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November 30, 2011

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IMO your insights on IQ ,economics ,class and race are better than your political ones.

Here's a good recent article from a software engineer who made lots of money from Netscape about value creators and value transferers:

"Watch a VC use my name to sell a con."

http://www.jwz.org/blog/2011/11/watch-a-vc-use-my-name-to-sell-a-con/

"Michael Arrington posted this article, "Startups Are Hard. So Work More, Cry Less, And Quit All The Whining" which quotes extensively from my 1994 diary.

He's trying to make the point that the only path to success in the software industry is to work insane hours, sleep under your desk, and give up your one and only youth, and if you don't do that, you're a pussy. He's using my words to try and back up that thesis.

I hate this, because it's not true, and it's disingenuous.

What is true is that for a VC's business model to work, it's necessary for you to give up your life in order for him to become richer.

Follow the fucking money. When a VC tells you what's good for you, check your wallet, then count your fingers.

He's telling you the story of, "If you bust your ass and don't sleep, you'll get rich" because the only way that people in his line of work get richer is if young, poorly-socialized, naive geniuses believe that story! Without those coat-tails to ride, VCs might have to work for a living. Once that kid burns out, they'll just slot a new one in.

I did make a bunch of money by winning the Netscape Startup Lottery, it's true. So did most of the early engineers. But the people who made 100x as much as the engineers did? I can tell you for a fact that none of them slept under their desk. If you look at a list of financially successful people from the software industry, I'll bet you get a very different view of what kind of sleep habits and office hours are successful than the one presented here.

So if your goal is to enrich the Arringtons of the world while maybe, if you win the lottery, scooping some of the groundscore that they overlooked, then by all means, bust your ass while the bankers and speculators cheer you on."

Of course value creation can be non-linear. You just object to it being rewarded in a non-linear fashion. Your posts on this always hinge on the issue of property rights, which you don't seem to be a big fan of. You keep repeating that competition should drive down profits to nothing. Which would be true, in the absence of businesses having moats. Property rights are one type of moat.

Consider the case of a start-up drug company that discovers a cure or treatment for a disease that affects tens of millions of individuals: the founders' rewards for that discovery will be non-linear if its drug's formula is protected by patents, as the marginal cost of producing every dose after the first one will be negligible.

In theory, you could, instead, make those rewards linear by violating the company's patents and giving the founders a one time fee of few hundred thousand dollars for their discovery. But then private sector drug discovery would grind to a halt, because its the potential of non-linear rewards that makes up for the huge odds against success.

Think of it from an investment perspective: if 9 out of 10 early stage drug start-ups fail (the actual number is probably even worse than that), and your max return on an investment in any one of them is capped at 100%, you wouldn't invest a dime in them: the potential of non-linear rewards is what gives the investing math a chance to work.

I think you mean exponential growth. Logarithmic functions grow slowly; exponentials grow quickly.

DaveinHackensack,

I have a friend that works for a medical device manufacturer. He's an engineer that works 80 hours a week and flies all over the country to talk to surgeons. If the company hits it big on their next launch his stock options might be worth a few hundred thousand, maybe $500k if he's really lucky.

Now let's compare that to the CFO of his company. He was a legacy admit to Yale from a well off family that spent a little time in IB (which is how life works out for those people). What does he do all day? Well mostly he plays golf with other rich people and convinces fund managers with a passing knowledge of biotech to invest money because they liked how charismatic he was and they were dormates in college. He will make 100x what my friend makes if the company hits it big. Is he creating that much value? Yes and no. His connections really do help the company get money, but its his connections, not him, that do it. Any generic person with an above average IQ born into those circumstances could do the same. By contrast my friend is doing the hard work of actually making the product function.

"Think of it from an investment perspective: if 9 out of 10 early stage drug start-ups fail (the actual number is probably even worse than that), and your max return on an investment in any one of them is capped at 100%, you wouldn't invest a dime in them: the potential of non-linear rewards is what gives the investing math a chance to work."

You are making the assumption that any given start-up in the industry is as likely to fail as any other one.

This is not true. (If it were then we would just have the government allocate capital)

VCs / Angels/ Investment Managers are supposed to be good at figuring this stuff out and investing in worthy companies.

There are a few exceptions. But for the most part they are not any good.

Apparently Half Sigma can't handle genuine, civil criticism of his ideas because he keeps censoring comments that don't agree with his thinking.

half have your seen this video of your beloved romney?
http://www.youtube.com/watch?v=UU72izvZVRA&feature=player_embedded

proves he is a schill for big biz and will flood the country with more mexicans.

Value creation is definitely nonlinear. How much has society benefited from Issac Newton, Thomas Edison, or Winston Churchill? Billions upon billions of dollars.

DaveinHackensack -

"In theory, you could, instead, make those rewards linear by violating the company's patents and giving the founders a one time fee of few hundred thousand dollars for their discovery. But then private sector drug discovery would grind to a halt, because its the potential of non-linear rewards that makes up for the huge odds against success."

What you say is true but I do think that you're talking around Half's point.

The question to ask is this: does anyone really believe that the only barrier to entry for creating a business and making a fortune is the law against theft, the meeting of the expectations of customers, and your own natural endowment? Does anyone believe that there are no other barriers to entry in the way of achieving this or anything else?

@DaveinHack

The problem is those nonlinear rewards take money from other pursuits just as important.

Romney would be the most conservative candidate on immigration the Republicans have nominated in a long, long time. Republicans have a chance to nominate someone who has promised to cut off all benefits to illegals, and they're blowing it.

Oh, I understand that.

I wonder what regular commentators here don't.

But its nice hearing that again. Its an interesting topic to me.

"Value creation is a linear activity, which means that the amount of value that the world’s smartest and hardest working person can personally create is probably limited to a few hundred thousand dollars a year before he burns out."

I disagree, at least in terms of inventiveness.

A person like Tesla, or einstin, are worth hundreds of lesser geniuses slogging away at equations, and no amount of normals will amount to them.

The only value/wealth creators are the ones who print or release the money from computers. All other financial transactions are a form of value transference. If I dig up some rocks that people find valuable and give me money for them, all I am doing is transferring some rocks for money. If I buy wood to construct a cabinet and later sell it, all I am doing is transferring money to buy wood to make into a cabinet which I then transfer to another person in exchange for money.

Here is a balding liberal-arts herb with one of the lamest surnames imaginable who transferred his parents' value to himself in order to procure a beautiful, educated wife.

http://www.nytimes.com/2011/11/27/fashion/weddings/myriam-cifuentes-nicholas-goodbody-weddings.html

Society would certainly be better off if these good catches were marrying and having kids with robust value-creating guys, not regressing-to-the-mean heirs.

Those autistic animators at Pixar and those autistic programmers at Apple and the simple folks on the factory floor of Toyota are worthless by themselves. There are plenty of talented nerds and mechanical folks that can do interesting things in their garage but without the thousands of business linkages and organizational structures and operational management steps that the 'value stealers' bring, nothing is accomplished.

Just look at China. They are chock full of your 'productive' types, and HBD seems to suggest they have a higher IQ but are more 'Asperger-y' meaning that they aren't as good at what you would call 'value transference' but what is actually just the business side of an economy.

China works harder but on the average they are something like 10x poorer per capita than the West.

If doing business deals is 'value transference' then the rich are guilty as charged. Good for them. Doing business deals is making us all richer.

Dan: China was a totalitarian communist dictatorship until very recently. It is growing much faster than the United States and is not about to be engulfed by a giant pit of its own debt. Who knows what the future will bring and China certainly has its problems but its ridiculous to suggest that since we're richer than China at this moment that our system is superior. Wealth is a cumulative thing and is a result not just of the current system but ones in the past as well.

Perhaps part of the problem people are having with your 'value creation/value transference' distinction is that you haven't provided the slightest account of what it is you take value to be. Here's what people who do this for a living are looking for:
'Action/good/item/whatever has value insofar as X'
Where you fill out the X.

People in the marginal utility camp have a quick and intuitively very satisfying answer here: X is a function of the desire of others. Something has value insofar as it is desired by others. Of course, in proposing such a clean and intuitively satisfying answer, they have left your precious distinction out in the cold.

What's your X?

All of the good points in the comments to this post have been made in the past, but you have failed to come up with any satisfactory refutation of them.

Here is a summary of the most potent criticisms:

(1) You have no solid definition of the value of something. Deckin points this out, and I pointed it out in response to a previous post. Do you have a response?

(2) Inventors and investors need incentives. If you cap the return to invention or capital by government fiat, as you seem to suggest is appropriate, you will encourage under-investment in R&D. Daveinhack makes this point and I made it in response to a prior post of yours. Do you have a response?

(3) Inventions, goods and services don't come to market or succeed without the "business" side of a business, which includes corporate structures, relationships and managerial skills of top executives. Dan makes this point and I made it in response to a previous post. Do you have a response?

(4) Your arbitrary ceiling on one person's "value creation" is quite obviously false (barring some insane definition of value). Thomas Edison lit the world and contributed exponentially more than the factory workers who cranked out the light bulbs he invented. John and Noko point this out. Do you have a response?

The only quasi-response I have seen in your posts to any of these criticisms is an unfalsifiable claim to the effect that someone would have invented all of our great achievements anyway. That is clearly unsatisfactory given that humanity existed for tens of thousands of years without inventing any of the things that have been created in a few hundred years of a relatively free economy with strong property rights. Anyone proposing to radically change that system should bear a heavy evidentiary burden of persuasion, and you haven't come close to meeting it.

" Any generic person with an above average IQ born into those circumstances could do the same"

But any generic person with an above average IQ was not born into this circumstances. One's ability to create value may only be a function of family connections but is value nonetheless.

And I agree with everyone that it's absurd for half sigma to think value creation is linear. One doesn't even need to invoke great geniuses to see this. Walk into any work place and the best workers are ten times more productive than the worst workers. [HS: But they don't get paid ten times as much, everyone gets paid pretty much the same. This proves that value is being transferred from those super-workers to senior management.] Often something as simple as thinking of a more efficient way to do a job makes a world of difference.

Half sigma's problem is that he thinks that just because IQ forms a perfect bell curve, wealth should also form a perfect bell curve and any deviation from this suggests people are transferring value. But the truth is value creation is the product of both IQ and hard work.

Further, IQ is statistically forced to fit a bell curve but there's little evidence intelligence itself fits a bell curve. Some people can solve a brain teaser instantly, others would take years to solve the same problem. These colossal variations in natural ability translate into colossal variation in value creation and ultimately into income and wealth, especially when combined with variation in energy, industriousness, drive, special talents, looks, connections etc.

I don't deny that there are lots of arbitrary laws that disproportionately allow some people to unfairly benefit economically, but the bulk of economic inequality would still exist in a perfect free market, and there might be even more.

"(2) Inventors and investors need incentives. If you cap the return to invention or capital by government fiat, as you seem to suggest is appropriate, you will encourage under-investment in R&D. Daveinhack makes this point and I made it in response to a prior post of yours. Do you have a response?"

Most people don't get rich inventing things. As I've mentioned before we have data on this:

1) Finance
2) BIGLAW
3) CEOs of large megacorps (i.e. people good at playing corporate politics in large organizations that are already established in the business world)

That's most rich people. People act like every single rich person is Steve Jobs. They aren't. Most of them are investment bankers whose parents were investment bankers, and they don't do anything useful for anyone.

"(3) Inventions, goods and services don't come to market or succeed without the "business" side of a business, which includes corporate structures, relationships and managerial skills of top executives. Dan makes this point and I made it in response to a previous post. Do you have a response? "

Sure, but just because someone is at the top of a business hierarchy doesn't necessarily make them good at business. Most corps, once they reach the publicly traded cash cow stage where CEOs get the huge bonuses and golden parachutes, aren't particularly well managed. Getting to the top of that hierarchy is more about connections, luck, and ability to wow or buy lightly interested board members.

"But any generic person with an above average IQ was not born into this circumstances. One's ability to create value may only be a function of family connections but is value nonetheless."

What I'm saying is that the person isn't creating the value, circumstances are creating the value. Essentially, this persons value above replacement is zero, so why are we so worried about disincentivizing someone with no value above replacement?

Sigma is right unfortunately, all you people keep forgetting without a society filled with millions of people to buy your product or shift money in your direction your 'value creation' ability is more often then not, useless. If you're born into a tribe of less then 1000 people in historical time it doesn't matter much how smart/talented/beautiful/social and whatever it is you are. What everyone is missing is that historically wealth and knowledge that was discovered/invented long ago is still adding value today even though those people are long since dead. Todays "value creators" are sitting on top of a mountain of historical value which no one paid for and they can take advantage of.

It's like being born rich - you start out with a huge advantage.

This whole idea of the individual being a fucking hero has got to stop. Every human being from now on is easily replaceable barring some catastrophic event. Not only that asian countries will soon force a eugenics arms race with the west. Say what you will about the Chinese but at least their societies aren't riddled with the same kind of religious superstition and backwardness as the western societies are.

To me this discussion is hiding the bigger point in the details. The only interesting question is whether your salary=the value you produce. It clearly does not, and therefore the libertarian's metaphysical position that capitalism is a kind of cosmic justice unravels.

HS may be wrong to ignore the value creation of great inventors, but as davver notes, most of the wealthy are not great inventors. They are value transferer's primarily maintained by entry barriers. There's nothing special in that; no cosmic value to protect. It's just our particular system of power.

"The only interesting question is whether your salary=the value you produce and therefore the libertarian's metaphysical position that capitalism is a kind of cosmic justice unravels."

I don't know anyone who claims that "salary=the value you produce." And that's not what the criticisms of HS are saying. Salary is the price of *labor.* Why treat labor any differently than corn? For me, the "value" of a pound of corn is however much someone is willing to pay for it in a free trade. Similarly, the "value" of an hour of labor is whatever someone is willing to pay for it in a voluntary exchange. This is an easy and intuitive definition of "value." The value of someone's labor is what someone is willing to pay them for it, and that is driven by the supply and demand in the labor market, just like the value of corn is driven by the supply and demand in the corn market.

If you want to use some other definition of value to say someone's labor is *more* valuable than their salary, you need to come up with a definition of value to support that claim. You haven't done it, and neither has HS. You want to use my definition of value or something similar for goods produced and then use that to back into some intrinsic "value" of someone's labor. That is an ill-conceived solution to a problem that does not exist. We already have a mechanism for valuing labor. But HS doesn't want to use that because he thinks it's unfair or unreasonable that other people's labor is so highly valued.

Also, who says anything about "cosmic justice?" I prefer capitalism with strong property rights because it has empirically proven much better at spurring progress and improvements in living conditions than any other system. Every time central planning is tried, it fails, and fails miserably. I'm willing to live with having seemingly "unfair" big winners and big losers if that is the price of the system that transformed us from subsistence farmers to modern men capable of carrying on this conversation remotely via the internet. And, I would note, that every centrally planned government that began with notions of "fairness" as their rationale ended up incredibly unfair societies, creating an aristocracy of the politically connected insiders with the rest of the population reduced to living as functional peasants. No reason to think something different would happen this time around.

Jmanon, I appreciate the thoughtful post. Apologies for a lengthy response:

The idea of value transference is completely compatible with the idea that ones salary is set by the market value of your skills and credentials.

The point is that in many cases the market value of certain kinds of labor has nothing whatever to do with creating wealth. Lawyers don't create wealth except in a subjective sense. The "good" lawyer ensures that his clients receive a bigger slice of cake, but he doesn't actually make more cake. The great lawyer is really good at playing a zero sum game.

So when we look at this lawyer from the third person we see that he is actually a kind of pirate. He is very much like the medieval "champion" who decided juridical issues by a sword fight.

You could say "hey look, the champion is clearly worth his wages because someone in the market is willing to pay him." But there is another way to look at it: "actually, the champion doesn't produce anything. And therefore it might be rational, for example, to impose a salary cap on championism. Sure, that might lead some of the more versatile champions to leave the business, (and therefore reduce the overall 'quality' of championship), but having second rate champions has no effect on "value as wealth" whatsoever.

Similar but more complicated arguments could be made for advertisement, investment, etc. In these cases some "value as wealth" is created. You could argue, for instance, that if you banned advertising the better products might never receive attention, thereby reducing wealth. Of course there is a response which says: "perhaps, but there may be other ways of ensuring novel product publicity, and in any case advertisement is not directly concerned with providing "good" information."

That gets hairy quickly, but the important point is just that the salary of the expert advertisers =/= the value that they produce. If that isn't clear we could imagine an expert advertiser hired by a big brewery with an inferior product. In that case the advertiser would actually be accomplishing value destruction, and making millions at it.

All this says is that you should not be dogmatic about the free market. The typical libertarian response to market intervention is "but that will make us all poorer in the end." Maybe, but it is not an a priori fact. A salary cap on legal work might make the justice system less efficien, or it might do the opposite and free up a bunch of talent for something more useful. All I want to say is that there is no reason to automatically privilege the free market solution in cases of value transference.

That said, I think your point about prior failures at economic intervention is well taken. Even if we agree that the free market system is sub-optimal at wealth creation, you could still reasonably hold that the empirical record shows efforts to change it always end for the worse. Nonetheless, I think you somewhat overstate your case. You write that capitalist inequality is "the price of the system that transformed us from subsistence farmers to modern men." But obviously that's not literally true. No Western culture in history has ever been a Randian free market or anything close to it. Sure, the scientific and industrial revolutions didn't occur in a context of Soviet style central planning, but no one is advocating that. Speaking for myself I agree that market systems tend towards efficiency and are overall a reasonable way to a prosperous society. The question is only if market fundamentalism is the *best* way, or if some adjustments might improve it. I'm about to go to a top law school and make good money producing absolutely nothing in my adult life, along with all my top .1% classmates. That is not an efficient use of talent; it is just exploitation of a collective action problem. I can see no reason why a rational government should not stop me.

Tractal, overpaid lawyers are not the fault of capitalism, they are the fault of government interfering with the free market by demanding you must have a law degree to practice law. This limits the supply of lawyers while holding the demand constant thus artificially inflating their value. In a more libertarian society, lawyers would not make as much. That's probably why libertarians are against government regulation; it creates more value transference.

[HS: There's no shortage of people who have a law degree. A heck of a lot of them can't find jobs. And they make less money than investment bankers who theoretically don't need any degree at all.]

Drop the stuff about IQ and I generally agree. IQ doesn't really seem to be relevant to the more important point unless you're unable to let go of an idea that only smart people are valuable.

Drole Prole: the system is broken and controlled by bankers, we both agree I think. But the cabinet you build is a product of both the wood and your labor. The idea is that you get to sell the cabinet for more than the wood alone so the farmer buying it trades some of his labor for your labor. Thus you both might have cabinets as well as food to put in them, while each only focusing on one job.

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