The assumption here is that business cycle busts are caused by the inevitable collapse of companies that weren't sincere about creating a sustainable business in the first place. There are plenty of anecdotes to color in this story, but I don't believe it's the main driver of business cycles.
EDIT: Admittedly, I'm in a filter bubble of sincerity, since it's one of the main things we look for in YC founders.
The author's theory allows not just for insincere entrepreneurs but also incompetent ones. No matter how strongly an entrepreneur believes his idea to be a billion dollar business, it's very possible that it isn't, even if he's able to convince investors (and himself) that it could be based on some superficial metrics.
Right, and the the incompetence can be subtle and from many causes, such as poor management skills, just-less-than-necessary technical capability, in addition to the standard Dunning-Kruger effect, and cargo cultists who identify superficial qualities of entrepreneurships. Ironically, in an entrepreneur you want just the right amount of impostor syndrome, but the process may select for Dunning-Krugers.
But sincerity and youthful exuberance is a startup founder stereo type. People do go life coaches to manufacture a Win Friends and Influence People Tom Cruise persona precisely because they are seen as indicators of success by funders.
When you over select on certain qualities, those qualities will be mimicked. In business, correlation is causation.
For those of you unfamiliar with the austrian explanation of the business cycles, here is layman's intro via an excerpt from a talk given by the always-excellent-whether-I-agree-with-him-or-not Tom Woods:
(Personally, I think the orthodox austrians generally undervalue the mass-psychological explanations of things when they dip into rational-actor assumptions, but I still find their explanation compelling.)
I think that the mass psychological explanations are not undervalued by austrians, just given their right prominence. We all know that errors in allocation of capital and pricing of assets happen all the time in the market. But, most errors are corrected as information manifests to reprice them and reallocate resources, from losing actors to winning actors and everyone learns a lesson. What the austrian business cycle explains is the systemic errors (Called the cluster of errors) that happen when central banks allow the errors to propagate and grow by effectively delaying and amplifying their propagation manipulation of interest rates and money supply.
Personally, I think that Austrian economists generally undervalue empiricism. Ludwig von Mises himself wrote of his theory: ”Its statements and propositions are not derived from experience... They are not subject to verification or falsification on the ground of experience and facts." and F.A. Hayek wrote that any theories in the social sciences can "never be verified or falsified by reference to facts."
Shitty stereos on the 80s. Brands 'mimicked' themselves to get extra profit since consumers signaled off of the logo, the chrome and heft not the sound.
I think that the austrians would respond (and, again, I'm not an orthodox austrian) that value is subjective and, if consumers find that chrome and logos are what make stereos valuable, then that's the way it is. Perhaps the social-marker value when less knowledgable friends visit, or the general aesthetic look of their living room, is what's important to them. After a while, if the consumers really could tell the difference in sufficient numbers to warrant large scale production, superior stereos should win out.
I dislike shoddy stuff generally and how much brand matters (it matters to me, too, why oh why!?) so I don't intrinsically like that argument, but I understand the rational power of it. It implies, in as much as we should be angry with someone, we should be angry at ignorant consumers, rather than evil producers for shoddy stuff. And the stunningly great news is that we can fight that problem by simply blogging about what we are passionate about.
This is one of the great benefits of the internet I did not expect: the spread of knowledge across consumers has dramatically increased the quality of many things. To pick a few examples:
- I can get a cappuccino in Sacramento, CA that would have been available in only a few cities in the world two decades ago.
- There are more beers worth drinking being brewed within 50 miles of my house right now than there were in all of California in the 70's.
- There has been an absolute explosion in high quality, low cost mechanical watches in the last ten years (see stowa, chris ward, and steinhart, to name a few)
EDIT: I pick these examples to show how the internet has improved even old-fashioned, extremely non-digital things through the spread of knowledge.
I am not blaming anyone. Stereo equipment got very popular in the 70s and in the 80s it became very cheap to produce good enough electronics, so high valued brands effectively did a hostile takeover of themselves and burned their product lines down making things that mimicked their earlier higher quality goods.
There are a relatively small number of participants in any system doing stuff that is new or truly creative, everyone else copies the leader.
First it was netbooks, then it was tablets. Markets I think are sprouted by first movers, who after fail, and truly grown by an army of mimics.
Also, if some producers misunderstand consumer preferences, thinking that they would want a shiny stereo when in fact they wanted a better sounding stereo, those producers would be out of business or forced to eliminate their product line. That is why it is stupid to impose third party valuation of consumer preferences. If most people want shiny stereos that sound horrible, that is what should be produced (the moral argument), whether or not a few connoisseurs like it.
In brief: animals who are not poisonous or dangerous copy the markings / signals of animals who are and thus gain protection of being vicious killers without the metabolic cost.
This article posits that all the woes of Capitalism are due to copycat entrepreneurs offering "facebook for dogs" and eventually the investment that would go to killer companies to create wealth simply vanishes
I cry rubbish here. Firstly he destroys his argument in the article himself ("""alternatively, one could remember the rule "Red on yellow, kill a fellow; red on black, friend of Jack" """). Fairly simple rules of thumb allow even not-so-smart-money to avoid Facebook for dogs.
Secondly mimicry is only a useful defence against predators of the killers. Killer snake happily kill non-poisonous snakes as well as prey.
And finally, Hy Minsky seems to have this already sewn up - Hedging, Speculating, Ponzi.
Sidenote: my all time favourite Batesian mimicry is the Cheetah cub, (http://milgistrust.wildlifedirect.org/files/2009/01/23.12.08...) whose colouring reflects that of the adult Honey Badger. Honey Badgers are great, such vicious fighters that lions basically think "I'll leave that for another day" - the animal kingdom's equivalent of short hairless Glaswegian pub landlords.
It's not a "woe of Capitalism", just an inherent property of an economy. In fact, it's an inherent property of all life. Economic cycles and life/death cycles in species have a lot in common. The dynamic nature of such systems make them hard to predict, but you can be sure that they will continue to occur. It's a way of resetting (or reallocating) resources that is essential.
An interesting point - thank you. I was just listening to a bbc podcast on Minsky, and while everyone agreed that previous economics failed to predict their instability, everyone now thinks Minsky is the key to preventing instability - but no one mentioned that actually death is part of life and we need not to prevent the next crisis, just not let it cause such damage. Harm reduction as public policy - whatever next
I feel like this is also a suitable explanation of the impending correction that needs to happen in scientific research. We promote scientists who are adept at Batesian mimicry of the scientific power structure, and not necessarily adept at science.
This theory (is it a theory?) sounds good, but as someone else here implied, those who copy aren't employing mimicry, but are actually trying to compete with those they copy. I would say that the bubbles are closer to biological arms races than biological mimicry.
The irrational exuberance is met by companies that are competing to be the most successful in exploiting that exuberance. Hence Enron's success at being one of the best performers on the market until its bust.
I'm sure this stuff has been explained before, but it doesn't seem to be part of any popular economic theory?
Great read. I look forward to the day when Economic graduate programs are taught from a more biological/psychological perspective than through aggregate supply/demand and equilibria models. The real issue here is that macroeconomic systems cannot be predicted or successfully controlled, but they can surely be made more robust. The current policies in practice are potentially dangerous.
Nothing excites people like a false analogy. Looking to biology to model how economies work is like looking at stars and movements of heavenly bodies to see how stock prices change. I can find a thousand things common between them, but you know how accurate that science is.
No model is perfect. If it is a better model than the current one (which is the argument), it should be used as a replacement. Economic systems came from biological systems. As a result, they share some fundamental characteristics and the "false analogy" carries significant weight.
Yes. Some are much farther from perfect than the others. Economic systems came from biological systems that came from matter and physical forces. Therefore astrology?
The impetus is on the claimant to show how their models are "better". From the link above, it sounds more like a religion or cult than as a science " ecological economics is defined by its focus on nature, justice, and time" . Economics is supposed to be descriptive, not prescriptive or ideological. What financial crises/trends did these ecological economists predict to claim that their methodology is better?
What financial crises/trends do aggregate models predict? Unfortunately, current economic theory resides in a grey area of ideology because of how poorly it explains and predicts such things. Assumptions can often be made in any ideological direction.
I also don't claim that the entire Wikipedia article is useful, I just wanted to expose you to some of the ways economists are using biological system (ecology) to model an economy.
Except that analogy of those analogies is itself a false analogy. Bouncing models off each other is a typical mechanic of scientific innovation. No one is suggesting economists take the theories as wrote and apply them without due consideration.
Alarmingly the models used by mainstream economists don't seem to cover crashes (not as in can't predict their timing but really can't model them at all generally).
I'm highly sympathetic to austrian explanations of economics, and somewhat to chartalist explanations* (but I don't generally agree with chartalist prescriptions) but I'm unconvinced that debt causes crashes. I personally believe that debt systems aggregate small, localized crashes which happen all the time into large, systemic crashes.
A good resource is Mandelbrot's (mis)behavior of markets. It explains a lot of things like how the Pareto principle appears. Reading between the lines, it is easy to see how levy-alpha-stable distributed events can aggregate into bigger levy-alpha-stable distributed events, since this distribution obeys the undefined-variance equivalent of the central limit theorem.
*The "QE for the public" is a horrible public policy choice and to me is exactly a good example of where chartalist prescriptions go off the rails. The Jubilee is a better idea, but to prevent a total collapse of the banking system, you could structure it differently, like making all debts voluntary. Basically our society has been trending towards this (with currently the exception of educational debts) and so what we are seeing is that people with good credit that don't spend their line of credit boozing through their twenties being highly valued. But because lending from individuals is becoming tapped out as their credit is wasted, a lot of debts have become shifted to the public, in the form of municipal, state, and federal debt - sometimes through public spending and sometimes by explicitly converting private debt into public debt.
I don't think that debt, by itself, causes crashes. I think it's a bit more complicated than that.
Here's a market that's going up. People invest in it. Then it goes down. People lose money. The economy does not collapse, and life goes on.
Here's another market. It's going up. People look at it and think that it's going to keep going up, and therefore that it's safe to borrow money to invest in that market. The market goes down. People lose borrowed money. This is much more threatening to the health of the economy as a whole, because it can bring down the banks.
So it's not just debt. It's debt used to buy investments in a market that's in a bubble, that when it goes back down wipes out both the borrower and the lender.
I might look into the Mandelbrot book. From my perspective if you accept that GDP is the economy's production plus the change in aggregate debt it seems a small step to see how debt growth builds during the boom and stops suddenly reducing spending to form the crash. Debt in itself is not bad but in the absence of stabilisation it is likely to cause problems.
I quite like his Modern Jubilee idea a.k.a. QE for the public (although it is an alternative to TARP and the QE that took place in the midst of the 08/09 crisis not for now) I'm not sure how a traditional Jubilee would work and how it would stabilise the banks at all. The Jubilee Shares are the Keen policy I don't quite buy.
Basically it seems to me the distinction between the more contemporary, non-crazy, parts of the austrian school (i.e. not the goldbugs) and the chartalist position is how to deal with it. Austrians would suggest that debt is not fundamentally bad, but dangerous, and the market should price in the risk of debt (which it does not, because of things like bailouts and backed reserve lending), and that any attempt to stabilize the swings caused by lending activities will backfire and create moral hazard (the specific economic term).
A modern jubilee might take a form like, legally not permitting any debt to last beyond X years.
There is a particular moral hazard associated with sovereign and government debt - Unlike debt accrued by you or I, which is discharged upon our deaths, leaving the lender holding the bag (a risk that should be priced in the loan term), sovereign debt is unlimited. If you believe in the principle of "no taxation without representation" which really boils down to the idea that legitimate government should not act (i.e. spend) without the consent of governed - then is it really morally permissible for future generations to be legally bonded to the profligacy of previous generations? Where are the checks and balances? Can our grandchildren go back in time and vote against spending policies that they are responsible for paying back?
So generational debt, which is generally considered to be immoral along the lines of slavery, especially among progressives who see it as a means of keeping the poor poor, is suddenly okay when the state does it.
1) It's a history book, not particularly an econ book, but "Nation of Deadbeats" covers this well. Each boom-bust cycle is actually quite unique, and most of them are caused by human action and not spontaneous.
2) In the 20th Century, just about all depressions, recessions and hyperinflations were monetary in nature. The ones that were not were due to failed states. A lot of this was due to the gold standard - which is nearly tautological - because since the gold standard was in play, we saw those pathologies. Douglas A. Irwin has a paper "Did France Cause the Great Depression?" that was an eye-opener for me. It actually describes a real mechanism.
I liked the article. I think it captures something real. However it dismisses out of hand without discussions any number of other theories which do in fact have at least some explanatory or predictive value--exogenous shocks (i.e. gas crisis of the 1970s), credit/debt cycle, inventory cycle, interest rate cycle, fixed-investment cycle, and the 60 year Kondratiev waves which may be driven by a new technology introduction cycle. It also ignores recessions and depressions that don't fit it's thesis. See here http://en.wikipedia.org/wiki/Business_cycle.
EDIT: Admittedly, I'm in a filter bubble of sincerity, since it's one of the main things we look for in YC founders.