Bubbles and Crashes
The Boom and Bust of Technological Innovation
Published by: Stanford University Press
264 pages, 152.00 x 229.00 mm
- ISBN: 9780804793834
- Published: February 2019
Financial market bubbles are recurring, often painful, reminders of the costs and benefits of capitalism. While many books have studied financial manias and crises, most fail to compare times of turmoil with times of stability. In Bubbles and Crashes, Brent Goldfarb and David A. Kirsch give us new insights into the causes of speculative booms and busts. They identify a class of assets—major technological innovations—that can, but does not necessarily, produce bubbles. This methodological twist is essential: Only by comparing similar events that sometimes lead to booms and busts can we ascertain the root causes of bubbles.
Using a sample of eighty-eight technologies spanning 150 years, Goldfarb and Kirsch find that four factors play a key role in these episodes: the degree of uncertainty surrounding a particular innovation, the attentive presence of novice investors, the opportunity to directly invest in companies that specialize in the technology, and whether or not a technology is a good protagonist in a narrative. Goldfarb and Kirsch consider the implications of their analysis for technology bubbles that may be in the works today, offer tools for investors to identify whether a bubble is happening, and propose policy measures that may mitigate the risks associated with future speculative episodes.
The chapter describes the dot-com bubble and the narrative that fueled it, as well as the uncertainty that faced early dot-com start-ups. The introduction also describes the methodological challenge of studying bubbles, which requires identifying comparable assets that are and are not associated with bubbles. The chapter then provides a list of fifty-eight technologies that meet this criterion. The factors that cause bubbles are introduced, including uncertainty, the existence of pure-play investment, the susceptibility of technologies to narratives, and novice investors. The relevance of the factors is illustrated through the example of arc lighting—the first commercialized electric lighting technology.
The chapter begins with an in-depth definition of boom and bust cycles, as well as bubbles. It then compares the commercialization and financial histories of four technologies: the telephone, insulin, radio, and television. The chapter introduces a methodology and measure of speculative activity, frothiness. Stock index movements across time are compared, and boom and bust periods defined and identified. Booms and busts are found in radio, and to a lesser degree in television and telephone. No speculative activity is found in insulin, despite its dramatic effects in children's health care especially.
The chapter begins with a description of narratives and storytelling and their role in imagining development paths for new technologies. Theories of options, biases and expectations and belief coordination all contribute the construction of narratives when new technological paths are uncertain. The chapter then unbundles the various types of uncertainty into specific categories: technological, competitive, business model, value chain and regulatory, and demand uncertainty. Each type of uncertainty is explored through examples, including aviation, rubber, the telephone, the automobile, and radio, to understand how and why each can form a contextual foundation of a bubble narrative.
The chapter describes the host of biases that make novices more likely to believe speculative narratives through stories of stock market speculation in both recent and distant past. The biases are contextualized into the uncertainty associated with particular technology, and theories of sticky ideas and idea contagion are invoked to understand which narratives are more likely to emerge. The chapter then explores the history of financial innovations that have made the stock market more accessible to the public. In particular, technological, legal, and institutional innovation in the stock market is followed from the 1850s through the 1970s, as is the role these innovations had in democratizing US capital markets.
The chapter brings together the frameworks developed in this book to rank technologies according to their likelihood of producing a bubble and to evaluate whether market speculation did indeed occur. The usefulness of the framework is explored through the historical accounts of the automatic watch, phototypesetting, antibiotics, nylon hosiery, the jet engine, commercial aviation, the rotary (Wankel) engine, and the transistor. The chapter concludes with a discussion of technologies that theory predicted would lead to bubbles but for which no bubbles were observed.
The chapter applies the model of bubbles derived from historical cases of technological innovation to a set of thirty recent technologies. This test evaluates the generalizability of the model by determining whether it can be applied beyond the training set of contexts in which it was developed. Examples include the internet, personal computers, liquid crystal displays, and laparoscopic surgery. Additional examples from outside the domain of technological innovation include the housing bubble and the Great Recession of 2007–2009, as well as Tesla and the future of the electric vehicle. Readers are invited to engage with the data to provide additional interpretations.
The chapter considers the public and private policy implications of the model of speculative bubbles advanced in this book. Using a series of questions intended to help potential investors identify when they may be part of a bubble, the chapter proposes several policy ideas proceeding from first principles.
"Goldfarb and Kirsch possess a keen understanding of the history of technological innovation and the evolution and implementation of new technologies and their respective impact on society. Their work sheds light on causal factors that were not previously well understood with respect to technological innovation and the underlying dynamics which lead innovation to spawn speculative bubbles. Bubbles and Crashes provides important insights for both investors and policy makers to recognize bubbles and implement policies to minimize their impact." ~Jonathan Rosenberg, Senior Vice President, Alphabet
"A fascinating account of how and when new technologies lead to exuberant asset prices. Anyone who thinks about innovation and financial markets will enjoy this book." ~Jonathan Levin, Stanford Graduate School of Business
"Strongly grounding their work in historical evidence, Goldfarb and Kirsch advance our understanding of how technological innovations sometimes do, and sometimes don't, lead to financial bubbles. They move the discussion of bubbles and crashes away from journalism and toward science. Investors and finance professionals along with financial regulators and policy makers need to absorb the lessons of this provocative analysis." ~Richard Sylla, New York University
"What an engaging book! Why do booms and busts happen during the deployment of some technologies and not others? The work looks deeply at many memorable episodes of new technologies – electric lighting, vulcanized rubber, insulin, telephony, radio and television, electronic commerce, and much more. The authors bring accessible and penetrating insight to the economics, and illustrate with rich examples. It is a joy to read the stories and analysis. Highly recommended!" ~Shane Greenstein, Martin Marshall Professor of Business Administration, Harvard Business School
"When is a technology boom actually a bubble? In Bubbles and Crashes authors Goldfarb and Kirsch deliver a nuanced guide to answering this question. Based on the careful examination of 88 important innovations—ranging from the electric light to the World Wide Web—they demonstrate the importance of pure-play investment opportunities, naive investors, and powerful narratives in allowing runaway speculation that overwhelms the moderating forces of imitation, entry, and competition. This is must reading for anyone interested in how new technologies develop, how they are perceived when they first occur, and how some generate clear bubbles." ~Richard Rumelt, Professor Emeritus, UCLA Anderson
"Goldfarb and Kirsch provide an interesting take on some factors that facilitate the development and bursting of bubbles in technology industries...Readers may particularly appreciate the discussion on competition and policy...Practitioners, graduate students, and researchers may benefit by reading this book. Highly recommended."––S. R. Sisodiya, CHOICE