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What's driving the boom. Haltiwanger says that, basically, two big buckets of new businesses are being created these days. New businesses in the first bucket are capitalizing on a huge post-pandemic population shift. Many office workers are now either fully remote or hybrid. "People are not spending five days a week at the office in major downtown areas," Haltiwanger says. Where people spend their time, they spend their money. Bad news for businesses in downtown areas. Good news for businesses where office workers live. That's why one of the big areas for new business growth is in food and accommodations, particularly in the outskirts of cities. Haltiwanger, together with Ryan Decker, calls this "the donut effect." There's now a hole lacking vibrant economic activity in many major business districts, and a delicious fried dough of new business opportunities in the suburbs surrounding them. Office workers need their doughnuts, coffee and sandwiches near their office, which is now more often at home. However, if the story of the new business boom were limited to just delis, gyms and doughnut shops in suburban areas, the upside would be somewhat limited. Sure, remote and hybrid work is a revolutionary change for a large fraction of the workforce, but the business boom it has fed could be seen as mostly just a geographic reshuffling of economic activity. Fewer coffee shops in Manhattan. More in New Jersey or Brooklyn. That would likely have only a limited upside for the economy. That's why Haltiwanger is much more excited about the other big bucket of new businesses he has identified in the data: tech startups. This boom is proving, he says, to be the most persistent. These tech startups come in many stripes, but one subcategory has really caught his and other economists' attention: startups working in artificial intelligence. "I think we're in a new tech wave," Haltiwanger says. "I think AI is the poster child of this."

If there’s one lesson we’ve learned from delving into Barron’s archives in our centennial year, it is this: Don’t underestimate the resilience of the U.S. economy and stock market. We saw that theme time and again as we published a series of retrospective pieces during 2021—and the resilience is strikingly evident still.

When the Covid-ravaged economy contracted in 2020, it was just the 19th time since 1920 in which real gross domestic product had declined, year over year. And nine of those years came between 1930 and 1949, a result of the Great Depression or post–World War II demobilization.

First, war can occur at any stage of expansion, crisis, recession, recovery, so it is unrealistic to assume that wars occur at any particular stage of the business cycle. On the one hand, although the domestic economic problems in the crisis/recession/depression period break out and become prominent in a short time, in fact, such challenge exists at all stages of the business cycle. When countries cannot manage to solve these problems through conventional approaches, including fiscal and monetary policies, they may resort to military expansion to achieve their goals, a theory known as Lateral Pressure. [13] Under such circumstances, even countries in the period of economic expansion are facing downward pressure on the economy and may try to solve the problem through expansion. On the other hand, although the resources required for foreign wars are huge for countries in economic depression, the decision to wage wars depends largely on the consideration of the gain and loss of wars. Even during depression, governments can raise funding for war by issuing bonds. Argentina, for example, was mired in economic stagflation before the war on the Malvinas islands (also known as the Falkland islands in the UK). In fact, many governments would dramatically increase their expenditure to stimulate the economy during the recession, and economically war is the same as these policies, so the claim that a depressed economy cannot support a war is unfounded. In addition, during the crisis period of the business cycle, which is the early stage of the economic downturn, despite the economic crisis and potential depression, the country still retains the ability to start wars based on its economic and military power. Based on the above understanding, war has the conditions and reasons for its outbreak in all stages of the business cycle.

Second, the economic origin for the outbreak of war is downward pressure on the economy rather than optimism or competition for monopoly capital, which may exist during economic recession or economic prosperity. This is due to a fact that during economic prosperity, people are also worried about a potential economic recession. Blainey pointed out that wars often occur in the economic upturn, which is caused by the optimism in people's mind [14], that is, the confidence to prevail. This interpretation linking optimism and war ignores the strength contrast between the warring parties. Not all wars are equally comprehensive, and there have always been wars of unequal strength. In such a war, one of the parties tends to have an absolute advantage, so the expectation of the outcome of the war is not directly related to the economic situation of the country. Optimism is not a major factor leading to war, but may somewhat serve as stimulation. In addition, Lenin attributed the war to competition between monopoly capital. This theory may seem plausible, but its scope of application is obviously too narrow. Lenin's theory of imperialism is only applicable to developed capitalist countries in the late stage of the development capitalism, but in reality, many wars take place among developing countries whose economies are still at their beginning stages. Therefore, the theory centered on competition among monopoly capital cannot explain most foreign wars. Moreover, even wars that occur during periods of economic expansion are likely to result from the potential expectation of economic recession, the "limits of growth" [15] faced during prosperity — a potential deficiency of market demand. So the downward pressure on the economy is the cause of war.

Our primary finding is that great powers deal with decline by retrenching promptly and proportionately. Regardless of regime type, retrenchment is the most common response to decline, and preventive wars almost never happen during decline. Retrenchment helps great powers regain their former positions with some regularity, but states that fail to retrench never recover their rank. Although decline promotes retrenchment, the rate of decline is only a rough predictor of the extent of retrenchment. Great powers have a tendency to retrench less than might be expected given underlying power trends, but most errors are modest. Without question, our theory has anomalies, but rival views are only theories of anomalies.

Secondarily, we find that states that fall at similar rates behave similarly—there is a stepwise relationship between non-decliners, small decline-ers, medium decliners, and large decliners. Declining powers spend less on defense and slow the growth of military personnel more than other states. They are no more likely to form new alliances, but they are less likely to participate in disputes. We also find evidence that states refine retrenchment policies to prevailing structural conditions. While our structural modifiers have modest explanatory power on their own, collectively they perform impressively. Declining powers that are most favorably positioned have almost all retrenched.

This paper’s main contribution is to identify the precise conditions under which the probability of war increases despite rising opportunity costs. We show that, unlike other mechanisms, rising opportunity costs may counter-intuitively make war more likely because it also increases the difference between reservation points for unresolved versus resolved opponents. As a result, these informational asymmetries can lead states to screen their opponents and risk war. This new finding reshapes our understanding about the relationship between opportunity costs and war. It introduces a more nu-anced mechanism about when and how this relationship operates, sometimes contrary to expectations.

Our work advances economic interdependence theories of war in several ways. First, it provides new insight on the causes of war at odds with traditional cases where opportunity costs increased, yet conflict still erupted. Second, it demonstrates how and when competing effects of economic instruments predominate, driving changes in the probability of conflict. In contrast to previous work, we identify specific conditions under which increasing opportunity costs shifts the probability of conflict, consistent with the empirical evidence. Finally, it demonstrates the important, but subtle, effects of changing instruments, like trade flows, in the presence of uncertainty. The model advances a growing line of research that various sources of uncertainty have disparate effects on crisis bargaining.

There is a large literature on diversionary conflict in international relations, but it focuses on material conflicts like militarized interstate disputes rather than foreign policy rhetoric. It is based in social identity theory, which suggests that leaders can increase ingroup affinity by making intergroup distinctions more salient (Coser 1956; Simmel 1955; Tajfel and Turner 1979). A recent review concludes that though the internal logic of diversionary conflict is “compelling and theoretically well supported,” the empirical evidence is “decidedly mixed” (Baum and Philip 2008, 48). Several studies find evidence of diversionary aggression in US foreign policy (Clark 2003; DeRouen 2000; DeRouen and Peake 2002; Fordham 1998a,b; Hess and Orphanides 1995; Howell and Pevehouse 2005; James and Hristoulas 1994; James and Oneal 1991; Levy 1989a, 1989b; Clifton and Bickers 1992; Ostrom and Job 1986) and elsewhere (Bennett 2000; Dassel and Reinhardt 1999; Davies 2002; Enterline and Gleditsch 2000; Gelpi 1997; Heldt 1999; Lebow 1981; Mansfield and Snyder 1995; Oneal and Tir 2006; Russett 1990; Sobek 2007; Tir 2010). Yet skeptics have amassed opposing evidence (Chiozza and Goemans 2003, 2004; Foster and Palmer 2006; Gowa 1998; Johnston 1998; Leeds and Davis 1997; Lian and Oneal 1993; Meernik 2004, 2000; Meernik and Waterman 1996; Moore and Lanoue 2003; Potter 2007). Some cases are hard to reconcile with the theory: in Britain, there were rallies in the Falklands War and the Gulf War but not in other cases in which rallies would be expected, such as the Korean, Suez, and Kosovo wars (Lai and Reiter 2005). Some go so far as to call diversionary aggression a “myth” (Meernik and Waterman 1996).

Others have developed scope conditions for diversionary aggression. It is more likely between states with pre-standing rivalries (Mitchell and Prins 2004), when leaders are accountable (Carter 2018; Kisangani and Pickering 2011), and in mature democracies, consolidating autocracies, and transitional polities (Pickering and Kisangani 2005). It is less likely when states avoid provoking troubled rivals (Clark 2003; Fordham 2005; Leeds and Davis 1997; Miller 1999). Diversion appears more likely to produce a rally when supported by Security Council authorization (Chapman 2011; Chapman and Reiter 2004), when the White House draws attention to a dispute (Baker and Oneal 2001), and in conditions of media attention, popular leadership, divided government, non election years, and first terms (Colaresi 2007). Most recently, scholars have asked whether diversion occurs outside democracies. They find some autocracies, especially single party regimes, divert as well (Carter 2018; Pickering and Kisangani 2010).

One familiar argument is the so-called diversionary (or “scapegoat”) theory of war. It suggests that leaders who are worried about their popularity at home will try to divert attention from their failures by provoking a crisis with a foreign power and maybe even using force against it. Drawing on this logic, some Americans now worry that President Donald Trump will decide to attack a country like Iran or Venezuela in the run-up to the presidential election and especially if he thinks he’s likely to lose. This outcome strikes me as unlikely, even if one ignores the logical and empirical flaws in the theory itself. War is always a gamble, and should things go badly—even a little bit—it would hammer the last nail in the coffin of Trump’s declining fortunes. Moreover, none of the countries Trump might consider going after pose an imminent threat to U.S. security, and even his staunchest supporters may wonder why he is wasting time and money going after Iran or Venezuela at a moment when thousands of Americans are dying preventable deaths at home. Even a successful military action won’t put Americans back to work, create the sort of testing-and-tracing regime that competent governments around the world have been able to implement already, or hasten the development of a vaccine. The same logic is likely to guide the decisions of other world leaders too. Another familiar folk theory is “military Keynesianism.” War generates a lot of economic demand, and it can sometimes lift depressed economies out of the doldrums and back toward prosperity and full employment. The obvious case in point here is World War II, which did help the U.S economy finally escape the quicksand of the Great Depression. Those who are convinced that great powers go to war primarily to keep Big Business (or the arms industry) happy are naturally drawn to this sort of argument, and they might worry that governments looking at bleak economic forecasts will try to restart their economies through some sort of military adventure. I doubt it. It takes a really big war to generate a significant stimulus, and it is hard to imagine any country launching a large-scale war—with all its attendant risks—at a moment when debt levels are already soaring. More importantly, there are lots of easier and more direct ways to stimulate the economy—infrastructure spending, unemployment insurance, even “helicopter payments”—and launching a war has to be one of the least efficient methods available. The threat of war usually spooks investors too, which any politician with their eye on the stock market would be loath to do. Economic downturns can encourage war in some special circumstances, especially when a war would enable a country facing severe hardships to capture something of immediate and significant value. Saddam Hussein’s decision to seize Kuwait in 1990 fits this model perfectly: The Iraqi economy was in terrible shape after its long war with Iran; unemployment was threatening Saddam’s domestic position; Kuwait’s vast oil riches were a considerable prize; and seizing the lightly armed emirate was exceedingly easy to do. Iraq also owed Kuwait a lot of money, and a hostile takeover by Baghdad would wipe those debts off the books overnight. In this case, Iraq’s parlous economic condition clearly made war more likely. Yet I cannot think of any country in similar circumstances today. Now is hardly the time for Russia to try to grab more of Ukraine—if it even wanted to—or for China to make a play for Taiwan, because the costs of doing so would clearly outweigh the economic benefits. Even conquering an oil-rich country—the sort of greedy acquisitiveness that Trump occasionally hints at—doesn’t look attractive when there’s a vast glut on the market. I might be worried if some weak and defenseless country somehow came to possess the entire global stock of a successful coronavirus vaccine, but that scenario is not even remotely possible. If one takes a longer-term perspective, however, a sustained economic depression could make war more likely by strengthening fascist or xenophobic political movements, fueling protectionism and hypernationalism, and making it more difficult for countries to reach mutually acceptable bargains with each other. The history of the 1930s shows where such trends can lead, although the economic effects of the Depression are hardly the only reason world politics took such a deadly turn in the 1930s. Nationalism, xenophobia, and authoritarian rule were making a comeback well before COVID-19 struck, but the economic misery now occurring in every corner of the world could intensify these trends and leave us in a more war-prone condition when fear of the virus has diminished. On balance, however, I do not think that even the extraordinary economic conditions we are witnessing today are going to have much impact on the likelihood of war. Why? First of all, if depressions were a powerful cause of war, there would be a lot more of the latter. To take one example, the United States has suffered 40 or more recessions since the country was founded, yet it has fought perhaps 20 interstate wars, most of them unrelated to the state of the economy. To paraphrase the economist Paul Samuelson’s famous quip about the stock market, if recessions were a powerful cause of war, they would have predicted “nine out of the last five (or fewer).” Second, states do not start wars unless they believe they will win a quick and relatively cheap victory. As John Mearsheimer showed in his classic book Conventional Deterrence, national leaders avoid war when they are convinced it will be long, bloody, costly, and uncertain. To choose war, political leaders have to convince themselves they can either win a quick, cheap, and decisive victory or achieve some limited objective at low cost. Europe went to war in 1914 with each side believing it would win a rapid and easy victory, and Nazi Germany developed the strategy of blitzkrieg in order to subdue its foes as quickly and cheaply as possible. Iraq attacked Iran in 1980 because Saddam believed the Islamic Republic was in disarray and would be easy to defeat, and George W. Bush invaded Iraq in 2003 convinced the war would be short, successful, and pay for itself. The fact that each of these leaders miscalculated badly does not alter the main point: No matter what a country’s economic condition might be, its leaders will not go to war unless they think they can do so quickly, cheaply, and with a reasonable probability of success. Third, and most important, the primary motivation for most wars is the desire for security, not economic gain. For this reason, the odds of war increase when states believe the long-term balance of power may be shifting against them, when they are convinced that adversaries are unalterably hostile and cannot be accommodated, and when they are confident they can reverse the unfavorable trends and establish a secure position if they act now. The historian A.J.P. Taylor once observed that “every war between Great Powers [between 1848 and 1918] … started as a preventive war, not as a war of conquest,” and that remains true of most wars fought since then. The bottom line: Economic conditions (i.e., a depression) may affect the broader political environment in which decisions for war or peace are made, but they are only one factor among many and rarely the most significant. Even if the COVID-19 pandemic has large, lasting, and negative effects on the world economy—as seems quite likely—it is not likely to affect the probability of war very much, especially in the short term. To be sure, I can’t rule out another powerful cause of war—stupidity—especially when it is so much in evidence in some quarters these days. So there is no guarantee that we won’t see misguided leaders stumbling into another foolish bloodletting. But given that it’s hard to find any rays of sunshine at this particular moment in history, I’m going to hope I’m right about this one.

Small businesses have long been touted as America’s backbone and the main pillar of its economy. Almost every president in recent memory has campaigned on the importance of their survival, and the IRS has allowed them tax allowances and leeway that larger institutions are rarely afforded. However, recent studies have shown that small businesses are not the job generators they might have thought to have once been. According to the U.S. Small Business Administration, small businesses create over 66% of net new jobs. A new report also shows that small businesses account for 44% of total U.S. economic activity. Although this number has declined gradually in recent years, it still remains a significant portion of overall GDP contribution. The drop in GDP share small businesses contribute to while maintaining the majority of net new job sourcing is of particular importance. According to the USSBA, from 1998 to 2014, the small business share of GDP has fallen from 48% to 43.5%. Yet, over the same period, the amount of small business GDP has grown about 25%, at a rate of about 1.4% annually. They add that real GDP for large businesses has grown faster however, at 2.5% annually. So how does a sector that has decreasing importance on total GDP still account for 99.9% of all businesses in the United States? As with all economic data, context is key. The numbers cited by the SBA are from numbers accumulated up until 2014. A 2015 study by the Kauffman Foundation found that new businesses, not necessarily just small ones, account for virtually all new job creation in the United States and nearly 20% of gross job creation. In other words, startups spur greater job growth than larger companies. Another study by American Express and Dun & Bradstreet showed that mid-size firms (those with revenue between $10 million and $1 billion) were responsible for 92% of the net new job creation from 2008 through the end of 2014. This shows that SBA numbers and independent studies demonstrate conflicting figures as to who generates the majority of new jobs. One of the reasons behind this could be the “stickiness” of jobs per firm size, or the net vs. gross job creation. While startups and younger firms are very efficient at creating new jobs and quickly, they are also just as efficient at destroying them. Another Kauffman Foundation study in 2010 found that all net job growth comes from firms less than one year old. They add that the problem is that these firms also destroy jobs, as many go out of business soon after they open. Economist Johnathan Leonard told MIT Press that the largely ignored pattern is that “small establishments account for most net job loss just as surely as they account for most net job gain.” That’s to say that the SBA’s numbers are not necessarily wrong, but they do not offer the entire context. To sum it up: Small businesses create a lot of jobs, but they also destroy a lot of them too and people aren’t taking notice. In fact, the SBA themselves found in 2012 that just one-third of new businesses survive to their tenth year. That means that the majority of the small businesses that were job-churners in their early days, end up being lay-off machines and “net zero” employers in the end. So while it may be true that small businesses largely contribute to the amount of new jobs each year, overall they might not have as much of an impact on real job growth.

Back in 2020, when the world was navigating the hellscape of the COVID-19 pandemic, economist John Haltiwanger discovered something really strange happening in the U.S. economy: Americans were creating new businesses at a record rate. Haltiwanger is one of the top experts on new business creation in the United States. He even helped the U.S. Census Bureau set up official statistics that track it. A surge in new businesses, Haltiwanger says, tends to be a great sign for job creation, innovation and productivity growth in the economy. But, up until 2020, the data painted a sort of gloomy picture. Haltiwanger was writing research papers with titles like "Top Ten Signs of Declining Business Dynamism and Entrepreneurship in the U.S." And so, in the summer of 2020, when Haltiwanger first saw the data suggesting there was a startup boom, he and his colleagues were gobsmacked. "At first we thought, 'There's got to be something wrong,'" Haltiwanger says. By November 2020, when I first spoke to Haltiwanger for the Planet Money newsletter, it was clear that the startup boom was real. But it was unclear whether the surge in new businesses was just a pandemic-related blip that would quickly fizzle out. Much of the boom could be seen in the online retail sector. But then the startup boom kept … well, booming. We saw a second surge of new businesses beginning in 2021. So I spoke to Haltiwanger again in June of that year. By then, he was more optimistic that the surge of new businesses was a harbinger of great things to come for the economy. He was particularly struck by the revolutionary changes to business life created by widespread remote work. But, to be honest, I was still a bit cynical about the boom. Lots of small businesses were devastated by the pandemic and closed up shop. Many people lost their jobs. Maybe a lot of them were creating new businesses in a desperate attempt to pay the bills or to get more federal relief money, or just out of boredom. Most plausible to me: Maybe this surge in new businesses was just a reflection of the wild swing that we had been on to a weird pandemic-related economy and then back to normal again. The first swing created one-off business opportunities, like selling hand sanitizer or masks, or delivering cheeseburgers and fitness equipment to our front doors, or whatever. Then, as we swung back to normal and consumers began spending money outside again, that created new opportunities for the revival of face-to-face businesses, like bars, gyms and restaurants. These were the same types of businesses that had been devastated by the pandemic. Maybe, I figured, this was all just one long, arduous journey that ultimately brought us back to where we began, with limited long-term benefits for the economy. But we're now well past the pandemic crisis and even the pandemic recovery. It has been almost exactly four years since the startup boom began — and there's still a bonanza of new business creation in the United States. It's harder to be dismissive about it. "I'd say we're on a new plateau that started in 2021," Haltiwanger says. Comparing the three years before the onset of the pandemic with the three years after it, the data suggests there are now, on average, almost 60% more new businesses being created each year. The boom is real. It's sustained. It's visible in both businesses that are just a single person striking out on their own and, importantly, businesses that are likely to grow and employ people. It's seen in traditionally underrepresented minority communities. And, Haltiwanger says, this boom could be a sign that something fantastic is about to happen to the American economy: a long-awaited boost in productivity growth, which is the magic sauce for making society richer.

In our age of political polarization, the right, left and center agree on one thing: Big business is wicked, and small business is noble. President Donald Trump has declared: “We’re going to create an environment for small business like we haven’t had in many, many decades!” His enthusiasm echoes his predecessor, President Barack Obama, who claimed that “small businesses are the backbone of our economy and the cornerstones of America’s promise.” Indeed, politicians and pundits of every stripe argue that we can solve a host of problems, from creating jobs to boosting productivity to unleashing innovation, with hefty doses of the same miracle cure: aid to small business. But this alleged miracle cure is really snake oil. That is because, compared to large firms, small firms pay lower wages and provide fewer benefits, injure and lay off their workers more frequently, spend less to protect the environment, are less productive and less innovative, and create a smaller share of net new jobs. After World War II, as big firms emerged in industry after industry (hotels, banks, restaurants, retail), small firms began to cast themselves as victims and to ask public officials for relief. In 1953, Congress established the Small Business Administration to “aid, counsel, assist and protect, insofar as is possible, the interests of small business concerns.” But fairness was a relatively weak reed on which to build an elaborately discriminatory economic policy. What was needed was a positive rationale for giving preferential treatment to small businesses. Job creation became the new banner. Economist David Birch of the Massachusetts Institute of Technology claimed in the late 1970s—inaccurately, as it turned out—that small businesses were the jobs engine of the economy, which allowed advocates to argue that aid to small businesses was a driver of economic growth. This narrative was reinforced by the wave of startups in the tech sector in the 1980s and 1990s. By 2000, all new businesses, no matter how technologically primitive or undercapitalized, were being called startups. A new biotech company was a startup, but so was a new three-person lawn-mowing business. Only child-labor laws prevented lemonade stands from being classified as startups, too. As a result, firms with fewer than 11 employees are exempt from most workplace safety requirements. The Family and Medical Leave Act does not apply to small firms, and many civil rights laws contain exemptions for small firms. A firm with fewer than 20 employees can legally discriminate against workers on the basis of age; if it has fewer than 15 employees, it can discriminate against qualified individuals with disabilities. Only federal contractors with 50 or more workers are required to use affirmative action plans when hiring. The tax code also lavishes benefits on small firms. Profits from publicly traded companies (most of which are large) are typically taxed twice, once at the corporate level and again when shareholders accrue capital gains or dividends. By contrast, pass-through firms such as sole proprietorships, partnerships and LLCs—the lion’s share of which are small—are taxed only once, on the owners’ incomes. In addition, many tax incentives either apply only to small firms or are more generous for small firms, including (at least before recent tax-reform legislation) the ability to expense investments in new equipment, exemptions from imputed interest obligations, completed-contract rules, expensing of agricultural costs and a host of others. To give small businesses a leg up, federal agencies are required to buy goods and services from them even when their prices are higher. Federal agencies also provide a variety of special subsidies to small firms. Small firms get discounts when buying rights to use the radio spectrum and pay lower patent fees. And they get cut-rate financing, too. In 2016, the SBA supported loans to small businesses across the nation: $105 million for car dealers, $118 million for residential building construction, $312 million for liquor stores, $742 million for gas stations and $760 million for dentists. Advocates for small businesses often argue that such firms deserve special breaks because it is harder for them to bear the costs of complying with government regulation. After all, every firm must devote time and resources to filling out a given form, and big firms have the advantage of spreading those costs over a larger business. There’s some validity to this point. But most special favors for small businesses—lower tax rates, tax incentives, direct subsidies, cheap financing—have nothing to do with their difficulty in coping with regulation. And requiring small firms not to discriminate on the basis of age, gender, race or religion imposes no special regulatory burden. Some regulations do, in fact, create a competitive disadvantage for small firms. But why shouldn’t big firms enjoy lower costs from economies of scale in complying with regulations? If small businesses cannot handle the costs of regulation—or any other business cost for that matter—they must choose between growing to a more efficient size or losing market share. Government at every level can certainly do more to eliminate unnecessary regulations and to streamline those regulations that serve crucial public ends. But such reforms should benefit all businesses, regardless of size. Don’t all the breaks for small businesses at least help “the little guy”? No, in fact, they go mostly to the wealthy. In 2016, according to the nonpartisan Tax Policy Center, the top 1% of pass-through businesses earned 50.8% of the income for such firms. A mere 13.4% of all pass-through income went to the bottom 60%. A 2015 study by the Federal Reserve Bank of New York concluded, “More wealthy individuals are small-business owners than poor individuals. The subsidy on small-business ownership just transfers resources to the wealthy from the poor.” Beyond the injustice of it, small-business favoritism reverberates throughout the economy, slowing growth in two ways. First, subsidies and other size-based industrial policies slow productivity growth by enabling less efficient small firms to gain more market share than would otherwise be the case. Second, discriminatory policies provide an incentive for small firms to remain small. Why add five more workers when doing so would subject you to a host of new regulations and restrict your access to government handouts? Today, with the U.S. economy facing intense global economic competition and suffering from stagnant productivity and sluggish wage growth, we can no longer afford the luxury of tilting the economic playing field toward small business owners. To end the misallocation of resources caused by small-business cronyism, public policy should be guided by the principle of size neutrality. Policymakers should repeal virtually all special preferences for small business in the tax code and in government procurement policy and eliminate targeted subsidies, regulatory exemptions and exemptions from civil rights laws.

Using prizes to encourage inventors to solve problems is not a new idea. The Longitude Prize, sponsored by the British government, was famously awarded in 1737 to John Harrison for his novel, clock-based solution for determining a ship’s longitude. Prizes were also offered in Napoleonic France for a functional water turbine, and for a method of preserving food for the army: the precursor of the now ubiquitous tin can.Innovation prizes fell out of academic and political fashion for most of the 20th century (with the exception of the technologically backward Soviet Union), as patents and other forms of IP rights prevailed as the main driver of technological innovation. This move away from innovation prizes toward today’s market-based system of innovation reward was hardly surprising given the deep structural problems with prizes, as documented by economic historian Dr. Zorina Khan in her 2015 analysis of dozens of 19th-century innovation prizes administered in Britain, France, and the United States.2 As Khan concluded, “History indicates that the evolution of the institution of innovation prizes over the past three centuries serves as a cautionary tale rather than a success story.

The alternative to the patent right is a prize. Under the prize system, the patentee will enter and produce, without the right to exclude others, as long as the prize is at least as great as the breakeven level of profit. Since rivals are not excluded, competition will drive the price down to the competitive level. The entire potential surplus triangle, QXH, is enjoyed by consumers. There are two prize levels to consider. One is the minimum necessary prize, which is the breakeven level of profit. The other is the optimal prize, which is equal to the entire surplus (Shavell and Ypersele). The optimal prize ensures that entry occurs whenever the cost of development is less than the benefit to society. The minimum prize is sufficient to induce entry by the patentee. However, the original problem in the patent setting is that the patent authority does not know the development cost of the patentee; that is private information. Given this, if the patent authority were to choose a prize of a given amount, there would be some innovators who would refuse to enter. Because of the information problem, the minimum or break-even prize is not a workable solution to the entry problem. The optimal prize, equal to the entire surplus, effectively replicates perfect price discrimination. It would require the patent authority to gain knowledge on the market demand for the patentee’s product. This is implausible as a general matter. Patent authorities do not gather information on the market demand for a patented product. Perhaps in the case of a proposed drug that has gone through the Food and Drug Administration (FDA) testing process, it may be possible for the patent authority to gain enough information to determine the market demand for the product, but even this seems unlikely. The FDA determines safety and efficacy for drugs, and makes no attempt to determine market demand. Drug companies, by contrast, surely attempt to determine market demand. A prize system that requires the patent authority to gather information on market demand would leave the patent authority in the hands of the drug companies.

In the real world, of course, neither a prize or reward system nor a system of intellectual property rights will perfectly calibrate incentives and lead private parties to undertake all investments in the creation of inventions and works that have a positive social return. A critical virtue of intellectual property systems is that they minimize governmental discretion in assessing the value of works. But the need to determine when to grant intellectual property rights and to adjudicate the propriety of and infringement of such rights dictates a considerable governmental role. Thus, the effectiveness of a patent office and the courts are critical to assessing how existing intellectual property systems compare to prize or reward systems. To the extent that intellectual property systems do constrain administrative and judicial discretion with rules, the question becomes to what extent the rules successfully align creator incentives with social welfare. In principle, the ultimate comparison of prize systems with intellectual property systems is an empirical one. This chapter will provide some historical context, but there is little empirical data, particularly on the prize or reward system side of the ledger. And even to the extent some experimentation with prize or reward systems has occurred, the heterogeneity of such systems counsels restraint in attributing the virtues or vices of any one such system to all of them. Of course, it is also important not to compare some hypothetical ideal prize or reward system against a functioning intellectual property system. After all, there are many competing proposals to improve patent and copyright law, and even if there were broad scholarly agreement about the design of an ideal system, political considerations may make suboptimal intellectual property inevitable—and would likely mean the same for a prize or reward system

If an invention is valuable, the patent is going to reward it by profits in the market. But if the invention is useless, they're going to get nothing. And society also benefits, because the patentee discloses all of the information to the public. But what I point out is that prize awards belong to what I call administered innovation systems. These are top down arrangements, where economic decisions about rewards and values, and the allocation of resources, are going to be made by panels and by judges who will never have as much information as the market. Usually, these sorts of prize awards are very secretive. They don't tell you how and why they arrived at their decision. And certainly, they never put in place any mechanism to reveal information to everyone in the field. So I think that administered systems are a lot like command economies, because it's impossible for administrators to come up with the correct value. You have too low a prize, and that's a problem. You have too high a prize, and that also creates distortions and misallocates resources.

Suppose that you were to offer $200 million for a superior mousetrap. Well, your prize is surely going to attract a posse of people to try to fix your root problem. But at the same time, this disproportionate payment is going to have unforeseen consequences, like inducing oncologists to switch from finding cures for cancer, to competing for your mousetrap payout. And of course, there is no guarantee that the invention you select is actually going to be successful in the general marketplace.

We found little quantitative empirical evidence on the effect of prizes on innovation, arguably due to two factors: First, as there is a substantial divergence between economic theory and actual prizes implemented in practice, there is little theory for empirical research to test. Second, it’s difficult to do a counterfactual analysis, and there is an over-reliance on historical case studies, which are often misleading.

We found only a few studies on the impact of prizes on innovation and intermediate outcomes that have used a convincing counterfactual analysis (summary table here):

In theoretical terms, prizes have numerous advantages over patent protection. The actual implementation and operation of a prize system, however, complicates comparisons. 117Theoretical prizes are substitutes for patents, but prizes in action are generally complements. 118That is, as prize demand increases, prices for patents decrease. At the very least, prizes are often supplementary to patent protection. 119Complementarity, however, means that the differences between patents and prizes are slim when looking at the comparable quantum of their deadweight losses. 120For government-funded prizes, of course, the deadweight losses function differently, as they are spread out among a larger number of consumers, for instance through taxation. 121But then there is the problem of scale: prizes can incentivize the development of a new invention, but are not of a sufficient magnitude for the expense of upscaling a commercially-viable product. However, prizes are vulnerable to the criticisms of rent-seeking and picking winners that traditionally bolstered justifications for patents in the first place. 122With fine distinctions between patents and prizes, their merits should be determined on a case-by-case basis.

Prize proposals offer the benefit of putting inventions into the public domain as soon as possible. However, there is little consideration in the prize literature to the costs of putting inventions into the public domain at an early date.

Prize proposals go directly against Kitch’s (1977) prospect thesis, that the patent enables the patentee to coordinate further development of the invention. Kitch argues that it is only after the patent has been granted that the patentee is able to work with others who have complementary skills in order to optimize the social surplus from the patent. The patent right serves as an enclosure of the public domain, which would otherwise be mismanaged. In the absence of such a right to control development, which would be observed if the patent right were interpreted narrowly, multiple individuals would enter and attempt to take control of the path of the innovation. Knowing that this splintering would likely occur, the initial inventor would have weak incentives to develop the idea and weaker incentives, relative to the patent regime, to innovate in the first place.

The intellectual property regime is part of society's innovation system, and its intent is to provide incentives to innovate by allowing innovators to restrict the use of the knowledge they produce by allowing the imposition of charges on the use of that knowledge, thereby obtaining a return on their investment. But it is important when thinking about intellectual property rights (IPR) - which include patents, copyrights, and various other parts of the intellectual property system - to realize that there are many other parts of society's innovation system. There are other ways of financing and producing research - for instance, through universities and government-supported research labs. In fact, I would argue, perhaps [*1697] immodestly, that the most important ideas are those that are generated in universities, and many of the most important intellectual advances are not covered at all by the patent system. Look at the basic idea underlying the computer, Alan Turing's "Turing Machine": it was not protected by the patent system. 9 Ideas like asymmetric information are not covered by intellectual property. 10 Another example of important innovations not driven by IPR is the open source movement, which has been particularly successful in software. Even when research is financed by firms, there are other ways of providing returns on knowledge instead of using patents, such as trade secrets and advantages that come naturally to the first entrants in a market economy. There are also other ways of providing incentives; one of them I will discuss is a prize system, which has actually been a part of the innovation system for a couple hundred years. I will argue that, from a societal perspective, prizes have marked advantages over the patent system.

To give you a bit of insight: patent applications to the IPO increased by 7.3% and design applications by 8.9% between 2019 and 2020. And in the following year, TM applications reached a record high of a whopping 137,035; but despite this increase in activity, only 3% of originators actually make money from their designs. I’d like to tell you why, and how to avoid being part of the 97% of innovators who don’t make money from their patents.

There is today a widespread recognition that drug companies have insufficient incentives to develop medicines for the diseases that afflict the poor, simply because there is no money in those drugs. One of the widely discussed ideas for addressing this problem is a guaranteed purchase fund, where the World Bank or the Gates Foundation would guarantee one or two billion dollars to someone who discovers (and patents) a vaccine or a cure for AIDS or malaria or some other disease afflicting the developing world for the purchase of the drug. In effect, there would be a guaranteed market. The guarantee of purchasing one or two billion dollars of the drug would act like a prize, and a sufficiently large guarantee would motivate research. These guaranteed purchase funds, however, would still maintain the inefficiency of the monopoly patent system. The [*1721] discoverer receives his "prize" - the monopoly profits - by charging monopoly prices. The poor who get the drugs through the guaranteed purchase fund do not, of course, pay the monopoly price. But the funds are limited. When the funds are used up, a government that wants to provide to its citizens, say, the malaria medicine that has been incentivized through the guaranteed purchase fund will have to pay the full monopoly price. Money spent to purchase this drug at the monopoly price is money that cannot be spent on the country's other health needs. It is a transfer payment to the monopolist, beyond what the monopolist may have needed to undertake the research. It is far better to use the money for the guaranteed purchase fund to offer a prize, or to buy the patent, and make it available freely (or to anyone willing to pay a limited licensing fee). In short, in areas where there are well-defined needs (such as the need to develop a malaria vaccine) both the prize system and the patent system can provide comparable incentives to undertake research. Both have as an advantage over government-funded research that no one has to pick who should undertake the research: there is a process of self-selection; those who think that they have the best prospects of succeeding (and are able to finance the research and willing to bear the risk) undertake the project. But the prize system uses the force of competitive markets to ensure the widespread dissemination of the benefits of the innovation; the patent system uses monopoly power, restricting the usage, and often distorting the markets in other ways.