In Defence of Innovation Bubbles

Most economists see bubbles as market failures - irrational exuberance that misallocates resources and destroys value. William Janeway, the renowned venture capitalist and economic historian, sees something different: a powerful force for technological progress¹.

Here's the challenge that every research institute faces: the most important breakthroughs often look economically irrational at first. The transistor, recombinant DNA, quantum computing - none of these would have passed a traditional cost-benefit analysis in their early stages².

But somehow, they happened anyway. Why?

Economic historian Carlota Perez distinguishes between two fundamentally different types of bubbles³:

Mean-reversion bubbles

Where investors bet that current trends will continue indefinitely. Think housing bubbles or crypto speculation. These typically end in crashes that destroy value.

Installation bubbles

Where collective excitement about a fundamentally different future concentrates resources on otherwise "irrational" pursuits. These can actually accelerate progress.

The difference matters enormously.

While the 2008 financial crisis destroyed trillions in value, the 1990s tech bubble - despite its excesses - left behind the infrastructure and talent pool that built our modern digital economy⁴.

Perez's analysis of these "double bubbles" at technological turning points reveals how periods of intense speculation, despite their excesses, can play a crucial role in installing new technological infrastructure⁵.

Productive bubbles solve what economists call the "appropriability problem" in research⁶. When pursuing fundamental breakthroughs:

• The costs are immediate and concentrated
• The benefits are distant and dispersed
• Traditional ROI calculations break down
• Market mechanisms alone won't fund enough research

Bubbles of collective excitement can override these rational constraints. Consider three historical examples:

1. The Transistor Revolution

When Bell Labs began pursuing solid-state electronics in the 1940s, vacuum tubes were cheaper and more reliable. The research looked economically irrational. But wartime funding and postwar industrial optimism created a bubble of excitement that concentrated enough talent and resources to make transistors viable⁷.

2. The Biotech Wave

The early days of genetic engineering faced enormous technical uncertainty. But waves of excitement in the 1980s and 1990s funded hundreds of companies and experiments. Many failed, but the survivors transformed medicine⁸.

3. The Computer Revolution

The development of early computers required massive investment with unclear returns. But as documented by Nathan Rosenberg, the concentration of resources during this period created lasting technological capabilities⁹.

The most powerful example might be Bell Labs itself. As Jon Gertner documents in "The Idea Factory"¹⁰, Bell Labs didn't just create innovations - it created an environment that made innovation more likely by:

• Combining pure and applied research
• Enabling constant informal collaboration
• Making long-term thinking possible
• Creating excitement about future possibilities

It became what venture capitalist Marc Andreessen calls a "bubble machine"¹¹ - an environment that spawns productive bubbles across multiple fields.

For research institutes, this suggests a counterintuitive approach to innovation:

1. Cultivate Productive Excitement

• Share compelling visions of possibility
• Make progress visible and exciting
• Create spaces where ideas can collide
• Connect theory to practical impact

2. Enable Parallel Exploration

• Fund multiple competing approaches
• Make it easy to start experiments
• Reduce the cost of failure
• Celebrate learning from setbacks

3. Build on Solid Foundations

• Ground excitement in real science
• Keep individual experiments small
• Focus resources on fundamental value
• Maintain rigorous standards

The productive role of bubbles isn't just theory. Research supports it:

• Studies of innovation clusters show how concentrated excitement accelerates progress¹²
• Analysis of patent data reveals how bubbles drive parallel experimentation¹³
• Economic history demonstrates how productive bubbles leave behind useful infrastructure¹⁴

The best innovation combines:

• Rigorous science
• Engineering excellence
• Collective excitement

Your job isn't to avoid bubbles. It's to create and channel productive ones. To build environments where excitement about the future becomes a force that helps bring that future about.

Because sometimes the most rational approach to innovation is enabling productive "irrationality."

For research institutes, this means asking new questions:

Map Your Bubble Potential

• Which areas have "irrational" excitement?
• Where could resources concentrate?
• What infrastructure might persist?

Design Your Machine

• How could you enable parallel experiments?
• What feedback loops could you create?
• Which collaborations matter most?

Start Small But Think Big

• What tiny experiments could work?
• How will you show progress?
• What future could excite people?

References:

¹ Janeway, W. H. (2012). "Doing Capitalism in the Innovation Economy: Markets, Speculation and the State." Cambridge University Press.

² Arrow, K. (1962). "Economic Welfare and the Allocation of Resources for Invention." In The Rate and Direction of Inventive Activity: Economic and Social Factors, Princeton University Press.

³ Perez, C. (2002). "Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages." Edward Elgar Publishing.

⁴ O'Sullivan, M. (2007). "Funding New Industries: A Historical Perspective on the Financing Role of the U.S. Stock Market in the Twentieth Century." NBER Working Paper.

⁵ Perez, C. (2009). "The Double Bubble at the Turn of the Century: Technological Roots and Structural Implications." Cambridge Journal of Economics, 33(4), 779-805.

⁶ Arrow, K. (1962). "Economic Welfare and the Allocation of Resources for Invention." In The Rate and Direction of Inventive Activity: Economic and Social Factors, Princeton University Press.

⁷ Riordan, M., & Hoddeson, L. (1997). "Crystal Fire: The Invention of the Transistor and the Birth of the Information Age." W.W. Norton & Company.

⁸ Pisano, G. P. (2006). "Science Business: The Promise, the Reality, and the Future of Biotech." Harvard Business Press.

⁹ Rosenberg, N. (1983). "Inside the Black Box: Technology and Economics." Cambridge University Press.

¹⁰ Gertner, J. (2012). "The Idea Factory: Bell Labs and the Great Age of American Innovation." Penguin Press.

¹¹ Andreessen, M. (2014). "Why Bitcoin Matters." New York Times.

¹² Saxenian, A. (1996). "Regional Advantage: Culture and Competition in Silicon Valley and Route 128." Harvard University Press.

¹³ Lerner, J. (2009). "Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed--and What to Do About It." Princeton University Press.

¹⁴ Perez, C. (2009). "Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages." Cambridge Journal of Economics.