This is my post in a continuing debate on U.S. competitiveness and innovation found here at the Harvard blog.

The current trajectory leads eventually to a much larger global crisis than we are still currently experiencing. The total liabilities will catch total net worth (should have been asset value) in the U.S. at some point in the future — a junction that jumped forward a decade or more in the past 18 months– this means the U.S. will be in a crisis until the balance sheet provides at least a small measure of solvency given future liabilities. We’ve been playing a game of chicken for far too long between socio-economic ideologies, neither of which frankly are credible from an economic perspective.

Shall we discuss (advertising) editorial influence on mass media? Economic diversity? The real cost of social elitism? Root causes of bubble economics — pension funds and endowments chasing 30% returns with 20% of the world’s investment capital rather than historic levels in the single digits? How many economists understand what that does to markets? If we want to discuss protectionism elsewhere, can we avoid discussing the cost of ancient guilds? Were you as shocked as I when the ACM announced university ratings and only one U.S. school made it in the top 10– Russia and China with 2 each, no doubt achieved at a fraction of the cost? Anyone game for predicting the future cost of system-wide moral hazard that has been realized? Unbroken monopolies? Predation? Cultural management?

The worst case scenario is that entrepreneurs stop innovating– many of the best have already taken that route, some by choice, most by markets– I deal with them daily. The reaction has been to institutionalize the entrepreneurial function in an attempt to make MBA grads VCs and entrepreneurs out of scientists; and we wonder why our economy is challenged?

In order to do this topic justice and deal with the root causes– everything else is noise, we’ve got to look at what creates the trade imbalance– part of which is certainly outsourcing, but more importantly are the barriers to innovation in the U.S. — as is often the case the most valuable data is not visible. I do agree with those who suggest that outsourcing contains a high probability of losing key IP, but then frankly that threat dominates the lives of innovators everywhere now, or should, certainly to include the U.S. where the cost of defending IP has not been viable for small shops or individuals for many years– unaffordable justice is as comparatively destructive to the economy as unaffordable health care or failed education; perhaps more so. Outsourcing is necessary in a global economy, and does have many benefits, not least of which is a higher probability of peace, but inability to protect original work and take to market is already having catastrophic consequences. Where would the U.S. be today without the tech giants of the previous generations?

The innovation conversation needs to begin with the very frank understanding that the U.S. dominated tech innovation and venturing for decades — from seed to maturity — but in the past decade it has quickly become hyper-competitive globally. We’ll need to disperse with dogma and comfortable assumptions such as ‘data collected has sufficient embedded intelligence to make wise decisions’, particularly within the time frame required to make those decisions, even assuming that those making the decisions are sufficiently unconflicted and able. It is with some irony that we realize while drowning in a sea of data that none of us are necessarily even in the loop on some of the more important trends occurring, which is why first hand experience is so important. All venture capital data for example is voluntary — the sector is hidden by confidentiality for good reason, but the secrecy also does great harm in spreading ignorance –politicians and the social elite combine with the guy on mainstreet who think wrongly that some brilliant scientist at a university will partner with an entrepreneur to correct decades of very bad behavior.

In the late 90s when we were operating a global learning network for thought leaders, the most eager to learn about venturing and economics were not from the U.S. at all — even when we pleaded for regional professors to engage, but rather almost everywhere else– Mongolia to Thailand to South Africa to Brazil. In the U.S. and much of Europe everything we and others did in our incubators was perceived as a threat to entrenched interests. Most of the world lacking those same type of entrenched interests saw only opportunity.

A decade later the FRB was quite comfortable with its assumptions regarding systemic risk in financial institutions, yet even after it had become obvious that their strategy (and many others) was clearly wrongheaded (after Ben B became Chair), a public liaison informed me that he “wasn’t allowed to elevate information on systems designed to prevent systemic crises”. In other words, it was the policy of the FRB apparently to remain ignorant of knowledge systems outside of their (academic) silo. Similar situations are found in most crises I have studied, to include in venturing where we’ve been holding up a red flag for a dozen years. The audit rule that led to Enron.. the Asian contagion.. the dotcom bubble.. institutionalization of venture capital.. the housing bubble.. I missed the SEC rule allowing IBs to leverage up to 50 to 1 on mortgage securities– I was too busy designing systems to prevent crises…

One credible sign of a failing system is one that defends against improvement — in the U.S. there is no effective manner to sell new innovation to the governments, including systems that would make the government smarter and more functional– I’ve been trying for a dozen years, during which time I turned down offers from other governments foolishly.

I spent much of the past decade founding and operating an early stage tech VC while working on designing more functional knowledge systems. Among those I found before my peers, but unfortunately didn’t profit from (we’ll save alignment of interests and incentives for another day, despite the importance), were Google and Skype. Unlike most firms sprouting up in the past decade (VC radically changed when institutionalized in the 90s), we were not geographically strategic. What we discovered was that the Internet had changed the game in ways far beyond what most were considering in the U.S. Not only were collaborators disbursed worldwide with around the clock functionality, but the technologies and even business plans were very quickly becoming of higher quality in other countries. The smart kids and adults were learning at a much faster pace. I myself am a product of sorts of self-learning using the Internet, quickly catching up and passing the majority of post docs in my fields of interests.

During the past decade many other countries have proven more likely to support locally produced innovation than the U.S., particularly at the critical early stages with real dollars from real customers, during a time when the U.S. flooded VCs with capital and freeism as the primary adoption model (“sling spaghetti against the wall to see what sticks”) — extremely destructive to functional markets. Market after market in the U.S. embraced what I will call blind globalization, losing local support and bias as our culture became mobile, cities began to all look similar, and the soul of many communities were gutted. Franchises and global giants dominated, which requires much different skills of managers than independent businesses– not creativity or innovation — a very poor environment for creating business leaders or entrepreneurs.

What’s worse, I noticed a sharp decline in the level of competency in the venture firms, entrepreneurs, and senior managers in global companies– in VC we experienced a generation who had never built a real business, yet those were precisely the individuals institutions felt the most comfortable placing money with — for those willing to shell out $3k you too could learn that PE was no longer about competency, but rather relationships. We have thousands of people in venturing who are incompetent now. As IPO markets sprouted up around the world and capital poured into regional venture firms, real entrepreneurs became some of the world’s best VCs in other countries.

Innovation is a very complex topic that is less influenced by R&D dollars than lobbyists would have us believe. We’ve identified well over a dozen essential elements for markets to be successful in venturing, involving macro global issues (including markets), micro local issues, internally in the venture, and of course the interconnected relationships. Even though I refer to the elements as essential, exceptions occur missing one or two, and they are not the same in each case, particularly recently in emerging markets. No market in the U.S. still has all of the essential ingredients due to both local and global macro issues. The probability of the next Intel emerging from the U.S. is substantially less in my view than in several other countries, and the list is growing rapidly.

Imagine if you will a tech titan that experienced change within a decade from market dominance, manageable debt, and large reserves, to a market with dozens of competitors, many of which now have healthier balance sheets, equally competent workers, newer infrastructure, and much healthier markets. That scenario more closely resembles in my view what the U.S. is faced with today, and no where is it more challenging than for emerging innovation that is still the underlying engine of our economy; particularly of the type the economy desperately needs. We need revolutionary improvement in our systems, complete with much smarter learning systems, far more effective incentives, realignment of interests, and cultural management that places a priority on self-preservation rather than self-destruction.

Radical perhaps to some, but may well be too timid given the challenge.

Mark Montgomery
Founder & CEO – Kyield
Twitter: @kyield

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