The Three-Player Game of Innovation: State, Speculation, and Market in the Digital Age

Bill Janeway, author of "Doing Capitalism in the Innovation Economy," argues that innovation at the frontier is uniquely funded by two sources unconcerned with immediate economic value: a mission-driven state (citing examples like the US during the Cold War or China today) and financial speculation that, while generating bubbles, occasionally focuses on transformative technologies. He emphasizes that all participants in this "three-player game" operate under conditions of fundamental uncertainty, necessitating a hedging strategy he terms "cash and control"—sufficient access to capital and the authority to alter parameters when unforeseen challenges arise.

The podcast highlights how the digital revolution, initially sponsored by the American state (e.g., Defense Department), has matured to a point where it not only no longer needs state sponsorship but actively challenges state authority. This disruption manifests in micro-markets (Uber, Airbnb), attacks the integrity of the political process, and fundamentally alters the labor market through globalization and friction-free capital movement. Janeway critiques the US's compromised dual role in both facilitating innovation and coping with its consequences, attributing this partly to a shift towards a "government is the problem" ideology and the inadequacies of its social safety net.

Janeway also delivers a strong critique of mainstream economic theory, particularly the rational expectations revolution and its derivatives like DSGE models and the efficient market hypothesis. He argues these frameworks played a "thoroughly destructive role" by discrediting government intervention and blinding economists and policymakers to the true nature of financial systems and market participants' inherent inability to know the future. He posits that "efficiency is the enemy of innovation," as private, profit-seeking entities, driven by net present value calculations, inevitably favor shorter time horizons and less risky projects, leaving fundamental, uncertain research to the state or large, historically monopolistic firms.

The discussion concludes by addressing the broader implications, including the resurgence of inequality, political bifurcation, and the US's potential abdication of leadership in future technological revolutions like the Green Revolution. It points to the emergence of "superstar firms" and increased industry concentration, fueled by new sources of monopoly power like data. The European Union's proactive approach to data regulation (GDPR) and labor law in the gig economy is contrasted with the US's lagging response, underscoring the urgent need for a reconstruction of economic thinking that acknowledges positive state intervention and the inherent uncertainty of innovation.

"the sources of critical funding and demand for innovation at the frontier for investments where it is impossible to know in advance what the return is going to be that that funding can only come from two sources two sources that are unconcerned with direct immediate measurable economic value one a mission-driven state... and the other... financial speculation"

"all are operating under conditions of fundamental uncertainty I'd learned the hard way that the only way that you can hedge against the unknowable... is through what I call cash and control"

"the digital revolution that I participated in that had been sponsored in every particular by the American state by the American Defense Department had taken off on its own had reached a level of maturity that not only did it no longer need state sponsorship it was attacking the authority of the state at every level"

"Ronald Reagan could say government isn't the solution government is the problem"

"the consequences of globalization spill over into the labor markets of the country with enormous impact on the resurgence of inequality of income and wealth at levels that now exceed that of the goal of the Gilded Age"

"enormous increase in the concentration of industry sector by sector by sector enormous divergence... in the continued growth in productivity of the best the top 5% of businesses and across sectors with the rest lagging way behind the emergence of what David outdoor at MIT calls the superstar firms"

"efficiency is the enemy of innovation if you rank project based upon the net present value of their expected future cash flows the defining the fundamental economic value of an investment you will inevitably find that the costs can be estimated with far greater certainty than the benefits"

"these monopolies these digital information monopolies have another new entirely new source of monopolizing power historically monopolies... drew on economies of scale economies of scope network effects but now there's another one it's data"

"the notion that participants in those markets have full knowledge of the consequences of government initiatives and of their own responses and their ability through their own activity to offset and the expectation that they would offset and government intervention the rational expectations revolution lately called Ricardian equivalence"

"by discrediting by D legitimizing the government as an economic actor we're the only role for government was if you pardon the expression just screw up markets that otherwise would yield you the efficient optimal outcome it left us defenseless against the consequences of what George Soros called the the the the super bubble that exploded in 2008"