I was triggered by a techno-optimist...

Tiger Gao ‘21

Tiger Gao ‘21

Today’s email documents the “text fight” I had with my friend Theodor Marcu two nights ago. Theodor and I have quite contrasting thoughts about Silicon Valley (SV) and the necessary solutions to problems confronting our society: 

  • Theodor is a “techno-optimist” who believes that we need more tech thinking, more optimism about the future and how we can better our lives with technology, and that it’s pessimism and fake credentialism that are hurting us in the long term.

  • I, on the other hand, am much more skeptical as I see most of the innovations coming out of SV as either largely inconsequential to the lives of most Americans or detrimental to our social fabric. 

You may get a glimpse of our contrasting viewpoints in the debate presented below, which we thought would be interesting to share with you to hopefully spark some more discussion. Please feel free to let us know your thoughts – we’d be happy to explain our thinking in greater detail.

Fewer funds, more money

Our fight was triggered by this tweet:

Theodor Marcu ‘20

Theodor Marcu ‘20

The tweet shows a very simple trend: more money is going to a smaller number of VC funds. Meanwhile, more funds are losing money, and only a smaller number of funds actually generate positive returns (“alpha”). 

Theodor believes that this trend leads to two developments:

Because of the overabundance of capital, more funding can flow towards meaningful innovations (like the next SpaceX). In a tight capital market, traditional SaaS companies with clear metrics and revenue growth trajectories tend to be more attractive, whereas in a market with more cheap capital flowing around, companies that otherwise would be considered too risky will finally get the funding they need. For example, Elon Musk had to invest a lot of his own money during the 2000s to make it happen for SpaceX. This wouldn’t be the problem anymore if we had more money flowing around, and that would be amazing;

Inflation gradient that leads to a valuation bubble for tech companies (public and private) that will eventually burst. This is a less developed idea and I’m sure there’s some nice economics behind it, but my suspicion is that quantitative easing/MMT (Modern Monetary Theory) have simply created a world where every additional dollar is worth less, especially for big funds that tend to play the role of LPs to VC funds (so at the scale of hundreds of millions, not for your average millionaire). As a result of that, today’s frothy capital markets are temporary and they will eventually lead to a bubble that will burst. This is not to say that bubbles are not good. There’s actually been some interesting analysis on how bubbles can lead to more innovation specifically because they allocate resources to players that otherwise would not get them, but that also means the growth becomes unsustainable eventually.

Should government be the allocator of capital? 

I texted back that “I don’t see how any of this is good.” Sure, the next SpaceX will get funded, but at what cost? If it’s at the cost of billions of dollars wasted on phony “tech innovations” (we seriously don’t need another calendar app that says it’s gonna “change the world” – seriously that’s your big idea?!), then I’d say it’d be a big failure for society overall. Had we invested these money into public education, green infrastructure, or public projects that are outside of the tech bubble, America would be in a much better place today. 

Theodor vehemently disagreed:

The government turns out to be a pretty bad capital allocator. Just look at the San Francisco local government. They doubled their budget in 10 years, and more people are suffering than 10 years ago in homeless camps. Same with innovation. The process for seeking government grants is often convoluted and distracts people from working on truly innovative projects.

And last time I checked the government also bankrolled the funding for the US education and health systems which have the distinction of being both expensive and pretty bad for most people.

This is not to say that governments can’t be efficient in some areas, particularly if they have state capacity, but so far they have not demonstrated they can allocate capital effectively in the areas you mentioned above.

Investors are still being rewarded for horrible investments 

Theodor’s argument about the government being a bad allocator of capital has been made again and again, with one side claiming that “market is the solution.” This is true in many regards, but the issue at hand is a different one – namely I worry that too much private capital is going into VC & PE that inflate certain asset classes and “innovations” that do little to benefit the average Americans.

Sure, the government shouldn’t always be the arbiter of winners and losers, but we live in a weird age today where investors are not being properly punished for making horrible decisions. 

We know that a handful of big funds get more money from investors (as the tweet above shows), while most funds lose money. However, don’t forget that the finance professionals working in those money-losing funds would still get their 2% management fees. Most of them will probably still get to raise new funds even after not doing so well, since capital is just over-abundant and people are always throwing money at you when there are no other investment options today given the low interest rates. So, bad investors still make money.

And the entrepreneurs of failed startups often still become millionaires anyways with their high salaries and thanks to their arbitrarily scheduled rounds of dividend payouts and equity sales as long as the startup survives long enough. In today’s highly developed capital markets, a startup doesn’t need to be acquired or get listed through an IPO in order for its founders to do well for themselves. PE and VC funds sell stakes to each other all the time, bidding up the valuation round after round without needing the startup to be profitable or create actual value for society.

So, this entire class of people (financiers & entrepreneurs) playing the game of Silicon Valley innovations are doing just fine, even though most of their innovations don’t turn out to be anything. 

So yes, I would hope that the free market can pick the best innovations; but what we’ve seen is that bad investments don’t get properly punished, and the greater society is shouldering the expense for the tech elites to pursue their fanciful and dreamy ideals.

The opportunity cost of the Silicon Valley party

I agree with Theodor that certain bubbles can lead to innovations as long as the bubble is funding the real economy (rather than financial instruments), and this idea was advocated by our previous podcast guest and lengendary tech investor Bill Janeway.

However, my issue with tech bubbles is their opportunity cost – how much resources is a society willing to waste in order to produce a handful of great companies? 

We now live in an age of great paradox: where an unprecedented level of capital is flowing into VC/PE that’s supposed to “spur growth and innovation,” but we’re also at an unprecedented level of market concentration where all the innovations are mostly coming out of Fortune 500 companies and tech giants, and these large corporations are more powerful than ever. Together, we’re also at an unprecedented level of inequality and overall economic stagnation where the bottom 90% of Americans have taken declining shares of the nation’s income since 1973 according to economists Thomas Piketty and Emmanuel Saez, meaning that Silicon Valley has done very little for them.

So I think it’s a very simple story: most of the money going into VC, PE, and finance at large are just chasing money and fueling the growth of money, making the economy more anti-competitive. Most importantly, they take away a huge amount of public resources that could’ve otherwise be dedicated to investments that should likely generate a higher or similar level of return for the overall public well-being, but because that would lower the returns for those working in tech and finance, they’ve opted to largely maintain the status quo and dedicate these funding to areas most beneficial to themselves. What is needed, therefore, is strong government intervention – antitrust against tech giants, smarter regulations, and redirecting our resources in public finance.

The repeated failures of government intervention

Theodor disagreed again and explained why my view on innovations is too pessimistic and skewed:

I think that your solution is worse than the status quo! Private investors, unlike governments, are much faster to fail when they turn out to be bad capital allocators. This means that capital allocation is more efficient on a macro-level, even if in the short term the capital allocation may not be optimal.

If anything, we get stagnation because of governments adding additional regulations that make it prohibitively expensive to innovate in the real world. Let’s not forget that climate change would not even be a problem if the cost of getting a nuclear reactor design certified wasn’t so high that nobody is doing it (most nuclear reactors are based on technology designed with slide rules in the 60s because of that).

Similarly, we have a lot of things we could be working on (drugs, treatments, health tech) that are unattractive because commercializing them is a long and tedious process. The clearest example is the Moderna COVID vaccine - the company made it in 2 days in March but it took the government 9 months to approve it and start distributing it.

I also think that your perspective on market concentration is flawed. Google/Facebook/etc. are in a much weaker position than they seem. Unless they continue to be managed well, they will become irrelevant like other big companies that seemed to have a monopoly position before them (look at Sun Microsystems, Xerox, IBM, and Microsoft’s decline before current CEO Satya Nadella’s tenure as a few notable examples).

Your argument about innovation is interesting. While big companies are good at producing exciting lab results, monetizing those results is much harder. For all it’s worth, Google has been unable to create a serious standalone product (in terms of revenue) out of all the X lab creations it had in 20 years. The discoveries themselves are important and exciting and sometimes contribute to solving problems for Google (like Bell Labs’ back in the day or Xerox Parc), but it’s unlikely Google will also be able to monetize them effectively. Instead, it’s most likely that companies like Nuro (with founders who left Google’s self-driving car team) are going to dominate the new areas, echoing what happened in the 50s and 60s when Fairchild and eventually Intel were founded by people who left traditional East Coast tech companies. There are very few big companies that have survived time.

I also find that the whole conversation about “historic levels of inequality” is a bit overblown, although I do think that it’s worth looking into the general issues around stagnation since the 1970s. My main issue is that we tend to compare inequality in 1900 with inequality now which doesn’t make any sense. For what it’s worth, Bill Gates eats the same food and uses the same tech as your average American. It’s true that not everyone has access to the best healthcare and education, but most people finish high school and they won’t die before the age of two because of some random illness as a result of advancements made in the last 100 years. This is not to say we shouldn’t strive to do better, but the solution is restarting our innovation engine rather than trying to make it harder for people to build companies independently.

Last but not least, I would argue that the impact of a handful of successful / life-changing tech companies can often have disproportionate effects on society and economy. It was companies like Ford that transformed cars from novelties into a literal source of growth for the economy. The government certainly played a role too with the interstate system, but at the end of the day the government simply reaped the benefits of a handful of entrepreneurs.

I think Silicon Valley working on frivolous apps is a trope that can’t go out of fashion too soon. For every frivolous app there are entrepreneurs and investors working on groundbreaking companies that you never hear about. We could see more of those if the government didn’t make it so hard to innovate in the real world!

I also have to point out that most people who raise money end up forfeiting really good salaries with nothing to show for. Your text makes it sounds like anyone who raises some money from a VC ends up doing well, but the unfortunate reality is that being “acquired” is a happy but rare scenario for most founders. Fund managers do better, but that’s in many ways a symptom linked to the abundance of capital.

What do you think?

The arguments on both sides are legitimate and compelling, and there’s still a lot to be said on the topic. What do you think? What are the right tradeoffs to make when it comes to economic stagnation and innovation? We’ll continue the discussion moving forward, and we’d love to hear your thoughts!

Tiger GaoComment