by David Robertson, CFA
July 2018
The hit TV series Breaking Bad was compelling for a number of reasons, not least of which was its disarmingly believable depiction of the lead character’s transformation from a fairly normal school teacher to a very bad drug dealer. The journey started with adversity, a noble intent, and then a long and slippery slope of justifying the means with the ends.
Interestingly, a number of technologies (including the internet) have undergone a similar transformation. Bursting on to the scene with loads of potential to serve society, the long term benefits have often gotten compromised along the way. Given the pervasiveness of technology throughout the economic landscape and the increasingly dominant effect of Big Tech companies in major markets, these issues have a lot of implications for investors.
It’s not hard to find arguments extolling the virtues of technology and some of the most compelling come from Erik Brynjolfsson and Andrew McAfee. In their book, The Second Machine Age, they argued that the "transformations brought about by digital technology will be profoundly beneficial ones.” Part of the reason is that the surge in digitalization has two profound consequences: "new ways of acquiring knowledge (in other words, of doing science) and higher rates of innovation."
As a result, the authors reject claims that future growth will be lower by arguing that growth is "just being held back by our inability to process all the new ideas fast enough." Their brimming enthusiasm is captured well by the assessment, "If the first machine age helped unlock the forces of energy trapped in chemical bonds to reshape the physical world, the real promise of the second machine age is to help unleash the power of human ingenuity."
Despite such an exciting perspective of technology, some of the most qualified people in the business have become more vocal in their criticism of its application. In a recent report from the Economist [here], none other than Sir Tim Berners-Lee, the creator of the world wide web, indicated, "I wouldn't say the internet has failed with a capital F, but it has failed to deliver the positive, constructive society many of us had hoped for.”
Jaron Lanier also posts strong tech credentials and also complains about the direction of much of today’s technology. The Financial Times describes him [here] as “one of the early pioneers of virtual reality, founding VPL Research in the mid-1980s and developing VR goggles and gloves.” He later sold out to Sun Microsystems and has continued to “delineate the contours of our shape-shifting digital world.”
While Lanier "has been both evangelist and heretic, enthusing about technology’s creative possibilities while warning of its destructive effects," his rebukes have been especially sharp. For example, "He was among the first to raise the alarm about the harmful fallout of social media on our lives, a theme developed with passionate force in his latest book, Ten Arguments for Deleting Your Social Media Accounts Right Now.”
He explained, “We would all have a clearer understanding of our world ... if we relabelled the likes of Facebook and Google as 'behaviour manipulation empires'. His argument is that 'pervasive surveillance and constant, subtle manipulation is unethical, cruel, dangerous and inhumane'. In short, this weaponised form of advertising is polarising society, destroying democratic debate, and turning us into 'assholes'."
For all of this criticism, however, Lanier doesn't pin the blame on "bad" people. Instead, "he stresses that the problem is not so much the technology itself or even the corporate leadership as the economic incentive system in which we operate. Sadly, the early libertarian idealism of the internet has resulted in the creation of 'gargantuan, global data monopsonies'."
The Economist identifies a similar key failing: "the Internet has become much more "centralised" {in the tech crowd's terminology) than it was even ten years ago. Both in the West and in China, the activities this global network of networks makes possible are dominated by a few giants."
The path to that domination lies in the details of how the internet works. As the Economist report describes: "[L]ike most digital systems, it [the internet] is designed in layers. At the bottom are all the protocols that allow different sorts of networks and devices to exchange information, or 'internetwork' (hence internet). At that level, it is still largely decentralised: no single company controls these protocols (although the number of firms providing internet access has dropped sharply, too; most Americans have a choice between only two offerings)."
The problem, as the report explains, is at the next layer up, where "everything that happens on the internet itself -- has become much more concentrated.” It goes on to explain, “This is particularly true of the web and other internet applications, which include many consumer services, from online search to social networking." This state of affairs unfolded because the "internet's governance mechanisms" weren’t explicitly designed to prevent concentration and thus created the opportunity for a few private actors to “become the internet's memory."
If all of this sounds a bit technical and far-fetched, and maybe not even so relevant, there is an excellent empirical example to demonstrate otherwise — in finance. As Gillian Tett writes in the FT [here], “If you want to take a wider view of the underlying policy issues, ponder the parallels between this year's data harvesting tale [involving Facebook and Cambridge Analytica] and the growth in the 2000s of financial innovations such as credit derivatives.”
In neither case was there any indication of hurtful intent with the innovations: “For their part, the finance geeks were not hiding their innovations or being deliberately malicious; they told themselves (and others) that their inventions would improve the financial system, while also making them rich.”
As Tett continues, however, “But credit derivatives and other financial innovations were widely ignored because they seemed so ‘nerdy’ and mind-numbingly dull. Politicians and voters had no incentive to ask hard questions because they were enjoying the cheap mortgages and credit cards that the derivatives helped make possible. Regulators were largely toothless because the whizz kids were creating financial instruments that straddled national borders, regulatory silos and outdated laws.”
Tett follows, “Politicians and voters also failed to demand proper oversight. The world of big data seems as geeky and dull to outsiders now as derivatives did back then. Consumers like ‘free’ internet services as much as they enjoyed cheap mortgages. No one wanted to think about the hidden costs.” As it turned out, “The power rested with the geeks until their innovations were abused in a way that contributed to a financial crisis.”
The key lesson, Tett concludes, “is that innovation only delivers real benefits when there is a proper system of ethics, political oversight and up-to-date laws.” In other words, “the parallel — and policy lesson — lies in how politicians handle innovation; or mishandle it.”
The critical importance of strong institutions (such as rules and regulations) in facilitating the benefits of innovations is also explicitly endorsed by Brynjolfsson and McAfee. The two even go so far as to cite the authors of Why Nations Fail: “According to Acemoglu and Robinson, the true origins [of power, prosperity, and poverty] are not geography, natural resources, or culture. Instead, they’re institutions like democracy, property rights, and the rule of law; inclusive ones bring prosperity, and extractive ones—ones that bend the economy and the rules of the game to the service of entrenched elite—bring poverty."
Recognizing such constraints on the realization of the benefits of technological innovation, how can prosperity by way of inclusiveness be ensured? Conversely, how can the bending of rules to favor the entrenched elite be prevented? In short, how can “technology’s original promise” be revived?
Regulation is clearly one of the options, but Lanier, for his part fears that regulation “might only strengthen the incumbents.” He also notes that “Facebook and Google are more likely to reform themselves, partly in their own self-interest and partly under pressure from their own ethically minded employees.” His insight as a technology insider is: “The one thing that will kill them totally is if the good engineers start leaving. Then the companies will die.”
Instead, a number of technology veterans, including Lanier, are trying to recapture the “decentralised innocence” of the internet by taking matters into their own hands. As Lanier notes, “I don’t see how any society can hope to survive unless there’s at least some degree of alignment between society’s interests and economic incentives.” He summarizes wryly, “I miss the future.”
For his part, Lanier “has been working with a group of radical economists to design an alternative information economy. He is an eloquent champion of the Data-as-Labour movement, arguing that if people do use social media then they should at least be paid for their posts and photographs. He hints that he is involved in backroom dialogues with the tech companies to bring about such a restructuring.”
Lanier isn’t the only one. The FT also reports [here] about a new effort called Openbook designed as an alternative to Facebook. Its creator, Joel Hernandez described that he wanted the product “to be ‘more joyful’ than Facebook, with more personalisation and new ways to encourage people to connect.” In regards to Facebook, he also criticized, "The whole business model is based on users not having privacy."
Still, such efforts can only accomplish so much without the active endorsement of consumers. Lanier argues that improvements across society have “only come about because of the activism of the discontented.” As a result, he views his criticisms as serving a higher purpose: “At every increment of improvement in human history somebody got pissed off and said, ‘This can be better, this must be better’. To be an optimist has to mean being a critic. The enemy of the future is not the pessimist but the complacent person.”
This perspective also shines a bright light on the role of governments as well as individual members of society. Harnessing the full power of innovation, whether it is in technology or credit derivatives or anywhere else, requires involvement. Brynjolfsson and McAfee made this point clear: "Faster technological progress may ultimately bring greater wealth and longer lifespans, but it also requires faster adjustments by both people and institutions."
Such involvement entails making choices. Interestingly, for as optimistic as Brynjolfsson and McAfee come across, their parting words are reflective and indeterminate: “In the second machine age, we need to think much more deeply about what it is we really want and what we value, both as individuals and as a society. Our generation has inherited more opportunities to transform the world than any other. That’s a cause for optimism, but only if we’re mindful of our choices. Technology is not destiny. We shape our destiny.”
Pulling all of these ideas together not only helps to handicap technological transformations, but also reveals a number of important implications for investors. For starters, technology is not destiny, even though many investors seem to think so. For example, the notion that the existence of great technology alone is sufficient to justify expectations of strong economic growth is a widely held belief.
While Brynjolfsson and McAfee clearly promote the potential of digital technologies, they also make it clear that the potential is contingent upon inclusive institutions. To date, much of the technology industry uses innovations, like the financial industry before, to "straddle national borders, regulatory silos and outdated laws". As such, technology is tilted to "servicing the entrenched elite" at the expense of broader economic growth for society as a whole.
Another common belief among investors is that if a technology is great, then a company that deploys it also great by association. This thinking has been fueled by tech leaders who encourage it by proclaiming (essentially), what Lloyd Blankfein of Goldman Sachs did (literally), that they are doing "God's work". The belief that technology companies are mainly just sharing all the wonderful benefits of technological innovations with the rest of the world has created a strongly positive narrative for Big Tech stocks.
This view gets things almost completely wrong, however. Primarily, it conflates the potential of underlying technologies with the intentions of for-profit companies. The harsher reality is that the greatest economic gains tend to accrue to those who extract wealth for themselves rather than serving the broader interests of society. The disproportionate success of Big Tech companies, therefore, serves as a better indication that the "original promise" of technology has been subverted than that it has been fulfilled. Not surprisingly, the old saying, "power corrupts", still holds.
Of course it doesn't have to be this way. The ways in which technological innovation get realized are largely a matter of values and of choice; we shape our destiny. So, what do we really want? If we want to realize the full promise of "new ways of acquiring knowledge" and "higher rates of innovation", we are going to have to get up to speed on the issues and agree to some solid ground rules that allow everyone to benefit (and to prevent centralization). This will take effort. Conversely, if we are unwilling to exert that effort, we will likely have to accept a technology industry that will follow strong economic incentives to extract wealth from society and to concentrate its power.
Governance is another crucial factor that affects the nature of technology uptake and one that investors can also monitor. Unfortunately the prognosis for improvement is poor. In many cases, regulators are "toothless" due to the compartmentalized structure of many governing authorities. Further, just as in the case of credit derivatives and financial innovation, many of the most important issues are "mind-numbingly dull". As a result, just as in the case of credit derivatives and financial innovation, the belief that "someone is in charge" is largely a myth.
The governance vacuum is taking on even greater importance as the competition for technology takes on global dimensions. As the FT reports [here], "China is pouring money into AI [artificial intelligence] research and pioneering its deployment in many areas" in an effort to "become the primary AI innovation superpower by 2030". As the FT also notes, such competition moves the tradeoffs of centralization vs. decentralization to the geopolitical stage: "The AI competition may be better viewed as part of a broader struggle between a decentralised democratic model and a digital authoritarian system."
So are technology companies breaking bad? That would probably be an overstatement, but it is very fair to say that many of the elements crucial to harness the full potential technological innovation are underrepresented in today's environment. Knowledge of technologies is insufficient, governance is slow and weak, and public engagement is low. This creates a weak position from which to wrest power from companies with strong economic incentives. This is important for investors. Unless things change, there is a good chance that not only will the great potential of technological innovation fail to be realized, but also that such innovations will continue to be exploited right up until things break.
July 2018
The hit TV series Breaking Bad was compelling for a number of reasons, not least of which was its disarmingly believable depiction of the lead character’s transformation from a fairly normal school teacher to a very bad drug dealer. The journey started with adversity, a noble intent, and then a long and slippery slope of justifying the means with the ends.
Interestingly, a number of technologies (including the internet) have undergone a similar transformation. Bursting on to the scene with loads of potential to serve society, the long term benefits have often gotten compromised along the way. Given the pervasiveness of technology throughout the economic landscape and the increasingly dominant effect of Big Tech companies in major markets, these issues have a lot of implications for investors.
It’s not hard to find arguments extolling the virtues of technology and some of the most compelling come from Erik Brynjolfsson and Andrew McAfee. In their book, The Second Machine Age, they argued that the "transformations brought about by digital technology will be profoundly beneficial ones.” Part of the reason is that the surge in digitalization has two profound consequences: "new ways of acquiring knowledge (in other words, of doing science) and higher rates of innovation."
As a result, the authors reject claims that future growth will be lower by arguing that growth is "just being held back by our inability to process all the new ideas fast enough." Their brimming enthusiasm is captured well by the assessment, "If the first machine age helped unlock the forces of energy trapped in chemical bonds to reshape the physical world, the real promise of the second machine age is to help unleash the power of human ingenuity."
Despite such an exciting perspective of technology, some of the most qualified people in the business have become more vocal in their criticism of its application. In a recent report from the Economist [here], none other than Sir Tim Berners-Lee, the creator of the world wide web, indicated, "I wouldn't say the internet has failed with a capital F, but it has failed to deliver the positive, constructive society many of us had hoped for.”
Jaron Lanier also posts strong tech credentials and also complains about the direction of much of today’s technology. The Financial Times describes him [here] as “one of the early pioneers of virtual reality, founding VPL Research in the mid-1980s and developing VR goggles and gloves.” He later sold out to Sun Microsystems and has continued to “delineate the contours of our shape-shifting digital world.”
While Lanier "has been both evangelist and heretic, enthusing about technology’s creative possibilities while warning of its destructive effects," his rebukes have been especially sharp. For example, "He was among the first to raise the alarm about the harmful fallout of social media on our lives, a theme developed with passionate force in his latest book, Ten Arguments for Deleting Your Social Media Accounts Right Now.”
He explained, “We would all have a clearer understanding of our world ... if we relabelled the likes of Facebook and Google as 'behaviour manipulation empires'. His argument is that 'pervasive surveillance and constant, subtle manipulation is unethical, cruel, dangerous and inhumane'. In short, this weaponised form of advertising is polarising society, destroying democratic debate, and turning us into 'assholes'."
For all of this criticism, however, Lanier doesn't pin the blame on "bad" people. Instead, "he stresses that the problem is not so much the technology itself or even the corporate leadership as the economic incentive system in which we operate. Sadly, the early libertarian idealism of the internet has resulted in the creation of 'gargantuan, global data monopsonies'."
The Economist identifies a similar key failing: "the Internet has become much more "centralised" {in the tech crowd's terminology) than it was even ten years ago. Both in the West and in China, the activities this global network of networks makes possible are dominated by a few giants."
The path to that domination lies in the details of how the internet works. As the Economist report describes: "[L]ike most digital systems, it [the internet] is designed in layers. At the bottom are all the protocols that allow different sorts of networks and devices to exchange information, or 'internetwork' (hence internet). At that level, it is still largely decentralised: no single company controls these protocols (although the number of firms providing internet access has dropped sharply, too; most Americans have a choice between only two offerings)."
The problem, as the report explains, is at the next layer up, where "everything that happens on the internet itself -- has become much more concentrated.” It goes on to explain, “This is particularly true of the web and other internet applications, which include many consumer services, from online search to social networking." This state of affairs unfolded because the "internet's governance mechanisms" weren’t explicitly designed to prevent concentration and thus created the opportunity for a few private actors to “become the internet's memory."
If all of this sounds a bit technical and far-fetched, and maybe not even so relevant, there is an excellent empirical example to demonstrate otherwise — in finance. As Gillian Tett writes in the FT [here], “If you want to take a wider view of the underlying policy issues, ponder the parallels between this year's data harvesting tale [involving Facebook and Cambridge Analytica] and the growth in the 2000s of financial innovations such as credit derivatives.”
In neither case was there any indication of hurtful intent with the innovations: “For their part, the finance geeks were not hiding their innovations or being deliberately malicious; they told themselves (and others) that their inventions would improve the financial system, while also making them rich.”
As Tett continues, however, “But credit derivatives and other financial innovations were widely ignored because they seemed so ‘nerdy’ and mind-numbingly dull. Politicians and voters had no incentive to ask hard questions because they were enjoying the cheap mortgages and credit cards that the derivatives helped make possible. Regulators were largely toothless because the whizz kids were creating financial instruments that straddled national borders, regulatory silos and outdated laws.”
Tett follows, “Politicians and voters also failed to demand proper oversight. The world of big data seems as geeky and dull to outsiders now as derivatives did back then. Consumers like ‘free’ internet services as much as they enjoyed cheap mortgages. No one wanted to think about the hidden costs.” As it turned out, “The power rested with the geeks until their innovations were abused in a way that contributed to a financial crisis.”
The key lesson, Tett concludes, “is that innovation only delivers real benefits when there is a proper system of ethics, political oversight and up-to-date laws.” In other words, “the parallel — and policy lesson — lies in how politicians handle innovation; or mishandle it.”
The critical importance of strong institutions (such as rules and regulations) in facilitating the benefits of innovations is also explicitly endorsed by Brynjolfsson and McAfee. The two even go so far as to cite the authors of Why Nations Fail: “According to Acemoglu and Robinson, the true origins [of power, prosperity, and poverty] are not geography, natural resources, or culture. Instead, they’re institutions like democracy, property rights, and the rule of law; inclusive ones bring prosperity, and extractive ones—ones that bend the economy and the rules of the game to the service of entrenched elite—bring poverty."
Recognizing such constraints on the realization of the benefits of technological innovation, how can prosperity by way of inclusiveness be ensured? Conversely, how can the bending of rules to favor the entrenched elite be prevented? In short, how can “technology’s original promise” be revived?
Regulation is clearly one of the options, but Lanier, for his part fears that regulation “might only strengthen the incumbents.” He also notes that “Facebook and Google are more likely to reform themselves, partly in their own self-interest and partly under pressure from their own ethically minded employees.” His insight as a technology insider is: “The one thing that will kill them totally is if the good engineers start leaving. Then the companies will die.”
Instead, a number of technology veterans, including Lanier, are trying to recapture the “decentralised innocence” of the internet by taking matters into their own hands. As Lanier notes, “I don’t see how any society can hope to survive unless there’s at least some degree of alignment between society’s interests and economic incentives.” He summarizes wryly, “I miss the future.”
For his part, Lanier “has been working with a group of radical economists to design an alternative information economy. He is an eloquent champion of the Data-as-Labour movement, arguing that if people do use social media then they should at least be paid for their posts and photographs. He hints that he is involved in backroom dialogues with the tech companies to bring about such a restructuring.”
Lanier isn’t the only one. The FT also reports [here] about a new effort called Openbook designed as an alternative to Facebook. Its creator, Joel Hernandez described that he wanted the product “to be ‘more joyful’ than Facebook, with more personalisation and new ways to encourage people to connect.” In regards to Facebook, he also criticized, "The whole business model is based on users not having privacy."
Still, such efforts can only accomplish so much without the active endorsement of consumers. Lanier argues that improvements across society have “only come about because of the activism of the discontented.” As a result, he views his criticisms as serving a higher purpose: “At every increment of improvement in human history somebody got pissed off and said, ‘This can be better, this must be better’. To be an optimist has to mean being a critic. The enemy of the future is not the pessimist but the complacent person.”
This perspective also shines a bright light on the role of governments as well as individual members of society. Harnessing the full power of innovation, whether it is in technology or credit derivatives or anywhere else, requires involvement. Brynjolfsson and McAfee made this point clear: "Faster technological progress may ultimately bring greater wealth and longer lifespans, but it also requires faster adjustments by both people and institutions."
Such involvement entails making choices. Interestingly, for as optimistic as Brynjolfsson and McAfee come across, their parting words are reflective and indeterminate: “In the second machine age, we need to think much more deeply about what it is we really want and what we value, both as individuals and as a society. Our generation has inherited more opportunities to transform the world than any other. That’s a cause for optimism, but only if we’re mindful of our choices. Technology is not destiny. We shape our destiny.”
Pulling all of these ideas together not only helps to handicap technological transformations, but also reveals a number of important implications for investors. For starters, technology is not destiny, even though many investors seem to think so. For example, the notion that the existence of great technology alone is sufficient to justify expectations of strong economic growth is a widely held belief.
While Brynjolfsson and McAfee clearly promote the potential of digital technologies, they also make it clear that the potential is contingent upon inclusive institutions. To date, much of the technology industry uses innovations, like the financial industry before, to "straddle national borders, regulatory silos and outdated laws". As such, technology is tilted to "servicing the entrenched elite" at the expense of broader economic growth for society as a whole.
Another common belief among investors is that if a technology is great, then a company that deploys it also great by association. This thinking has been fueled by tech leaders who encourage it by proclaiming (essentially), what Lloyd Blankfein of Goldman Sachs did (literally), that they are doing "God's work". The belief that technology companies are mainly just sharing all the wonderful benefits of technological innovations with the rest of the world has created a strongly positive narrative for Big Tech stocks.
This view gets things almost completely wrong, however. Primarily, it conflates the potential of underlying technologies with the intentions of for-profit companies. The harsher reality is that the greatest economic gains tend to accrue to those who extract wealth for themselves rather than serving the broader interests of society. The disproportionate success of Big Tech companies, therefore, serves as a better indication that the "original promise" of technology has been subverted than that it has been fulfilled. Not surprisingly, the old saying, "power corrupts", still holds.
Of course it doesn't have to be this way. The ways in which technological innovation get realized are largely a matter of values and of choice; we shape our destiny. So, what do we really want? If we want to realize the full promise of "new ways of acquiring knowledge" and "higher rates of innovation", we are going to have to get up to speed on the issues and agree to some solid ground rules that allow everyone to benefit (and to prevent centralization). This will take effort. Conversely, if we are unwilling to exert that effort, we will likely have to accept a technology industry that will follow strong economic incentives to extract wealth from society and to concentrate its power.
Governance is another crucial factor that affects the nature of technology uptake and one that investors can also monitor. Unfortunately the prognosis for improvement is poor. In many cases, regulators are "toothless" due to the compartmentalized structure of many governing authorities. Further, just as in the case of credit derivatives and financial innovation, many of the most important issues are "mind-numbingly dull". As a result, just as in the case of credit derivatives and financial innovation, the belief that "someone is in charge" is largely a myth.
The governance vacuum is taking on even greater importance as the competition for technology takes on global dimensions. As the FT reports [here], "China is pouring money into AI [artificial intelligence] research and pioneering its deployment in many areas" in an effort to "become the primary AI innovation superpower by 2030". As the FT also notes, such competition moves the tradeoffs of centralization vs. decentralization to the geopolitical stage: "The AI competition may be better viewed as part of a broader struggle between a decentralised democratic model and a digital authoritarian system."
So are technology companies breaking bad? That would probably be an overstatement, but it is very fair to say that many of the elements crucial to harness the full potential technological innovation are underrepresented in today's environment. Knowledge of technologies is insufficient, governance is slow and weak, and public engagement is low. This creates a weak position from which to wrest power from companies with strong economic incentives. This is important for investors. Unless things change, there is a good chance that not only will the great potential of technological innovation fail to be realized, but also that such innovations will continue to be exploited right up until things break.
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