The bubble this time

What is a bubble anyway? A positive feedback loop where the governor is on a time-delay. It's not necessarily a money thing. It's just that financial bubbles are easy to spot because price is easy to measure and a graph of the exponential positive feedback followed by the screeching halt (and ensuing positive feedback on the decline) of the governor kicking in is easy to read.

But I don't think we're in a financial bubble. Some prices seem pretty high, but nothing like the willing-suspension-of-disbelief levels I saw in 1999. The positive feedback loop is in the innovation industry.

Let me say, first, that I'm in favor of innovation. I believe long-run economic growth per capita is driven by innovation. I've dedicated my last fifteen years to trying to create or nurture innovative ideas, I'm part of this bubble.

But innovation is pretty constant. Look at this graph of US GDP per capita.

If the primary determinant of the slope is the level of innovation, then the level of innovation is remarkably constant over the time period shown*. This means that while those of us in the innovation industry are doing our jobs, grinding it out year after year, there's not much innovation in the innovation department. Also, it means that all the things we do to cheerlead innovation don't really have much of an effect. Innovation is a system we don't fully understand, one where we do not know how to change the level of output.

But over the past six months I have been inundated with talk of innovation. Incubators, summer programs, new venture funds, university initiatives, think-tank initiatives, government initiatives, innovation consultancies, etc. etc. The level of innovation stays the same, but the industry built around it is growing exponentially. As it will continue to, until reality kicks in; a classic bubble.

Again, don't get me wrong. I support this. In fact, despite the carnage that bubbles cause, I don't believe they're all bad. Here's a quote I've used before:

"Reckless, booming anarchy," in short, produced fundamental progress. It was not a stable system, racked as it was by bank failures and collapsed business ventures, outrageous speculation and defaulted loans. Yet it was also energetic and inventive, creating permanent economic growth that endured after the froth was blown away... Those who gambled on the future rise of the public lands in the West... were madmen only in the short-run business sense--only in thinking that future prospects could be realized all at once by means of an infinitely expansible credit system--and not in their basic sense of direction.

This is Greider describing the 1830's. Bubbles are the reckless booming anarchy that create permanent economic growth once the froth blows away. And, especially if you're an entrepreneur, more people trying to fund you, more people trying to give you below-market rent, more people trying to introduce you to more other people, more talented engineers willing to forgo big-company salaries for the chance to build something meaningful, it's all good.

But here's my worry. I've been investing in NYC tech startups for 15 years now. That means I've lived through 2002-2003 and 2007-2008. Those were hard times, times when a lot of people decided that starting tech companies was a bad idea, when people who had been gung-ho up and disappeared. Most of the people who started companies in the late 1990s stopped trying to start companies after the bubble burst: having learned a hard lesson, they decided not to put that valuable learning to use. The same positive feedback that creates exponential growth creates exponential decline.

I can't complain. My big breaks have come by being steadfast when others were fleeing. If I hadn't persisted in 2003, I wouldn't have the wherewithal to make investments today. In late 2007 and early 2008, I got the chance to invest in some amazing companies--even though I had no track record as an angel--because so few others were willing to write checks. But I'm just a born contrarian**. My worry is that when things smooth out, when people calm down a bit, this new build-up in the innovation industry suddenly disappears, leaving a whole new generation of entrepreneurs high and dry and with a distaste for the rhetoric of the venture capitalists and others who encouraged them to take a risk and do something meaningful.

There's no known way to recognize or gradually deflate a bubble. But this bubble, like all bubbles, is just froth around the constant innovation that occurs, bubble or not. It's possible to focus on the reality of the underlying innovation and not on the froth. Some VCs--USV, First Round Capital, Chris Dixon/Founder's Collective, Roger Ehrenberg/IA Ventures were the ones I ran into--continued investing in 2007-2008, when things looked grim. HackNY was running hackathons and NYC Seed was trying to support the NYC tech startup culture when others were backing away. There are many others who continued to build the ecosystem here then, and that gives me reason to believe they will continue to build it when the carpetbaggers have left.

I'm not saying that entrepreneurs should think about these things when raising money or that engineers should when looking for a job. But those of us who have the breathing room to make choices now, and who care about building a NYC tech ecosystem for the long run, should try to support the entities and people we think will be here whether it's rain or shine.

[Edit: I want to make sure this is clear: I'm not saying we should support people who were here, I'm saying we should support people who will be here. Having been here when it was hard is just a good indicator that they will be here when it's hard again, as it inevitably will be.]

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* For a longer run look at economic growth, which I think supports this thesis by showing that the level of innovation does change occasionally, read A Farewell to Alms.
** A loved one tells me that I am not a contrarian, I am just contrary.