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“Entrepreneurship: Productive, Unproductive and Destructive,” W. Baumol (1990)

William Baumol, who strikes me as one of the leading contenders for a Nobel in the near future, has written a surprising amount of interesting economic history. Many economic historians see innovation – the expansion of ideas and the diffusion of products containing those ideas, generally driven by entrepreneurs – as critical for growth. But we find it very difficult to see any reason why the “spirit of innovation” or the net amount of cleverness in society is varying over time. Indeed, great inventions, as undeveloped ideas, occur almost everywhere at almost all times. The steam engine of Heron of Alexandria, which was used for parlor tricks like opening temple doors and little else, is surely the most famous example of a great idea, undeveloped.

Why, then, do entrepreneurs develop ideas and cause products to diffuse widely at some times in history and not at others? Schumpeter gave five roles for an entrepreneur: introducing new products, new production methods, new markets, new supply sources or new firm and industry organizations. All of these are productive forms of entrepreneurship. Baumol points out that clever folks can also spend their time innovating new war implements, or new methods of rent seeking, or new methods of advancing in government. If incentives are such that those activities are where the very clever are able to prosper, both financially and socially, then it should be no surprise that “entrepreneurship” in this broad sense is unproductive or, worse, destructive.

History offers a great deal of support here. Despite quite a bit of productive entrepreneurship in the Middle East before the rise of Athens and Rome, the Greeks and Romans, especially the latter, are well-known for their lack of widespread diffusion of new productive innovations. Beyond the steam engine, the Romans also knew of the water wheel yet used it very little. There are countless other examples. Why? Let’s turn to Cicero: “Of all the sources of wealth, farming is the best, the most able, the most profitable, the most noble.” Earning a governorship and stripping assets was also seen as noble. What we now call productive work? Not so much. Even the freed slaves who worked as merchants had the goal of, after acquiring enough money, retiring to “domum pulchram, multum serit, multum fenerat”: a fine house, land under cultivation and short-term loans for voyages.

Baumol goes on to discuss China, where passing the imperial exam and moving into government was the easiest way to wealth, and the early middle ages of Europe, where seizing assets from neighboring towns was more profitable than expanding trade. The historical content of Baumol’s essay was greatly expanded in a book he edited alongside Joel Mokyr and David Landes called The Invention of Enterprise, which discusses the relative return to productive entrepreneurship versus other forms of entrepreneurship from Babylon up to post-war Japan.

The relative incentives for different types of “clever work” are relevant today as well. Consider Luigi Zingales’ new lecture, Does Finance Benefit Society? I can’t imagine anyone would consider Zingales hostile to the financial sector, but he nonetheless discusses in exhaustive detail the ways in which incentives push some workers in that sector toward rent-seeking and fraud rather than innovation which helps the consumer.

Final JPE copy (RePEc IDEAS). Murphy, Schleifer and Vishny have a paper, also from the JPE in 1990, on the topic of how clever people in many countries are incentivized toward rent-seeking; their work is more theoretical and empirical than historical. If you are interested in innovation and entrepreneurship, I uploaded the reading list for my PhD course on the topic here.

Personal Note: Moving to Toronto

Before discussing a lovely application of High Micro Theory to a long-standing debate in macro in a post coming right behind this one, a personal note: starting this summer, I am joining the Strategy group at the University of Toronto Rotman School of Management as an Assistant Professor. I am, of course, very excited about the opportunity, and am glad that Rotman was willing to give me a shot even though I have a fairly unusual set of interests. Some friends asked recently if I have any job market advice, and I told them that I basically just spent five years reading interesting papers, trying to develop a strong toolkit, and using that knowledge base to attack questions I am curious about as precisely as I could, with essentially no concern about how the market might view this. Even if you want to be strategic, though, this type of idiosyncrasy might not be a bad strategy.

Consider the following model: any school evaluates you according to v+e(s), where v is a common signal of your quality and e(s) is a school-specific taste shock. You get an offer if v+e(s) is maximized for some school s; you are maximizing a first-order statistic, essentially. What this means is that increasing v (by being smarter, or harder-working, or in a hotter field) and increasing the variance of e (by, e.g., working on very specific topics even if they are not “hot”, or by developing an unusual set of talents) are equally effective in garnering a job you will be happy with. And, at least in my case, increasing v provides disutility whereas increasing the variance of e can be quite enjoyable! If you do not want to play such a high-variance strategy, though, my friend James Bailey (heading from Temple’s PhD program to work at Creighton) has posted some more sober yet still excellent job market advice. I should also note that writing a research-oriented blog seemed to be weakly beneficial as far as interviews were concerned; in perhaps a third of my interviews, someone mentioned this site, and I didn’t receive any negative feedback. Moving from personal anecdote to the minimal sense of the word data, Jonathan Dingel of Trade Diversion also seems to have had a great deal of success. Given this, I would suggest that there isn’t much need to worry that writing publicly about economics, especially if restricted to technical content, will torpedo a future job search.

“Compulsory Licensing – Evidence from the Trading with the Enemy Act,” P. Moser & A. Voena (2011)

Petra Moser is unquestionably doing the most interesting data-driven work on invention and growth of any economist working today; indeed, if only she applied her great data more directly to puzzles in theory, I think she would become a good bet for a Clark medal in a few years. The present paper, with Alessandra Voena, a star on last year’s junior job market, is forthcoming in the AER, and deservedly.

The problem at hand is compulsory licensing. This is a big deal in the Doha Round of WTO negotiations, since many poor and middle-income countries (think Thailand and Brazil) force drugmakers to license some particularly important drugs to local manufacturers. This helps lower the cost of AIDS retrovirals, but probably also has some negative effect on the incentive to develop newer drugs for diseases prevalent in the third world. But the tradeoff is not this simple! Because the drugs are licensed to local firms, who then produce them, there is some technology transfer and presumably some learning-by-doing. Does compulsory licensing help infant industries grow in the recipient country? And by how much?

The historical experiment is the Trading with the Enemy Act. During WWI, the US government seized a bunch of property owned by German firms, including their patents. They then licensed these at low cost to US firms. Germany was well ahead of the US technologically in organic chemistry, and Moser and Voena use this fact to study the impact of compulsory licenses for a variety of chemical dyes. They find that in (very narrowly defined) technological areas where patents where licensed, future propensity to patent by US firms roughly doubled. No such increase was seen in non-American firms who didn’t have access to such cheap licenses. The impact on future patents occurred a few years after WWI, consistent with a learning by doing story. Relevant for the Doha Round debate, German firms quickly began working on new chemistry inventions after the war, which you might interpret as consistent with a one-time seizure of IP having no long-term impact on invention if it truly an exceptional circumstance.

Why the delay if you have a patent explaining what to do? It turns out that patents – and this is true even today – are often woefully insufficient to replicate an original invention. DuPont’s first attempt at (German-invented) indigo dye turned out green instead of blue! BASF’s Haber-Bosch process patent didn’t include certain tricky details regarding chemical nature of the appropriate catalyst; it took 10 years for US firms to figure out the secret.

http://ssrn.com/abstract=1313867 (July 2011 working paper. Moser and Voena also, according to Moser’s website, have a forthcoming working paper on the impact of TRIPS licensing on the US pharma industry which I certainly want to check out. As far as I know, that paper hasn’t begun to circulate.)

“Converting Pirates without Cannibalizing Users,” B. Danaher, S. Dhanasobhon, M. Smith & R. Telang (2010)

“You can’t compete with free,” right? Somehow, iTunes and other online distributors manage to sell a large number of TV episodes a la carte, even though free pirated copies of these shows are widely available on BitTorrent. Are there just two different types of consumers with different moral preferences? Or might many consumers become pirates if incentivized to do so? How much does piracy eat into sales?

Danaher et al have a great natural experiment. In 2007, NBC played hardball with Apple over iTunes pricing of individual episodes. From December 2007 to September 2008, NBC and affiliate shows were not available on iTunes, the dominant legal site for TV downloads. The authors scraped daily reports on torrent traffic for a huge number of TV episodes, as well as daily Amazon sales date for the box sets of these shows.

The results are insightful. Piracy of NBC shows jumped 11% after the shows were removed from iTunes. This increase may be understated since it is 11% above and beyond the increase in piracy of non-NBC classic shows during the same period – if NBC’s actions led some users to try piracy, and those users also began to pirate ABC shows, the actual effect of removing the legal channel for NBC shows on total online piracy may be even bigger than 11.4%. To put that number in perspective, the increase in NBC downloads per week was approximately twice the total number of downloads of these shows via iTunes when they were available. The impact of DVD box sales is close to zero, perhaps suggesting that “digital consumers” are in this instance quite separate in their demand from buyers of DVDs.

What might lead to this result? One explanation is that piracy involves a fixed cost, such as learning BitTorrent or “getting over one’s moral qualms.” Once that price is paid, all content is free, hence demand will be higher than demand for $2 episodes on iTunes. This is further supported by the fact that NBC piracy did not fall back to its November 2007 level after legal NBC shows returned to iTunes in 2008.

Two takeaways here. For piracy researchers, modeling consumers as “non-pirates” and “pirates” who do not respond to incentives across this divide is probably not accurate. For firms, when facing competition with free bootleg copies, the costs of mistakes in pricing strategy can be severe indeed!

http://www.heinz.cmu.edu/~rtelang/ms_nbc.pdf (Final WP version – published in Management Science 2010)

[Hat tip to the commenter who pointed me to this article.]

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