By Michael Parker*
[This is Chapter 4 of the book, The Pine Tree Paradox. The Introduction was previously published here », Chapter 1 is here », Chapter 2 is here », and Chapter 3 is here »]
PART II: THE INNOVATION CYCLE
The way to make innovation a key part of the New Zealand economy is to build a university that will sit at the centre of an Innovation Cycle that also includes start-up companies, R&D centres, venture-capital firms and a variety of other creative enterprises.
"Don’t try to control the world… just try to out-think it."
—Sanford C. Bernstein
After a short period of time living in Northern California, a young New Zealander is likely to discover that, in every respect but one, he or she may as well be back home.
The people you meet are friendly, open-minded and outgoing with a passion for the outdoors, for the environment and for the great locally grown food and wine. Beautiful beaches, forests, rivers, lakes and mountains surround you.
At the weekend, your friends and workmates will mountain bike and windsurf in the summer and head for the ski-fields around Lake Tahoe all winter. Or they may surf at Santa Cruz, go wine tasting in Napa, or hike up Mount Tamalpais. The range of activities based around food, wine, sport and the outdoors is endless but, again, to a New Zealand ear, strikingly familiar.
Occasionally you will meet a New Yorker who, while acknowledging that San Francisco has an opera company, a symphony orchestra and a modern art museum each of some renown, will say something like: “Of course, it’s beautiful here… but it’s very provincial”. This is generally not what a young New Zealander who has recently moved to San Francisco to experience life in the Big City wants to hear.
The similarities between Northern California and New Zealand are so striking that, after a few months, a New Zealander might be forgiven for asking: “Why did I make the effort to move here at all?”
Of course, the answer is never far from view.
For as similar as Northern California and New Zealand are socially, geographically, politically and, in many regards, culturally - there is one giant divide: economics.
Take a drive south from San Francisco on Highway 101 through Menlo Park, Palo Alto, Mountain View, Santa Clara and on to San Jose and you will pass land that 50 years ago was covered in orange groves.
Today, those orange groves have been dug up and that same land houses the headquarters of Adobe, Amazon, Apple, Applied Materials, Cisco, E-Bay, Electronic Arts, Google, HP, Intel, Oracle, Sun, Yahoo! and a hundred other successful Bay Area start-ups.
Ever since two Stanford graduates, Dave Packard and William Hewlett, first experimented with designs for an audio oscillator in Packard’s garage in Palo Alto, technology companies have headquartered themselves in what is known as Silicon Valley in between San Francisco and San Jose.
If you want to work for one of these companies, move to Northern California. If you want to work for an accounting firm, a law firm or an advertising agency that counts these firms as their clients, move to Northern California. If you want to invest in the “next Google”, move to Northern California. If you want to start the “next Google”, move to Northern California. If you want to manage money, create art or decorate homes for the tens of thousands of people who have become rich doing any of the above, move to Northern California.
Thanks in part to the high-tech industry in Northern California, today California has the largest economy of any state in the U.S.
Ranked globally, the state of California would be among the top ten national economies by total size. And the top five counties in California based on GDP per capita are all in the San Francisco Bay Area (based on the 2000 census).
Northern California has transformed itself over the last 50 years from a predominantly agricultural economy to a position of global high-tech leadership without disturbing the natural beauty of the area, the liberal and experimental disposition of the people and the outdoor lifestyle that everyone there cherishes.
In fact, for most people who move to Northern California, these qualities are a key part of why they stay. The money enables the lifestyle and, counter-intuitively, the lifestyle enables the money.
Northern California’s income per capita was 60% higher than New Zealand’s in 2000 (the last time U.S. county-level statistics were prepared). If we were living like Northern Californians today, our national output would not have been US$113 billion in 2008 but US$180 billion - US$ 67 billion higher.
As a very rough calculation, this US$67 billion perpetuity translates into a difference in total aggregate wealth (at a discount rate of around 6.5%) of US$1 trillion.
In short, I would argue - and only half in jest - that the decision in New Zealand to follow an economic path based on agriculture rather than an economic path based on innovation has cost us over one trillion US dollars.
Any New Zealander with an interest in the long-term economic development of this country, the loss of talented New Zealanders overseas and the preservation of our lifestyle should, at some point, look at Northern California and ask: why not us?
Deconstructing Silicon Valley
The idea of regional development based upon creating the “next Silicon Valley” is, of course, nothing novel. Since at least the 1980s, city councils all over the world have looked to the San Francisco Bay Area as an example of the “good” kind of economic development - well-paid, highly-skilled, white-collar jobs with virtually no environmental impact.
The first step in emulating Northern California is to determine what makes Northern California work so successfully as a hub of innovation.
There is a tremendous amount of scholarship looking into the process of developing a regional concentration of innovative companies and why such companies cluster in specific regions. Two American academics, Richard Morrill and Paul Sommers, characterise35 the competing theories as essentially a debate between the “Death of Distance” and the “Global City”.
The “Death of Distance” argument is familiar to any New Zealand economic discussion. In short, the improved communications introduced globally in the 1990s in the form of the mobile phone, the Internet and global, fibre-optic cable networks meant the “death of distance” for business and personal communications.
With modern communications, documents drafted in New Zealand may be viewed instantaneously in New York, Shanghai and Sao Paulo. Teams of people, separated by thousands of miles, can work together. Since work can happen anywhere, why not here? The argument suggests that innovative, global companies can be located anywhere.
The counter-argument is that while, technologically, it is possible to have teams work across great distances, large cities still attract a superior talent pool because of higher quality supporting resources. A “Global City” tends to draw innovative people because of the high concentration of financial, cultural and educational institutions.
Morrill and Sommers note that the contradiction between the “Death of Distance” and “Global City” camps is reconciled for many companies by placing routine activities in low cost locations and R&D and management functions in the higher cost cities.
Of course, neither of these viewpoints provides a prescription for what New Zealand should do to encourage innovative New Zealand companies. And neither theory addresses the question of why Northern California has developed into an innovation cluster.
Obviously, the “Death of Distance” trend is beneficial to the extent that New Zealand focuses more on producing ideas and services and less on producing tangible goods that then have to be shipped to distant markets. To the extent that the “Global City” argument suggests that innovation only occurs in cities with a high concentration of financial, cultural and educational institutions, it seems overstated. Research and innovation hubs exist in Northern Virginia; Raleigh-Durham, North Carolina; and Austin, Texas. These are not Global Cities by anyone’s definition.
The author Richard Florida36 provides an elegant way of talking down the “Global City” requirement for developing regional centres of innovation. He refers to the idea of a creative class. Florida argues that liberal cities are attractive to innovative and creative thinkers - the creative class. He further argues that this creative class is a necessary part of the environment that fosters creative and innovative companies.
Therefore, cities with high tolerance for unconventional, liberal and artistic endeavours, including high levels of acceptance of gay and lesbian communities, are the cities where creative and innovative companies locate. This claim is certainly backed up by the high correlation of liberal cities and high-tech development during the 1990s.
In the United States, San Francisco, Seattle and Austin are the clear examples where this effect has played out. None of these cities fall into the category of “Global City” in the sense of New York, Hong Kong, London, Paris or Shanghai. Yet all of them attract the creative class necessary, according to Richard Florida, to establish areas of innovation.
Steve Carden, a New Zealand writer, suggests that there are several prerequisites for a region to stimulate innovation. Specifically, the region must be able to generate new ideas and a have willingness to change and absorb these new ideas37.
However, each of these formulations for successful regional development is unsatisfactory as a prescription for what we should do next. Carden tends towards generalities. Florida relies too heavily on the strict definition of a creative class without explaining the other factors at play. The “Death of Distance” is an observation of a trend, not a prescription for action. The “Global City” argument is too restrictive and is inconsistent with the facts.
In this book, I refer to the concept of an “Innovation Cycle” as a more structured formulation of the thinking of Florida and Carden and the concept of the Global City.
I argue that an Innovation Cycle requires the presence in the region of four separate economic and social dynamics. I use the concept of a cycle because the key to success is, in my view, the interaction between disparate elements in the cycle, including universities, start-up companies, R&D centres, law firms, venture-capital firms, banks, accounting firms, advertising agencies, art galleries, music venues and yoga studios.
Northern California contains these four separate dynamics working simultaneously. Auckland - with one strategic injection - could too.
Dynamic #1: The Boom Generator
The first dynamic is the boom “generator”. In an extraction economy, this boom generator might be oil or gold. In a services economy, this boom generator might be the America’s Cup or the Rugby World Cup hosting rights. In an innovation economy, the boom generator is a university.
In any Boom Town, workers, investors and entrepreneurs flood in to take advantage of the new opportunity. Workers move where the successful companies and, therefore, the jobs are. Entrepreneurs move in, forming new companies to exploit the new opportunity and hiring experienced workers. Investors go where the new companies are. And all of this happens simultaneously.
This is the same boom cycle that plays out in any Boom Town - from Deadwood to Dubai to San Francisco during the dotcom period to Auckland during the America’s Cup defences. To trigger a boom period, a natural resource, a unique event or a new discovery is required. The cycle continues until the gold, or the oil, or the money or, in Auckland’s case, the trophies run out. Then comes the bust.
This boom cycle has played out many times over the last 50 years in Northern California. However, in Northern California, the bust cycles that follow are generally shorter and less dramatic than the booms. There has been a consistent procession over the last 40 years of new, successful companies emerging in Northern California bringing with them a new “Boom”. There are other dynamics at play.
Dynamic #2: The Cluster Effect
If the generator can continue to pump out the gold, or oil, or America’s Cup victories, then, over time, the Boom Town turns into a cluster that both attracts companies in similar lines of business and creates expertise and a unique supporting infrastructure. In the America’s Cup example, if Team New Zealand always won the America’s Cup and the regatta was hosted in Auckland permanently, Auckland would attract all of the America’s Cup syndicates and sponsors, together with the world’s best sailors and boat and sail designers, into a near permanent “hub” on the Waitemata.
This is the second dynamic - the Cluster Effect38. Under a Cluster Effect, the leading companies in a specific industry tend to gravitate to one place.
The benefit of concentration outweighs the cost of the increased competition.
A cluster may emerge from a long boom cycle. If the boom period continues for long enough in one place, the companies in that region will develop special expertise, unique reputations or scale advantages. The boom period becomes self-perpetuating.
A classic example of the Cluster Effect is the Diamond District in Manhattan. The Diamond District could have established itself on 46th Street or 48th Street, but it happens to be on 47th Street. It may have been that, in the late 1940s, 47th Street was where the most persuasive salesmen, or the best-sourced diamonds, or the cheapest leases were. In any event, that’s where the cheapest diamonds were. Therefore, that’s where everyone who wanted to buy a diamond went. As a result, that’s where everyone who wanted to sell diamonds had to be. Sixty years later, it’s all still there.
In any cluster, a supporting infrastructure including lawyers, bankers and accountants follow along. That supporting infrastructure becomes expert at particular types of transactions. Some of the best diamond appraisers in the world are in the Diamond District in New York because that is where all the diamond merchants are. The diamond appraisers get plenty of practice.
In the same way, if you want to invest in a start-up technology company or form a venture-capital fund, call the San Jose offices of law firms like Wilson Sonsini or Morrison Foerster. They get plenty of practice with those types of transactions because of the high-tech cluster in Northern California.
As a result of this high-tech cluster, despite the high salaries and the high cost of doing business, new high-tech start-ups continue to establish themselves in Northern California every year because that is where all the industry experts are.
In addition, companies in related fields are also likely to move to Northern California. As an example, Northern California has in the last five years become home to a number of successful and innovative solar energy companies: SunPower, Nanosolar, Miasole and Solyndra are all based there. This is an incredibly expensive part of the U.S. to start a new company in a fledgling industry. Yet the technology used in solar panels is similar to the technology used in semiconductors. If a company wants to find semiconductor expertise, Northern California - home of Intel and AMD - is a good place to look.
Established companies in Northern California may wish to move to a lower-cost part of the country where the threat of the competition stealing your talent is lower. But there are two problems. The first is that, perversely, the presence of the competition works both ways: while it is true that your competitors are trying to steal your employees, there is also a large and experienced, regional talent pool just outside your door in the form of your competitor’s employees. Access to this talent pool is difficult to abandon.
And, in Northern California, there is another, more pervasive problem that keeps the companies in the region: the employees do not want to leave.
Dynamic #3: The Lifestyle Effect
People who work in Northern California generally want to stay there. They enjoy the skiing, the sailing, the wine, the organic food, the liberal politics and the progressive nature of the region. There is simply no guarantee that the R&D staff of a large, high-tech company would follow if the company relocated to Phoenix.
This is the difference between a simple cluster and the Northern Californian experience. Once the money is made, do the newly wealthy return home or do they stay? In other words, other than the work and the money, is there something to keep people in the area in terms of lifestyle?
If the newly wealthy stay, then this affluent class of knowledge workers becomes a permanent group. The income of the knowledge worker is, in a sense, converted into permanent wealth for the entire region as those workers put down roots.
Dynamic #4: The Creative Class
This wealth feeds the fourth dynamic - Richard Florida’s notion of a “Creative City”. Once this wealthy class of knowledge worker makes the decision to settle in the region and start spending money, they entice a new wave of “creatives” - the designers, the chefs, the interior decorators, the ski instructors, the artists, the musicians and yogis - to follow along.
Careful readers will note that the second and the fourth dynamics - the Cluster Effect and the Creative Class - occur automatically unless there are specific government policies in place (immigration, taxation, etc) to prevent them.
Our areas of focus should therefore be on the Boom Generator and the Lifestyle Effect. In Northern California - as in New Zealand - the attractive lifestyle is already in place, given the climate, the food, the wine, the geography, the ocean, the mountains, and the attitude of the people. The missing component in New Zealand is the Boom Generator.
The Cobain Calculation
With these four dynamics in place, each feeds off itself and the others. As an example, a more sophisticated musical and artistic environment attracts more sophisticated musicians and artists. This elevated cultural environment provides added enticement to engineers or lawyers considering moving to the region. This increased level of patronage may well encourage a young local artist, musician or designer to stay put rather than moving to London or New York.
The symbiosis is often counter-intuitive and the effect can be profound. The existence of all four dynamics together can create something entirely new and unpredictable. And I don’t just mean software.
My favourite example of the unpredictable output of the Innovation Cycle may be Microsoft’s impact on Seattle’s music community in the 1980s39.
In the 1970s, Seattle was a predominantly white, blue-collar, industrial, union town. The popular music on the radio was heavy metal. Jimi Hendrix and Queensrÿche - a hard rock band from Bellevue, Washington - may have been Seattle’s most successful, local acts of the 1960s and 1970s respectively. KISW was one of the biggest radio stations in Seattle in the late 1970s and early 1980s, playing a steady diet of Ozzy Osbourne, Van Halen and Rush.
With Microsoft’s growth beginning in the mid 1980s in Seattle, there were a tremendous number of young engineers and software programmers suddenly moving to Seattle.
The hundreds and then thousands of college-educated, predominantly male, twenty-somethings who arrived in the region each year from across the country to work at Microsoft didn’t work all the time. Together with their programming firepower, this influx of young, single, college graduates brought an appetite for a broader range of entertainment choices to the area.
As a rule, young men like loud music. As a rule, smart, young men like loud, experimental music.
The young college graduates who moved to Seattle in the mid 1980s were used to listening to and attending shows by “indie” bands like Sonic Youth from New York, Husker Du from Minneapolis, REM from Athens, Georgia, and the Pixies and Dinosaur Jr. from Boston. In Seattle in the mid 1980s, there was no comparable college or independent music scene to address this new market.
Then, in 1986, record label Sub Pop emerged. Bands like Mudhoney, Green River and Soundgarden combined the Pacific Northwest’s love of hard rock with a more experimental edge informed by college radio. Sub Pop found an audience for this distinctive Northwest sound. Then, in November 1988, Sub Pop released a single called “Love Buzz” by a trio from Aberdeen, Washington. That band’s name was Nirvana.
I am not suggesting that everyone at Nirvana’s first gig worked at Microsoft. Nor am I suggesting that Kurt Cobain would have become a truck driver in Aberdeen if not for Microsoft. My point is that the injection of young, driven, innovative people into a city or region is likely to change things in unexpected and positive ways. It is not possible to prove a direct causal link between Microsoft and Kurt Cobain, but it remains tempting to think of Bill Gates as the godfather of grunge.
As preposterous as that sounds, the inverse is even less likely. Seattle had no tradition of independent or college rock before the emergence of Sub Pop records. It is difficult to imagine that an independent label signing experimental garage bands could survive in Seattle without this influx of the college-educated, twenty-somethings working at Microsoft, and at the law firms and advertising agencies that supported Microsoft. Further, without an appetite in the region for this kind of music, would the local bands have even evolved in this manner?
And it works both ways.
The emergence of Nirvana and the popularity of grunge as a musical genre in the early 1990s suddenly made Seattle cool. The music - together with the sailing in the summer, the skiing in the winter and the vineyards in the emerging Columbia Valley wine region in western Washington state - made Seattle a different city. Recruiting young people to move to Seattle (or enticing them to stay) to work at Microsoft or Boeing or Starbucks became a lot easier.
The reason I like the Nirvana story so much is that the members of Nirvana were all from the Seattle area and none of them ever worked for Microsoft. They weren’t directly affected by Microsoft’s growth in the region at all. They very well may have been oblivious to it. I certainly like to think so.
The anecdote is not about what foreigners or outsiders can achieve economically once we “let them in”. It is about what we can achieve in all areas of endeavour, if we create the right environment for ourselves.
In New Zealand, we feel the sharp end of that question every day.
Think of it as the Cobain Calculation: what could all the ex-pat lawyers, engineers, artists, designers and musicians create together in New Zealand, if they were still here rather than in London, Sydney, Los Angeles and a hundred other cities across the globe?
For decades, young New Zealand lawyers, designers and engineers have moved to London because of, among other things, lack of opportunity in New Zealand. What would happen if, for example, we had law firms like Morrison Forster and Wilson Sonsini in New Zealand offering a level of specialisation that could be matched in few other places in the world?
If we create a Cluster Effect in New Zealand, a young New Zealand lawyer would have a reason to stay here. Of course, she may wish to go to London for a few years anyway. But now she would have a compelling professional reason to come back.
Similarly, with Auckland as a growing “Creative City”, a young designer who has commissions and a thriving business in New Zealand may go to Europe for a six-month sabbatical for the exposure, but is far less likely to move overseas permanently on the basis that “you can’t do what I do in New Zealand”.
The full measure of the talent lost cannot be calculated simply as the sum total of the work produced by the New Zealand lawyer, the engineer and the designer in London.
The problem is knottier than that. It is the Cobain Calculation: what would they have produced if living, working and interacting together in an innovative, creative New Zealand.
Or pose the question in a positive light: what could we create here in New Zealand if we could attract not just our own ex-pats back to New Zealand but innovative and creative people from all over the world to study, live and work in New Zealand?
The Innovators, They Are Us
Why can’t we develop economically in the same way that Northern California has, and use those economic opportunities to keep New Zealanders in New Zealand and attract more talented foreigners as well?
The proximate answers are simple. Unlike Northern California, New Zealand doesn’t have a Sand Hill Road - a single street housing a collection of large, experienced venture-capital firms willing and ready to invest in a wide array of early-stage companies developing new technology. New Zealand does not have the same talent pool of highly qualified employees that start-up companies can lure away from their current employers with stock options at pre-IPO valuations.
We don’t reward our young and ambitious for building start-ups from scratch. We send them to London for experience and opportunities at large banks and multinationals.
New Zealand’s stock market does not have the history of the NASDAQ turning start-ups into public companies and giving early-stage investors an exit opportunity at a “pop” valuation.
The concise reply to most of these explanations is “yet”. A more thoughtful review suggests that the problem has nothing to do with the New Zealand Stock Exchange’s track record of IPO’ing technology companies, or the Great Kiwi OE or the depth of venture-capital funding in New Zealand.
Lack of investment capital cannot be the answer. There was no significant start-up investment community in Northern California in the first half of the 20th century. There was certainly wealth from the railroad, from agriculture, from shipping and from gold mining. But the venture-capital firms of Sand Hill Road were not a prerequisite for the economic success of Northern California. They followed once investment opportunities emerged.
In terms of funding, the important prerequisite is the access to capital, not its proximity. An investor could fly from the East Coast to San Francisco to meet with a start-up company and, if sufficiently impressed, could invest in the company. If really impressed, the investor could establish a fund to invest in other similar start-ups throughout Silicon Valley. The point is that the investor community is a subsequent addition to the Cycle, not a requirement from the outset.
The reason New Zealand is not currently an innovation hub is that we do not currently have a Boom Generator for innovation. And that is where the difference between New Zealand and North California comes into stark relief. Northern California already has two permanent “generators”: Stanford University and the University of California at Berkeley. We do not.
A world-class research university in New Zealand would produce graduate students with innovative ideas. Investors would chase promising ideas and fund innovative thinkers, turning some of those thinkers into successful entrepreneurs (the “Boom Generator”). Lawyers and bankers would follow investors, and new companies would advance the breakthroughs of the older successes (the “Cluster Effect”). Artists and interior decorators would follow the successful entrepreneurs (the “Creative Class”).
The only truly difficult part of this process is how do you keep successful innovators and entrepreneurs in New Zealand once they have tasted success. Once the company is funded or the IPO has occurred, how do you keep the engineers and software developers and entrepreneurs here in New Zealand? How do we ensure we have the Lifestyle Effect covered?
And this is the part of the puzzle that, as New Zealanders, we understand the least about ourselves and about our country.
After ten years living abroad and meeting thousands of foreigners, there are only two conclusions that I have reached about the rest of the world: Six billion people would love to move to New Zealand and none of them know who Richie McCaw is.
An incredibly small minority of the world’s population cares about our obsession with rugby. The rest of the world is fascinated by our beaches, our mountains, our fjords, our lakes, our rivers, our sailing, our sea-kayaking, our skiing, our bungee jumping, our wine, our lamb, our crayfish, our mussels, our giant squid, our flightless birds, our ability to shut down as a country for three weeks every year beginning on Christmas Eve, our female ex-Prime Ministers, our film industry, our Nuclear-Free policy, our lack of people, our numerous sheep, our environmental focus, our open economy… and occasionally our America’s Cup challenges.
From an economic development perspective, this fascination with New Zealand is great news. The rest of the world already aspires to our lifestyle. Therefore, of the four dynamics of the Innovation Cycle, the difficult one is already taken care of. We have the Lifestyle Effect in place. All we need do now is figure out how to encourage innovation in New Zealand. Let the investors, entrepreneurs, lawyers, bankers, accountants, artists, musicians, yogis and ski instructors follow. Once they are here, the lifestyle will give them the reason to stay, or, more bluntly, the means to turn their income into our collective wealth.
This process will take some time - thirty years or more. But that is also great news.
There are very few regions in the world that have any hope of achieving an Innovation Cycle no matter the timeline. The prerequisites are incredibly intimidating for just about any other region on the planet and yet we take them all for granted: a stable, democratic government, a corruption-free public service, a high level of acceptance of creative people and alternative lifestyles, an open economy, an English-speaking population, a friendly and welcoming attitude, low population density plus a unique physical landscape suited to winemaking, sailing, skiing and any number of other outdoor pursuits.
So how do we attract these innovators that are the key to the “Boom Generator”? Well, the short answer is that a lot of them are already here. They just don’t know that they are innovators yet. The innovators, they are us. The resource that New Zealand lacks that Northern California had and has is the presence of a truly great university - or two - to tease out and sharpen that innovative capability.
I have seen the future, and it is just off Highway 101
In Northern California, Silicon Valley is bordered by Stanford University to the south and the University of California at Berkeley to the north. These two institutions created an academic environment that fostered excellence in its students and, over time, attracted top talent from all over the country and all over the world.
In the 1930s, that talent created HP. In the 1950s, it was Wang. In the 1970s and 1980s, that talent formed Apple, Oracle, Intel and Cisco with the help of the burgeoning venture-capital community. The cycle repeated itself in the 1990s with Yahoo!, E-Bay, Google and Amazon and continues today with Web 2.0: Facebook, YouTube and Twitter.
All the while, the lifestyle in Northern California has kept the participants there. The area became a national and then a global magnet for talented, ambitious engineers, investors, marketers, lawyers, accountants, bankers and anyone else looking to work on the Next Big Thing.
We can replicate that experience here. But the missing ingredient in New Zealand is the great research university. That is the simple prescription at the heart of this book: ensure that we are arming New Zealanders with a world-class education. Create a reason to bring talented people to New Zealand. Let the ideas fly. Trust that the global investment community will not leave promising ideas unfunded for long. Wait for a few of the ideas to spark and catch fire, resulting in new jobs, profits and new investment flowing into New Zealand. Rely on the lifestyle here to make those who move here for the initial job opportunity look for a reason to stay. Allow the wealth created to attract and retain the creative class. Repeat.
Of course, a reasonable question might be: but why do we need a university? Why doesn’t the government just decide what the new opportunities are going to be and fund companies to do that, be it nanotechnology or biometrics or film production? I agree that that process would surely be easier, faster and cheaper. However, it is simply not possible. No government is going to successfully “pick winners” in a global marketplace on an ongoing basis.
The problem with waiting for government departments to tell the rest of the country what the next areas of economic growth are going to be is that—setting aside the poor history of central planning everywhere in the world including New Zealand—the decisions made by bureaucratic organisations are likely to be based on simple extrapolations of recent trends that have succeeded elsewhere. Life simply doesn’t work that way. And if anyone tries to tell you different, check your wallet.
Beware of Economists Bearing Protractors
Whenever I hear someone making a straight-line extrapolation of past events onto the future (“last year Country A’s GDP increased x%; an x% growth rate for the next five years suggests that by…”), I try to block out the message entirely and instead replay in my mind the 1988 Bruce Willis action movie, Die Hard.
It is the rare economist or analyst who can match Alan Rickman with a German accent for pure entertainment value. And, more importantly, the movie provides a cautionary lesson for students of economics and finance about the very real risk of straight-line extrapolation of past events onto the uncertain future.
In the film, Bruce Willis plays a plucky, New York City police officer in Los Angeles for Christmas in an attempt to reconcile with his estranged wife. Christmas does not go as planned.
Willis’ wife works for the Japanese-owned Nakatomi Corporation. On Christmas Eve, Willis attends a party with his wife on the top floor of Nakatomi Plaza in downtown Los Angeles. As the American workers eat and drink and make merry, they are oblivious to a group of German thieves who have broken into Nakatomi Plaza with plans to steal hundreds of millions of dollars worth of bearer bonds from the building’s basement. Thanks to Bruce Willis’ interventions, soon the Los Angeles Police Department, the news media and the FBI are all surrounding the building. The German thieves are unfazed. The police, the press and the Feds just make a bad situation worse as they are outsmarted and outwitted at every turn by the Germans.
Fortunately, Bruce Willis - acting against the instructions of the authorities and relying solely upon his quick wits, determination and brute strength - is able to save the hostages, prevent the robbery and get the girl. There are many explosions.
Based upon the American economic experience in the 20 years before 1988, the premise of the film is entirely plausible. America’s trade deficit and national debt were both rising at accelerating rates, the U.S. was being sold off piece-by-piece to the hard-working Japanese or “stolen” by the quick-witted Germans. America was on the verge of losing global primacy - the Japanese and the German economies were growing faster, making higher-quality products, with more innovative work practices and a more studious and educated population. Traditional American authority figures seemed powerless to stop the trend.
The movie takes a snapshot of American news headlines circa 1988 - and extrapolates one day forward. Die Hard paints a picture of the world that seemed not just plausible but inevitable. It made total sense in 1988 that the world was going to evolve as portrayed in Die Hard. It just didn’t.
Instead, America entered the long boom of the 1990s based on the productivity boom and investment cycle triggered by the internet. Threats of German and Japanese economic dominance waned in the 1990s because of - in part - German reunification and structural problems in the Japanese economy.
The point is: it’s tough to make predictions, especially about the future (as the Yogi Berra line goes). And straight-line extrapolations are doubly dangerous because they are so plausible they hardly feel like predictions at all. Beware of economists bearing protractors.
That lesson informs two aspects of this book. First, there is no recommendation or prediction in this book as to what the companies that evolve out of the proposed Innovation Cycle are going to do.
I am not advocating we focus on high tech or biotech or healthcare. In fact, I am intentionally silent on this issue.
It is vital that the university build world-class faculties in engineering and in anthropology, in biochemistry and in sociology, in medicine and in classical studies. Events do not happen in a straight line and innovations happen where you least expect them. We should prepare ourselves for as many futures as possible. The key is to create people with real expertise who can think in the face of uncertainty.
Second, and far more importantly, there is no short cut available. The unpredictability of the future means a government strategy of “picking winners” - that is, selecting a company or industry for preferential treatment on the basis that it is more likely to succeed than others - is bound to fail in an open, modern, global economy.
We cannot short-circuit the long process of building talent by simply spotting the Next Big Thing as a nation and jumping on it.
More accurately, that would be a terrific strategy - if it were possible.
If we, as a country, had any way of predicting with accuracy what the next wave of innovation and driver of global economic growth is going to be, we could save a lot of time by focusing on that. We don’t.
Today, nanotechnology and renewable energy sound like good ideas for future investment for the same reason that the Labour Government’s 2002 Growth and Innovation Framework proposal focused on biotechnology, information and communication technology and the creative sector.
These sectors sound like good ideas for future investment because so much well-publicised progress has been made in these areas in the last five years.
Said differently, these areas are played out from the perspective of a venture capitalist. The key prerequisites that a government department is likely to look for before making an investment (picking a winner) - articles in important international periodicals, recommendations of blue-ribbon committees, fact-finding missions to international conferences and hard data of early successes elsewhere in the world - are also the signifiers for successful early stage investors that an opportunity has come… and gone.
There is a name for this investment style: it’s called being a sucker.
This is precisely the strategy that inspired bad investors to overweight technology companies in 2000, or mortgage-backed securities in 2007.
By the time that the third-party confirmation of an opportunity has been compiled, privately held venture-capital funds have already picked over the idea, and taken the most promising opportunities public. New Zealand government departments are simply not nimble enough—or, said differently, far too accountable to the taxpayer—to operate successfully in this environment.
And, even if we were to find a person or group that was still able to make good investment decisions despite these clear impediments, why on earth would they be working for the New Zealand government? For the fund manager with the true Midas touch, the world beckons.
There is good news here. In a modern economy, with the free flow of capital and information, money is not the problem. Investors will find their way to promising ideas and technologies. That is not what is lacking from the New Zealand growth story. What is missing is the environment to create those ideas.
As a nation, we have no choice but to take a more prosaic approach. Go back to the beginning.
Build the institution that is going to create and attract talented researchers, innovators and entrepreneurs. Allow them to interact and exchange ideas.
Trust that the market will isolate and fund the promising ideas to the point that the good ideas are separated from the bad. Permit the investors and entrepreneurs who developed those good ideas the full measure of profit from their discoveries and risk.
Rely on the natural beauty of the country and the open-minded, creative nature of the people to ensure those who meet with success do not immediately leave and that others are attracted. And then allow the process to start again.
And what does this institution at the heart of this system look like? It looks like a university.
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35. Seattle as a digital city: unexpected or inevitable?, Canadian Journal of Regional Science, Summer 2005
36. Florida, Richard, "The Rise of the Creative Class: And How It's Transforming Work, Leisure, Community and Everyday Life"
37. Carden, Steve with Murray, Campbell, "New Zealand Unleashed", Random House, 2007, page 125
38. Michael Porter, The Competitive Advantage of Nations, 1990
39. This tantalising connection between Microsoft and Nirvana was brought to my attention by a reader of the Seattle magazine, the Stranger. She recalled an article that was published in the Stranger in the mid-1990s pointing out the connection. I have been unable to find the article or the author. However, I wish to give this (unfortunately) unnamed author the credit for this powerful idea.
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This is the sixth part of a serialisation of the book, The Pine Tree Paradox. It will be published online here in eleven parts.
The Introduction is here »
Chapter 1 is here »
Chapter 2 is here »
Chapter 3 is here »
Chapter 4 is here »
Chapter 5 is here »
Chapter 6 is here »
Chapter 7 is here »
If you would like to buy a copy of the full book, you can do so by credit card here » (Visa or Mastercard only.)
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Michael Parker is an equity analyst living in Hong Kong. Originally from Wellington, he has spent the last decade in San Francisco, New York and - on good days - Waiheke. He has a law degree and bachelor of commerce from the University of Otago and an MBA from NYU. You can contact him here »
Used with permission. © Michael Parker. This book was originally published in 2010.
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