One Deep Cause of the Financial Crisis

Posted by: Michael Mandel on April 16

A major underlying cause for the financial crisis has been unexpected and repeated failures in nonfinancial innovation over the past ten years. These disappointments, in the aggregate, undercut the long-term growth rate, and gradually dragged all those leveraged bets into the red.

The technological failures continue, unfortunately, as per this story in this morning’s NYT:

The era of personal genomic medicine may have to wait. The genetic analysis of common disease is turning out to be a lot more complex than expected.

Since the human genome was decoded in 2003, researchers have been developing a powerful method for comparing the genomes of patients and healthy people, with the hope of pinpointing the DNA changes responsible for common diseases.

This method, called a genomewide association study, has proved technically successful despite many skeptics’ initial doubts. But it has been disappointing in that the kind of genetic variation it detects has turned out to explain surprisingly little of the genetic links to most diseases.

Growth runs on successful technological innovation, which translates into economically compelling products and services. The massive spending on healthcare research in recent years has produced enormous gains in scientific knowledge—and a relatively paucity of “Big Things.”

I’m almost ready with my next post in the “reverse Black Swan” series which bears on this question.


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Reader Comments

Sea

April 16, 2009 12:16 PM

Show some semblance of patience.

Brian

April 16, 2009 02:50 PM

Michael, I'm normally a fan, but this seems to be stretching here. Of course successful nonfinanical innovation is the key to long-term growth and increasing prosperity. But that shouldn't mean the blame for the financial crises could reasonably be laid on those who were "supposed" to develop new technologies. The failure to develop new technologies should result in a leveling-off of economic prosperity, not send the economy into the abyss. The blame lies squarely on those who were short sighted, didn't appropriately asses risk, and made poor bets.

Mike Mandel

April 16, 2009 02:58 PM

What does 'short-sighted' mean? Big innovations hit at unpredictably and potentially long time intervals. The question is, as consumers and businesses make their plans, what long-term growth rate should they assume? If you assume that the long-term growth rate is high--that is, there is likely to be more innovations in the pipeline--then should a'rational' long-term person borrow if there is a short-term dip in growth?


CompEng

April 16, 2009 03:00 PM

Mike,
do you mean money lost that was invested in innovation but didn't pan out hurt growth?

Or do you just mean that if we'd invested in innovation that did pan out, we'd be in better shape? Because that could be true, but it's also quite a bit to ask.

Tom Cole

April 16, 2009 06:14 PM

Good observation. I wonder, however, if the problem lies a bit less with technological failures, and more with the massive amounts of capital (i.e. excessive risk) that have been thrown at any new idea regardless of its naciency? i.e. it seems we should keep the incubator to be just that - a small, warm place. The massive amounts of money has corrupted innovation. A good-sounding idea is all that is needed to gain immediate fame and wealth. Meanwhile, many of the most important technologies were developed in somebody's garage.

Kartik

April 16, 2009 06:27 PM

Michael,

There have been substantial innovations this decade. The only thing is, most of the innovation was around bringing mature technologies down to ultra-low costs, for the benefit of China and India.

Those countries saw solid, near-double-digit growth in this decade, and even 5% growth in 2009.

But these innovation can't drive growth in OECD countries, where the market for such technologies are already saturated.

So the innovation still was rapid, but was not geared towards gains for developed countries.

Remember that there is no guarantee that innovation has to suit the economic needs of America. The higher ROI market in this decade were developing markets who never had their first cellphone, PC, or TV prior to 2000, but now have ultra-cheap versions of all of them.

Lord

April 16, 2009 11:20 PM

I would go even farther. The internet gave us the short lived tech bubble but since then been massively deflationary, heavily focused on cost cutting and in many cases revenue cutting. It has spurred rapid growth in emerging markets while at the same time suppressing growth in the developed world. Innovation is costly compared to lowering costs and not nearly so immediately profitable. This is part of the self-limiting nature of innovation; the more we have to adapt to previous innovation, the more effort is focused on that and the less able or willing we are to produce new innovation. Falling trade may then actually represent progress, meaning falling returns to cost cutting and a necessary shift back to expensive hard innovation. The difficulty will be the will to sustain it even as profits disappear. A profitless economy is not a dynamic one. Even so, it might take another decade before another big innovation comes along.

Ajay

April 16, 2009 11:38 PM

Mike, regardless of the true long-term growth rate, there was no reason for house prices to inflate so much and equities were somewhat overvalued also. I remember looking at Apple's share price in late 2007 in amazement, as I thought they were overvalued after their previous runup to $90/share, let alone their 2007 peak. Yes, it'd be great if innovation happened much quicker and saved everybody's ass from all the mistakes they've made. But innovation doesn't happen like that and current institutions, both academic and investing, are fairly bad at fostering innovation. Until we fix those root causes, talk of innovation is just that, talk. I hope to fix those root causes someday, by replacing VCs with seed investing and destroying the existing education system with online education, but I need some time to build up some capital first. ;)

Steven Hales

April 19, 2009 03:55 PM

I think you are thinking in the wrong timescales. When the science for wireless communications was first outlined in universities in the 1880s and 1890s it took RD efforts starting in 1897 through 1910 to begin to see a profitable company. It wasn't until the 1920's that profits began to surge. And broadcasting after 1927 was advertising supported.

So here we have a theory and no real world practible device invented in the 1880s but no real commercial broadcasting industry until over 40 years later. And in between the 1880s and 1920s were literally thousands of patents whose sharing and cross licensing had to be negotiated among firms from Italy, Germany, France and England and later on America. Lastly there was the innovation of advertising supported broadcasting that allowed the diffusion of this innovation to the general public. Television followed a similar pattern first emerging in 1897 in Germany, interupted by WWII but the advertising model innovation was easily applied and after WWII it took off. There was a nearly 50 year lag time and again thousands of patents later we have, well, you know, a thousand channels and nothing on.

I think you need to think about real payoffs in genomic research in terms of decades, say 2040s to the 2050s. Every chemical brute force pharmaceutical company is transforming into a biotech company based on genetic and genomic research. Roche recently acquired the fastest gene sequencing company in the world. So, to say the personal genomic medicines are not here yet or that dividends are not being returned you are rushing a bit to judgement.

CompEng

April 19, 2009 06:21 PM

Steven,

Well said.

LAO

April 20, 2009 11:19 PM

Forgive me, but I can no longer constrain my opinionated reaction (or call it a rant) regarding the "massive spending on healthcare research". I just don't see how it could possibly lead to any kind of broad economic boom, ever.

This may sound cold but it is not meant that way. Did someone demonstrate that the economy tanked because of a few hundred thousand polio cases, or boomed because of polio elimination? Did the economy stagger because of the death of 50,000 Vietnam soldiers? Would recouping the damage to 100,000 or so Iraq veterans save us from this recession? How many people will become more productive when medical miracles abound? Where will they find jobs? How many people will lose their jobs when their patients are cured? Will people spend retirement in destitution if life expectancy shoots up 5 or 10 years? How many good paying jobs will result? Is any disease costing the economy a significant amount in productivity? Would a fountain of youth that few can afford do anything good for the economy? Will conquering malaria make Africa an exploitable market? Why have I never heard the logic for diverting research dollars from other sciences?

Did we think that insurance and pharmaceutical companies and hospitals would eventually wither and create a windfall of health care savings for business and the public? Were we expecting wonder crops and beef cattle that deliver increased food value and volume with no new inputs (something from nothing)? Super man? Has any of this money been invested in figuring out how to simply deliver health care efficiently and effectively?

If I could magically create a "technology" that would crank up the economy for a generation or two, it would not look anything like this. It would be something that would get half of us so excited that we just had to try starting a business to exploit it. Or it would be such an obvious help or savings in our harried lives that we had to have it. It would get creative juices flowing in every arena.

Thanks for bearing with me. I've been stewing about this for a very long time.

Steve

April 21, 2009 03:13 AM

I think investments in 'technology innovation' will surely help after some period of time. So innovation in financial system is much needed now.
http://www.check2cash.co.uk/

Rycoka

April 21, 2009 05:58 PM

Just a stray thought. If financial innovation has been sucking trillions of dollars out of the economy and in the process saddling people with restrictive debt it seems logical that non finacial innovation would suffer, regardless of how many "good ideas" there are.

CompEng

April 22, 2009 01:29 PM

LAO,

While your rant has some merit, the typical counterpoint is that huge and quickly rising amounts of money are spent on healthcare, and therefore that any real innovation in efficiency there could free up huge amounts of capital. You could analogize the stimulus healthcare spending to the Iraq troop surge: an attempt to get over an effectiveness hump.

cm

April 24, 2009 03:33 PM

So in summary, our current predicament is the fault of researchers and engineers who have failed to deliver the exponential growth in new tech paradigms needed to sustain this gargantuan debt bubble???

tomaso spingardi

May 7, 2009 02:10 PM

I am Tomaso Spingardi, and i sit on the investment committee of several institutional investors. stress tests. what an embarassment for risk control groups of financial institutions, populated bu PHDs and researchers from some of the best universities. I guess LTCM didn't teach us much.

As a practitioner, I do find hard to beileve that government run tests are going to shed any further light on the risk position of the book of any financial institutions.

at this point it goes beyond the concept of whether size matters or not. both in terms of scale efficiencies and of too big too fail.

recent experience seems to suggest that we all kind of fooled ourselves by thinking that we had it all under control.

Tomaso Spingardi

massimo armanini

June 30, 2009 05:49 PM

Tomaso I agree on the point, all banks after the result of the stress test are busy repaying....
tomaso spingardi


massimo armanini

massimo armanini

June 30, 2009 05:49 PM

Tomaso I agree on the point, all banks after the result of the stress test are busy repaying....

massimo armanini

johnatan

August 17, 2009 01:21 AM

I agree with Massimo Armanini and Tomaso Spingardi

johnatan

August 17, 2009 01:21 AM

I agree with Massimo Armanini and Tomaso Spingardi

Peter

March 26, 2010 03:56 PM

Tomaso Spingardi, Massimo Armanini it is easy to state this after it happened...

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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