow patent cases to be resolved in under a year. Perhaps the court would be limited to issuing injunctions as a remedy as opposed to economic damages. The goal of this new court is to establish the US as the premier arbiter of patent rights. The US is the best positioned country to protect patent rights, despite our recent history. This would increase the US’s standing as a technological leader in the world and draw innovative companies and people to the US.
Judges: Appoint judges with technical backgrounds and who have passed the patent bar to adjudicate patent cases. Judges without these qualifications make silly mistakes, such as stating that any invention that is just a combination of known elements is suspect whether it should obtain a patent. All inventions are combinations of known elements – it is called conservation of matter and energy. You cannot create something from nothing. (For more on the Supreme Court’s ignorance see http://hallingblog.com/2010/01/19/ksr-supreme-ignorance-by-supreme-court-2/ )
Patent Reciprocity: One of the largest costs of obtaining patent protection is foreign filing. Patent reciprocity would significantly reduce this cost.
If you drive your car across the border into Canada you do not lose title to your car. If you take your manuscript across the border into Canada you do not lose the copyright to your manuscript. But, if you take your invention across the border into Canada, you lose your patent protection and anyone can steal the invention – not the physical embodiment, but the underlying invention.
Patent reciprocity would automatically provide patent rights in a foreign country when you obtained a patent in the US and vice versa. This idea was first proposed by the US in the mid 1800s according to B. Zorina Kahn’s book “The Democratization of Invention: Patents and Copyrights in American Economic Development, 1790-1920“. Unfortunately, the idea died and since then patent rights have been part of the convoluted process of trade negotiations.
Patent reciprocity would significantly increase the value of patents and increase the value of research and development. As a result, it would spur investment in innovation. Reciprocity would increase the valuation of technology start-up companies in all countries that participated. It would also increase per capita income.
Eliminate Maintenance Fees: Maintenance fees are the major cost associated with a patents filed outside the US.
Maintenance fees are a backhanded way of introducing a “working requirement” to patents. Working requirements for patents have always been rejected in the US. These fees favor large entities and reduce the effective life of patents.
A strong patent system pays for itself several times over in increased tax revenues from increased economic activity. The supply side returns from a strong patent system probably exceed the return resulting from lowering the capital gains tax.
Reduce Formalism in Patents: A large part of the cost of obtaining and litigating a patent is overly formalistic requirements. The Non-obviousness requirement should be repealed. It is not logically a part of the definition of an invention and is the source of uncertainty, and increases the cost of both obtaining and enforcing/defending patent lawsuits. For more information see Non-Obviousness a Case of Judicial Activism http://hallingblog.com/2010/06/18/non-obviousness-a-case-study-in-judicial-activism/.
Some of the other overly formalistic requirements include the rules on restrictions, the inequitable defense, and the silly requirements related to section 101. Restrictions are required for trivial differences that are embodiments of the same inventive idea. The doctrine of equivalents has been dead for over a decade. Formalism over logic rules in the realm of inequitable conduct. USC 101 issues related to software inventions also place form over function that require absurd recitations to computer hardware. All of these formalistic requirements favor patent thieves at the expense of real innovators.
- Interesting Academic Study on Value of Patents to Startups
- CLS Reply Brief: Alice v. CLS Bank Supreme Court
- Win a FREE Copy of Pendulum of Justice
- Are Patents too Vague?
- Halling asked to Speak at Atlas Summit 2014
- Book Review: The Nature of Technology
- Business Method Patents: A Solution?
- Philosophy of Science
- Guest Post: Stop the Destruction of Independent Invention
- DK Halling Interview with Fran Lewis