Epidemics vs information cascades

As I was looking at publishers’ websites for my New Year round up of forthcoming books, I noticed OUP billing Paul Geroski’s The Evolution of New Markets as due out in January 2018. This is odd as it was published in 2003, and Paul died in 2005; it isn’t obvious why there’s a reprint now. He was Deputy Chairman and then Chairman of the Competition Commission during my years there, and was a brilliant economist as well as a wonderful person. I learnt an amazing amount from being a member of his inquiry team.

Anyway, the catalogue entry for the reprint sent me back to my copy of the book, along with Fast Second, which Paul co-authored with Constantinos Markides. Fast Second challenges the received wisdom of first mover advantage: Amazon was not the first online books retailer, Charles Schwab not the first online brokerage, and so on. The opportunity lies in between being early in a radical new market and being late because a dominant design and business model have already emerged. The Fast Second business competes for dominance – and supposed first mover advantages are usually fast second advantages.

Paul’s book The Evolution of New Markets – in which I found a handwritten note he’d sent me with it, which made for an emotional moment – does what it says, and explores models of innovation diffusion – so in other words, models of S-curves. His view was that the epidemic model of S-curves, which seems to be the standard one, was a misleading metaphor. He argued that information cascades best fit the observed reality. The epidemic model assumes that a new technology is adopted as information about it is diffused. Each user passes on the info to the next user. However, as the book points out, information diffuses far faster than use. Users need to be persuaded rather than just informed.

More appropriate is a model whereby new technologies arrive in a number of variants at slightly different times, making adoption risky and costly – especially when there are network externalities or when people realize there is going to be a standards battle. Most new products fail, after all. But once one variant starts to dominate, the cost and risk decline and adoption will occur much faster.

It’s a persuasive argument, and a very readable book. Although the list price is surprisingly high for a short paperback, one can be confident second hand copies are just as good.

Price: Check on Amazon
 

 

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Social limits to growth

In preparing for an event tomorrow celebrating the 40th anniversary of the publication of Fred Hirsch’s The Social Limits to Growth, I’ve naturally been re-reading the book. It’s full of comments that leap out from the page, such as this: “The extent of interdependence of many forms of consumption in advanced, urbanized societies has brought increasing recognition that to give effect to public choice among the available economic alternatives represents a still unresolved intellectual and administrative problem, rather than requiring merely the sweeping away of impediments to the working of the market mechanism.” And, “To see total economic advance as individual advance writ large is to set up expectations that cannot be fulfilled, ever.”

These comments reminded me very much of Will Baumol’s long overlooked book (his PhD thesis!), Welfare Economics and the Theory of the State, which I read quite recently. Part of his argument is that interdependence is far more extensive than in textbook world. The changes in the character of the economy since 1977 have made this ever more true. Hirsch is of course famous for the concept of positional goods, where there are negative consumption externalities – I am worse off if you have the status symbol and I don’t. Some of this has been absorbed in modern signalling models. However, positive consumption externalities – network effects, direct and indirect – are now becoming widespread too.

The conventional matrix of goods (according to whether they are easy or hard to exclude and rivalrous in consumption or not) needs extending:

—————————-Easy to exclude                        Hard to exclude

Rivalrous+neg externality      Positional                           Commons good

Rivalrous                               Private good                      Commons good

Non-rivalrous                         Club good                         Public good

Non-rival+pos externality       Network club                     Network commons

In only one of these boxes does the standard ‘free market’ presumption apply.

 

 

 

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‘Free’ markets

I read recently The Illusion of Free Markets by Bernard Harcourt (date), on the recommendation of an esteemed colleague. The bulk of the book is about state discipline – Bentham’s Panopticon, Foucault, the American penitentiary state. The bit that really appealed to me was the opening section on French grain markets in the 18th century, compared with Chicago commodities markets in the late 20th century.

The book opens with great detail about how intensively regulated markets were in early 18th century France, with even trivial breaches of the rules in theory liable to punishment, imposed by the police des grains. Harcourt then draws the comparison with what we think of as a model of free market capitalism, the open outcry pit of the Chicago Board of Trade (I visited once  – an amazing experience). As he convincingly establishes, there os no sharp contrast, as the modern market rules are in fact just as detailed as the 18th century version.

Why then do we contrast ‘free markets’ as today’s ideal with the over-regulated past? The book attributes the turn to the Physiocrats, and “that contested moment in the 18th century when notions of natural order were beginning to take shape.” The argument is that they shaped a sharp dichotomy between “the economy as the realm of natural order” and everything else which was thereby in the sphere of being policed by the state. “In other words, the market is efficient, and within that space there is no need for government intervention. What is criminalized and punished is behaviour outside the sphere of the orderly market.” The government can legitimately penalize non-market behaviours.

But of course, the dichotomy is a false one. The state is present in all markets, and often in just as much detail as the C18th police des grains. The rhetoric of ‘free markets’ is misleading.

I certainly agree with this last point, as does anybody who (like me) has spent some time as an economic regulator (the UK Competition Commission in my case). Modern economies are highly regulated, and that goes for the Anglo-Saxons as much as anyone else. I don’t know nearly enough about the C18th or the literature on punishment to evaluate those parts of Harcourt’s book. But it certainly offers food for thought.

 

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Markets, states and humans

I was eager to read Paul De Grauwe’s The Limits of the Market because I profoundly agree with its premise that the false dichotomy between ‘the state’ and ‘the market’ has led to bad public policies and lower social welfare. The book is a short overview of the flaws of this dichotomous view of the world. It organises its discussion around two sets of reasons why a ‘free market’ is a meaningless abstraction: externalities and ‘internalities’.

The idea of an externality is familiar of course – that individual choices by a person or business have consequences, good or bad, for others. Once you start thinking about it, you realise externalities are pervasive. Indeed, they include many not acknowledged in standard economic theory which assumes fixed preferences, when of course preferences are socially determined. As De Grauwe points out, it is not easy to address externalities with government policies (not that this means there’s no point in trying): “The market fails in the face of externalities. When this happens, the government must step in. However …. that is also the moment at which the discrepancy between individual and collective interest is widest.”

The word ‘internality’ is new to me – though this is the second time I’ve come across it used by a Francophone author. It refers to the capacity humans have to make decisions that damage their ‘rational’ self-interest. I would think of this as a failure of one of the other assumptions of standard welfare economics, namely individual utility maximisation. The book makes use of Daniel Kahneman’s distinction between System I thinking (emotion, instinct) and System II (reasoned calculation). Market outcomes that satisfy the latter can adversely affect – say – our fairness instinct. “This dissatisfaction creates an opportunity for governments to fill the emotional gap left by the free market and to focus on System I, which steers our emotions. Many emotions find an outlet through government.” Well, most people probably have rather negative feelings about government, but one sees what he means.

The book is an extended reflection on this dual set of market failures, and the inevitable involvement of both (coercive) government actions and individual choices in the economy. I ended up being a bit disappointed, as it does fall between the two stools of accessibility for the general readership and technical rigour for professional economists, so I didn’t feel I got tremendous new insights. It’s also expensive for a very short book (£25 for 160 pages), albeit not in stupid academic book price territory. Still, the framework set out for thinking about the roles of government and market is neat, and I’ll recommend it to students who are particularly interested in the welfare economics but won’t want anything technical.

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Digi-trust-busting

As someone who spent eight years on the Competition Commission, the changing shape of competition in the digital world is a question of compelling interest to me. Mainly, I blocked mergers, but the exceptions were retail inquiries where the growing competition from online retailers (especially Amazon) was, to me, a clear constraint on merging high street chains (some of my colleagues were less convinced – this was 2001-2009). Looking more recently at the literature on digital platforms, it is clear that economists have to step up and deliver new, practical analytical tools for competition authorities. As Jean Tirole and his co-authors famously established, the old tools of market definition and SSNIP tests are inadequate for assessing competitive conditions. And when the dynamics of competing for versus in the market, and the evolution of ecosystems, are so important now, the longstanding failure of competition economics to deliver a systematic way of thinking about static versus dynamic impacts of mergers really matters.

This is a long-winded preamble to mentioning Virtual Competition: the promise and perils of the algorithm-driven economy by Ariel Ezrachi and Maurice Stucke. The authors clearly are concerned about the failure of competition policy tools in the new context, and although it tries to be even-handed the book paints a picture of a world of increasing market power, to the detriment of consumers and citizens.

The most interesting thread in the book from an economist’s perspective is the reflection on the role of information in markets. Reductions in search costs should improve consumer and economic welfare, make markets more competitive. However, the greater availability of information in the online world is illusory because there is a staggering imbalance. Digital platforms have an extraordinary amount of extra information about us – and there are very interesting chapters covering the struggle between platforms, advertisers, app developers etc to gather and aggregate the personal information. However, the information we consumers get about the goods and services we’re looking to purchase is diminishing. The book raises the question as to whether the use of cookies and geo-tracking is enabling ever-better price discrimination by platforms and online sellers; there has been no systematic evidnce that this is so, but then it would be hard to gather the data to test this properly.

At the start of the internet era, there was great optimism that this was a technology for empowering consumers with more nearly perfect information, allowing easy price and product comparisons. In fact, it may be returning us to the era of the bazaar, with reducing transparency of information about prevailing market prices and conditions. “In a market that is in reality controlled by bots and algorithms, what power does the invisible hand posess?” Instead, maybe we have a digitalized hand, determining the specific market price in any given context. As others have done (Francis Spufford in Red Plenty – not cited – and Eden Medina in Cybernetic Revolutionaries – which is cited here), the book notes that in the limit a profit-maximizing market with perfect information and a social-welfare maximising central planner similarly well-informed would reach the same prices and allocations (although contrasting distributions).

The book does a good job of describing the changing dynamics of competition in digital markets, and why there is every reason to be concerned. Written by two lawyers, it is frustrating that it hardly mentions the economic research literature, which is proliferating even if not yet reaching policy-ready conclusions. The authors also over-do some of their critique of digital businesses – for example, they include a section on the use of framing and choice architecture to manipulate consumer choice, but that dates back to the pre-digital days of Mad Men. Still I share their view that we are in an age similar to those of the giant industrial trusts, and some digi-trust-busting is going to be needed.

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