Wednesday, September 28, 2011

Maker Faire is Awesome

Here are a few videos I took at Marker Faire New York the weekend before last:

The Kauffman Foundation has put together this video with clips from Maker Faire Kansas City (slightly higher production value here):

I could go on at great length about why I think this is important. (Tween kid overhead saying to Dad: "We are soooo coming back here next year!") But Tom Kalil's already done a good job of that. And, anyhow, where would I start?. "Maker Faire is integrative..."? "Maker Faire is open-ended..."? "Maker Faire is essential for..."? Sure. Yadda yadda. But the bottom line? Simple.

Maker Faire is awesome.

Sunday, September 25, 2011

Regional Ecologies of Innovation

I wrote this piece with Lewis Branscomb and Richard Zeckhauser in 2001. As it was part of a grant application, it was never published. The topic of innovation ecosystems keeps coming up (e.g. here), so it seems worth posting. More on related themes here, herehere, here, and here.

The problem of regional imbalances in technology-based innovation is hugely important.[1] Standard approaches to this problem tend to assume that technology-based innovation and resultant economic growth will automatically occur if
·         local research institutions are sufficiently strong;
·         the regional concentration of high tech firms is sufficiently high;
·         the regulatory environment is sufficiently favorable to risk capital,
·         political leadership is sufficiently strong.
All of the above "conditions" for regional innovation are necessary, but they are not sufficient. No amount of government support for a nascent venture capital industry will help a region devoid of technology entrepreneurs. A state-funded technology park established near a top research university will house few tenants if the university discourages faculty from seeking to commercialize their innovations. An isolated cluster of heavily subsidized start-up firms constitutes an innovation ecosystem no more than an assemblage of parrots and potted ferns is a rainforest.

Private sector actors in the innovation system, informed policy makers, and academics all know that, to paraphrase [former House speaker] Tip O’Neil about politics with modest hypebole, “all innovation is local.” However, the more specific questions that engage policy makers lie beyond our current state of knowledge:
  • Where an innovation-based economy does exist, how does government act (or refrain from acting) to support its continued growth? Where one does not exist, what can be done to encourage one to develop?
  •  What are the critical links in the innovation network? What opportunities, if any, exist for partnerships between governmental bodies operating at different scales or in neighboring jurisdictions and various actors in the innovation system? What should be the roles of local, state, and federal governments in supporting innovation?
  • In an ideal world, what programs should local, state, and federal government fund, how much should the programs receive, and how should their success be measured?
A better understanding of regional innovation, and thus better public policy and program design, depends on being able to answer the follow questions:
  • What fundamental set of behaviors, contracts and incentives characterizes the “regional ecology of innovation”? By what processes are basic scientific breakthroughs translated into commercializable products and processes? What of incremental improvements to products and processes?
  • In innovation ecosystems, how do networks of relationships and trust form? What are their limitations of scale and scope (e.g. geographical scope, number of names in the "Rolodex," qualitative variety of contacts)?
  •  How do the local, state, and federal governments engage in the innovation system, positively and negatively? What kinds of policies and programs at each scale of government best support currently thriving innovation ecosystems, and which best nurture the development of new ones?
  • To what extent is regional specialization—e.g., the development of regional technology “clusters”—truly a requirement for successful competition in global markets for knowledge-based goods and services? Does regional specialization increase the likelihood of capturing economic gains from innovations locally? In an era when technologies, products, and services are increasingly developed upon shared platforms, with networks of research centers, suppliers, and customers linked in complex ways across industry boundaries, are clusters less important? How relevant today are assumed boundaries between ‘traditional’ economic activities (e.g. textiles, fishing, and agriculture) and new, technology-based industry areas considering, for example, advances in robotics and ag-biotech? How do new technologies provide p remote regions overcome traditional limitation in the digital economy, given new technologies?[2]
We use the terms “ecology” and “ecosystem” metaphorically. At the same time, we recognize that the project may benefit from exploring further the insights for human systems of research by leading ecologists and evolutionary biologists (see e.g. Levin 1992). The use of evolutionary and ecological metaphors in economics has a long history in economics, dating back at least to Marshall (1890). Yet natural system differ from human social systems in fundamentals respects.

Technology-based innovation and economic growth
In the 1950s and 1960s many economic models informing public policy assumed that basic science (and spinoffs from military R&D) “automatically” led to productivity and market growth.[3] However most industrial innovation is based on modest extensions of existing technology, so most productivity gains result neither from advances in basic science nor from radical new technologies, but rather from steady improvements to existing innovations. During the 1980s, Japanese success in the high tech industries in which U.S. firms had been dominant were finally understood as a failure of domestic firms to adequately prioritize manufacturing efficiency and consumer satisfaction.[4]  In the 1990s the U.S. economy surged. Growth derived fundamentally from a dramatic increase in productivity. While the sources of these productivity gains are debated among economists,[5] most attribute a substantial part of this growth in real terms to the surge in the creation of entrepreneurial, venture capital-backed, technology firms.

At the end of the 1990s, perceptions shifted again toward a view that technology-based radical innovations uniquely replenish the economy’s long-term potential—though their short-term contribution to economic growth is relatively minor. The role of technology entrepreneurship in general, and particularly the institution of venture capital, as engines of U.S. economic expansion became almost an article of faith among politicians, pundits, policy-makers and the public. The stampede of investors into, then out of, the public market for equity in technology-based “new economy” firms and the volume of traffic from Silicon Valley to Wall Street came increasingly to represent not just a single economic sector, but rather the scorecard for the economy as a whole.[6]

The actual relationship between innovation and job growth and venture capital investment is a considerably murkier problem than newspaper accounts or stump speeches would suggest.[7] Innovation today is usually the product of many different types of entities working together.  The techno-wizards, perhaps joined by a few others in small start-up efforts, bring their new ideas.  Venture capitalists and angels add their money, their contacts, and their vision of the marketplace.  Strategic partners offer downstream or upstream customers, rapid access to established marketing networks, and swift scalability in manufacture.  Investment bankers proffer the end-of-the-rainbow pots of gold.  Beyond this, universities may provide basic technologies for license, governments key incentives for location, lawyers effective structures to allocate shares and align incentives. Specialization across firm types and corporate boundaries characterizes today's successful high tech firm.  The success of each of these firm types, the metaphorical equivalent of species in an ecosystem, depends on the presence of others.[8] Understanding the detailed characteristics of the processes supporting innovation at a microeconomic level is critical not only to resolving their impacts at the macroeconomic level, but to designing public policy that allow them to function efficiently and equitably.
Technology entrepreneurs in the innovation system: What do we know?
Schumpeter (1912) foreshadowed current discussions, referring to the role of the entrepreneurs in bringing together resources to create “new combinations” of economic activity—ones that occasionally succeeded in challenging incumbent forms of economic activity.[9] At the start of the 21st century, what do we know about the process by which technology entrepreneurs in partnership with venture capitalists, corporate technology managers, university technology licensing officers and others in the innovation system conceive and implement “new combinations”? Though our understanding is fragmentary, we can make some observations:
  • Both technologies and the markets in which they are bought and sold are becoming increasingly complex. Arriving at a detailed understanding of either requires many years of painstaking effort. Yet, having reached the frontier of knowledge regarding a technological area or a market, an innovator cannot rest for long because knowledge depreciates rapidly.[10] Markets exert pressure to standardize and modularize. Complexity on one hand and standardization on the other are thus almost yin and yang forces, the former reinforcing the traditional role of personal contacts, the latter pushing the drive toward impersonal markets.[11]
  • Nearly all new technological applications arise either from incremental change to, or new combinations of existing technologies. Understanding how to combine existing technologies (e.g., the internal combustion engine and the air-foil) to create a new product (e.g., the airplane) requires having some understanding of how each of the technologies works separately. As technologies become more complex, new combinations require collaboration.[12]
  •  The key obstacle to funding a technological collaboration—bringing into existence a new technological and/or economic combination—is the ability to identify the minute subset of potential combinations for which a viable market exists and which matches the skill set of a group of specialized technologists  whose services can be engaged—a task referred to by venture capitalists as “due diligence.”
  • Technology entrepreneurs are not, as a rule, able to carry out this work on their own. To build one’s knowledge base to the point where one is working at or near the technological frontier and to organize a quality research team is a challenging enough job description. Most technology entrepreneurs cannot additionally maintain a venture capital caliber network of business contacts.
  • Quality venture capitalists and angel investors must be able to evaluate the quality of new combinations. They must also be able to gain and maintain a good knowledge of the abilities of a large group of potential participants in such projects, particularly those with high levels of technological abilities. Furthermore, venture capital companies continue to add value along the way. They do this in partly by helping companies develop their business plans, products, and marketing strategies. They also do this extensively through their reputations and connections—making introductions, and attesting to quality.[13] The success of the best venture capital firms (those that capture a disproportionate share of the returns in the industry) depends far less on their ability to pick winners than on their ability to create winners. This both adds value to the firms they fund and enables them to attract the most promising firms. Given the particular difficulties of the contracting for technological information,[14] barriers to entry will be high, so individuals and firms that successfully manage such contracting should reap high rewards (a theoretical prediction readily supported by data).
  •  The effort to value technological information—assessing the market possibilities of new, perhaps recombined, technologies—is likely to be severely constrained; few skilled individuals are available to evaluate of new combinations. There will be always be many more potential new combinations of technologies—imaginable, but not tried—than there are companies and their financial supporters to try them out. The gap between potential breakthrough ideas and the number that receive a fair trial may grow in the future, as the execution of new technological combinations increasingly requires the collaboration of different actors with specialized skills.
  •  Modern technologies require the continual exchange of information and products; yet traditional markets can not accommodate such transactions.  In response, contracting is now accomplished with alternative arrangements.  The firmest ties come through a merger.  Incentives get aligned, information exchange is no longer guarded.  At the opposite extreme we see alliances, where two or more firms work together for a time, often with capabilities but not dollars changing hands.  Alliances may even be institutionalized, as they are with the Internet, where no charge is imposed by any provider to carry the information initiated by others.  Diagrams of firms’ relationships with strategic partners often have dozens or even hundreds of lines of connection.

The regional ecology of innovation: Rainforests or amber waves of grain?
Historical evidence amply documents the presence of significant knowledge spillovers and other intra-industry increasing returns to scale within regions—automobiles in Detroit, venture capital in Silicon Valley, biotechnology in the Boston metro region and carpets in North Carolina. Persuasive theoretical arguments, and some empirical evidence, support the claim that sustained regional growth requires not only the presence of specialized industry clusters, but also a certain degree of economic diversity. Barriers to entry in the field of any complementary capability will hurt the entrepreneurial industry as a whole.  Not surprisingly, the most innovative regions of the country have seen rapid entry in such fields as venture capital, or technology-oriented law firms. Countries or regions with rigid regulatory structures for investment entities will find themselves disadvantaged  way beyond what we would expect from a purely first order analysis.
Nonetheless, generalizing from the experience of particular regions is dangerous. Reason why include the following:
  • Regions vary not only in their economic structure, but also in their culture and history. Even within regions of the U.S., attitudes towards trust, reputation and risk vary significantly.
  • Ex post analyses may infer incorrectly infer causation from chance.
  •  For competing regions just as for competing firms, entering a market in which there already exists an established incumbent—e.g. a Silicon Valley—is very different from creating a new market.

[1] The National Venture Capital Association ( reports that, in 1999 for example, 76 percent of venture capital investments were concentrated in four states. Within Massachusetts, for example, multiple initiatives have failed to generate economic growth based on high technology innovation in various regions outside the Boston metro. Other areas, such as the route 495 corridor, have begun to develop a regional ecology of innovation relatively spontaneously.
[2] A state with a limited technology base might reasonably do as West Virginia and Arizona have done in the fields of biometrics and optics, respectively: seek to nurture and support specific innovation/industry clusters from the ground up. However, in regions with a well developed innovation system such as that in the Boston metro area, there is a far greater reason to believe that a large scale, targeted state program would distort, rather than enhance, private incentives.
[3] Alic et al. (1992).
[4] Dertouzos, Lester and Solow (1989).
[5] Important recent contributions to this literature include Jorgenson and Stiroh (2000) and Nordhaus (2001). Bresnahan and Trajtenberg (1995) directly address measurement issues involved in assessing the contribution to growth of “general purpose technologies.”
[6] Such perceptions are reinforced by the astounding growth and magnitudes of venture capital disbursements—in 2000 alone exceeding $100 billion.
[7] Gompers and Lerner (1999, p. 137) note: “Demonstrating a causal relationship between innovation and job growth on the one hand and the presence of venture capital investment on the other is, however, a challenging empirical problem. To what extent are the mechanisms [of venture capital] uniquely suited to addressing the needs of entrepreneurial, high-technology firms? To what extent is venture capital just one of many financing alternatives for these firms, with its own set of strengths and limitations? This topic will reward creative researchers in the years to come. A recent paper by Kortum and Lerner (2000) represents are rare, or possibly unique attempt to isolate the contribution of venture capital to innovation in the U.S.
[8] David Teece (1987) introduced the concept of  “complementary assets” to describe these external dependencies that govern subsequent economic success of high tech innovations. This has been expanded into the notion of the economic efficiency of social capital, Fountain (1998).
[9] This combinatorial approach to innovation has been taken up recently by Romer (1996), Weitzman (1998; see quote above), and Auerswald, Kauffman, Lobo and Shell (2000). Romer (1996: p. 204) suggests likens combinatorial innovation to the discovery of new recipes:
New growth theorists... start by dividing the world into two fundamentally different types of productive inputs that can be called “ideas” and “things.” Ideas are nonrival goods that could be stored in a bit string. Things are rival goods with mass (or energy). With ideas and things, one can explain how economic growth works. Nonrival ideas can be used to rearrange things, for example, when one follows a recipe and transforms noxious olives into tasty and healthful olive oil. Economic growth arises from the discovery of new recipes and the transformation of things from low to high value configurations.
[10] The increasing complexity of both technological and market environments pressures venture capital firms to try to develop synergies through specialization within their own domain.  Where one firm nurtures contacts in Internet advertising, another does so in biotechnology.  The specialization goes beyond expertise to the structure of the network of relationships developed by the firm.
[11] Consider, for example, the PC—for some years now a mature technology. The insides of a personal computer suggest a production process easy to decentralize and distribute among a large number of fiercely competing small firms.  Modular standards have been clearly established. Prices are falling precipitously.  Outsourcing of production is the norm. Yet, at the same time, there are dozens of new technologies appearing on the horizon that are requiring complex contracting, networks and trust. These are the new combinations—amply associated with uncertainties, informational asymmetries and unknowables—that are well suited to the venture and angel mode of support.
[12] See Somay and Teece (2000) and Tassey (2001) for a further discussion of increasing technological complexity and its implications for innovation policy.
[13] Reputations and the link to networks explains why a new MBA hired by a leading VC firm like Kleiner Perkins can generate a million dollars of business, but that same MBA forming a new firm with three peers could not expect to generate a fraction of this business.

Saturday, September 10, 2011

Resilience is Security

I wrote this in 2007. It's still my view on the eve of the 10th anniversary of the 9/11 attacks:
Illusory threats, if not recognized as such, can provoke reactions far more costly and dangerous than the threats themselves. And when leaders deliberately exaggerate threats to create fear for political purposes, the success of such adversaries is enhanced further. 
Such successes are not inevitable. Wise leaders do have the option of responding to vulnerabilities by honestly acknowledging the fact that Americans, like any other people who enjoy an open society, will always be vulnerable to terrorism and to the actions of rogue states. A responsible democratic government should act to minimize these threats, particularly when they involve potentially catastrophic outcomes, but innovation, resilience and adaptability are ultimately the most powerful tools to counter them. When political leaders and private citizens band together to cultivate technology, cut through red tape and build the capacity for response and recovery at home, lasting security may be achieved even under the shadow of persistent threats from abroad.
Full essay is here.

Thursday, September 8, 2011

Time to Bring Entrepreneurship and Innovation to the National Mall

More than a century ago an idealistic scientist gave his fortune to a country he'd never visited to create a research institute in a swamp. The scientist was James Smithson, the country the United States, and the swamp the National Mall. Smithson’s gift provided its author with an enduring legacy extending over nearly two centuries. Generations of trustees have carried out the founder’s vision of advancing "the increase and diffusion of knowledge among men."  Now the time has come to update Smithson's vision for the the 21st century and create a space on the National Mall dedicated to entrepreneurship and innovation.

While the mission of the Smithsonian has remained constant, the nature of knowledge has not. At the end of the nineteenth Century the advancement of knowledge generally meant heroic discovery or patient inquiry conducted in isolation; the Smithsonian's infrastructure was accordingly designed to document and display physical artifacts related to that process. Yet in the twenty-first century, as Secretary of the Smithsonian Wayne Clough has noted, "the great issues of the day typically are interdisciplinary." Advances in knowledge increasingly require collaboration and open communication across both disciplinary and geographical boundaries. The complexity and urgency of terrestrial challenges have compelled an increase in the value placed on knowledge developed in the search for practical solutions to global challenges.

Museums today provide a bridge from past discoveries to future opportunities. Among the Smithsonian’s greatest assets is its unique ability to reach, and to touch, millions of people with inspiring and educational experiences. At their best, the Smithsonian’s programs open minds and change lives. In that spirit the Smithsonian can use its great collections and unique location to inspire its visitors to think deeply about the interaction between our planet and the life that populates it, about our major challenges, and about the astounding progress that is attainable through entrepreneurship and innovation.

At different intervals in the history of the United States, the Mall and the Smithsonian have provided us, the people of this country, with a setting for our own redefinition and reinvention. In the midst of the Great Depression, Andrew Mellon funded the creation of a National Gallery of Art, to affirm America's position as a global power. In the midst of the Cold War, the Smithsonian established the Air & Space Museum, to celebrate the trans-atmospheric supremacy that was, for a time, so critical to our national self-conception.

Now the time has come, once again, for the Mall to play a central role in the renewal of our national narrative; the time has come to establish a permanent space to recognize--in words President Obama himself spoke on the Mall in his inaugural address—"the risk-takers, the doers, the makers of things--some celebrated but more often men and women obscure in their labor, who have carried us up the long, rugged path towards prosperity and freedom." No plexiglass this time. Rather Maker Faire. Tech Shop. Fab Lab and D-Lab. Resources for brainstorming about entrepreneurial solutions to global challenges. A "Genius Bar" with the resources to start a company in an hour or less. And maybe a few robotic Pterodactyls swooping down occasionally from the high arches to pick up trash.

Remarkably, there exists an empty building on the Mall that can do this. It is a building with a history perfectly suited to celebrating entrepreneurship and innovation by all Americans and advancing America’s vital role in the 21st century as a source of entrepreneurial solutions to global challenges. Completed in 1881, the Arts & Industries building (situated directly to the East of the Smithsonian Castle) was the first building expressly built as a museum on the Mall. It was designed by renowned architect Adolf Cluss to receive the collections of the 1876 Centennial Exposition. The building was also designed to exhibit the results of research being conducted by Smithsonian scientists working in the Castle next door. But the exhibits were left largely untouched for much of the next century, changing the function of the building from celebrating the new to archiving the old. The original Arts & Industries exhibits were eventually moved, and the building closed to the public in 2004.

The first Secretary of the Smithsonian once said that "The worth and importance of the Institution is not to be estimated by what it accumulates within the walls of its building, but by what it sends forth to the world." The same can be said for the United States. Our worth in the twenty-first century will be determined by the continued efforts of the millions of entrepreneurs and innovators who daily invent a new and more promising reality for their communities, their regions, their country, and the planet we all share.

There is no progress without purpose. Identity is what we are, but initiative is what we become. A nation needs both. Let's renew our national narrative by creating at the Arts & Industries building a National Center for Entrepreneurship and Innovation.

Full concept statement

twitter: @innovateonmall

What if Development Economics Was Actually About Development?

Pop quiz: Is a "business-friendly" environment the same as an "entrepreneur-friendly" environment?

Answer to that is coming up. But my guess is that 9/10 entrepreneurs get the answer right (10/10?), and 9/10 economists get it wrong.

Now as for the topic of this post, "What if Development Economics Was Actually About Development?" You might rightly ask, "What is development economics about, if not development?" Read recent books co-authored by Dean Karlan and Esther Duflo, or this volume edited by Jessica Cohen and Bill Easterly, and you will find out. "Development economics" is about improving the effectiveness of development projects. It's about enhancing the value we get from the ~$125 billion that flows each year from rich countries to poor countries to improve the lives of poor people. That's "development economics."

Development economics is mostly not about the technological and organizational transformations that are propelling the human community into an unprecedented era of increased prosperity. It is mostly not about structural changes in a $69 trillion global economy. It is mostly not about the global revolution in mobile telephony--the most ubiquitous and powerful technology people have ever created. It is mostly not about the creation and diffusion of vital standards--ISO, container shipping, TCP/IP--that have enabled global economic integration. It is mostly not about the astounding power of migration to improves lives and livelihoods. And it is mostly not about the initiative of entrepreneurs who bring imagination to opportunity to create new forms of business, products, and services that even they did not imagine could exist when they first started out.

Most of all, "development economics" is mostly not about development. That is because projects don't develop. And they don't create development. Here's a definition (thank you


  [dih-vel-uhp-muhnt]  Show IPA
the act or process of developing growth; progress: child development; economic development.

"Process of developing" means that there is change. A transition from one state of being to another. That is what development means. So social scientists who study development should be interested in how societies change.

Development, therefore, is a dynamic phenomenon. But the tools that define "development economics" are, overwhelmingly, static. In order for a project to be evaluated--for example with a "randomized controlled trial" (RCT)--the parameters of the project have to be strictly defined. ("Controlled" says it all). The project is a recipe. The assessment is method for determining if that recipe works in a particular place, and at a particular time.

In my last post I addressed the limitations to RCTs created by the "in a particular place" clause. (Ref. the challenge of "external validity".) But the "at a particular time" clause is even more problematic.

The point is simple: If the phenomenon under consideration is actually important to the process of development, it will, by definition, be changing. Consider just the example of mobile telephony offered above. The numbers, options, and opportunities change on an almost monthly basis. Not just superficially, but fundamentally--at the level of options, learning, and even human preferences. (Ref. "non-stationarity of the underlying process" mentioned in my last post.) But the tools of "development economics" in its current form are inherently, even assertively, static. The viability of the RCT method, in particular, depends on applying precisely the same "treatment" to each target population. If the treatment is not the same, or if important elements are omitted from the "recipe" (they will  be), then the assessment is invalid.

Is ingenious program evaluation a total waste of time? Of course not. It is a people charged with managing projects anyway. But it is not the study of development.

I almost forgot: Is a "business-friendly" environment the same as an "entrepreneur-friendly" environment? ... Hmm. Well here is a book that is actually about development that provides some answers. More on that in my next post ;)

UPDATE: Citing this paper by Casey, Glennerster, and Miguel as an example, Dean Karlan (@deankarlan) points out to me that RCTs can be used to evaluate "a process of change that includes the decision on what to do, who does it, etc."

Wednesday, September 7, 2011

Why Randomized Controlled Trials Work in Public Health...and Not Much Else

If there is a next big thing at the moment in the field of economics, it is the application of techniques from medical research—specifically, “randomized controlled trials,” or RCTs—to assess the effectiveness of development or other government-initiated projects. The general thrust of the work is as simple as it is brilliant: rather than employ complex, and often unreliable, statistical methods to tease out the extent to which a project or policy actually had a beneficial impact on intended beneficiaries, why not follow the tried and true methods employed by pharmaceutical researchers to assess the efficacy of medical treatments? The steps are: 1) randomly divide the experimental population into a treatment group that receives “benefits” from the program, and a control group that doesn’t; 2) assess outcomes for both groups; and 3) determine whether or not a significant difference exists between the two groups.

This approach, championed by MIT economist Esther Duflo (winner of the prestigious Bates Clark Medal, granted to the most promising economist under the age of forty) among others, is a marked improvement on the status quo in development aid, which not infrequently involves assessing program effectiveness by simply checking whether or not the money was spent. Clearly, a world in which aid money is allocated to projects that actually benefit people is preferable to one in which money goes to whoever most effectively maneuvers to get the money to start with and then most reliably manages to spend it. In this way, the use of RCTs in development arguably advances the goal of aid effectiveness.

So, to be clear, RCTs quite credibly represent the “gold standard” in program assessment. If other methods are used, it is usually because RCTs are too expensive or otherwise impractical. Describe your favorite entrepreneurial initiative to an economist and the most probable skeptical response you’ll receive is: “Sounds wonderful, but where’s the evidence of effectiveness? In order to find out whether or not it worked, you really need to do a randomized controlled trial."

So what is the problem with applying RCTs to development?  The Achilles heel of RCTs is a little thing known to the statistically inclined as “external validity”—a phrase that translates informally to “Who cares?” (In a future post I'll elaborate on another fundamental flaw of RCTs, which is technically termed the "non-stationarity" of underlying processes.)

The concept of external validity is straightforward. For any assessment, “internal validity” refers to the mechanism of conducting a clinical trial, and the reliability of results on the original setting. A professionally conducted RCT that yields a high level of statistical significance is said to be “internally valid.” However, it is fairly obvious that an intervention rigorously proven to work in one setting may or may not work in another setting. This second criterion—the extent to which results apply outside the original research setting—is known as “external validity.” External validity may be low because the populations in the original and the new research setting are not really comparable—for example, results of a clinical trial conducted on adults may not apply to children. But external validity may also be low because the environment in the new study setting is different in some fundamental way, not accounted for by the researcher, from the original study setting. Econometric studies that seek to draw conclusions about effectiveness from data that span large geographical areas or highly varied populations thus typically have lower levels of internal validity, but higher levels of external validity.

So, once again, the fundamental issue is not the purity of the methodology employed (as exciting as such methodological purity is to the technically inclined) but rather the inherent complexity of the world being studied.

For this precise reason, it turns out that those who most vociferously and naïvely advocate that we apply techniques from public health to economics (a group that does not include Esther Duflo) make a fundamental error.  They fail to appreciate the fact that, when it comes to external validity, public health is the exception that proves the rule. Indeed, in aid-led development in general, of the few real historical successes, nearly all are in public health. Outside of public health, few of the large-scale, top-down development programs have in fact succeeded. 

Why is this? Multiple conjectures are possible. But one persuasive one is this: when it comes to biophysical function, people are people. For this reason, a carefully developed medical protocol (read “recipes”) proven to be effective for one population is highly likely to work for another population. The smallpox vaccine tested on one population tended to work on other populations; this made it possible to eradicate smallpox. Oral rehydration therapy tested on one group of children tended to work of other groups of children; millions of children have been spared preventable deaths because the technique has been adopted on a global basis. Indeed, medical protocols have such a high level of external validity that, in the United States alone, tens if not hundreds of thousands of lives could be saved every year through a more determined focus on adherence to their particulars.[1]

These huge successes were achieved, and continue to be achievable, though bold action taken by public health officials. They are rightly celebrated and encouraged, but—outside of other public health applications—not easily replicated. Successes in medicine contrast sharply with failures in other domains. Decades of efforts to design and deploy improved cook-stoves—with the linked aims of reducing both deforestation and the illness and death due to indoor air pollution—have so far primarily yielded an accumulation of Western inventions maladapted to needs and realities in various parts of the world, along with locally developed innovations that cannot be expanded to meet the true scale of the challenge.[2] For development programs in general, and RCTs in particular, public health is the exception that proves the rule.

What does work in areas outside of public health? How is it possible to design, test, and implement effective solutions in environments where complexity and volatility are dominant? The general principle applies: Success requires adaptability as well as structure, flexibility as well as structure—a societal capacity to scale successful efforts combined with an ingrained practice of entrepreneurial exploration. As the uniquely insightful Mancur Olson wrote in his classic Power and Prosperity (pp. 188-189):
Because uncertainties are so pervasive and unfathomable, the most dynamic and prosperous societies are those that try many, many things. They are societies with countless thousands of entrepreneurs who have relatively good access to credit and venture capital.
What works in development, according to Olsen, is entrepreneurial exploration. Why? Because we don't know what works.

[1] See Atul Gawande (2009), Checklist Manifesto: How to Get Things Right. New York: Metropolitan Books.
[2] Burkhard Bilger (2009), Hearth Surgery: The Quest for a Stove That Can Save the World. The New Yorker. December 21.

Tuesday, September 6, 2011

The Myth of the Market

In the beginning, there was usury.

In the deflationary, no-growth world of the early Middle Ages, lending was frequently predatory. More often than not, the predators were priests. The poor were not the only victims. Nobles also forfeited property—even entire estates—to rapacious moneylenders.

The Church was powerful, but ultimately it could not resist pressure to curb abusive practices within its ranks. In 1049, Pope Leo IX outlawed interest-bearing loans, declaring at the Council of Reims that “No cleric or layman should be a usurer.”

At that point, a surprising thing happened: the trade in interest-bearing loans—officially outlawed by the Church—took off. With the usurious energies of the clergy becalmed, if not entirely dissipated, a new market space opened up in which the medieval “private sector” could provide loans.  At the center of this transformation was a financial innovation known as the bill of exchange, predecessor to today’s garden variety bank check. Bills of exchange were important not only because they enabled commerce to occur over long distances, which facilitated trade, but also—and importantly—because they created a loophole in the papal ban on interest-bearing loans. By carefully designing their terms, the earliest merchant bankers could employ bills of exchange as a way to extend short-term loans.

As financial institutions developed around bills of exchange and other innovations, they changed the social function of banking. “What made the new banking different from the old,” says Robert Lopez, a pioneering scholar of early financial institutions, “was its shift from an agrarian to a commercial orientation and from an antagonistic to a collaborative attitude of borrowers and lenders.” Where the old banking was fundamentally extractive, the new banking had the potential to be creative. Alongside lending, a new and deeply disruptive financial form took shape: private investment.

The special edition of Innovations journal being released today at the 2011 Social Capital Markets conference at Fort Mason, in San Francisco, is a report from the evolutionary frontier of capital, and of capitalism. The authors of the essays, case narratives, and analytic papers published in these pages are a veritable Who’s Who in the linked domains of blended value and impact investing.

In this brief essay I will reinforce a simple point also made by Antony Bugg-Levine and Jed Emerson in their contribution to this issue: The nascent world of “impact investing” is not entirely new and unprecedented, nor is it simply an incremental tweak to a now nearly perfected “market system.” Instead, the development of impact investing and of new approaches to assessing value represents the latest stage in the invention, and reinvention, of the concept of economic self-interest and the reality of market-based capitalism over the period of centuries.

In other words, the movement described in the pages that follow is not a fad. It is the next step in a historical progression that dates back to the 11th century. Consequently, there is good reason to think that the transformations suggested by contributors to this special edition are just getting started.

The full text of my into to the special edition of Innovations for SOCAP11 is here.

Monday, September 5, 2011

Money + Meaning = Huh?

SOCAP11 is getting going today at Fort Mason in San Francisco. I'm not going to be there. So why should I care?

Well, there's one obvious reason that I, personally, should care: Innovations journal (which I co-edit with Iqbal Quadir) has partnered with Kevin Doyle Jones and the Social Capital Markets team to produce a special issue on impact investing that is being released at SOCAP11 this week. The issue was proposed and guest edited by Paul Hudnut (@BOPreneur), Rob Katz (@robertkatz), and Patrick Maloney (@pemaloney). Anyone who's not going to be attending the opening session of SOCAP11 tomorrow can get the special edition as an eBook on Amazon.

In my next post I'll summarize the content; there's also more here at the SOCAP11 site. But I'll tell you this up front: If you don't get "impact investing" now, you will by the time you're done reading through the great contributions to this special edition. Wayne Silby, Elizabeth Littlefield, Jed Emerson, Anthony Bugg-Levine, Mirjam Schöning, Mario Morino, Christine Eibs Singer, and other great contributors to this special edition... these are the pathfinders. Where they have been is where finance is going--if it is going anywhere at all, that is.

So... is the release of this special edition the only reason that I'm excited about what's going to be happening at Fort Mason this week? No. If there wasn't another reason, we at Innovations wouldn't have jumped at the chance to partner with SOCAP on an impact investing special edition in the first place.

Kevin Doyle Jones and the SOCAP11 team are framing this year's meeting with the following Twitter-friendly koan:
$ + <3 = ?
I read this as: Can money (markets) and meaning (purpose) co-exist? Can they be separated?

The facile answer to this question is well known: "Markets are impersonal. They have to do with exchange and they have to do with value. But they have nothing to do with the creation of 'meaning' or the pursuit of 'purpose.'"

The facile answer is--as facile answers tend to be--wrong. The incomparable Matthew Bishop (@mattbish) offered one take on how markets and meaning connect in a piece he wrote for Innovations last year. I made my own first attempt at answering this question in a piece I wrote in 2009 for the Stanford Social Innovation Review.

But the most compelling answer isn't to be found any any single essay, narrative, or line of argument--amazingly, even my own or Matthew's. The best answer is to be found in the mosaic of insights and experiences of the people who have spent their careers exploring the shared space between money (markets) and meaning (purpose). People like Ben & Jerry's co-founder Ben Cohen, who wrote about "The Meaning of Business" in the Spring issue of Innovations. People like Kalsoom Lakhani, Eden Full, Manoj Sinha, and Saba Gul, who will be among the hundreds of entrepreneurs seeking to connect markets and meaning at Fort Mason this year. And it's to be found in the words of the remarkable people who took time away from their daily doing to get their thoughts into words and their words into bits so that you could read them here.