This week we revisit a favourite topic of ours, further exploring our framework for understanding innovation. This time we focus on the role that necessity plays in creating true paradigm shifts as opposed to the incremental development we often see masquerading as innovation. The answer? Patient capital... This week we would like to revisit a favourite topic of ours; the question of innovation. In particular we have previously asserted that innovation occurs in clusters and posited four specific variables that create a conducive environment for it to take place:
We would like to focus further on the second this week, necessity. In this day and age we are constantly bombarded with news of major breakthroughs and the dominant viewpoint seems to be, so we are told, that we live in a golden age of technological and social progress, a nirvana so to speak. After all, just think of the screen you sit in front of or the market capitalisation of the ever-so favourite FAANG stocks or WAAX stocks closer to home. Something about this narrative doesn’t seem to fit though. To (mis)quote the French philosopher Baudrillard ‘we live in a world where there is more and more information and less and less meaning.’ Too often we try to rationalize our existing conceptions and try to make the world fit our own reality. Hence those of us that are the cynics might look at the market and the whole technological/informational revolution as much ado about nothing, hype so to speak. On the other hand there are those who push the existing narrative to its limits by suggesting that the world is on the verge of a paradigm shift, one in which everything from Artificial Intelligence to breakthroughs in the generation of energy will fundamentally change the way economies work. The truth is that the reality might be somewhere in between. It is true that innovation occurs in paradigms and much of it is down to chance. The reality of the situation is that the world does not work in a linear fashion and neither do markets. One of the most interesting readings we have come across recently was on political development and political decay by Francis Fukayama. In the book Mr. Fukuyama suggests that state development and, more specifically, political formation is historically contingent and is often a precursor to technological change. One of his central points was that much of the catalyst for early state development was propensity for war, rather than some fundamental differences in cultural norms. War facilitated the development of early states from Han China to the development of polities in the wake of the fall of the Roman Empire in Europe. In fact, the greatest innovations with regards to bureaucracy and political development took place in militaristic Prussia. How is this relevant to technology or technological innovation? Well, if we can posit strong government incentives are required for technological innovation to take place than it follows that some of the very factors that enable the formation of strong and modern states are also the precursors of innovation. There are plenty of examples of some of modern medicines greatest achievements having less than stellar origins, such as those rooted in the experiments conducted in Nazi concentration camps, or the invention of Colossus, the first programmable computer originally designed to decipher codes (you wouldn’t have your smart phone without this start). Indeed, one could argue that the Industrial Revolution was the paradigm shift of its day and the golden age of innovation in the post-modern world took place during the period of WWII and the decades after until the 1980s (the Cold War certainly didn’t hurt the drive to innovate). Just about everything that defines the modern world either came about, or had its seeds sown, during this time. The Pill. Electronics. Computers and the birth of the internet. Nuclear power. Television. Antibiotics. Space travel. Civil rights. One could argue that everything since have only been incremental or procedural innovations. Here we come to the first major point we would like to make about innovation, not only is necessity a prerequisite, we must also be able to distinguish between the procedural and truly paradigmatic innovations. The invention of the super computer was a paradigm shift, whereas the incremental additions and consumer led innovations are just that, tactical. As investors it is the unfortunate truth that we are primarily motivated and driven to find as well as allocate capital to companies that make incremental or procedural inventions. After all, as the old story of the VHS vs. VCR shows, it isn’t necessarily about the best product or invention but rather what is scalable and easily commercialised. And so we might not have the same amount of patience for Apple to spend billions on its R&D on coming up with the next great idea but rather quarterly sales of its iPhone product. The subtle difference in thinking is not necessarily to come up with a great product that is fundamentally game-changing but to make newer and newer incremental changes that enable consumers to buy more. There is nothing substantially wrong with this, as investors we do not necessarily buy blue-chip companies with the expectation that they deliver outsized returns but rather incremental improvements to their balance sheet and therefore our own. From an innovation standpoint this can be extremely detrimental. Historically capitalism has been a relatively effective mechanism for this trap to be avoided through price-discovery mechanisms and having a risk-reward mechanism. With increased consolidation and financialisation of the real economy in addition to disincentives for capital expenditure, we have seen a global trend where companies increasingly spend less and less on productivity improvements. Indeed, one of the most troubling trends has been the decreased expenditure by big pharma on something as vital as new antibiotics. Why? Again this brings us to the point of necessity. We are by no means promoting the idea that the world needs another war, but there has to be a shift in how investors think about capital allocation over the long-run and indeed where required, state intervention on a reasonable basis. Investors cannot be expected to spend hundreds of billions of dollars on fighting the war against cancer or on fusion technology that might deliver returns 50 years from now. We cannot be blamed for being rational within the current context and allocate based on earnings growth rather than broader outcomes that facilitate innovation. However, we must also be aware that the companies we choose to invest in and ideas we hear about on a daily basis are incremental changes to a pre existing paradigm. If we truly want to look for innovation on a grander scale that jumpstarts the next wave of inventions we do think that there is a place for a rethink of the policy settings. Ask yourself the question, why is it that war creates technological innovations? The answer is that it mobilises societies to take decisive action and provides patient capital from governments. It is this reason that made us want to put a man on the moon and then took us seven decades to even consider doing anything on the same proportion or scale. As always, there are exceptions to the rule. We have previously talked of the remarkable story of Israel with its breathtaking transformation from an agricultural society to a modern R&D focused economy. But even here, as we have also previously mentioned, the centrality of the Israeli state in the name of national security and sheer necessity cannot be understated. For those of you more interested in getting a taster of what this looks like, feel free to look up our previous article or read about Unit 8200. Unit 8200 is an elite intelligence unit that recruits 18-21 year olds with exceptional talent in the signals directorate. What is rather telling about this program are the number of recruits that have gone on to Silicon Valley or founded some of the best up and coming companies in fields ranging from Cyber Security to Artificial Intelligence. And so yes, the world is moving inexorably towards incremental changes and some of the technologies and innovations that we have been hearing about will make massive changes to our societies (potentially also make us richer, we are on the optimistic side and characterising current valuations as bubble like is a stretch). We must also be aware that these are procedural and must be active in looking for opportunities or promoting policies that provide a conducive environment for the next wave of innovations to take place. Progress is not a phenomena but an obligation.
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