Should investment in innovation worry about geographic dispersion? Steve Case says "yes", but what about Pareto?

Does it matter that most innovative activity, at least in the United States, is taking place in a small number of VC-funded locations? Steve Case seems to think so. For Kat readers who may not recognize the name, Case was co-founder in the 1980’s of what later was called AOL. The company was a pioneer internet company, particularly in its vision of exploiting the platform in the creation of on-line communities. Case and AOL gained particular notoriety as a result of the merger with Time Warner in 2001. The deal has been criticized by some as one of the worst mergers of the internet age. Whether or not, Case’s guru status in the digital world seems to have been unaffected.

Case has become preoccupied with the future sources of innovation (who can argue with that?) and he has penned a widely-discussed book, “The Third Wave: an Entrepreneur’s Vision of the Future”. One of Case’s recent concerns, as he discussed in a recent interview and podcast on Bloomberg radio, is that 78% of all venture capital is invested in only three locations—San Francisco/Silicon Valley, Boston, and New York. So troubled is Case about this state of affairs that he has embarked on Rise of the Rest road trips in the US to seek/encourage significant innovation that might/should take place in other locations and which, in time, will also presumably enjoy a fair share of venture capital funding.

He pointed to medical technology and the advantages of supporting the tethering of innovative activities to leading medical centers. I.e., instead of opening yet another start -up in Silicon Valley, why not promote start-ups in Cleveland to support the innovation coming out of the Cleveland Clinic, or in Baltimore to support similar activities at the Johns Hopkins School of Medicine. Or, more generally, to encourage start-ups in Detroit instead of, e.g., Boston or New York, to take advantage of the large pool of engineers in Michigan (due in part to the presence of the auto industry), the lower cost of living and the more relaxed Midwestern life style.

Far be it from this Kat to take on Steve Case. Still, this Kat is having some difficulty in understanding the advantages to entrepreneurship and innovation that would follow from a greater geographic dispersion of such activity. (For purposes of this post, I disregard what may be a prime political consideration, namely that such dispersion might help prevent a further economic hollowing out on a geographic basis, thereby reducing the likelihood of populist excesses.) Once we discount this, the question is whether such dispersion will lead to greater aggregate innovative activity at the national level.

What comes to mind in addressing this issue are the dynamics of the so-called Pareto principle, which is described by Wikipedia as follows--

"The Pareto principle (also known as the 80/20 rule, the law of the vital few, or the principle of factor sparsity states that, for many events, roughly 80% of the effects come from 20% of the causes. Management consultant Joseph M. Juran suggested the principle and named it after Italian economist Vilfredo Pareto, who noted the 80/20 connection while at the University of Lausanne in 1896, as published in his first paper, "Cours d'économie politique". Essentially, Pareto showed that approximately 80% of the land in Italy was owned by 20% of the population; Pareto developed the principle by observing that about 20% of the peapods in his garden contained 80% of the peas.

It is a common rule of thumb in business; e.g., "80% of your sales come from 20% of your clients." Mathematically, the 80/20 rule is roughly followed by a power law distribution (also known as a Pareto distribution) for a particular set of parameters, and many natural phenomena have been shown empirically to exhibit such a distribution [footnotes omitted].”

Is not the current dispersion pattern perhaps an exaggerated instance of the Pareto principle? This Kat understands that this principle is far more nuanced that a single quotation might suggest and indeed it means different things to different people. But the underlying point suggests that the concentration of venture capital funding in only three centers is not necessarily a bad thing, and may even be positive. If a fourth (or fifth or sixth) start-up center for attracting significant venture capital will emerge, it will do on an organic basis, because the factors that have facilitated the current locations will also find a home in these additional locations. But it cannot be willed into existence.

Kat readers who want further convincing are invited to read the piece that appeared on February 28, 2017, on Bloomberg.com, “Why It’s So Hard to Build the Next Silicon Valley: Google brought its high-speed internet to Kansas City, but it didn’t turn the city into a tech paradise.”

The image at the top right was originally posted to Flickr by Thiago Avancini

The image at the lower left was made by Bill Ebbesen