I attended a fascinating, if somewhat disturbing talk at the Cranlana Programme by Scott Borg, director and chief economist at the US Cyber Consequences Unit, who is a cyber warfare specialist and economist at the US Cyber Consequences Unit.
It included horrible descriptions of the end of the world as we know it, much as expected. It turns out that mutually assured destruction exists just as much in the cyber realm as in the nuclear realm.
But Borg was also exploring an economic approach that looks like it starts from much sounder premises that most economic ideas. As he commented to me, most macro economic theory is borrowed from eighteenth century physics. He said “One of the nice things about the value creation stuff that I and my colleagues do is that we started from scratch. We are not importing a bunch of concepts and mathematics from physics.”
Here are excerpts from my interview with him, in which I think he showed an unusual degree of common sense. Borg very much concentrates on micro economics. He is reluctant even to comment on macro economics:
“Micro economics can identify mechanisms by which things operate. And so it is certainly a science. A lot of macro economics is pretty borderline because it is not identifying mechanisms it is looking for statistical correlations. It is a rule of thumb that if you have statistical correlations only you are not really dealing with a science.
A science doesn’t need statistical correlations because it can say absolutely what happens and how it happens. If I am doing chemistry I don’t have to say there is a statistical correlation that suggests this reaction. We have got this reaction or we don’t. Whenever people are talking statistics they are usually not there as a science.”
Nice to hear someone say it. I asked him about his view of comparative advantage, which Paul Krugman has described as a “badge of honour” for economists (he mainly means macro economists). It has been the mantra behind free trade for decades. Borg argues essentially that it has legitimacy at the micro level, although it needs to be refined. But that’s about it. He is seeking to answer the question that really maters: how to economies grow? And unlike those would be eighteenth century physics, he does not assume a steady state system:
“Countries should seize opportunities to create value. They should not fall into some stereotyped idea that someone has foisted on them of what they are good at and stick to that. That would preclude all kind of economic ventures. So basically comparative advantage as a concept is incontestable. Comparative advantage (as a dictum that countries should only specialise in what they are good at) is a great fallacy.
Countries and companies and individuals should seize opportunities to create value. The value that you can create depends on what you can do that your competitor can’t. If you can’t do something better than your competitor you are not creating any value at all. It is better to have you out of the game.
There is a better way to describe these economic points. It is to think in terms of value creation. The value that is created by an activity is the opportunity, it is the willingness to pay of the customers minus the opportunity cost to suppliers. The willingness to pay is based on the best alternative is for those customers if they don’t do that particular deal. The opportunity cost is based on what the best opportunity is for the suppliers if they don’t do that particular deal. So to create value you need to have a gap between the willingness to pay the opportunity cost and that amount of value creating is always done on a comparative basis. It is always based on what the other alternatives are.
When people use phrases like comparative advantage they are trying to look at one picture, one piece of that gestalt of that bigger picture and not look at the whole picture.
(Nobel prize winner) Paul Romer doesn’t really have a theory of economic growth or innovation. What he did was he fiddled with the equations so that there is another variable in there it is a little bit rearranged. But the model is just fiddling with the equation, it is not an actual theory of innovation or economic growth.
Adam Brandenburger from NYU and Harbone Stewart (are developing these ideas using) co-operative game theory based value creation. A lot of what people have heard about complementary value chains and value this and value that comes out of work that was pioneered by Brandenburger and Stewart.”
Borg says the cluster theory developed by Michael Porter, another attempt to explain growth at a micro economic level is “all very fine it is not very rigorous:
” It is fine as far as it goes. We need a lot finer grained understanding of that now and the reason I cite B and S breakthrough articles that you can use to build a better understanding. Cyber security it has enabled me to do a lot of new economic theory. Cyber attacks can mess with anything in such a fine grained way that you can’t do any of this wave the hand stuff any more. You can’t approximate a willingness to pay curve, you can’t call it a demand curve and just draw it in some kind of vague smooth line. You have to appreciate that it is a step curve and each step is determined by what the alternatives are to using that product. The same way with an opportunity cost curve, you have to start looking at that much more analytically.
The mechanisms within that market by which people negotiate their way in also can’t be just done with a wave of the hand, you can’t just assume they will actually do that. You have to start looking how that market functions in the real world. That allows much finer grained micro economics and it make a lot of what people are taught as micro economics in undergraduate text books so crude as to be misleading. Even wrong.”