FEATURED ARTICLE | OCTOBER 2, 2006
Two Steves and One Soichiro: Why Politicians Can't Judge Innovation
How times have changed! Nobody (well, nobody outside of college English departments) still believes that socialism outperforms markets, of course. And Japan has gone into the same muddy tank that Sweden has wallowed in for years. Even Alfred Kahn, Jimmy Carter's inflation guru, said by the end of the '70s that we should "Cast a skeptical eye on glib references to the alleged success of government interventions in other countries in picking and supporting industrial winners."
But we still face the same basic problem. The boundary we fight over today divides what is decided collectively for all of us from what is decided by each of us. You might think of it as a property line, dividing what is mine from what is ours. And all along that property line is a contested frontier in a war of ideas and rhetoric.
For political decisions, "good" simply means what most people think is good, and everyone has to accept the same thing. In markets, the good is decided by individuals, and we each get what we choose. This matters more than you might think. I don't just mean that in markets you need money and in politics you need good hair and an entourage. Rather, the very nature of choices, and who chooses, is different in the two settings. P.J. O'Rourke has a nice illustration of the way that democracies choose.
Imagine if all of life were determined by majority rule. Every meal would be a pizza. Every pair of pants, even those in a Brooks Brothers suit, would be stone-washed denim. Celebrity diets and exercise books would be the only thing on the shelves at the library. And—since women are a majority of the population, we'd all be married to Mel Gibson. (Parliament of Whores, 1991, p. 5).
O'Rourke was writing in 1991. Today, we might all be married to Ashton Kutcher, instead. But you get the idea: Politics makes the middle the master. The average person chooses not just for herself, but for everyone else, too. Let's see why.
Imagine five people have to choose a road salt budget for their hamlet. Mr. A doesn't drive, but has azaleas; he wants zero salt. Mr. B would spend enough to clear the main road. Mr. C would spend a little more, salting the side roads a bit. Mr. D advocates a "clear roads for all" budget, and Mr. E wants clear roads and also sidewalks (he hates azaleas).
So, their diverse goals look something like this:
|Person||Salt Budget Preference|
One of the achievements of modern public choice theory (beginning with Black, 1958) is to show definitively that, if anyone can make proposals, the middle preference must win. So Mr. C, and the town, get a budget of $10,000 for salt next year. Mr. A has more azaleas killed, and Mr. E sees more azaleas survive, than either would prefer. And this makes sense: the town has just one road salt budget, and the choice is a compromise.
And we know exactly where the compromise lies: it's the median, not the average. In our example, the average is $8,420, and it is easy to see that this budget is not possible for the town. All that would be necessary is for Mr. C to propose $10,000, and a majority (C, D, and E) would all vote for it, preferring $10,000 to $8,420. Only A and B would prefer the $8,420 average, and they would lose out. The bottom line is that $10,000 beats any other budget, by the same logic, by a vote of 3-2 or more.
This approach to decision making resists change or new ideas from individuals. Suppose that Mr. E decides not only that he doesn't like azaleas, but that ice itself is immoral. He demands that no ice be allowed to form on any surface in the city limits. Mr. E estimates that this would require a 1/4 inch coating of salt, dropped from rented crop dusters. The total cost would be $2,500,000. He puts up a banner at the town meeting: "E: Ending Ice as We Know It." After Mr. E tells the other voter of his insights on icicular immorality, we can present the revised goals of our citizens this way:
|Person||Salt Budget Preference|
The effect on the median and on our town's road salt budget is... nothing, even though Mr. E changed the average desired salt budget to more than $500,000. Nobody has to talk E out of it; the town still chooses $10,000, because the median is unchanged by movements at the extremes. Large democracies are inherently, and in many ways intentionally, resistant to changes in the ideas of just a few individuals. And that can be a good thing, since a lot of towns have a Mr. E.
But what if we asked citizens to make one-size-fits-all choices on everything? For example, instead of a proposal to "end ice as we know it," suppose we asked the middle guy (call him "Median Joe") what he thinks of personal computers? And to make it more interesting, let's go back before personal computers even existed; how would Median Joe have reacted to that new idea? Is that a decision that the middle sort person would have made better than someone at the extremes? Let's take a look.
In 1976, there were two Steves, in a garage. One worked for Hewlett-Packard, and the other for Atari, in California. The Atari guy, Steve Jobs, had the garage, and the two Steves worked on a revolutionary machine. Or so they hoped. Near the end of 1976 the Steves, Jobs and Wozniak (the HP guy), released into the market a metal box attached to a TV screen, and tried to charge $666.66 for each one. The contraptions were called Apple I's.
Suppose we had taken a vote at that point on this "personal computer" thing. Most people would have guessed that there was no future in these silly, overpriced boxes. ($666.66 is more than a satanic pricing point; it is also $2,350 in 2006 dollars. This for a paper weight with no fixed memory and 16k of RAM.) No government agency would have funded the thing, unless Messrs. Jobs and Wozniak were also big campaign contributors. And it is unlikely that there would have been a grass roots wave of support, since no one even knew who the Steves were or what they were trying to accomplish.
But Jobs and Wozniak were out at the extreme of opinions about computers and the future. They moved out of the garage in 1976, and in 1980 they rolled out the $3,495 Apple III (that's about $9,000 today!). Clearly, this company had no future. Of course, they had not received, or risked, any public money, so it was no one's problem but theirs. Their hunch, their money, their loss.
Then, the Steves held a public stock offering of stock later in 1980. And against all expectations, they became instant millionaires, selling 4.6 million shares. That's a lot of shares; is Median Joe a risk taker, after all? Not really; suppose that each sale was for just one share, to 4.6 million people. That would still mean that more than 97% of the U.S. population thought the stock was a bowzer. And in fact just a few people bought any shares at all, though these few oddballs bought heavily, making a "yes" bet when everyone else was betting "no."
And who wouldn't bet against the overpriced boxes? The business editor at Prentice Hall said, in 1957: ""I have traveled the length and breadth of this country and talked with the best people, and I can assure you that data processing is a fad that won't last out the year." Later, when the microchip was invented, an engineer at IBM's Advanced Computing Systems was puzzled: "But what ... is it good for?" And in 1977, Ken Olson, founder of computer giant DEC, sniffed that "There is no reason anyone would want a computer in their home."
Let's give DEC's Olson his due: He was right, in a very unimportant way. For years, few did want home computers. If we had put it to a vote, computers would have lost, with more than 95% of population voting "no." But we didn't vote. We left it up to the individuals at the extremes. By 1985, only 5% of American households had voted "yes," with people having some kind of access to personal computers. For a political comparison, Ross Perot got 19% of the vote in 1992, and that was after he announced (accurately, if you have seen a picture) that he was "all ears."
By 2005, a majority of "we the people" had changed their minds. Just over 60% of households had at least one computer, with even more having access at work or libraries. Those who bet "yes" on personal computers early on, won. And eventually most of the rest of us came along, free riding on the correct guess. None of the skeptics had to risk anything on the success of the computer, and were free to wait until all the up-front costs of development were paid by others. And had PCs flopped, none of the skeptics would have lost any money. It would just have been "I told you so!" time.
Sometimes, the person saying "I told you so" gets to say it to the government, or to the political process. In the late 1950s, MITI (the Japanese Ministry of International Trade and Industry) decided to rationalize and streamline the Japanese automobile industry. The goal was to realize economies of scale in design and production, and increase the number of cars that Japanese companies would export to the U.S. and elsewhere.
It was decided that just two auto companies (Toyota and Nissan) would get government financial support. All other companies were told that they should direct their energies to motorcycles, or blenders, or perhaps those new televisions. Costs would fall as each company produced more cars. The logic was undeniable: fewer producers, lower costs.
But there was one strange loner, named Soichiro. He was an odd prickly person, and wouldn't listen to MITI, or anyone else. Soichiro's company sold excellent high-performance motorcycles, and he thought his engines and manufacturing procedures would work well in automobiles. In 1959, in spite of the bleating of MITI, Soichiro's company introduced the S360 sports car.
Today, you have likely heard of the company led by an oddball, a guy who refused to comply with the dictates of the central authority. By the mid 1950s, the company had come to be known by Soichiro's last name, Honda. If the policy had prevailed, Honda would be...well, it wouldn't be. But because Soichiro Honda refused to give in, consumers all over the world got one more choice of automobiles. And millions of them choose Honda, a car that now appeals to the comfy median very well indeed.
On many kinds of policy, where one unique alternative must be selected from among many, and the legitimacy of that choice is at least as important as the choice itself, democracy has no equal. One defense budget, one speed limit on any one stretch of road, one standard width for railways, and one choice (left side or right side?) for driving automobiles.
But many choices aren't like that. There may not be a "we" that has to choose at all, imposing the median view on everyone. Instead, individuals can make their own choices. This is particularly true for innovations, or new ideas cooked up by some oddball. Some (in fact, most) of those ideas will fail, but we can't tell the winners from the losers in advance. The most significant innovations and advances in human history have been the result of the efforts of men and women too determined, or maybe just too strange and isolated, to know that the whole world was betting against them.
Think back to the ice-hating Mr. E in our road salt budgeting example. He wanted to impose his choice on everyone, not just himself. And he wanted everyone to pony up 1/5 of the costs of his strangely salty utopia. Democracies are stable in part because they deny any effective voice to the extremes, unless many other citizens are also persuaded. If the choice is one-size-fits-all, and the new guy wants to play with house money, it pays to say "no" most of the time.
That's why there are such important differences in our examples of the two Steves, or the one Soichiro. For one thing, even though their ideas were nearly as wild as Mr. E's, their proposal for innovation was but one of many alternatives, not one-size-fits-all. And for another, they were betting their own money, not the taxpayers'. If they went all in and lost, Uncle Sam (or Cousin MITI) didn't have to raise taxes to make up the shortfall.
For connoisseurs of bad innovations...Check out the "Pet Away" video at YouTube. Remember: most innovations are like this! But we don't need the government to protect us from this kind of invention, when common sense does just fine.
And that brings me to my final two points, the really key points I want the reader to take away from this essay. The first one is this: The conventional wisdom rejects innovation, and is usually right; that's why it's conventional. But the reason Median Joe is right to be skeptical is that most innovations are just balloon juice.
Still, a pessimist would then point out (and be right!) the flip side: the conventional wisdom is nearly always wrong, at least at first, about innovations that work. If you always say no, you do turn down all the bad ideas, but you turn down all the good ideas as well. Only if the innovation gets its chance, probably to fail but possibly to succeed, on its own merits and unconstrained by the views of Median Joe, will we find out what works and what doesn't.
Second, and no less important, this problem, this choice between collective and individual judgments, is at least as vital today as it was when Khrushchev was threatening burial, or Honda was nearly getting run off the road, or even when the two Steves were noodling in their garage. True, no one wants to return to a Soviet system, or an industrial policy with an agency of experts who make national investment decisions. But we still face the same basic problem: can I decide, and risk just my money, for great reward if I'm right? Or will we decide, and risk our whole future budget, on things we aren't very good at deciding?
The examples come thick and fast: should we have a uniform ethanol standard in all gasoline, or should we let gas stations (or individuals) concoct their own fuel mix formulas? Should the government subsidize hydrogen fuel cell cars, or let people at the extremes, perhaps two Mikes in some garage, work on the problem? Why not allow terminally ill, or even mildly ill, people to use whatever drugs they want, regardless of whether Median Joe (working through his stone-faced employee, the FDA) thinks that drug has five chances in a million of giving you a stroke?
Markets, and market processes, are themselves a pretty important innovation, one not always approved or understood by Median Joe. Why not let the market work at an even more radical level, one that many people might think goes too far? Imagine that airlines could compete based on the level of security they provide. Let passengers choose their own security, along with a mix of price and inconvenience that some entrepreneur thinks would increase profits.
And we could go further: imagine a security line at the airport where the guard looks at your boarding pass and asks, "Are you carrying any weapons?" When you say no, he gives you one, a 9mm Glock. "All passengers are required to carry these, sir. Airline policy." Not all airlines, mind you; only "Glock Air" (motto: "We just flew in from Cleveland, and boy are our arms locked and loaded"). You might choose to fly Glock. They have never had a terrorist incident, and if you push the flight attendant call button the guy comes running.
Or, you might not fly Glock. You don't have to. You might choose some other airline with a unique combination of services, safety, and schedule. In the current regulatory environment, too many decisions are one-size-fits-all, because we don't recognize the possibility that it could be different.
We have become too accepting of the views of the middle, in too many aspects of our lives. Worse, we have fallen victim to a soft but encroaching political paternalism. In many cases, it isn't even the median citizen who enforces his views on everyone. Instead, special interests and "public" lobbyists dominate the making of rules and decisions that force all of us to act as if we all had the same views on risk, taste, and service.
The thing to keep in mind is that market processes, working through diverse private choice and individual responsibility, are a social choice process at least as powerful as voting. And markets are often more accurate in delivering not just satisfaction, but safety. We simply don't recognize the power of the market's commands on our behalf. As Ludwig von Mises famously said, in Liberty and Property, "The market process is a daily repeated plebiscite, and it ejects inevitably from the ranks of profitable people those who do not employ their property according to the orders given by the public."
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