Archive for the ‘Economics’ Category

Patent Wars

Posted: August 20, 2012 in Economics, Game Theory

The idea of patents made a lot of sense when technological advance was true innovation where blood sweat and tears were poured into the research and development of a new product but these days we’ve got people trying to enforce stuff like “look and feel” as a patent.  The patent wars that we’re currently witnessing between the mobile device firms seems to be a massive waste of money that will only lead to the mutual destruction of all involved.  You would think that the mobile device firms would have realised by now that so long as they are all making money and innovating to ensure future revenue that there is no long term benefit to the extensive legal actions that is probably costing 100s of million in legal fees and damaging the market for all participants. However what will evidently be a very irrational long term impact is essentially fuelled by the very rational short term strategy that creates an escalating hostile environment.

This is actually a perfect example of the “dollar auction” where it is posed that 2 players may bid in whole cents for a single dollar, the winner gets the dollar for their bid, and the loser gets nothing and still needs to pay their bid. It is logical to maximise profit and bid a single cent for that dollar to make 99 cents profit, the second player seeing an opportunity to make 98 cents bids 2 cents and this goes on until the bid is 99 cents where it is then more preferable to bid a dollar and make nothing than lose 98 cents. This then escalates into increasing irrational bids above the single dollar as it is preferable to lose 1 cents as compared to 99 cents and so on.

This game is actually infinite, except in the real world there is a limitation of resources where the first player to run out of resources to bid will essentially lose. While the other player can bask in the light of their victory it should be noted that while they beat their opponent, it came at a massive cost to themselves as well. The patent wars will most likely play out in a mutually assured destruction of the players involved but on the bright side maybe a patent war will teach the world about the follies of actual war… or maybe it won’t.

A friend recently approached me about share trading (technical trading combined with macro fundamental) as he knew that I have said some incredible insightful things in the past about market movements. He proceeded to ask me how much money I play with on the stock markets and too his surprise I said “Zero”.

He questioned me further as too why I read up and look into these things when I don’t invest, where I simply responded that finance and economics is an interest for me in the same way that other people are interested in sports, and while some people like to put some money down on their interests, gambling isn’t for everyone. Now he was even more confused and said to me that investing isn’t like sports, and went to say that sports is gambling because the outcome is random while the movements of share prices can be predicted.

I gave him credit and said that everything in life can be predicted if you had enough information and the computational power to process that information but for all extensive purposes both are gambling, where share trading is essentially gambling on rationality. Share trading is a game where the decisions of all collective players contribute to form the share price and any purchase of shares on the basis that the price will increase or decrease is reliant on a few key rationalisations;

  1. the share price is undervalued or overvalued, and that this is a rational conclusion
  2. all knowledge required to come to this rational conclusion is common knowledge
  3. all other players think exactly as you do and have come to the same rational conclusion
  4. you are able to come to and act upon such a conclusion faster than all other players

Ignoring the problems 4. creates and assume that you are able to act faster than others; the interesting issue is that 2. and 3. are not a given in reality where if you conclude that a share is undervalued while the majority of other players believe it is overvalued you will lose. Essentially it doesn’t matter what you conclude, you will only win if you can predict what the majority of players will conclude and act accordingly. Since 2. and 3. do not hold in reality, a winning formula relies on having superior knowledge and a firm understanding of how other people rationalise information. In essence, short-term investment is nothing more than a gamble on the rationality of others.

Final Remarks

The common form of this game is known as the Keynesian beauty contest and requires a successful player to be able to discard their preferences and act on the preference of other players. This of course doesn’t count for long term fundamental trading which is about long term performance of the company as opposed to gambling against the rationality of all other players.

I am a little tired of seeing all the media hate around executive pay cheques and I find it insulting that the same media outlets that write “no one is worth that much” will have a whole section celebrating their favourite sporting stars and singers who earn just as much in their early 20s.

Executives earn what they earn for the same simple reason that sporting stars and singers do, that is they are “special” and have unique and superior skills and abilities; the only difference is that executive gained their skills through decades of blood, sweat and tears. The general public rationalise that sporting stars and singers are simply naturally talented and that they themselves would not be able to emulate their performance regardless of how hard they worked at it, so when their favourite sporting stars and singers are reported to earn millions of dollars a year the public don’t think twice about it. However, when the public rationalises that they could do what an executive does and that while that they may not have the skills, knowledge or ability to do the job today, that they could have those things if they chose to. The reality of course is that the vast majority of the public do not chose to put in such decades of sacrifice, and even out of those that do, only a few make it to the top and regardless of this fact they are willing to crucify those who would put in such effort and call foul and inequity. 

Tall poppy syndrome

So why do people suffer from this form of selective tall poppy syndrome?

I would postulate that it is largely tied to the psychology around the perceived rules of the game, where the following beliefs exist because most people are not striving to obtain fame, wealth and power through sporting or musical performance but they are striving for those things working for corporations, and as such they see success in the sporting and music industry as mutually exclusive while empathising with anti-executive sentiments, especially when executives continue to do well and their fellow hard working peers continue to seemingly struggle. 

For someone not in the sporting or musical fields the following would hold true;

  1. The success of naturally talented individuals in sports and music does not diminish their ability to be successful
  2. The success of those in the business world does diminish their ability to be successful, as success if perceived to be a zero-sum game

Final Remarks

The reality would be that executives only seemingly do well in good and bad times because there needs to be leadership in corporations regardless of economic conditions. To penalise corporate leadership under a crab mentality in bad economic conditions would only undermine the efficiency of the economy further. I would say education is the answer but unfortunately tall poppy syndrome and crab mentality is something that will always exist. Even if educated there will always be people that are willing to drag other’s down at a cost to themselves but I’ll leave that topic for another time.