Innovation and Creative Destruction (With Arthur Diamond)

Arthur Diamond joins the show to talk about how good policy could actually encourage innovation.

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Entrepreneurs disrupt industries and throw equilibria out of whack, but where would the modern world be without entrepreneurs? The economics of innovation is particularly important to understand at a time when more politicians on both the right and the left are calling for industrial policy. Such proposals raise the question can and should entrepreneurship and innovation be planned? Arthur Diamond joins the show to talk about how good policy could actually encourage innovation.

How do innovators think about the world? Is there a way to predict what the next big innovation will be? Should we let innovators be free? Why did no one predict the creation of the internet?

Further Reading:

Openness to Creative Destruction: Sustaining Innovative Dynamism, written by Arthur M., Jr. Diamond

Econtalk on Artificial Intelligence with Melanie Mitchell

Innovation Unbound, written by Arthur Diamond

Related Content:

Essential Hayek: Knowledge and Prices, featuring Donald J. Boudreaux

On Innovation: Don’t Ask for Permission, Building Tomorrow Podcast

Emerging Tech (with Matthew Feeney), Building Tomorrow Podcast

[music]

00:07 Trevor Burrus: Welcome to Free Thoughts. I’m Trevor Burrus.

00:09 Aaron Ross Powell: And I’m Aaron Powell.

00:10 Trevor Burrus: Economics textbooks spend a lot of time talking about the manufacture and distribution of stuff, but they pay much less attention to the innovative ideas behind all that stuff. On today’s episode, we talk about the economics of innovation. How does it happen? What factors make it more likely? What role, if any, should government play?

00:28 Aaron Ross Powell: Entrepreneurs disrupt industries and throw equilibria out of whack, but where would the modern world be without entrepreneurs? The economics of innovation is particularly important to understand at a time when more politicians on both the right and the left are calling for industrial policy. Such proposals raise the question can and should entrepreneurship and innovation be planned?

00:49 Trevor Burrus: Joining us today is Arthur M. Diamond Jr., Professor of Economics at the University of Nebraska, Omaha. His new book is Openness to Creative Destruction: Sustaining Innovative Dynamism. Welcome to Free Thoughts, Art.

01:00 Arthur Diamond: I’m looking forward to it.

01:01 Trevor Burrus: Now, most people, when they think about the main concepts of economics, they think about things like equilibrium, if they ever think about them. They had an Economics class. They might have drawn a supply and demand curve and talked about perfect competition and all of these things, but you persuasively argue in your book that we need a little bit more when it comes to understanding of economics.

01:21 Arthur Diamond: Absolutely, and I taught exactly what you were sketching there, the equilibrium standard economics. And I think that’s important, I think you can solve a lot of problems, you can avoid a lot of mistakes, if you understand that. But what really matters in terms of human betterment, making the world better, making our lives better and longer is not how do you get back to equilibrium, but how do you move to the next equilibrium? How do you move forward? And that’s an issue that was emphasized by Joseph Schumpeter. And in some ways, he’s one of my heroes. But a lot of the economics profession hasn’t given it enough attention. And I thought I wanted to see if I could nudge economists and policymakers and everybody a little bit more toward thinking in terms of dynamism in terms of moving forward, rather than just in terms of how do we get back to an equilibrium.

02:11 Aaron Ross Powell: Why don’t they pay more attention to it? Is it that there’s economics is understanding how things work, but entrepreneurship looks more like a creative process which is slightly different or why is it not privileged in what we talk about?

02:25 Arthur Diamond: Well, there’s more than one reason people have given for that. One account is that if you have a hammer, the whole world is a nail. And what economists have are equilibrium models. And so they look to see what can they use those models on and the models are nice and they kind of pull you in. They have an aesthetic beauty to them, they have a simplicity. They’re mathematical, whereas creativity and dynamism is messier, and it’s richer, empirically richer, which I find much more interesting. I spend more time these days reading history and psychology and sociology than I do reading mainstream economics, because an essay written few decades ago by Deirdre McCloskey. She described it as a thin methodology versus a thick methodology, and the economics is thin. It’s got a lot of model but not much meat in terms of the empirical content, whereas history and psychology and sociology, you can get a lot more of of the empirical content.

03:23 Arthur Diamond: So I think to some extent economists are becoming entranced with the models that they’re good at and that they know how to apply and so that leads them to ignore parts of the world that are not so easily put into that framework. There was a joke, you’ve probably heard it a million times, but the joke that Zvi Griliches told, when he knew he was dying, looking back on his life, he said there was a story of an economist who came along and saw somebody who’d had too much to drink and were on their hands and knees under a light, a lamp, and they said, “What are you doing?” “I’m looking for my car keys.” They said, “Well, let me come down and help you.” They said, “This is where you dropped them?” And the guy says “No. No, no, I dropped them over there, but it’s dark over there.” And so then what Griliches says is that if he had a regret from his career, it’s that he didn’t get down on his hands and knees in the dark, where the important issues are and instead stayed under the lamp where you could see, but where the important issues weren’t.

04:20 Trevor Burrus: It is interesting, because I am not trained as an economist, but I think like many people, at least in the Cato building, learned a lot from EconTalk, for example, which is a good way of learning economics. But you think about these models and a perfect competition is obviously not possible with human beings and limited knowledge or things like this. And then you also with equilibrium, the entrepreneur or the innovator is trying to constantly throw the equilibrium off balance, that itself is a fleeting… Hayek kind of made these points that equilibrium is always trying to be maintained, but always being thrown out of balance. And then you have these innovators and entrepreneurs come in and they could completely change the game tomorrow, and then you gotta draw new graphs and maybe even think of new goods and new ways of doing things entirely.

05:10 Arthur Diamond: Yeah. The usual supply and demand diagrams that we emphasize so much in principles classes and beyond, they take for granted some of what’s most important, the goals of getting back to equilibrium and having the perfect competition you’re talking about is to lower prices and that’s certainly important. We want lower prices because then we can buy more of stuff, but the more important issue is how do we get the new stuff that really makes big advances in our lives and that isn’t… You don’t see that in the supply and demand diagrams.

05:42 Arthur Diamond: So you can avoid a lot of bad policy mistakes if you know supply and demand. You can avoid price ceilings imposed by the government. You can avoid price floors that are put in by the government. You can discuss taxes and see the bad effects of taxes all within the supply and demand equilibrium framework. So I’m not saying it’s worthless. It’s got value, but it doesn’t address the main issue and more attention has to be on the main issue. What are these entrepreneurs and innovators and vendors doing and how are they thinking and what constrains them when they’re trying to make these big leaps? And I think if we look at that, maybe we can make some nudges in policies and institutions to make it easier for them to bring us the great things that’ll make our lives better.

06:26 Aaron Ross Powell: Yeah, that gets to, I think, the next question I had which is, when we’re studying supply and demand curves and we’re looking at the effects of tax and all that, that’s like something that exists here in the world that we can measure the effects of and study. But it seems like innovation is necessarily unpredicted stuff, right? It’s changes that people haven’t thought of yet. And so, how does… How do you, as an economist studying innovation go about studying innovation, if all of the innovations are not just things that haven’t happened yet, but things that you can’t meaningfully have thought of yet.

07:03 Arthur Diamond: Yeah. I had a student last year criticize my book for saying that I have too much that’s too far in the past, that he wanted to hear more about what’s going on right now. Why don’t I have more attention to Elon Musk and less attention to Stephenson who invented the locomotive? And my answer to him was it’s a balance. On the one hand, I really am more interested in what’s going on now just like he was. But on the other hand, I don’t know what’s gonna work and what’s not. I am rooting for Elon Musk, but I don’t know if he’s gonna make it to Mars. I hope he does. I think the odds are he won’t. But if you study the established ones who succeeded and look and see what were their obstacles, and how… What are those… Some obstacles are necessary because we live in a world where there’s laws of physics.

07:53 Arthur Diamond: But there are some obstacles, like government regulations, that are not necessary. So if you look at the historical cases where we already know that these are successes, you can come up with conclusions about here’s the policies that would be most effective. Now, that’s not gonna let you predict what the entrepreneurs are gonna do with that increased freedom, if you let them free, if you take the shackles off. I can’t predict exactly what’s gonna happen, whether we’ll have flying cars soon, or what the next big advance, whether we’re… What you can do is you can say we’re gonna have faster progress in a bunch of different directions brought about by creative people doing things that we can’t even anticipate. And I’m hoping and believing, and I think it would be right if most people would say, “That’s great. We don’t need to have all the details as long as we know that we’re gonna have progress, and it’s gonna be faster, we’re with you.”

08:44 Trevor Burrus: I think it’s interesting when you talk about visions of the future. There’s a lot of examples of this, and sometimes you have the… I see no more than five computers, that famous quote, or with… Lacking prediction. I always found it interesting that in every sci-fi movie, there’s… Video phones are everywhere, but they never would predict that we’d all get video phones in our pocket, and we completely stop calling each other, and we just start writing little messages to each other. No one would have predicted that. And then also every sci-fi movie still has taxis. You could have… No one’s thought of Uber, and pay phones are quite common in sci-fi movies, but they still have taxis. So you have people thinking about new and new robotics and crazy new worlds, but they still have to hail a cab. ‘Cause no one was like, “Oh, Uber. That should be a thing.” And of course, if you look at, say, Popular Mechanics magazine in 1958 and what it says the future is gonna be like is almost entirely wrong. What is it about entrepreneurs and innovators? How do they think about the world in a way that’s different than, say, a sci-fi author who’s trying to think new thoughts but is not actually trying to build anything?

09:54 Arthur Diamond: Well, this is an area where I think there’s still an awful lot to learn, and I wish I had decades and decades to study further. But I identify in the book sort of three characteristics that are often the case that go along with entrepreneurs innovating. I talk about the importance of serendipity, and I give some examples where that was important. I talk about nimble trial and error experiments. And I talk about having vague [10:23] ____, sort of inchoate hunches that sometimes have to be followed up over a long period of time and developed. And these are… If you look at the serendipitous aspect, part of the reason why we can’t predict what’s gonna happen is serendipitous occurrences happen to individuals and they have to be… They have to recognize that they’re there, and they have to think about how can I apply them. And that’s something where we can’t… Each individual, Hayek’s point about local knowledge, I have serendipitous things happen to me, you have different serendipitous things that happen to you.

11:00 Arthur Diamond: I’m carrying around in my head some problems that need solving. Maybe I’ll be lucky and some serendipitous event will happen that solves a problem I’m carrying around. You’re carrying around a different set of problems that you think need solving, and you have a different set of serendipitous events that happen in your life. But I don’t know your serendipitous events or the problems you’re carrying around, so it’s hard for me to predict what you are gonna be able to make progress on, what possibly you can… Innovations you can create. So that’s part of the reason why the aspects of… The individual aspects of the creativity process. I don’t think you can ever get away from them. And in some ways, I think that’s wonderful because I kinda like individualism. In some ways, it’s frustrating because when people ask me, “Predict,” people think… When they hear I’m an economist, they’d say, “What’s the interest rate’s gonna be six months from now?” And I try to say, “I don’t know,” but people don’t like that.

11:54 Arthur Diamond: So then I come up with something, but it’s really that I don’t know. And you say, “What’s gonna be the next big innovation?” I wanted to end my book on a strong note of saying, “Okay. Here’s what we can have. This is… Here’s some of the good stuff we can have if you will let innovators be free.” And the best you can do, I think, is to extrapolate something that is fairly close and possible right now. So at the end of the last chapter, I talk about how, if we had less regulation and changed some of our policies in healthcare, we could cure more cancers faster. And I think you can make limited extrapolation, but in terms of the really big things that are further off, there were some technology experts back several decades ago, who put their predictions into a time capsule. And they predicted the things that you could predict by extrapolation, like they predicted satellites, that communication satellites… They didn’t predict the internet, and that’s because the internet was so different from anything that was then currently happening that very few people had that at all on their radar screen. So I think we can learn more.

13:03 Arthur Diamond: There’s a big issue about how is artificial intelligence going to take jobs or not take jobs or create new innovations or not and so on. And there was a nice… I heard a nice interview Russ had on EconTalk with, I think her name is Melanie Mitchell. I got her book but I haven’t read it yet, but one of the points she made is that we underestimate how many things we know that we can’t articulate. And this is related to some things that Hayek and Polanyi and other people have said, but if… That’s one of the reasons why entrepreneurs can create more that’s unpredictable, but that turns out to really benefit us if we let them follow what they know that they can’t articulate. But unfortunately, a lot of our institutions require that you articulate it before you can get funding or permission to pursue it, and that slows down the things that we can actually be making progress on.

14:00 Aaron Ross Powell: I was struck… Two, so two out of the three factors that you listed for innovation are serendipity and hunches and that made me think… So you’ve said economists don’t spend a lot of time studying innovation or at least they don’t spend as much time as they should, but one area where you can find lots of stuff on innovation is in business books. The bookshelves are just filled with books that claim to be able to basically systematize innovation, “I will teach you how to be a successful entrepreneur,” “I will teach you how to be a successful innovator.” The internet is full of these things, you have TED talks about it and so on. But if the bulk of it is serendipity, which is basically luck and hunches, which are by nature something that can’t be taught or can’t be systematized, it’s just feelings you have or insights that suddenly come upon you. Are all of those sorts of books, I guess, fundamentally misleading?

14:52 Arthur Diamond: I think a lot of them are, and I think they mean well. I think a lot of the people… Everybody’s in favor of innovation, but when push comes to shove a lot of people are not rewarded on the basis of innovation and they’re not rewarded by creating the kind of environment where innovation can occur. And so then they have to go against their current incentive structure, and that, some people are willing to do that. There’s a nice book by a guy named Gary Klein called Seeing What Others Don’t, I think was the name of it, something like that. And he talks about how managers in business all say they’re in favor of innovation, but if you look at how are they judged, how are they evaluated in doing their jobs, they have annual reviews or quarterly reviews and what their managers will look at is, “Have you met your targets?”

15:43 Arthur Diamond: Well, if you need the slow hunch, and if you need the serendipitous, it’s highly unpredictable, and you’re not gonna show good results very often on a quarterly basis or even on a yearly basis, sometimes it takes longer. So anybody who protects their employees, the people under them, any manager who protects the people who might be thinking on the long term following an important hunch that might pay up or might not, they’re probably gonna pay a price in terms of their annual evaluation, right?

16:13 Arthur Diamond: And so that’s why I think that a lot of the big innovations occur in new startups, but don’t occur in established incumbent firms. A great scholar that we lost just a few weeks ago, Clayton Christensen, wrote some good books relevant to this, and he actually tried to get us to be sympathetic to incumbent firms, which is the opposite of the usual attitude. And he said that the problem is they’ve got so much going against them in terms of being really innovative. There’s vested interests in doing things the way they’ve already done them. There’s the issues I just talked about in terms of rewarding short-term objectives rather than long-term objectives. And so what he finally says is that it’s gonna be the disruptive startup that is going to be the one that’s going to innovate because they are free of some of these constraints.

17:05 Trevor Burrus: Well, that was Blockbuster. They had a lot of forces working against Blockbuster to be the one to innovate Netflix. Although they had the movie stockpile, I guess, but they were brick and mortar instead of walking into a company and saying, “Let’s move this entire business model over to a different business model,” versus “Let’s try to protect our business model,” or maybe even encourage regulations to be passed that make it harder for Netflix to have its business model. You’ve mentioned in the book that some companies that have realized this have tried to create… It’s like… What is it, is it skunkworks, is that the term that I’m…

17:47 Arthur Diamond: It is. Right, it’s skunkworks.

17:49 Trevor Burrus: Yeah. Those skunkworks, these are kind of totally separate, right? They’re free to do whatever.

17:56 Arthur Diamond: Yeah, sometimes. Well, it depends on how committed the parent company is to letting the skunkworks continue to operate with autonomy. One example where the parent company didn’t stick with it was IBM. IBM set up kind of a skunkworks down in Boca Raton in a very un-IBM-ish run-down building to develop the PC and see what they could do with it. And they were given some autonomy for a while, but after they got to be succeeding they got pulled back into the mother ship and then things slowed down because then they had to go through all the onerous processes and committee decision-making and all that which was the standard IBM procedure. Christiansen and co-authors have tried to measure how often this succeeds, the skunkworks idea, and they say that, in the face of a disruptive innovation, if you don’t do it, the chances that you the incumbent firm will survive or I don’t know what the exact figure is, something like 6%, and they say if you adopt a skunkworks process and you stick with it, and you do it right, you can… The survival rate goes up to 30%.

19:13 Arthur Diamond: When I talk about this with my students, I say, those are obviously rough numbers ‘cause they’re hard to figure out. But, so let’s say those are right, is that good news or bad news for the incumbent firm? On the one hand, if you do the skunkworks, it increases several times the likelihood that you’ll survive. But just still the odds are you’re not gonna survive, right? 30% survival, chance of survival is better than 7%, but still 70% chance you’re not gonna make it, so the incumbent firm’s still in a bad spot. And then they discuss some about is there anything that you can say about which firms are more likely to succeed with the skunkworks. And part of what they say is that to succeed, you have to have some powerful people who have the determination to make it happen. And who are the powerful people who could do that? They tend to be people who are founders and who have maintained a substantial control in the company. Enough equity that if they wanna do something they can go against other vested interests within the company and make it happen.

20:13 Arthur Diamond: One of their main examples was Hewlett and Packard, when Hewlett and Packard still were part of Hewlett and Packard. Somebody came to them with the idea of a new kind of printer and the bread and butter printer at that point… Moneymaker for Hewlett Packard was laser jets and this was an idea for something that we call a ink jet. And what they did was they set up basically a skunkworks kind of operation in Boise and Christiansen says, “If they hadn’t been in charge, if it had been just your normal CEO, there probably wouldn’t have been the resolve to make it done.” Because it’s true what the people would have complained in the incumbent company was, “We were doing really well with laser jets. Why are you bringing something in that’s gonna eat LaserJet’s lunch? And it did, it did take business away from LaserJet, but what Hewlett and Packard said was, “This is the future. This is gonna be better. We need to do it.” And they did it. So it’s a discouraging situation for a firm that faces disruption where there aren’t people like the founders still in charge. It’s a long shot for them to self-disrupt and survive.

21:26 Aaron Ross Powell: Is that, then, what would explain, say, Google, Amazon and Apple? Because when you talked about incumbent, large incumbent firms not innovating, those were the ones that immediately popped to mind because they’re three of the largest companies in the world, if not the largest companies in the world. But they all seem to be wildly innovative on an ongoing basis. And I guess in the case of Apple, the founder’s not still around, but in Google and Amazon, they are. Is that what explains those or are those exceptions to this rule?

22:01 Arthur Diamond: I think those are good examples. You were saying about Apple, the founder’s no longer around and I think you could also argue they’re no longer as innovative. One of the big co-innovators with Jobs was a guy named Jony Ive. And it was announced in the papers… I don’t remember, just the last couple of months, I think, that Ive was leaving Apple. And he had been increasingly detached. The money they’re making now, they’re making from services, they’re moving away, they’re not saying this so explicitly, but a lot of commentators have noticed that its services and apps and various things that are not the kind of innovation that Jobs was famous for and that he wanted the company to continue to do. So they’re still doing well, but I would predict that… I don’t know. So don’t invest your money based on my prediction. [chuckle] I don’t want you to get mad at me. But I would not be at all surprised if they start to go downhill some.

23:00 Arthur Diamond: And I do think it’s an important reason for the success and continuing success of Google and especially of Amazon’s a really good example, is that the founding entrepreneurs stayed on board. I remember back, there was a nice paper done in economics by a guy named Robert Hall quite a few years ago where he was comparing Amazon and eBay and whether their valuations were totally… Their stock market equity valuations was totally bubble. He was arguing they weren’t. But part of the idea back then was that eBay was the dominant one and was likely to stay the dominant one and yet the exact reverse happened. And so you scratch your head and say, “What is that?” People get, “Why is that?” People have given different accounts.

23:43 Arthur Diamond: But the account I give is, at least in part, I think, is because the founding entrepreneur of eBay jumped ship fairly early on. Pierre Omidyar I think was his name, whereas Bezos stuck with it. In my book I call the kind of people who stick with it project entrepreneurs. They’re more interested in getting something into the world than they are in making money as a goal in its own sake. They like money. But they like money because the money helps them get the project done. But it’s not liking money for its own sake. The people who like the money for its own sake are the ones who are more likely to cash out early and then their company slows in its achievement of continuous innovations. And Bezos, I think, it was amazing… He was reporting losses quarter after quarter, year after year and then he had that easily identified laugh where he would sort of explain what he was doing and he got away with it. And now it’s paid off. There were skeptics all over the place, including me. But he did it. [chuckle] And that’s where I wonder is if Musk can do what Bezos did, maybe in 20 years we’ll be signing up for Mars.

24:54 Trevor Burrus: Possibly. It was kind of interesting. I have often wondered if Bezos, when he started a bookstore if he initially just thought it was gonna be a bookstore and then in some way a click is like, “I can do everything on the planet and have this sort of Elon Musk moment.” But on this point of these sort of wildcat innovators, there is this possibility that the government research, government funding, especially doing high-level research, scientific research without maybe a known technological use to it, but some day can be used, like the government can direct this stuff, that we could have government departments of innovation, government research grants and have governments come in and help out this sort of innovative dynamism. What would you say to that?

25:40 Arthur Diamond: Well, they haven’t had a very great track record of doing that. I listened to your podcast back a little bit with Terrence Kiely. A long while ago, I read one of, his first book. And I think he makes a strong point that if scientific research is done when it’s tied to particular technological objectives, even if indirectly tied, it’s more likely to stay grounded and useful, as opposed to just becoming theory, where you’re spinning theory on theory that ends up not really giving us much better understanding in a deep sense or in an applied sense either. And if you look at particular projects that they picked… I talk in the book. I had to cut way back the content of the book because it was too long, so I don’t have as much on this as I wanted to. But I have a little section where I talk about the two main examples that people give of government involvement, and that’s DARPA in the United States and MITI in Japan.

26:47 Arthur Diamond: And when you dig deep into both of those, you find that they’re given credit for the internet. But I think a credible case, I’m talking about DARPA in this case, a credible case can be made that what really mattered in terms of innovations happened at the private Xerox PARC group, not so much… And in fact, the person who was the main person leading DARPA’s effort on the internet got frustrated working within the government and jumped ship and became one of the leading people in the private Xerox PARC operation. But a lot of the great innovations that were important, ethernet by Metcalfe, the mouse, the graphical user interface, those were all done at the private Xerox PARC.

27:32 Arthur Diamond: In terms of MITI in Japan, they put a lot of their money in what turned out to be a much inferior high-definition TV kind of a platform. They did not put their money, and this is something George Gilder pointed out, he’s written about DARPA and MITI in one of his books. He points out they totally missed what was the enormous innovation of the time period, which was the personal computer. And so, he does give them credit that at one particular point in their history, a DARPA [28:07] ____, they favored lower taxes for business, which he thinks did have some effect in making it easier for startups to start up and to do innovative things. So he thought, when they did general policy, to argue for less government in some other ways MITI made a contribution. But when they tried to pick the winners, they were not doing that so much. I may have strayed a little bit from your intended question, but…

28:31 Trevor Burrus: No, I think government… Well, that’s part of the question too, where if you think about the forces of, the political forces that control government money and the kind of weird iconoclasm that some entrepreneurs have to say you guys are saying that this is the only way of doing it and I totally disagree that there’s a way of doing this that no one has thought of. Is it likely they get funding from someone you have to convince is a good idea. It kind of reminds you, you talk about the Wright brothers in the book a fair amount and the idea that flight on a theoretical level, most people would not have endorsed it. And I actually weirdly saw a story this morning in Scientific American called No One Can Explain Why Planes Stay in the Air, still. I’m not sure that really mattered to Wilbur or Orville Wright. I hope it’s not like a cartoon character where we all suddenly realize that we don’t know why we’re staying in the air and then we fall down. That’d be bad.

29:31 Aaron Ross Powell: I wanna ask, though. So, Schumpeter’s phrase creative destruction, for talking about innovation. One of the things when we talk, when we say, well, we should cut back on regulations and taxes. We should free up this dynamism, innovation is good, one of the responses we get, it used to be primarily from the left but it’s also increasingly from the right now, is we’re under-emphasizing the destructive nature of creative destruction, that these innovators are bringing us new things, and that’s great, but at the same time, they are destroying old industries, destroying old careers, and in some ways destroying old ways of life.

30:15 Trevor Burrus: Whole towns.

30:16 Aaron Ross Powell: Whole towns, whole regions. And that’s something that we, who are advancing policies to spur innovation, need to be taking into account more than we are. Do you think there’s anything to that?

30:31 Arthur Diamond: Well, I think that’s a crucial issue. And when I first started thinking about this book and I was going to different academic publishers at the AA meetings and saying, “Would you be interested in a book like this?” I remember talking to one and giving them the spiel about how important the new goods and the new processes are, and how much they benefit humanity. And he kind of was nodding with kind of a slightly smirk on his face. And after I gave my two-minute spiel, he said, “Well, that’s all well and good, and most people are gonna salute that. But the problem is that people are gonna be worried about losing their jobs. And that if push comes to shove, if they have to choose between the neat new things and processes and the fragility of losing their jobs, they’re gonna go with the fragility of losing their jobs and they’re gonna be against what you’re saying.” And then he kind of walked off with a sneer. And I thought, “What a jerk.”

31:20 Arthur Diamond: But I also thought he was making a point that’s worth thinking about. And so part of what I resolved to do in the book was to take that seriously and to do as best I can to address it and to see how much truth there was and what his complaint was. That one of my favorite books that does some of the same thing… Some are the same of what I do, is a book by Baumol, Litan and Schramm, called Good Capitalism, Bad Capitalism. And it got reviewed in the Wall Street Journal, and it was a positive review except near the end. It said, “The problem of this book is it neglects the elephant in the room. And the elephant in the room is job loss, and that workers are gonna suffer, and that’s why most people will reject what they’re saying.” And it’s true that in that book, they didn’t have it. So in my book, I’ve got something like two-and-a-third chapters that deal with these issues.

32:07 Arthur Diamond: I think it’s a bum rap, largely. Part of why I was torn on whether to use the phrase “creative destruction” or the phrase that I prefer, “innovative dynamism,” is that I think having destruction in the phrase overemphasizes the negative from what it truly is. When I started the project, I thought there were gonna be huge trade-offs, that we benefit as consumers from innovation, but we are hurt as workers. And one of, what I think is, the big conclusions in my book is that the epiphany is, if you want a fancy word, is that what really matter… What happens is that we benefit both as consumers and as workers. And what I suggest is, part of what makes it hard to show this, is that people do sometimes lose their jobs, and it gets laid at the feet of innovation, and sometimes that’s true, but sometimes it’s not so clear that it’s true.

33:00 Arthur Diamond: And I give some examples in the book, like, I talk about two camera stores. When I arrived in Omaha, one was called Deans, one was called Rockbrook. And I was an amateur photographer, and so I used both of them at different times. Digital photography started to become an innovation that was growing more popular, and Deans refused to have anything to do with it. And they said, film is photography, and this stuff isn’t. Rockbrook embraced it. They started offering along with their film cameras, digital cameras, they set up kiosks that allowed people to bring in their memory chips that had their photography and to do projects, Christmas cards and such. They gave classes on digital photography. Well, Deans went out of business, Rockbrook is flourishing, they now have three stores instead of just one. And you say, okay, was Deans… The people who worked for Deans, did they lose their jobs because of innovation and creative destruction, or did they… That’s the usual story, that’s what you would usually say.

34:06 Arthur Diamond: But you could have another count, that I think is maybe right, which is that they lost their jobs because they rejected the new, better innovations. And that if you embrace those innovations, the negative effects are much less. That’s part of my answer. Another part of my answer is that I think some of the job loss that we see is because we have put restrictions on innovative firms creating new jobs, we’ve made it harder for them to do that through regulations. And there’s a book that I thought I wasn’t gonna like, that I actually turned out to like a lot more of it than I thought I would, by a guy named Oren Cass called…

34:51 Trevor Burrus: Death of the American worker, The Once and Future Worker.

34:55 Arthur Diamond: Yes, The Once and Future Worker, that’s at least real close, if not exactly. And he’s got a chapter where he talks about… Maybe a couple of chapters, talks about regulations. He points out that some of the heaviest regulations are things like OSHA. And he says, okay, who does OSHA hurt? Does OSHA hurt the Silicon Valley people doing the high tech stuff? No, it hurts people doing manufacturing. And who are the people who are working for manufacturing firms? They tend to be some of the least well-off. And so our regulations have disproportionately hurt people who a lot of us are most wanting to help, that is the people who are less educated, maybe less skilled, the people who are trying to improve their lives from a low starting point. And I think he’s making a point, and I think then you say, okay, how much of the current plight of some of those people that’s highlighted in books like Hillbilly Elegy, Janesville. There’s a lot of attention, and people on our general side also are concerned about this, Charles Murray, Michael Munger have both… Are worried that technology and innovation is gonna have a bad effect on these people, the people who are at the bottom.

36:12 Trevor Burrus: And my argument is that it’s not technology and innovation that’s a problem, it’s that we were hobbling and over-regulating the innovative entrepreneurs who would be creating jobs for people such as them, and were disproportionately regulating and hobbling the creation of those kinds of jobs. I’m working on a paper now that expands on my idea of the robustly redundant labor market. And part of my argument is, people, the workers will accept innovations if they know that if they did lose a job due to innovation, that there’d be another job just as good fairly quickly waiting for them, and that’s what I basically mean by a robustly redundant labor market. We don’t have that as much as we should right now, and why is it? Because we restrain firms from… Part of I say, what do you expect entrepreneurs to do, innovative entrepreneurs? Entrepreneurs find uses for things that haven’t previously had a use. There was an article in the Wall Street Journal a few months ago on the front page where they have the quirky… There was a quirky article on the front page of every issue.

37:19 Arthur Diamond: Well, this was their quirky one on one particular day. There’s this cotton, this weed that produces stuff like cotton if you open the pod. And when I was a kid, I used to like to open those pods and see the stuff float off. Well, that’s totally worthless, farmers hate that stuff. And yet somebody now has come, an entrepreneur has come and found that that stuff is good insulator for parkas. And so now there are farmers actually growing these weeds. And what was previously a weed is now a resource. Well, there was another article in the New York Times a few months ago where there’s misshapen, not quite rightly made cornflakes that usually gets thrown away. Some entrepreneur has figured out that if you take those, you can make a really good-tasting beer out of them, right? And so here’s… The argument is, if entrepreneurs who were alert and looking for opportunity can make something out of weeds and bad cornflakes, can’t they find something that they can make use of with workers who are less skilled or less well-educated? And if they’re not, why not?

38:40 Arthur Diamond: Well, then, I give a more practical example, which is, there was a firm that is well known for having tried to do something like this, which is Nucor, the steel company. And what Nucor did was they did something real strange, they didn’t hire people with any experience in steel, they hired farmers. And you say, okay, farmers don’t know anything about making steel. Well, that’s true, but they said that farmers have certain character traits that we can work with, they’re used to working hard, they’re used to getting up, they’re used to be willing to try a lot of different things, because they have to on their farm. And so there’s a neat book called American Steel where they talk about the Nucor plant that was put up, an innovative plant in Crawfordsville, Indiana. And they talk about how these farmers made mistakes. And they did dangerous things in the process of learning how to do what they were doing.

39:30 Arthur Diamond: And this firm got nailed again and again by OSHA. There was constant fighting with OSHA, but after a year-and-a-half, they hit steel workers who used to be farmers. And they were doing innovative… Apart from that, they were doing innovative things also in terms of how they were making the steel. And the problem was, what you get from that is, they were burdened by government regulations in bringing jobs to the sort of people who most need jobs. And if we freed them and allowed others to do what Nucor did under great duress and stress, then I think there’d be less cases where you could say there was a great harm and penalty going to workers from innovation.

40:15 Trevor Burrus: How much is the profit motive matter in this? It’s discussed a lot but I don’t think it’s highlighted even in the proper way by free market advocates where the desire to find inefficiencies and fix them and then be able to profit from that is why people want to find inefficiencies. And it’s something I bring up all the time in healthcare where it’s… You have to have someone… I would argue it’s immoral to not let people profit off of the healthcare business ‘cause you have to have someone who sees a better, more efficient way of doing things and can profit from that, because if you don’t have that, then no one is out there looking, essentially.

41:00 Arthur Diamond: Yeah, I agree with you. There’s a guy I had never heard of but heard of in the last few months in Oklahoma who’s got a for-profit surgical.

41:12 Trevor Burrus: The Surgery Center of Oklahoma, yeah.

41:14 Arthur Diamond: Yes, yes, that’s it. I think that’s it. And I think that would be an example of what you’re talking about. On the broader issue, I’m torn a little bit, because what I emphasize in the book most, I praise and show all of the good that comes from innovative entrepreneurs. And I say there’s different motives for different innovative entrepreneurs. Some of them have profit as their motive. Some of them have fame or winning a contest as their motives. Some of them have getting a project into the world as their main motive.

41:48 Trevor Burrus: Just the challenge of it.

41:49 Arthur Diamond: Well, not necessarily, no. I mean, that could be part of it, but I would emphasize more that they want… The phrase I like is one that Jobs used, which is… He famously, when he was trying to recruit Sculley from who was working… A lower level executive at Pepsi, he said to Sculley, “Do you wanna spend the rest of your life selling sugar water or do you want a chance to make a ding in the universe?” And then, Sculley reports that when you put it that way, it’s hard to keep selling the sugar water, so he went over to Apple. And so, it’s making a ding in the universe, which is a little different than a challenge, ‘cause a lot of things are challenging. I studied Latin in college and it was challenging, but I don’t know if it made a ding… Helped me make a ding in the universe.

42:41 Arthur Diamond: The thing, I view… Project entrepreneurs want money, but they want money not as a metric of success or fulfillment. They want money to help them get the project done, and I think that’s sometimes a subtle difference. But I think people who are in it for the project rather than in it for the money are actually likely to be more successful in making a ding in the universe than those who are in it for the money. Because I think one of the things that happens for the people who are in it for the money is they jump ship too early. Like they have the IPO and it’s part of their plan to have the IPO and then sit back and be a venture capitalist for the rest of their adult life. Whereas the people who take the big risks… There was a time, and if you read about Zuckerberg, there was a time he could have had an early IPO and then had a huge number of millions of dollars just to sit back and use the rest of his life. But he had ideas about how to make Facebook better and he needed to stay in control to be able to do it.

43:36 Arthur Diamond: The motive there is not profit because… At least it’s not mainly profit. It’s mainly wanting to get the job done, and even if you risk the profit… ‘Cause the people who cash in early, sometimes the people who stick with it, they risk that they won’t have the chance of cashing in. Things will go south in the firm and they’ll have wished that they cashed in early like some of the… Like Omidyar did with eBay. I think the profit motive, a lot of good things can come from it, but I think a lot of times the best things come from a different motive, which is to wanna make a ding in the universe, for that you need the money. And it’s money as an enabler but not as a goal.

44:19 Aaron Ross Powell: You mentioned venture capitalists. And so, what is their role in this? Because we think right now what’s the most dynamic sector of the economy, it’s the tech sector and it’s Silicon Valley. And Silicon Valley is largely driven by venture capital and angel investors. So what role are they playing in this innovative process? And is their role different than… There’s always been investors in businesses, but is there something unique about the nature of that kind of funding structure?

44:50 Arthur Diamond: I think I still have a lot to learn on this and my position may change, but I’m kind of skeptical of venture capitalists in some ways. We talked earlier in our conversation about… Mentioned Christensen. And one point he makes in The Innovator’s Solution, a book with Raynor, is that venture capitalists did a great disservice to many firms in the dotcom era, because the venture capitalists pushed those firms to grow fast and not to be profitable fast. And there’s a chapter in that book where Christensen says that his advice is you wanna make a profit fast and grow slow. He thinks of having this idea that you need to be making a profit early on is a way to discipline the firm and give the firm direction and feedback that it’s on the right path and to make corrections at an early stage. But a lot of the venture capitalists, they poured money on these dotcoms that were growing without worrying about profits and then at some point things all of a sudden went bad and they didn’t have any reserves, they’d used all their money. They also didn’t have any discipline in terms of their spending, so a lot of them went under that might not have gone under. He calls that bad money.

46:07 Trevor Burrus: It’s basically the story of Season 2 of Silicon Valley, if you’ve ever seen that show. [chuckle]

46:11 Arthur Diamond: I’ve wanted to but I’ve never watched it. I never had…

46:14 Trevor Burrus: It’s worth it especially for understanding VCs. So, but what’s better than VCs, then?

46:20 Arthur Diamond: I think, to some extent, that you’re not gonna be able to get away from self-funding, and especially at the early stages, is what I emphasize most. If you look at all, almost all the great innovators, they have what some people call skin in the game, that I guess Nassim Taleb made a big deal of that phrase. But the part of the problem is, if what’s involved is serendipity, and if what’s involved is knowledge that’s hard to articulate, especially at the early stages, it’s gonna be hard to convince anybody that this is a good use of their money, especially if they have a fiduciary role where they’re responsible to the taxpayers or to the investors, they’re gonna wanna be able to make a case that’s articulate, and it’s gonna be hard. So how are you gonna be able to finance it? You’re gonna need to finance it yourself. And if you look at case after case, if you look at Apple, we’ve talked about Apple some, Steve Jobs sold his old van. His buddy Wozniak sold his HP calculator. This is back at a time when calculators cost several hundred dollars apiece. They got investment, a little bit of help, in terms of where to do the work from, Steve Jobs’ father let him use the garage.

47:38 Arthur Diamond: So, they were self-financing. At a stage where they’d got a little further, Jobs went to his old boss who was the head of Atari, a guy named Bushnell, and said, “Would you invest $50,000? And for that, I’ll give you a third of the equity at Apple.” And Bushnell knew Jobs, he’d hired him. He knew technology, he was the head of Atari. He turned down that offer, because he thought it was too speculative. And if you think about that, that could be the biggest investment mistake in the history of the world, [chuckle] to have had a third of the most successful company, or at least one of the two or three most successful, but…

48:22 Trevor Burrus: It’s like Pete Best being kicked out of the Beatles. Yeah.

[laughter]

48:24 Trevor Burrus: Yeah. Yeah, he says he doesn’t have regrets, but I can’t believe…

[laughter]

48:30 Arthur Diamond: But the venture cap… [48:34] ____ is another person who’s written some interesting stuff on entrepreneurship and he says that if you look at a lot of the venture capitalists, what they tend to do is they still want a business plan. They want something that is innovative, but not too innovative, because they wanna be able to evaluate what are the prospects, is this is gonna succeed. So he says the paradigm kind of a case of a firm they’re gonna support his Compaq back when it started. Compaq was gonna make something kind of like what IBM’s personal computer was. It was gonna be more portable, although it really wasn’t that portable if you ever saw one. And it was gonna be run by people who had a track record of running companies. So it was a little riskier than the average investment, but it was still not that risky. It wasn’t gonna be a total breakthrough new thing. So part of what [49:26] ____ says is you can’t… There’s not enough venture capital, and also it’s gonna be too risk averse if you’re looking to it as the main source for the really major innovations.

49:35 Arthur Diamond: And there’s other arguments you can make. They, and this is one of those half-empty, half-full arguments. Sometimes the advantage of venture capitalists is that, well, they’ll give you mentorship and advice. But on the other side of that, sometimes the mentorship and advice is not good mentorship and advice. And I’ve seen people argue both ways, it’s certainly in the case of the Silicon Valley dotcom era, if Christensen’s right, their advice and mentorship there was not good, but there’s a thing, Y Combinator, that in Silicon Valley where there’s a lot of people saying that Y Combinator does give good advice and helps these young fledgling firms. But even if you buy that, they’re doing it for a limited set of innovative firms. They’re doing the dotcom thing. There’s a neat passage from The Frackers, a book about the innovators behind fracking by a guy named Zuckerman. And he’s reporting… It’s a conversation that one of the main entrepreneurs, a guy named George Mitchell had. And he was upset and was really complaining, “These venture capitalists won’t give me a dime. And I’m trying to do this.”

50:44 Arthur Diamond: And when I talk to my students about this, I say, “You think about why wouldn’t they? Well, the people who where the venture capitalists were mainly used to funding people in Silicon Valley.” And these people developing fracking in Oklahoma and Texas, they didn’t look like Steve Jobs or Bill Gates. They didn’t sound like Steve Jobs or Bill Gates. They were profane, they usually weren’t very well educated. They were salt of the earth kind of people, and they weren’t getting any money. So they had to self-fund. And so what I argue is that that’s gonna be the case, and likely to be the case. Venture capital, I do wanna say on the other hand, economists always say, “On the one hand, on the other hand.”

[chuckle]

51:24 Arthur Diamond: On the other hand, at later stages, venture capital has helped some important firms do good things. And one of my illustrations in the book of how regulation can restrain innovation is to talk about what happened with the first venture capitalist, a guy named Doriot, Georges Doriot. The SEC came in and was trying to shut him down. They knew nothing about what he was up to, ‘cause he was doing something new. And he wrote these really passionate memos about how they were slowing him down and keeping him from doing something that now we recognize as a great innovation. I’m saying it’s not as great as some people think, but still it’s good. And the SEC was sending people who didn’t know anything about it, but who were making it really hard for him to do what we now see as something that was positive.

52:13 Trevor Burrus: So, on that point, a question with this whole conversation. Do we take innovation for granted, and not understand that there’s ways that it could be somewhat fragile, that it could be throttled or destroyed if you over-regulate or take away different parts of the economic system?

52:16 Arthur Diamond: Yeah, we do take innovation for granted sometimes. And this is true of some very good people, like Kevin Kelly who, he wrote a book called What Technology Wants, and he’s got some great parts in there talking about the Amish, and their attitudes toward technology, and about how old technologies never totally leave us. But one of the things I don’t like about his book is that he thinks that technology will just continue forward, no matter what policies or institutions you have. He gives an example in a blog and it’s related in the book where he says that if you had technology, if you had a society, an economy run by communist dictators, Moore’s law would still continue, you’d still continue to have this great advance in computing power year after year after year. And there’s a nice book by Pagan Kennedy where she quotes him on that, but then several chapters later talks about invention within the Soviet Union at the time of Stalin.

53:29 Arthur Diamond: And it turns out that the inevitability just wasn’t there. By any measure, patents or any other measure, the inventiveness of the Soviet Union fell precipitously under Stalin. And then, I don’t know if it’s my remark or her remark, I can’t remember, but one of us says that maybe it had something to do with the great number of inventors who were either imprisoned or executed by Stalin. And so it’s not inevitable, this is an extreme example, but you really can slow down invention, you really can chain Prometheus. And if you want Prometheus to bring fire, to bring the great innovations that make life better, you have to take the chains off.

[music]

54:25 Trevor Burrus: Thank you for listening. If you enjoy Free Thoughts, make sure to rate and review us on Apple Podcasts, or on your favorite podcast app. Free Thoughts is produced by Landry Ayres. If you’d like to learn more about libertarianism, visit us on the web at www.libertarianism.org.