Finding That Free Lunch

from the looking-at-economic-growth dept

One of the most common sayings in economics is "there's no such thing as a free lunch." And, it's true: everything you do has some sort of cost in terms of opportunity costs. That was the point of that statement. Unfortunately, however, it appears that some have tried twisting that statement into saying that "free" doesn't work as a part of economics. A few weeks back the Economist (normally good on such subjects) wrote an article that trashed the concept of "free" within a business model, totally misunderstanding how free is a part of a business model, rather than the business model itself. Chris Anderson already did a good job ripping apart the Economist's article, but I wanted to address a different aspect of the whole "free lunch" question.

Too many people, it seems, assume that "there is no free lunch" means that the market is entirely static. That is, they believe it's a zero sum game. If I do x, then y loses out. So, if I am offered free internet service or a free lunch, then whoever provided that is out the same. But that's simply not true. Economics is not a zero sum game, but is built around economic growth -- where the sum of economic activity can be greater than the parts. If I do a transaction with you, and in the end, we're both better off (i.e., we both got more value than we gave up), then the amount of overall value in the world increased. It might not be a "free" lunch (the economic transaction cost me something), but new utility is created above and beyond what was there before.

This is a key point that is often overlooked by those who slam the concept of free and assume that it can't happen or it can't work. They overlook how free is a part of a larger economic transaction that actually does increase overall utility and economic growth. This is the key insight that economist Paul Romer had a few years back in noting that the core way to increase an economic market was to insert what he called "non-rivalrous, non-excludable goods" -- which I've taken to calling "infinite goods." These are "goods" that can be replicated at absolutely no cost, increasing the size of a market and increasing the overall utility in the world. As Romer noted:

Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. Human history teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material.

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 add up. They multiply.

The trick (and where the trouble comes in) is that it's not always easy to figure out how to capture a piece of that larger market -- especially if your old business model was based on a very different type of scarcity. Yet, those who figure out how to put these models into practice will find that their markets grow bigger and bigger, and while there are tradeoffs, they'll have something about as close to a "free lunch" as you can imagine.

Anyway... we'll be exploring these ideas and more at The Free! Summit next month, so hopefully you'll be able to join us. Speaking of which, if you're interested in presenting a case study about how you're leveraging free, the organizers of the event are holding a competition via Vator.tv where you can enter to present.

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Some Thoughts On Saving The Economy

from the that-interest-isn't-special dept

The NY Times Magazine is running a well worth reading (if long) article on the question of what sort of efforts are needed by the government to help "save" the economy. While almost anyone (myself included) will find points worth quibbling about in the article, there's a lot of good points made that are worth reflecting on in more detail. The key point is understanding the difference between just creating more jobs in the short term and actually creating sustainable economic growth that will make it possible to pay off our debts in the future (and more).

As the article notes, if you just want to create jobs, you put people to work digging useless ditches. That creates jobs, but it does little else to stimulate the economy -- and, in fact, can do plenty to hinder future economic growth by inefficiently allocating resources. It's Bastiat's old Broken Window's Fallacy of inefficiently allocated resources. The problem, though, is that the folks who are most interested in making sure those resources are allocated inefficiently, are in the best position to make that happen. And that's incredibly dangerous. The article refers to Mancur Olson's theory of how stable and affluent nations decline and fall. The NY Time's summary is a good one:

Successful countries give rise to interest groups that accumulate more and more influence over time. Eventually, the groups become powerful enough to win government favors, in the form of new laws or friendly regulators. These favors allow the groups to benefit at the expense of everyone else; not only do they end up with a larger piece of the economy's pie, but they do so in a way that keeps the pie from growing as much as it otherwise would. Trade barriers and tariffs are the classic example. They help the domestic manufacturer of a product at the expense of millions of consumers, who must pay high prices and choose from a limited selection of goods.

While the article is right about trade barriers and tariffs, don't get hung up on just those. It applies in numerous other ways as well. The healthcare system (which the article discusses in great detail) is a disaster based on a series of rules and regulations that have inefficiently allocated healthcare resources. Our entire healthcare system is a ponzi scheme, of sorts, based on ignoring the very basic lessons of moral hazard -- where we've totally separated the actual costs from the actual payment for healthcare, and created a massively inefficient bubble that encourages bad spending on the wrong things, rather than work towards keeping people healthy. Pile on top of that a bad patent policy that diverts massive funds from actual healthcare into drugs without recognizing that the two are not the same thing, and you have a massive problem that doesn't get solved overnight. And, of course, we're not even discussing policies that work hard to actually artificially limit healthcare providers...

But, while the article paints some positive pictures of some of what the new administration is doing (and saying) -- and I'm thrilled with what some of the administration folks are talking about, there are way too many examples of things going in the other direction. We've already covered the broadband stimulus plan -- which really does look like a huge gift to incumbent players. When pushed on that, Obama's transition guy, Blair Levin, defended it in exactly the way you'd worry about based on the above, saying that the short term focus was on creating jobs, not solving the wider broadband question. The problem is that in creating those jobs in the short-run, they're likely harming overall economic growth in the long run.

Then there are additional things that are troubling, such as the decision to include "buy American" clauses in the stimulus. This is the sort of thing that is often demanded by folks who have little understanding of economics, but plenty of understanding about how things appear politically. Buy American sounds good, but in this case it actually does plenty to harm the American economy -- as it did in the last Great Depression. When the American producers are a lot less efficient, the end result is that we end up spending more and getting a lot less for our taxpayer dollars. That hinders growth (significantly, in some cases) and actually does plenty to damage the American economy. It also falsely boosts the incumbent providers bottom line (see above, again, about those special interests) and doesn't get them to adjust and adapt to the changing market in a timely fashion. Even worse, it often pushes other countries to retaliate in ways that make our economy even worse off. It's a terrible policy and it does significant harm to our economy.

I still remain unconvinced that a massive government spending plan is necessary, but given that's the route we're clearly going down, all our focus should be on making sure that the choices made within that stimulus package are not focused on protecting any particular industry or company, but in creating platforms and infrastructure that allow anyone to compete and contribute to economic growth. To date, there's little evidence that this is actually happening, and that's scary.

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Putting The Financial Crisis In Perspective: It's Tough To Keep Economic Growth Down

from the 140-year-view dept

If you're at all interested in economics in general, you should read David Warsh's Economic Principals column, which is always interesting (and you should absolutely read his fantastic book Knowlege and the Wealth of Nations, which is highly relevant to many of the discussions we have around here). Anyway, his latest column shows a nice little chart of per capita GDP in the US over the past 140 years or so, which effectively shows a pretty consistent upward trajectory, where even recessions and the Great Depression -- which is noticeable -- are hard pressed to stop the eventual economic growth. The message is pretty clear: it's hard to keep economic growth down. In the midst of a great contraction and massive deleveraging, that message seems to get lost pretty quickly -- but it's worth remembering.

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If Washington Wants To Create Jobs, It Should Get Out Of The Way In Silicon Valley

from the lead,-follow-or-get-out-of-the-way dept

It's already quite clear that Sarbanes-Oxley has done very little to actually prevent fraud of any kind, but it has been a tremendous burden, especially on smaller, innovative companies that help grow the economy and create new jobs. It's basically become a huge tax on tapping into public financial markets for growth. Michael S. Malone is now making the argument that if the incoming presidential administration is serious about creating jobs, it's time to roll back SarbOx and other accounting rules that have acted more for theatrical purposes rather than any legitimate reason. Basically, all they've done is create new reporting requirements that do little to nothing to either prevent fraud or clarify a company's actual financial position (its intended purpose). Regulators love these sorts of bogus rules because it makes it look like they've done something, when really all they've done is put up huge hurdles for actually doing anything. I'm all for radical transparency in financial info, but that's not what has been done. Instead, we've made it burdensome to actually grow a company -- and that doesn't help create jobs. It helps kill them.

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