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Archive for November, 2010


Ayn Rand & Economics

Many people first become interested in economics because of Ayn Rand’s works such as Atlas Shrugged.  Ayn Rand did not develop a science of economics, she defined the moral codes for an economic system – specifically capitalism.  In the very first sentences of Capitalism: The Unknown Idea, Rand states:

This book is not a treatise on economics.  It is a collection of essays on the moral aspects of capitalism.

As a result, when students of Rand want to understand the science of economics they would often start examining the works of classical economics.  Adam Smith explained that the invisible hand resulted in people pursuing their own interest efficiently allocating scarce resources.  He also explained how specialization resulted in increased wealth using the example of a pin factory.  Commonly, people will then read Hayek who explains the limits of bureaucrats’ knowledge and how the price system is an information system for organizing resources.  Friedman who explains the problems of manipulating the money supply and Austrian economists who show that the value of a product (service) is subjective.  This study usually leads to two organizing principles of economics: supply and demand and that wealth is created in a free market by competition driving down the price of goods.

This leads to certain conflicts between economic science and Ayn Rand’s Philosophy.  For instance, if competition is an unqualified good then antitrust laws that encourage competition should be good.  But Ayn Rand believed that antitrust laws interfered with the free market and property rights.  If competition was constantly squeezing profit margins how could any person or firm become significantly wealthier than the average person unless they subverted the market.  The extreme version of this was set forth in the book “A Random Walk Down Wall Street.”  The stock market has already priced in all generally available information, so there is no way to beat the market.[1] This is related to the efficient market hypothesis, which is the application of perfect competition to the stock market.  The conclusion from economic science is that those people who get wealthy somehow subvert supply and demand by excluding competition and therefore are not competing fairly.  In other words, people who become wealthy in a free market are acting immorally.  The common solution to this dilemma is to note that human skills vary significantly from one person to the next.  Those with higher skills are able to consistently stay ahead of their competition.  We should not demonize them because those people who get rich do so by providing pleasure to a large number of people.

Alternatively, people who have enjoyed Any Rand’s works usually are interested in business and consider running a successful business, virtuous.  When they start to study business, they find that the last thing you want to do as a business is compete on price with a commodity product or service.  The whole goal of a business is to find or create a market where you can have a competitive advantage.  This is in complete contradiction to what they have learned from economic science.  Markets where a business is able to sustain a competitive advantage result in misallocation of resources, according to economic theory.  However, these are exactly the conditions a successful business seeks.  Ayn Rand says that capitalism and creating wealth in a free market are both virtuous.

By now our objectivist is completely confused.  One solution is to concentrate on personally creating wealth and ignore the free market theorists.  Their ideas of perfect competition are not consistent with Rand’s ideas anyway.  This person will then spend more time studying business.  As they start studying business they will learn that all the really tough problems involve management of people, either customers or employees.  Great business ideas and inventions are a dime a dozen, right?.  A successful businessperson needs to concentrate on the motivations and goals of customers and employees who may not be rational.  Because people are not rational we need to concentrate on their emotions.  This is beginning to sound more like Ellesworth Toohey or James Taggart than John Galt, Dagny Taggart or Howard Roark.

Finding this line of thought a little too emotive our objectivist will search for the real bastions of capitalism.  This search will lead them to Wall Street and the stock market, where no one is afraid to say they are trying to make money.  Here they will find fundamental and technical analysis of stocks.  Fundamental analysis is based on a detailed understanding of a company’s financial statements.  So real wealth is created by finance, right?.  When they study technical analysis they learn that the art of divination is not dead.  Nevertheless with economics focused on the money supply, government debt, tax rates, supply and demand and business focused on venture capital, stock prices, initial public offerings, and bond rates it appears that real wealth is created by finance.  Funny John Galt was not an financier instead of an inventor[2].  How could Ayn Rand have gotten things so wrong?


[1] Of course this does not apply to insider trading.

[2] There are inventors in finance and despite the bad name financial innovation has gotten recently, financial inventions have been critical to the modern economy.  For instance, fractional reserve banking is key to unlocking dead assets and more recently swept banking accounts increased the value of banking deposits.  Even collateralized mortgage obligations probably decrease risk and increase access to capital, when they are not manipulated by GSEs and given false bond ratings by government sanctioned ratings agencies.

 

Thomas Hager’s book The Alchemy of Air, describes the pursuit to fix nitrogen.  A major limitation for food production is the ability to fix nitrogen.  Historically, the solution was the use of manure to provide fixed nitrogen for agriculture.  However, this required huge amounts of manure for very limited results.  Guano and other sources of natural nitrogen were found to be much more effective.  Soils treated with these sources of nitrogen often produced significantly higher returns than those treated with manure.

Sir William Crookes in an 1898 speech warned that the world could soon run out of these natural deposits fixed nitrogen.  If the world did not find a substitute source of fixed nitrogen, then millions of people would starve.  Today we would call this “Peak Nitrogen.”  A number of researchers took up the challenge.  One area of research was to use electric arcs to fix nitrogen.  Another area of research was cyanamide, which combines nitrogen with calcium carbide with a catalyst.

Fritz Haber invented the process of combining nitrogen and hydrogen under pressure and heat with a catalyst to produce ammonia.  The pressures necessary for this process, 100-200 atmospheres, were unheard of at the time.  Haber was only able to accomplish this by carving a chamber out of quartz.  The catalyst he found was osmium.  Naturally, on the eve of rolling out the production process, the patent for this process was challenged.  The challengers argued that Haber’s invention was nothing but a straightforward extrapolation of known applications.  No matter that no one had ever worked at these pressures before, no matter that no one had ever used osmium as a catalyst – it was a straightforward application.  Fritz Haber who invented the basic process and Carl Bosch who scaled up the process for commercial production both received the Nobel Prize in Chemistry.

This shows that critics of patents are not objective.  Even being awarded for a Nobel prize for your work is not enough for many critics of patents.  The Haber Bosch process was a combination of known elements.  Nothing in their process was unexpected in the sense that it violated any laws of physics or chemistry.  Note that the Supreme Court’s KSR opinion cast dispersions on inventions that are a “mere combination of known elements.”  It also suggested that only inventions where an element performed in an unexpected manner did it deserved a patent.  The Supreme Court and critics of the patent system have no idea what they are talking about.  All inventions are combinations of known elements.  The critics attack on patents is more about their biases than the validity of patents.

 

 
Failing of Free Market Theory

I went to an excellent talk by Professor Gary Wolfram, of Hillsdale College, at the Pikes Peak Economic Club last night.  He explained that free market capitalism is associated with the wealthiest nations in the world and centrally planned economies are associated with the poorest nations of the world.  Free markets are based on property rights and the rule of law, not the rule of man.  The freest nations economically have the longest life spans.  The poorest ten percent of the population in the freest countries have a greater share of the total wealth than in non-free countries.  A poor person in the wealthiest/freest countries is likely to live in a house they own, the house is generally a three bedroom house, and most likely has air conditioning.

Professor Wolfram explained that the way you get rich in a free society is to provide goods and services that large numbers of people want.  He stated that we should celebrate people and companies that make large profits, because they have made a large number of people happy.  A big reason why free market countries are so wealth is because they provide an incentive to innovate.  He pointed out how many products that we use today did not exist 30 or 50 years ago.

In the question period of the talk, I pointed out to Professor Wolfram that there is a strong relationship between economically free countries and those that have strong property rights for inventions or patents.  The most innovative countries in the world are those with the strongest patent systems.  Those countries that first escaped the Malthusian Trap were those with strong patent systems.  Vice versa those countries with weak patent systems or non-existent patent systems are poor, not innovative, and are often still mired in the Malthusian Trap.  I then asked why so many “free market” proponents want to weaken or eliminate property rights for inventions (patents).

He rejected my premise that many free market proponents were anti-patent.  He went on to explain that some inventions deserve patent protection that had shorter periods of time and that other inventions deserved longer periods of protection according to a perfect theoretical model of economics.  For instance, inventions that would have been discovered by someone else shortly thereafter should receive shorter terms than “truly novel” inventions.  He also suggested that patents inhibit the diffusion of new technologies.  Finally, he implied that the way we increase our wealth is by driving down the profits associated with products and services.  Reducing the profit margin in goods and services increases the availability of these goods and services.  It is common for free market proponents to see the market process of reducing the profit and cost of goods and services as the major way free markets increase wealth.

Several people pointed out that his proposal for different lengths of patent protection seemed to contradict his idea that capitalism is based on the rule of law, not the rule of man.  The implication was that someone would have to decide which inventions would receive which term length.  As a result, this would be an arbitrary rule of man decision.  In fairness, Professor Wolfram pointed out that this was not true as long as the standard was objective.  While I disagree that we should have different terms for different inventions, Professor Wolfram is clearly correct that this is not necessarily subjective.

The empirical evidence does not support the suggestion by the Professor that patents inhibit the diffusion of inventions and technology.  Those countries with the strongest patent rights also have the greatest technology diffusion.  A major goal of modern patent systems is to spread the information associated with inventions, so that other inventors can build on the work of previous inventors.  There is also no empirical evidence for the idea that inventions would occur without property rights for inventions.  Those countries without strong patent systems do not produce inventions.  The suggestion that, in a free market system, inventions will just occur is at best speculation and the evidence we have shows the opposite.  When the US has weakened its patent system, our innovation has suffered as well as our economy.  For instance, in the 1970s we weakened our patent system and the US started to technologically fall behind Japan.  For more information see Foreigners Receive More Patents Than US!

The most troubling part of Professor Wolfram’s response was the implication that wealth is created in a free market economy by driving down profits.  Professor Wolfram seemed to imply that there was a “correct” or “optimal” amount of return an inventor should receive for a patent.  Shouldn’t we celebrate inventors who create something that everyone wants?  If an inventor creates something very few people want, how does that hurt technological diffusion?  More importantly, is it really true that wealth is created in a free market by driving down the profit margins of manufacturers (or inventors)?

The idea that the real power of the free market to create wealth is in its ability to foster competition (for the same product) and therefore drive down profit margins is incorrect.  If we were able to obtain every product available in 1900 at its cost or even free, we would not be nearly as wealthy as we are today.  Wealth is mainly created, not by cost or profit reduction, but by the creation of new inventions, i.e., technology.  We do not want people/companies competing to produce me-too products, but competing based on inventions.  Shortening the length of patents will encourage competition on me-too products instead of creating new products.  While the optimal length for patents may be difficult to determine, shorter terms will discourage innovation.  There is no evidence that the present length of patents are inhibiting innovation or the economy.

The idea by free market economists that the power of free markets is there ability to reduce the cost of existing products also leads to fallacies about antitrust law (now rebranded as competition law).  This cost reduction theory suggests that we should aggressively apply antitrust law to create competition.  However, the empirical evidence shows that periods of aggressive antitrust enforcement result is low levels of invention and weak economic growth.  For more information see Foreigners Receive More Patents Than US!

Wealth in a free market is mainly created by the invention of new technologies.  It is a failing of economists to suggest that the power of a free market is its cost reduction of existing products.  This fallacy results in an anti-property right policy towards inventions and an aggressive application of antitrust laws.  The empirical evidence shows these policies do not create wealth.

 
Sustainability Isn’t Sustainable

Sustainability is all the rage today.  What do we mean by sustainability?  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.[1] This definition is not testable and is incredibly vague.  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.  Entropy is the second law of thermodynamics and is normally defined as the measure of the disorder of a system or a measure of the energy not available for work.  Entropy was discovered as part of thermodynamics and it explains that a perpetual motion machine is impossible.  Entropy always increases in a closed system.  Sustainability taken literally is an attempt to create a perpetual motion machine.

Some of the key issues for the sustainability crowd revolve around so called non-renewable resources, such as the use of fossil fuels and the using up of other natural resources.  The way this is often phrased today is Peak Oil, Peak Water, Peak _____ (Pick Your Favorite Resource).  For more information see Peak Everything: Eight Things We are Running Out of and Why.[2] 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.”[3] What is 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 is 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 converted 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.[4] 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 nonsense.  It violates the second law of thermodynamics, entropy.

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 guano was an excellent fertilizer.  Population exploded, as guano was used in Europe, because of the additional food that was produced because 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?  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.[5]

 

Reason magazine in the article Peak Everything? discussed how logical, scientific projections showed we would run out of lithium, neodymium, and phosphorus.[6] 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.  It is paradigm shift created by a new invention.  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 a that phosphorous is product of human urine.  The phosphorous can be recycled using a no mix toilet according to the article.

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.”[7]

The computer industry has also been beset by predictions of impeding 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 this reached their limit, they were replaced with relay devices, then these were replaced with vacuum tubes, then transistors, and then integrated circuits.[8]

Life is a fight against entropy.  The unique way humans overcome entropy is by inventing.  Inventions are not subject to diminishing returns or entropy.  Potential inventions grow factorially, which is much faster than diminishing returns from natural resources shrinks.  We do not have natural resources problem, we have an invention problem.  The sustainability crowd are pushing a political slogan not science.  In the process they are actually inhibiting new technologies from being developed, by diverting resources from the most promising technologies to the politically acceptable technologies.

 

 

Sustainability Violate the Second Law of Thermodynamics.

Sustainability is a Political Slogan, not Science.

 


[1] Brundtland Commision, Wikipedia, http://en.wikipedia.org/wiki/Brundtland_Commission, 11/7/10.

[2] Alter, Lloyd, Peak Everything: Eight Things We are Running Out of and Why, Treehugger: A Discovery Company, 5/27/08, http://www.treehugger.com/files/2008/05/peak-everything-8-things-we-are-running-out-of.php 11/7/10.

[4] Note that have been some alternative explanations proposed for how oil is produced that does not involve this biomass conversion

[5] Mark Ridley had numerous “Peak Oil” examples in his book The Rational Optimist: How Prosperity Evolves, Harper Collins, 2010, New York, pp 121 -156.

[6] Bailey, Ronald, Reason.com, Peak Everything?, April 27, 2010, http://reason.com/archives/2010/04/27/peak-everything, 10/16/10.

[7] Bailey, Ronald, Reason.com, Peak Everything?, April 27, 2010, http://reason.com/archives/2010/04/27/peak-everything, 10/16/10.

[8] Kurzwiel, Ray, The Singularity is Near: When Humans Transcend Human Biology, Penguin Books, 2005, p 67.

 

 
Regional Patent Offices

According to David Kappos, Director of the Patent and Trademark Office, we can expect regional patent offices shortly.  He made this announcement at the AIPLA meeting in Washington DC in October.  There are a number of advantages to regional patent offices.  The USPTO is located in Arlington Virginia, next to Washington D.C., where the cost of living is expensive and the 9000 government employees have little significance to the state of Virginia.  By having USPTO west in Denver, Portland, Seattle, Austin, Minneapolis, etc. or some combination thereof, examiner retention rates are likely to significantly increase, since the cost of living is lower.  The pool of qualified, English speaking applicants for patent examiners would increase, since the USPTO has admitted they have a hard time keeping examiners who are not from the northeast.

The USPTO mission is about promoting technology and it makes sense that the USPTO should be located near the centers of technology, not the center of political power.  By having the USPTO near great centers of innovation, examiners are more likely to have a better understanding of the underlying technologies they examine.  Locating the USPTO in multiple congressional districts increases the likelihood it will remain fully funded.

I hope that these regional patent office are fully functioning patent office the with appeal boards and all the art units.  I think this will eliminate the group think that we have seen at patent office in recent years.

 

 
Inventing Wealth

Inventing is the way in which humans create wealth.  Despite this no major school of economics pays more than lip service to invention.  Economics is the study or how people produce goods and services to meet their needs.  If human beings did not invent, then studying economics would be the same as studying evolutionary biology.  Note this is true of history also.  If people did not invent, then the history of humans would be like the history of every other organism.  The only events of interest would be changes in our environment and our biology.  It is only because humans invent, that economics exists.  Below I will review the basics percepts of the major schools of economic thought and their relation to inventions.

Neoclassical economics focuses on the determination of prices, outputs, and income distributions in markets through supply and demand.[1] This school of economics concentrates on equilibrium in the market, which optimizes resources.  This occurs at the price where supply equals demand.  The policy focus of neoclassical economics is disruptions in market equilibriums.  Inventions are not a focus of neoclassical economics.  Inventions disrupt the equilibrium in markets.  They also do not generally fit into supply and demand curves.  What is the demand for an invention that has not been created?

Keynesian economics is in general agreement with neoclassical economics except they see a bigger role for government, particularly to stimulate demand.  Under neoclassical economics changes in supply and demand are equivalent (inversely proportional).  It does not matter if supply increases or demand decreases, the price of the good goes down.  Keynesians use this principle to argue that governments should stimulate demand when the economy is in a recession.  This will stimulate supply or production.  There is no place of invention in this school of economics either.

Marxists economic thought is based on the physical labour theory of value.  It denies the value of mental labor and capital.  As a result, there is no place for invention, which is mainly the product of mental labor.

Austrian economics differs from classical economics in its emphasis on the subject theory of value.  This school emphasizes a very limited role for the government.  Recently it has focused on the Federal Reserves’ adverse effect on the economy.  Austrian’s also do not see a significant role for invention in economics.

Monetarists focus on the effects of central banks on the economy.  They argue that fluctuations in the money supply are tied to business cycle.  According to this school of thought, central banks should focus price stability.  Inventions have no role under this theory.

While there has been economic research on the role of inventions in the economy, which we will examine later, no school of economic thought has integrated the role of inventions into their models of the economy.


[1] Neoclassical Economics, Wikipedia, http://en.wikipedia.org/wiki/Neoclassical_economics, 10/31/10.

 

 

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