“Protocols” and Wealth Creation

Here’s David Brooks, writing in The New York Times:

In the 19th and 20th centuries we made stuff: corn and steel and trucks. Now, we make protocols: sets of instructions. A software program is a protocol for organizing information. A new drug is a protocol for organizing chemicals. Wal-Mart produces protocols for moving and marketing consumer goods. Even when you are buying a car, you are mostly paying for the knowledge embedded in its design, not the metal and glass. (via Isegoria)

Read the whole thing. The argument that Brooks is making here is very similar to the argument made by Rich Karlgaard of Forbes, which I critiqued in my post myths of the knowledge society.

In summary: The 19th and 20th centuries were also “knowledge economies” (in Karlgaard’s formulation) or “protocol economies” (in the Brooksian terminology). The value of a Boulton & Watt steam engine was not in the “stuff” it was made out of (which could be purchased for a far lower amount than you would pay for the steam engine itself) but rather for the design knowledge contributed by James Watt and the manufacturing process knowledge (protocol knowledge) contributed by Matthew Boulton..and for innumerable additions to that knowledge base by their employees. To take a more recent example, the early 20th century assembly line as implemented by Henry Ford, and the kinds of precise work planning and industrial engineering developed by Taylor and the Gilbreths, certainly represent “protocols” just as much as do Wal-Mart’s supply-chain management procedures.

One could argue that a “protocol” in the form of pure software has no variable cost, unlike a physical product. But in reality, the software is only usable when it is incarnated into a physical device such as a computer. And many of the highest-value forms of software are in fact sold only as an embedded part of a physical device: iPhones, aircraft autopilots, and CNC machine tools, for example. And Wal-Mart obtains financial value from its supply-chain management expertise only when the results of that expertise are sold in the form of “stuff.”

Brooks is correct about the importance of intellectual property protection: however, this is not new. For example–would the General Electric Company (founded in 1890) have been able to thrive for more than a century without strong patent protection? Indeed, the original foundation of the company was the Edison patents.

(Although much “protocol” knowledge is in fact not patent-protected and indeed often not patent-protectable, but rather is embedded in a corporate culture–the Toyota Production System being the most prominent example.)

There’s some truth in what Brooks/Karlgaard are saying, but it’s overstated, and the belief that changes in society are more discontinuous than they actually are is dangerous from a policy standpoint…and from an investment standpoint. (Remember all the “it’s different this time” arguments made during the dot-com boom?) For the last 15 years or so, theories about the discontinuous nature of the modern “knowledge society” have been used to support a deemphasis of–and even a disrespect for–American manufacturing, whether this was the intention of their proponents or not.

For those interested in this subject, here’s a link to my earlier post.

Again I quote Andrew Carnegie, speaking in 1892:

Let flood or fire destroy my plant from the face of the earth, but if I retain my organization, I would be whole again in six months.

The “six months” was surely optimistic. But Mr Carnegie clearly understood that the basis of his business was not the physical assets–as important as these were–but the aggregate knowledge embodied in his organization.

14 thoughts on ““Protocols” and Wealth Creation”

  1. This is a very good point.

    I’m as tired of hearing about the “new” economy (every ten years or so) as I am of being told that spending lots of tax dollars to attract the ‘creative class’ will magically overcome high taxes, bureaucratic red tape and a generally lousy business environment.

  2. It is the excuse they are using to drive all of the “dirty” jobs to China and India. It is also diagnostic of our mandarinate, what they do is important, what the hewers of wood and drawers of water do is unimportant.

  3. It’s entirely logical that they would look down on the American worker. They’ve been trying to replace us for decades with workers from every corner of the globe or send our work over to them. Just once I’d like to see some ivory tower job threated by H1B or L1 visas. I bet if we’d start importing Mexican psychologists to plunder all the illegals (or the treasury) we’d finally see some understanding of what they’ve been doing to the rest of us at all levels. OR…why not Indian trained lawyers? We just need answers right? The bit stream can come from anywhere.

  4. The most important “protocols” are the ones that nudge “stationary bandits” — that is, politicians — toward the least destructive means of collecting economic rents — or getting their cut.

  5. A software program is a protocol for organizing information.

    Spoken like a man who has never written a line of code.

  6. The Watt steam engine needed two additional “protocols.”

    It needed a ready market supply of coal (or wood) which England had at the time. Coal could be mined in bluffs by or near the river so could be transported cheaply to users by river. At time, only water transport was energy-efficient enough for bulk coal at a distance.

    It also needed demand. Of course, the first demand were coal pits themselves, to aid in dewatering. But the real take-off was the textile producers. Some machine spinning and weaving had been developed based on water power but the coal-fired steam engine allowed industrial processes to be located with much more efficiency. The application of steam to water and land transport multiplied the whole system.

    As to GE, note that it made a BIG move into finance under Jack Welch. By 2000, over half their earnings came from financing activities. That’s coming back to bite them. Their current liabilities of more than $500 billion vastly exceeds their liquid assets. Look for them to lose their AAA rating which might cause their house of cards to collapse.

    Today, GE has retreated from earning money the old fashisioned way by making stuff people want to buy and has turn to rather naked rent seeking.

    Look for GE to go the way of GM.

    The discontinuities that so many business writers extolled was not about how business worked but how the US economy was changing as a result of no longer wanting to compete.

  7. GE has issues, but I don’t think it will go the way of GM. While Welch put too much emphasis on financial services, there is plenty of other stuff in the company. You can be sure that circa 2000, there were a lot of analysts and others who thought it was really dumb of the company to retain “old line” businesses like locomotive manufacturing…fortunately, at least some of this trendiness was ignored.

    I also think the media business was a poor fit for GE, and has been allowed way too much rope…glad to see it going away.

    (disclosure: GE shareholder)

  8. The developing countries are recapitulating the path we followed in the industrial era’s opening period, as they move from agricultural to manufacturing work for an increasing fraction of their populations. It is unrealistic to demand that all the traditional job opportunities remain unchanged in this country, when the workforce which would perform this work would never consent to the basic level of pay and working conditions experienced by earlier generations , and now acceptable to the new “proletariat” in places like China or India.

    One of the challenging and sometimes painful aspects of creative destruction in an innovative economic system is that the traditional stabilities of learning a job and then doing that for life, and for several generations, don’t exist. Development, innovation, new processes, revamped procedures are all constant and demanding. Continuous education and lifelong learning are now demanded of most employees, even highly skilled highly paid professionals at the top of the pay scales.

    Indeed, doctors, engineers, pharmacists, and any number of other skilled professionals would be utterly outmoded and unemployable if they were plucked from their workplace in 1900 and placed in a comparable position in 2010. While I understand the difficulties faced by blue collar workers compared to their parents and grandparents, the idea that, somehow, the same job opportunities could be preserved indefinitely is just as unrealistic as believing someone could still make a living as a dentist with the knowledge and equipment of a century ago.

    One of the virtues of capitalism is that it demands increasingly more complex intellectual achievements in order to remain at the forefront of any type of work, even traditionally blue collar jobs, because the relentless incentive to discover more productive and efficient techniques and procedures, and therefore create more return for investment, never lets up.

    To condemn such a system for demanding constantly improving intellectual achievements is to contend that it is better for some people just to mark time and stay put, instead of the possibility that they might exert the effort necessary to improve themselves and their families’ fortunes.

    As I have said on many other occasions, the problem with our society’s ability to maintain itself and advance economically is directly related to the very poor performance of our educational system. Our current school system fails to adequately educate our youth, and, what’s worse, breeds actual contempt for learning by its pathetic pc/multi-culti attitude that demanding accomplishment from all students is somehow wrong, so we demand little or nothing from anyone.

    It is a disgrace that the first two years of most college programs are now remedial courses for all the skills that were not learned in high school, and most businesses must spend a great deal of time and money training employees to perform routine tasks that they should have mastered the skills for while in school.

    One of the reasons we are struggling in some critical economic areas is the unfortunate fact that so many members of our workforce are functionally uneducated. The responsibility for this sad state of affairs rests squarely on the heads of the “educated class” that Brooks finds so attractive. The “treason of the clerks” has exacted a steep, and increasingly dangerous, price.

  9. The “educated elite” has done pretty well under Obama so somebody knew what they were getting.

    This presidency represents not a traditional ideology but a new politics that mirrors the rise of a new, and potentially hegemonic class, one for which Obama is a near-perfect representative.

    Every president and political movement, of course, brings to power an often-hoary group of grasping interest groups. Under the conservatives and George W. Bush, the favored classes included standbys like the fossil-fuel energy companies, Big Agriculture, suburban homebuilders, and the defense industry.

    Rather than the “good old boys,” Obama’s core group hails from what may be best described as the “creative class” – the cognitive elite, or, to borrow from Daniel Bell’s The Coming of Postindustrial Society, the “hierophants of the new society.” They come not from traditional productive industry, but the self-conscious “knowledge” sectors – such as financial services, the software industry, and academia.

    From early on, Barack Obama attracted big-money people like George Soros, Warren Buffett, and JP Morgan’s Jamie Dimon far more effectively than his opponents in either party. As The New York Times’ Andrew Sorkin put it back in April, “Mr. Obama might be struggling with the blue-collar vote in Pennsylvania, but he has nailed the hedge-fund vote.”

    Other bastions of support could be found in Silicon Valley, where Google Chairman Eric Schmidt and venture capitalist John Doerr were all early backers. Obama, the former law school professor, also did exceedingly well with academics, and many of his pivotal wins in the Midwest rested heavily on both votes and volunteers from college constituencies.

    Finally Obama gained the early support of public-sector unions, now arguably the dominant power within the Democratic Party. Together, these groups now enjoy the lion’s share of influence inside the administration.

    Soros has commented that he has had a “very good crisis so far.”

    It is no mistake that those sectors have been the recipients of much of the “stimulus” money.

    I keep thinking of the origins of the French Revolution when I read about the Obama folks.

  10. “The value of a Boulton & Watt steam engine was not in the “stuff” it was made out of (which could be purchased for a far lower amount than you would pay for the steam engine itself) but rather for the design knowledge contributed by James Watt”

    This is a pre-modern understanding of economics. It is very close to Ayn Rand’s belief, the complement of Marx’s, and entirely seperate from marginal economics.

    The value of the steam engine comes from the intersection of supply and demand of the goods that can be produced with it, after you account the opportunity cost of the steam engine, adjusted for your discount rate.

    It is fashionable to criticize Tom Friedman, but his idea that the degree of a knoweldge economy can be measured by dividing the weight of a country’s GNP with the economic value of its GNP strikes me as a good first approximation.

  11. Tdaxp…so do you think if business #1 is in possession of patent or trade-secret protectible knowledge required to make its product, and business #2 makes a product with no such “moat”, then (all other things being equal) the return on invested capital of the two businesses will be equal?

  12. Tdaxp…so do you think if business #1 is in possession of patent or trade-secret protectible knowledge required to make its product, and business #2 makes a product with no such “moat”, then (all other things being equal) the return on invested capital of the two businesses will be equal?

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