The Other Decoupling Theory

Written by Bernard Lunn / February 24, 2009 1:10 PM / 17 Comments

A lifetime ago, before the market meltdown, when it was just an ordinary recession, there was a theory that the big emerging markets (BRIC: Brazil, Russia, India, China) were "decoupled" from the US economy. According to this theory, when America had problems due to subprime mortgages, these countries would only be affected marginally. Well, that theory has been totally discredited. It turns out that the other web, the web of financial transactions, makes the global economy tightly coupled. But it is possible, faintly possible, that there is another form of decoupling happening between the traditional economy and the innovation economy.

Loosely Coupled Is Better than Tightly Coupled

Software engineers know how nasty tightly coupled systems can be. When a bug hits a tightly coupled system, the web of interconnections ("tangle," "spaghetti code," "hairball" if we are being rude) creates cascading failures that lead to chaos and crashes.

Well, that just happened to the whole world, thanks to the web of financial transactions connecting bankers, hedge funds, and, well, just about everybody.

We just saw chaos theory in action. The classic chaos theory analogy, illustrating the complexity of the global weather system, is that of a butterfly flapping its wings in China and creating a hurricane in Florida. In this case, a bunch of people defaulted on their mortgages in Florida and created food riots in China.

So, it would be great if the global financial system was loosely coupled, if Lehman Brothers was a component neatly insulated from AIG. The government would let banks fail if they screw up, just as they let you and me fail if we screw up.

It would also be great if Iceland did not have to go bankrupt because a bunch of people in America could not pay their mortgages; or that British government officials did not have to wake up in a cold sweat at 3:00 am thinking about Reyjkjavik-on-the-Thames (i.e. that the UK, as another relatively small country with an over-active banking system, could go smash).

But we are all connected. The dream of the web came true and turned into a nightmare. Yes, we love the web, but bad stuff can travel down the same wires. Not all connections are good.

So let's hope that those geeky guys, Ben Bernanke and Tim Geithner, can do some major refactoring and create some clean interfaces. What do you reckon? Are they up to the job? Can those guys at Google lend a hand maybe? Some of that 20% time could come in handy here perhaps?

Actually, all they need to do is copy the architecture of the Internet, which was invented by DARPA all those years ago precisely to avoid a cascading failure from a Soviet nuclear attack hitting one location and thereby disabling the whole country. Despite phenomenal growth and what seems like a crazy, anarchic structure, the Internet has never seen a major systemic failure. Its problems have been temporary and isolated.

Simple refactoring, huh? Well, other than politics, power and money are also involved. A lot, in fact. So, it is not a simple case of refactoring, unfortunately.

Our best hope, then, is that there is another economy that is decoupled, one that works just fine and does not care a hoot if the General Motors, AIG, Citi behemoth all go smash. In fact, this other economy is just chomping at the bit to get its day in the sun as the behemoth crumbles.

I have been seeing some strange signs that this may be happening. I see these as straws in the wind. I see the straws, so the wind must be there, but I can't see the wind. I'd be very interested in hearing from people who see similar straws. I would also love to hear from those who assume I must be smoking something and are totally certain there is no wind.

September 2008: Weird Scenes Inside the Gold Mine

I went to the Web 2.0 Expo in New York City the week that the markets imploded and giant household-name firms evaporated in front of our eyes. These were "weird scenes inside the gold mine," as Jim Morrison sang and as I reported at the time for ReadWriteWeb. The disconnect was stunning. Maybe the Web 2.0 guys just did not know what was happening and what was about to hit them, too busy singing Kumbaya and bloviating about Facebook and Twitter? Perhaps. That was at least partly true.

But a few weeks later, in San Francisco for DreamForce, I saw real growth and optimism among the SaaS vendor crowd. I can usually tell when somebody is spinning the "We are fine" story as they go whistling past the graveyard. I did not get that sense. I saw companies that were growing in revenue and profits. Then I realized I was seeing the Barbarians bashing down the gates of Rome (the established enterprise vendors). Sure, it was doom and gloom in Rome, but the Barbarians were on a roll!

Message from the Singapore Shopkeepers

Straws in the wind matter, because the hard data, those official GDP and employment numbers, are out of date by the time we hear them. Using them to run your business is like driving with only a rear-view mirror: dangerous!

I learned this when my wife and I moved to Singapore in 1994. As we arrived, the newspapers were reporting strong GDP growth. When we saw rather empty shops and asked shopkeepers, "How's business," we heard in response, "It's bad". Guess which information source proved more accurate?

The same is true at the other end of a cycle, when all the official news is negative. If you wait till it turns positive, you'll have missed your opportunity.

Straws in the Wind Today

Joel on Software asks, "Is the tech recession over," based on strong sales in his own business. The comments are well worth reading.

At ReadWriteWeb, we like sounding the contrarian trumpet, sending warnings when it all looks great and reporting some good news when everybody is gloomy. Recently, we have been reporting on gritty entrepreneurs who are doing well, new jobs being created, and growth in Series A financing. We even reported -- shock, horror -- on profitable VC-backed ventures.

Fred Wilson relates a growth story at some of Union Square Ventures' portfolio companies. There is a FriendFeed Good News Community. The EmploymentCrossing site tracks daily and weekly job creation. On the day I looked:

New jobs this week: 212,755
Jobs added today: 6,943

The Bits of Destruction Theory

Fred Wilson describes eloquently why we might be seeing this decoupling. He calls it "bits of destruction." His conclusion is worth printing and pinning on your wall:

"This downturn will be marked in history as the time where many of the business models built in the industrial era finally collapsed as a result of being undermined by the information age. It's creative destruction at work. It's painful and many jobs will be lost permanently. But let's also remember that its inevitable and we can't fight it. Technology and information forces are unstoppable and they will reshape the world as we know it regardless of whether or not we want them to."

Coase's Theorem

The original decoupling story came with a theory. The theory was that the growth in BRIC economies was strong, and that a slowdown in exports created by a recession in the West would shave off a GDP point or two for a few quarters, and that would be it. That would have been true if the financial system had been built on a loosely coupled architecture similar to the Internet's.

What theory could explain a lot of tiny little start-ups being in good shape, while big companies in all markets and all countries are struggling?

This fundamental secular shift in power from large business to small business can be explained by Coase's Theorem (which won its author the Nobel prize in Economics in 1991). Here is the key bit:

"The theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights."

Yes, the Internet reduces those transaction costs. So, you don't need to be big to compete. You don't need vertical integration. This dramatically changes the Nature of the Firm.

Barbarian or Roman, Your Choice

If this all sounds like optimism run rampant, like rose-colored spectacles worn by entrepreneurs who have to be positive just to get out of bed, ask yourself which of these you would prefer to be running now:

GM/Ford/Chrysler or a tiny all-electric startup like ZennCars?
Citi/BankAm/Wells Fargo or a startup like Virgin Money, which is doing an end run around the whole banking system?
Oracle/SAP or 37 Signals, Zoho, Relenta? (Yes, this is a very short list of my current favorite SaaS providers; the full list is a lot longer).

One can make a similar case in virtually every market. In short, it is a better time to be a Barbarian than a Roman, better to be attacking than defending.

This is not the normal story in a downturn, when start-ups go smash and Big Co entrenches its position. Something seems to be fundamentally different this time.

Nah, Just Stock up on Canned Food and Guns?

In late 1999, I was doing some heavy-duty gardening, pulling up some roots, digging away energetically. A neighbor asked me what I was doing. I said, "Planting potatoes. Have you not heard? Y2K is coming, and there will be no food in the shops?" I was new in the area, so she did not know I was kidding. "OMG," she said, "You are in the computer business, so you really know this is true, right?". I cooled her down. It was ridiculous then, and it's ridiculous now. Rome survived; there were just different people in charge, and those Barbarians eventually became civilized and boring. This is just a transfer of wealth and power.

Report the Straws You Are Seeing

Take a break from the gloomy headlines and tell us what is happening in your market. Are you seeing any growth?

Photo by Joe Geranio.

Comments

Subscribe to comments for this post OR Subscribe to comments for all ReadWriteEnterprise posts

USA Grosbank IN KRIZE

von Raivo Pommer -Eesti

Die bisher in der Finanzkrise stets profitable US-Großbank J.P. Morgan Chase streicht ihre Dividende drastisch zusammen. Die Quartalsausschüttung werde um fast 90 Prozent auf lediglich noch 0,05 Dollar je Aktie gekürzt, teilte der Konzern mit.

Der Bank blieben so pro Jahr fünf Milliarden Dollar (4 Mrd Euro) mehr in der Kasse. Im laufenden ersten Quartal sieht sich J.P. Morgan weiter in der Gewinnzone. Die Reserven etwa für faule Kredite hätten allerdings nochmals aufgestockt werden müssen, hieß es am Montagabend (Ortszeit) nach US-Börsenschluss in New York. Mit ihren Zahlen sieht sich die Bank derzeit im Rahmen der Analystenerwartungen. Experten gehen bisher von einem Ergebnis je Aktie von 0,35 Dollar aus im Vergleich zu noch 0,68 Dollar ein Jahr zuvor.

Posted by: j.morgan | February 24, 2009 1:48 PM

A really good and timely article.

You are missing a point. How many jobs 37 Signals and Co. will be creating say 10 years from now? Probably in 100s? How many jobs have been created by Oracle/SAP in 10000s! So we do need those biga*s companies.

Sole reason of this economic recession is human greed. Lets not point fingers at Americans it applies to everyone (including YOU!)

Posted by: DJ | February 24, 2009 2:03 PM

While I like the overarching theme of this post, it does show that you have no idea about the concepts of tightly-coupled, chaos theory, and what it means to have a systemic failure. The good news is, it won't really take away from the points you're trying to make. So let's view this as a constructive exercise.

1) Tightly-coupled is about how far changes need to propagate. If something is loosely-coupled, it tends to be more resilient to change and therefore easier to maintain. Though if you change it enough, even loosely-coupled systems will be affected. However, tightly/loosely coupled has absolutely nothing to do with bugs. Independent systems, on the other hand, are resilient to failures of other systems (hence the name). For example, your left suspension is independent of your right suspension (assuming you don't have a fixed axis).

2) Chaos theory is about minute changes having a big impact. It's not a few people who defaulted on their loans in Florida that had an impact on the banking crisis... it's an entire nation of people! That's hardly chaos theory in action.

3) A systemic failure is exactly that, a system-wide failure. Even the Internet cannot survive a systemic failure. If all the routers go belly up, you have a problem. The reality of the crisis is that it is so widespread that it overpowered almost all financial institutions.

Those points aside, I like your post! :)

Posted by: Steve Bjorg | February 24, 2009 2:03 PM

Hey Bernard, really interesting ideas in here. I think you're on the money with a lot of it. There's about to be big changes happening with the economy, and I don't thing Washington can do that much to prevent it, but should instead just try to ease the transition. The mindset of continuous growth, producing more and more every year, is completely unsustainable. People's homes and garages are overflowing with junk. After a certain point, it doesn't make sense that so much of our lives are devoted to acquiring stuff. It also doesn't make sense that we have exported most of our manufacturing. We're on an unsustainable course.

What I'd like to see in the future is a return to producing and buying locally. Call me a portland hippy if you want, but I imagine a society where small, independent farmers can compete with the mega-farms (which probably means an end of subsidies for the corporate-farms), and where there is an appreciation for artisian, handcrafted goods. Add in some local green energy production in the form of rooftop solar, local wind farms, and the smart-grid. As you mentioned above, this return to functioning local economies would help ease other financial crises in the future.

It does seem like for a major transition to really happen though, these huge Washington backed corporations must be allowed to fail, which will mean a lot of pain in the short term. Many of the business are completely unsound, currently producing more than the market demands, and many of the banks owe more that there assets are worth.

What Washington has been doing is sorta like trying to hold back the flood waters. The potential for a shift has been building and growing, and the longer we try to hold it back with bailouts, the more severe it's going to feel when it finally hits. I support what Obama's trying to do with the stimulus and the bailouts, because if they just let go at this point and let the "Creative Destruction" of capitalism really do its thing, it's going to be really messy. But from wall-street to main-street, the market is deflating, and there's not much they can do to re-inflate the credit bubble at this point. Hold on, it's going to be a bumpy ride.

Posted by: Tony | February 24, 2009 2:10 PM

Decoupling and any other number of software engineering concepts are about reducing complexity so that a mere mortal can understand what is going on.

But economies are way more complex than software. The US economy alone has over 305Million autonomous agents interoperating in countless different ways. Many millions of those cross borders into other national economies.

North Korea is sufficiently decoupled from the world's economy that they are relatively unscathed. Which means about naught to your average starving peasant.

South Korea is more tightly coupled with the global economy. Your average South Korean farmer is suffering at the moment but incontestably enjoys a much better standard of living than their Northern Brethren. Wind the clock back 60-70 years and they started from the same point.

I don't think that the metaphor fits.

Posted by: Allen | February 24, 2009 6:20 PM

Hi Bernard,
Some very interesting observations here. The 'decoupling' from a loosely or tightly coupled system started with the internet. as the internet grew into everyone's life in western countries certain instituional businesses, brands and business models started showing early signs of collapse - some of which we are seeing everday ( Newspaper Bankruptcies for example ). Financial industry woes , some say, are due to too much of freedom , however I would say it is because of too little innovation in the right direction. The internet is giving us models like microloans and micro credits and creating brands like VirginMoney, and then you have the lehman's of the world focussing on overtly innovating and missing the fundamentals.
Putting it succintly it is a transfer of wealth and power , from one government to another , from one instituion to another or from a certain set of economies to another. ( If i may take the liberty of saying taking money out of the institutionalised systems into the internet is still a fair bit away but the process has started).
We hear rhetoric like never before : "fundamentally change..." , " the world is flat.." etc etc. Yet through all of this it has been forgotten that unless a business or a system or an insitution delivers true value to its customer it is primed for failure. The internet has delivered tangible and intangible value to every user on this planet and brands an instituions are being created within its systemic framework.

Yes I see growth , I see growth in new business models, in unfamiliar revenue channels , in new value creators. The reason why we dont hear about this yet is because the outdated majority of leadership is screaming for survival - we will start hearing these voices of growth when the outdated majority is silenced on life support !

Thank you for this post.

Posted by: Ashish Thomas | February 24, 2009 6:23 PM

The biggest trend that I'm seeing, is a move away from the large scale, high end shops (marketing, design, programming, apps) and people moving to smaller, less expensive, less recognized shops.
I think this is happening because people still need these services, they just can no longer afford to pay the outrageous costs of big brand creative services.

Posted by: Troy Peterson | February 24, 2009 9:03 PM

When the market is saturated, the price of goods in zero down to near zero. case in point
http://portland.craigslist.org/zip/

Posted by: jimbo mcscreed. | February 24, 2009 11:29 PM

Dinosaurs always get extinct as they are not longer adapted to their new environment.

Rich countries always get "extinct" as the service industry becomes more important than producing (Rome, Venice, UK, ...) simply because people choose the most convenient way to make money and live a life.

Prosperity always comes after destruction (war, crisis) of the assets as the demand for new goods and assets increases.

The problem is: you only know the moment or cause of the turning point long after.

When the rules of the game are known, the windows of opportunity have long been closed.

Posted by: Engago Team | February 25, 2009 12:39 AM

The characteristics you are observing in the economy are well explained by Complexity Theory, which surpassed Chaos Theory some years ago. Complexity Theory not only explains how everything is interconnected and interdependent, but also how living systems naturally emerge, evolve, and adapt to constant change in order to survive.

Viewing the global economy as a giant ecosystem is far more enlightening than using old industrial models which often include linear determinism.

You can learn a lot more by Googling Complexity, and also reading a basic introduction, "Complexity Made Simple," I wrote a few years ago after learning about this new view of reality, at http://www.lciweb.com/Complexity

P.S. ReadWriteWeb is the only email newsletter I read top to bottom daily, and I get a bunch of them. Keep up the great work!

Posted by: Buck Lawrimore | February 25, 2009 4:44 AM

Thanks to all who commented.

DJ # 2, yes the job creation from startups does not even make a dent in the job losses at mega firms. But they might over time. Not at a few big high profile VC backed firms. What is much more important is thousands of small firms making a few $ mill, way off the VC and media radar screen. And even more significant millions of free agents. The reduction in transaction friction enables that. In 1955, Fortune 500 firms accounted for 1/3 of US GDP; in 2000 that grew to 2/3. It is possible that mega trend is now in reverse.

And yes this is a global problem and not a US problem and all countries are looking to innovation and education as the way forward. I was told yesterday that in Egypt, the person in charge of ICT (Info Comms Tech) became Prime Minister ie like CTO becoming CEO.

Steve # 3, I could debate those points at length but I am more interested right now in the observation than the theory. If you look at how a mortgage becomes a CDO and how that is ensured as a CDS and then introduce a "bug" (a default in this case) you do see the cascading failure that leads to systemic failure.

For those interested in these kind of subjects, I will be tweeting from the Accel Symposium at Stanford University today.

Posted by: Bernard Lunn | February 25, 2009 6:17 AM

Great analogy - IMO, worth exploring - the crisis has illustrated the importance of a systemic view to business and economy and coupling is a systems architecture concept after all.

That said, my first thought on loosely coupling an economy came to labour - entrepreneurship, freelancing, outsourcing and global relocation being at ends of a full spectrum of options an innovation economy would need to support. And we must admit the issues here are way more complex than in software.

Keep up the great content.

Posted by: Eduardo | February 25, 2009 12:15 PM

Great analogy - IMO, worth exploring - the crisis has illustrated the importance of a systemic view to business and economy and coupling is a systems architecture concept after all.

That said, my first thought on loosely coupling an economy came to labour - entrepreneurship, freelancing, outsourcing and global relocation being at ends of a full spectrum of options an innovation economy would need to support. And we must admit the issues here are way more complex than in software.

Posted by: Eduardo | February 25, 2009 12:20 PM

Bernard: If you're interested in the "Refactoring" of our economic system, watch the second half of this video (interview with David Korten, author of “Agenda for a New Economy: From Phantom Wealth to Real Wealth”):

http://www.democracynow.org/2009/1/26/david_korten_agenda_for_a_new

Posted by: Tony | February 25, 2009 5:39 PM

Chaos is one of “Physics Foibles”. Recognizing the physics foibles has led to greater understanding.

Posted by: Melvin Goldstein | March 8, 2009 8:49 AM

This economic contraction we're likely to face could result in a lot of opportunity to repatriate production.
As the concept of Thrift continues to work its way into mainstream thinking regional production should see a strong uptick.The trick will be in supply chain development and appropriate financing methods, some form of discount on flow system I suspect.

Your analogies were fine, I read it and got the point.

Oh, and yes, I sense the earth is shifting economically speaking.

Posted by: Graham | March 15, 2009 3:09 PM