Hwang and Horowitt’s The Rainforest

A couple of months ago I linked to a piece by Ronald Coase about the state of economics. Coase wrote:

Economics as currently presented in textbooks and taught in the classroom does not have much to do with business management, and still less with entrepreneurship. The degree to which economics is isolated from the ordinary business of life is extraordinary and unfortunate.

As readers of this blog would know, most of what I read and write is relatively isolated from ordinary business life. But reading a book such as Victor Hwang and Greg Horowitt’s The Rainforest: The Secret to Building the Next Silicon Valley shows that the topic of this blog can be relevant to the business world.

The world dealt with in The Rainforest is innovation ecosystems of the type that we see in Silicon Valley. Why is Silicon Valley such an innovative place, and why do most attempts to create new Silicon Valleys around the world usually end in failure?

To answer this, Hwang and Horowitt turn to a biological metaphor - the rainforest. In a “rainforest”, innovators are able to tinker and engage in trial and error to discover the most efficient ways of combining capital, talent and ideas. This provides for an evolutionary - not engineered - process, where new innovations can emerge.

Hwang and Horowitt argue that to understand a rainforest, we need to understand something of biology, psychology, neuroscience and sociology. Some of the background materials that I had read on the book, such as Victor Hwang’s blog at Forbes, pointed to E.O. Wilson’s recent forays into group selection. However, when you get into the book, it’s ideas from the Wilson of pre-2005 that dominate. And although not explicitly named, the fingerprints of the likes of Robert Trivers are also present.

Hwang and Horowitt described many elements of a successful rainforest, but the one that stood out for me was trust. When trust is high, transaction costs are low (Coase also plays a fairly prominent role) and people can easily enter into new engagements. Lawyers are not required to draft terms and the entrepreneur is willing to share their ideas without fear of them being stolen.

So why does this trust exist? In part, it is because there is a strong normative culture with punishment against defectors. Take a transaction between an entrepreneur and a venture capitalist. In a single transaction, there might be opportunity for the venture capitalist to take as much of a stake in the company as they can. However, with strong norms about what a fair agreement looks like and a willingness to punish those who push for unfair terms, that venture capitalist’s reputation will spread quickly and their one-off gain turns into a long-term loss. Trust is also supported by a strong culture of reciprocation (hence my reference to Trivers above).

While Wilson’s group selection gets mentioned, the rationale given by Hwang and Horowitt for the forming of cooperative groups is generally rooted in the strong individual advantages. They relate the example of people moving to the Western frontier in the early days of settlement in the United States. Despite a reputation as a period of rugged individualism, almost no-one embarked on the journey alone. The personal benefits to cooperation were vital. In the same way, to succeed in an innovative ecosystem, a person needs to be be connected to a broad variety of people. One of the primary ways of measuring the health of the rainforest is to look at those connections and the flows that occur along them.

The question that these types of explanations naturally draw out is how this culture exists in the first place. As Hwang and Horowitt point out, while people are naturally groupish, we distrust people dissimilar from ourselves and will generally act in our self interest. Places like Silicon Valley are particularly diverse, so we might expect them to be relatively atomised.

One reason is what they call extra-rational motivations. People are not purely self-interested in a money sense, but also seek adventure, interest, membership of groups and the like. Embarking on a start-up venture has pay-offs beyond the financial. They pick on neoclassical economists for ignoring these motivations, but I think this is more a case of ignorance in the models than ignorance that they exist. These motivations mean that people are willing to cooperate and enter into new ventures for the non-monetary benefits that they receive.

A second answer that they hint at is the self selection of the people in places such as Silicon Valley. I suspect this is where much of the answer lies, because apart from their wish to be entrepreneurs, one of the selected characteristics are high levels of intelligence, which is in turn correlated with trust (both trusting and trustworthiness). In a community where most people are trusting and trustworthy, and people are willing to punish the occasional defectors (even if that is by simply never dealing with them again), cooperation can be expected to be highly beneficial and will flourish. Hwang and Horowitt return to the self-selection issue at the end of the book when they suggest that the people now moving to Silicon Valley have different characteristics to those who create the innovative culture. They suggest that new arrivals who are more interested in employment than entrepreneurship may change the culture. I also wonder in what other characteristics they differ?

Hwang and Horowitt are regularly engaged to support the establishment of innovative ecosystems in various countries and parts of the world. An interesting experiment would be to run experimental games such as the prisoner’s dilemma and public goods game with the groups whom the authors work and see what the results are. Are the results of these games predictive of whether a vibrant innovative ecosystem will be established? Does the level of cooperation in these games increase in successful environments?

There are plenty of other interesting ideas in the book, although I’m still to be convinced about the degree of control we can have when trying to create these types of innovative ecosystems. I probably need to see it to believe it. Still, it is nice to see ideas that I often talk about abstractly, such as  reciprocation, altruism and trust, being used in some practical analysis.