THE THIRD ANSWER HOW MARKET-CREATING DRIVES ECONOMIC GROWTH AND DEVELOPMENT

CLAYTON M. CHRISTENSEN, EFOSA OJOMO, GABRIELLE DAINES GAY, AND PHILIP E. AUERSWALD Two schools of thought have dominated the theory of economic growth over the past half-century. The first and predominant philosophy—associated with Paul Romer, corecipient of the 2019 Nobel Prize in economics, and others— holds that ideas drive economic growth.1. Because ideas, once produced, can be copied and shared with minimal cost (so the story goes), they can fuel sustained economic growth in ways that are not possible for other factors of production. The second school of thought pace globally until the 18th-century Age of acknowledges that ideas may be the seeds Enlightenment, when the simultaneous of growth but points out that such seeds emergence of scientific methods and pro- cannot, and will not, grow in poor soil. cedures of modern democracy propelled The most fertile soil for growth is quality humanity into an era of learning and dis- institutions—the lack of which is the ulti- covery far beyond any previously mate limiting factor in most places. known.3. Institutions refers to a nation’s “soft” So, which is it—do ideas or institu- infrastructure and includes entities that tions fundamentally drive long-term eco- make up the financial, judicial, legal, nomic growth? In this essay, we propose political, and even some social systems. that the most historically accurate and Institutions can be formal (nation-states, practically useful answer to this question schools, hospitals) or informal (practices is, in fact, neither. In the place of these and structures of authority that derive two conjectured fundamental drivers of from custom and culture rather than laws long-term economic growth we propose a and policies). This line of argument has third: market-creating innovation. been so persuasive that some internation- What supports this assertion? First, al organizations, such as the United ideas result in economic growth and Nations and the World Bank, collectively development only when they are realized spend billions of dollars trying to help through market-creating innovation. (We people in poor countries develop new explain below why we emphasize “mar- institutions or fix existing ones.2. ket-creating” innovation). The actual Both of these perspectives have evi- process of market-creating innovation is dent merit—indeed, they are historically nothing like the zero-cost transfer of linked. Economies expanded at a snail’s ideas—knowledge spillovers—that are the

10 / Blockchain for Global Development II centerpiece of ideas-based theories of time, the revolution in transport brought economic growth.4. Market-creating about by automobiles and motorcycles. innovation is costly and difficult.5. It This example generalizes broadly. involves highly specialized and skilled In very different ways, ideas-based agents working over extended periods of and institution-based theories of eco- time. nomic development both fail to account Furthermore, contrary to expert con- adequately for the central role of market- sensus but consistent with history, mar- creating innovation and its close relative, ket-creating innovation drives institu- individual agency. Individual agency and tional growth, not the other way around. innovation bring ideas into economic Institutions represent the adaptive practice and in so doing they shape the response of human communities to evolution of institutions. changes in the environment.6. For exam- In this essay, we begin by offering a ple, in every city in the world we observe definition and two examples of market- a complex set of institutions designed to creating innovation that provide a foun- handle traffic—traffic-management sys- dation for the historically informed theo- tems (stoplights, railway crossings), ry that follows. With this definition and urban planning (crosswalks, overpasses), the examples in mind, we next assess the a legal apparatus to enforce traffic laws, two dominant theories of development— and so forth. However, these institutions essentially, the currently dominant clearly did not create urban traffic; the answers to the centuries-old question of traffic came first, and human communi- why some countries prosper while others ties had to come up with ways to deal do not. Building on this, we assess how with it. But what created the traffic? new influences such as Blockchain tech- Market-creating innovation—in our nology and emerging business models

ABOUT THE AUTHORS Clayton M. Christensen is the Kim B. Clark Professor of Business Administration at the . Christensen is the author of nine books and more than a hundred articles, most recently including The Prosperity Paradox: How Innovation Can Lift Nations Out of Poverty, with Efosa Ojomo and Karen Dillon. Efosa Ojomo is a Senior Research Fellow at the Institute for . Ojomo holds an MBA from the Harvard Business School. Gabrielle Daines Gay is the COO of Ensign College of Public Health in Kpong, Ghana; Director of Emerging Market Strategies at Kensington Capital Holdings; and Executive Director of The Schumpeter Center for Innovation and Development. Gay holds an MBA from INSEAD. Philip E. Auerswald is an Associate Professor of Public Policy at the Schar School of Government, George Mason University; cofounder and CEO of Zilla Global LLC; and the cofounder and coed- itor of Innovations journal. His most recent book is The Code Economy: A Forty-Thousand-Year History.

© 2018 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald innovations / volume 12, number 3/4 11 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald relate to market-creating innovation, ubiquitous and represent a critical com- institutional evolution, and, ultimately, ponent of economies worldwide. They economic development. We offer specific often enable companies and their host examples of how Blockchain technology countries to remain competitive, but their is being deployed to support market-cre- impact on an economy differs from that ating innovation. We conclude by consid- of market-creating innovations. For ering how a better understanding of the instance, companies rarely need to build drivers of development prompts us to new sales, distribution, marketing, and reconsider the definition of development manufacturing engines when they devel- itself. op sustaining innovations in a mature market because they are using established RESCUING “INNOVATION” channels to sell to an existing customer FROM MISUSE AND base within a familiar segment of the pop- OVERUSE ulation. Examples of sustaining innovations The word “innovation” is routinely over- are all around us: a new model of mobile used and “under-understood.” For clarity, telephone, a new car model, a new flavor we use the definition that innovation is “a at a local ice cream parlor, or a new dish- change in the process by which an organ- washing detergent. While these innova- ization transforms labor, capital, materi- tions keep economies vibrant and excit- als, or information into products and ing, they have a far more limited effect services of greater value.”7. In essence, than market-creating innovations on job innovation is not necessarily high tech, creation, profit generation, and changing overly advanced, or even entirely new, the economic climate. and therefore is different from invention. Efficiency innovations enable com- From an economic development stand- panies to do more with fewer resources. point, innovations can be market-creat- More precisely, as companies squeeze as ing or sustaining, or improve efficiency. much as possible from existing and newly Market-creating innovations do acquired resources, their underlying busi- exactly what the term implies: they create ness model and the customers they are new markets. But these are not just any targeting remain the same. Therefore, as new markets; they are new markets that market sectors become more crowded serve people for whom either no products and competitive, efficiency innovations existed or existing products were not are crucial for companies to remain accessible for a variety of reasons, includ- viable. Efficiency innovations typically are ing cost or a lack of the expertise required process innovations that focus on how a to use them. Market-creating innovations product is made and not necessarily on transform complicated and expensive whom the product is sold to. Efficiency products into ones that are much more innovations can make a company more affordable and accessible to an increased profitable and, critically, free up cash number of consumers. In some cases, flow. Outsourcing is one of the most com- such innovation can create entirely new mon examples of efficiency innovation. product categories. When a firm decides to move any part of Sustaining innovations are improve- its operation to a region where costs are ments to solutions already on the market. lower, it is practicing efficiency innova- They typically target customers who tion. Another example is when an organ- require better performance from a prod- ization uses technology to reduce the cost uct or service. Sustaining innovations are of operating so it can generate more prof-

12 innovations / Blockchain for Global Development II The Third Answer its. Resource extraction and low-wage tions, and many others. Singer under- manufacturing industries are prime stood that to create this market he needed examples of operations that thrive on effi- to build and manage a system that would ciency innovations. make it easy for customers to purchase and use these machines. This also would TWO EXAMPLES OF bring costs down and make the machine MARKET-CREATING accessible to many more Americans. INNOVATION

In the 1850s, several American entrepre- neurs were challenging one another in The key to Singer’s court for patent infringement related to the sewing machine. These entrepreneurs success, however, continued to sue one another until they wasn’t simply the realized that the strategy was pointless. No one was making any money or any technology. It was in progress—with the possible exception of the lawyers who filed the suits. In 1856, his , recognizing this impasse, the men had the which targeted non- inspired idea to join together and create the world’s first patent pool: the Sewing consumption and Machine Combination. Each would build their company using the pooled technolo- created a new market gy and would pay a royalty to the patent pool, to their collective benefit.8. for a whole set of One entrepreneur who joined the people who previously sewing machine patent pool was Isaac M. Singer. Unlike the other entrepreneurs in had no sewing the pool, Singer’s genius stemmed from the fact that he built a company focused machine. not just on making a good sewing machine but on creating a market for the machines. At the time, the sewing machine was not only expensive for the The success of Singer’s company was average American family, it was also not unprecedented. I. M. Singer & Co. part of the cultural norm. People had few became the first major multinational sets of clothing and organized their lives American company built by an entrepre- around that fact. Singer was told time and neur without major government support. again by the experts of the time that he His operation led to the creation of many would fail. Instead of listening to the other industries: the closet/wardrobe experts, he built the systems required to industry so people could store their create a new market. Some of his innova- clothes, the fashion industry, textile man- tions, many of which seem mundane ufacturing, clothing stores, and many today, include branch sales offices, door- others. to-door sales, lessons for prospective cus- Another outcome of Singer’s innova- tomers on how to use the machine, selling tion was that workers in the textile indus- on credit, building distribution and trans- try, and in a few others such as steel, coal, portation infrastructure into his opera- and other manufacturing, played a signifi- innovations / volume 12, number 3/4 13 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald cant role in the labor movement to add more than $210 billion in value to improve workers’ rights and the condi- African economies. It is hard to believe tion in which they worked. The institu- that, as recently as the turn of the century, tions that led these changes emerged only cell phones were largely toys for the rich. after market-creating innovators had cre- To achieve his success, however, Ibrahim ated enough workers and consumers. It first had to create the market. Once he didn’t happen the other way around. did, the attendant benefits—taxes, The key to Singer’s success, however, enforceable regulations, jobs, infrastruc- wasn’t simply the technology. It was in his ture, and so on—followed. business model, which targeted non-con- sumption and created a new market for a MARKET-CREATING whole set of people who previously had INNOVATION AS A VEHICLE no sewing machine. In Singer’s case, and FOR CONVERTING IDEAS whenever that happens, society benefits INTO ECONOMIC GROWTH immensely. AND DEVELOPMENT Today the frontier for market-creat- ing innovation is arguably in the coun- In ideas-based theories of economic tries that have most recently become part growth, “ideas” are special in two ways. of the global economy—so-called devel- First, they augment production, as a larg- oping countries. In the late 1990s, before er pool of ideas allows more output with Sudanese entrepreneur Mo Ibrahim cre- the same set of inputs. Second, although ated a market for mobile phones in investment is required to generate new Africa, fewer than 20 million, or 2.5 per- ideas, once an idea is produced it is trans- cent, of the 800 million people living in ferable at zero cost. In technical parlance, Africa had mobile phones. The ideas in such models are characterized as Democratic Republic of Congo, for being non-rival and non-excludable. instance, with a population of more than Non-rival means that one person’s use of 55 million people, had only 3,000 cell an idea does not keep another person phones. Nigeria had fewer than one mil- from using it; non-excludable means it is lion telephone lines for its 126 million impossible to keep a person from using an people. In just six years, however, idea once it is out in the open. Another Ibrahim’s Celtel built mobile telecommu- term, “knowledge spillovers,” refers to the nications operations in 13 African coun- free transmission of ideas that are non- tries—including Uganda, Malawi, the two rival and non-excludable. In contrast, a Congos, Gabon, and Sierra Leone—and product is rivalrous if its consumption by gained 5.2 million customers. It was com- one person precludes its consumption by mon to see eager customers line up by the another; it is excludable if access to it can hundreds for the opening of many of be limited. An automobile, for example, is Ibrahim’s stores. rivalrous and excludable; sunshine is nei- Celtel was so successful that, by 2004, ther.9. revenues had reached $614 million and Let’s now reconsider the story of Mo net profits were $147 million. Ibrahim Ibrahim and Celtel in light of the argu- sold the company in 2005—for $3.4 bil- ment that, because ideas are non-rival and lion. Perhaps more impressive is the fact non-excludable, economically relevant that the mobile telecommunications mar- innovations are characteristically subject ket in Africa now supports more than 950 to knowledge spillovers. The idea for the million subscriptions, employs more than mobile phone and for mobile phone net- three million people, and is forecast to

14 innovations / Blockchain for Global Development II The Third Answer works—which in this context we’ll con- knowledge spillovers, then evidence of sider the “invention” of the mobile spillovers will be everywhere. However, phone—existed long before Ibrahim the critical point we are making is that, began to bring mobile phone service to when such pathways involve economic the African continent. However, it is a benefit derived from market-creating gross over-simplification to say that the innovation, they usually also involve sig- idea for the mobile phone and mobile nificant costs: recruiting a key employee phone networks simply “spilled over” from a competitor firm or industry leader; into Uganda, Malawi, and Sierra Leone, undertaking research to invent around an ultimately creating a $3.4 billion company existing patent; reverse-engineering a that provided service where it was previ- product; paying for employees to attend ously unavailable. What was required to conferences; hiring consultants; and bring the mobile phone to sub-Saharan building trusted relationships with buyers Africa to provide service to those who had and suppliers. no access to telecommunications of any type and in so doing to propel economic growth was not the idea for the mobile phone and for mobile phone networks. What was required to What was required was market-creating bring the mobile phone innovation. As pioneering evolutionary econo- to sub-Saharan Africa mist Sid Winter wrote fully 50 years ago, “‘Knowing how to bake a cake’ is clearly ... was not the idea for not the same thing as ‘knowing how to the mobile phone and bring together all of the ingredients for a cake.’ Knowing how to bake a cake is for mobile phone knowing how to execute the sequence of operations that are specified, more or less networks. What was closely, in a cake recipe.”10. Much of the work of executing the “recipe” for mar- required was market- ket-creating innovation is not available in creating innovation. any “innovation recipe book” and cannot be transferred at a low cost. To the con- trary, the ideas (or recipes) that are criti- cal to market-creating innovation, and Market-creating innovation thus nec- that actually propel growth and develop- essarily and systematically involves the ment, are overwhelmingly uncodified, search for ideas that are, in fact, rivalrous context dependent, and transferable only and excludable (at least temporarily), out at significant cost—which is to say that of which ventures with proprietary value tacit knowledge dominates, information can be created.12. The impediment to mar- asymmetries are the norm, and transac- ket-creating innovation that matters most tion costs are significant.11. is not a lack of appropriability of returns There is no disputing that ideas creat- (as default New Growth formulation ed by one person or one firm can reach would suggest) but the everyday battles other people or firms through multiple involved in communicating ideas, build- pathways, many of which do not involve ing trust, and making deals.13. the beneficiary directly compensating the Consequently, while knowledge spillovers innovator. If we define such pathways as of the type emphasized by Romer are innovations / volume 12, number 3/4 15 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald present everywhere, they are unlikely to keep Japanese drivers safe. As a result, the be relevant to the activities that are most country has one of the lowest traffic fatal- critical to economic growth and develop- ity rates in the world—6.5 fatalities per ment.14. 100,000 vehicles each year. To put that In this sense, there is almost total into perspective, the United States has contrast between the view of productive twice the rate of fatalities, Europe has knowledge that emerges from the micro- almost three times as many deaths per theory of entrepreneurship and the view vehicle, and China has a fatality rate that characterizes dominant macro-theo- approximately 16 times that of Japan. ries of economic growth. From that vantage point, the Japanese institutions that manage the nation’s traf- MARKET-CREATING fic and transportation are working. But INNOVATION AS A DRIVER that was not always the case. Japan’s traf- OF INSTITUTIONAL fic laws have in fact evolved to solve the EVOLUTION specific challenges brought about by the proliferation of motor vehicle innova- Our simple definition of innovation tions in the country. and its categorization into three types Jeffrey Alexander’s book, Japan’s provides a frame for how innovations Motorcycle Wars: An Industry History, impact an economy and, more specifi- provides a brilliant summary of how the cally, the development of institutions in Japanese government developed traffic an economy. Our experience has institutions first as a response to the pro- revealed that innovation is not some- liferation of all wheeled vehicles and later specifically to motorized vehicles. In the thing that happens on the fringes of early 1900s, it was common to find “cars, society after society has “fixed” itself— trucks, motorcycles, horses, horses, ox- that is, after it has developed function- drawn vehicles, rickshaws, men pulling ing and trusted institutions. Innovation wagons, and pedestrians” on urban roads. is, rather, the process by which institu- Alexander writes, “Improved traffic tions that are critical to development enforcement was thus required in urban emerge. It is through innovations that centres such as Tokyo, and the motorcy- create or connect to new markets that cle came to play a key role.”15. He explains societies can create jobs, pay taxes, and, that the government responded to the ultimately, build strong and lasting spread of vehicles by legislating who institutions. Innovation, we have found, could access and operate motor vehicles. is what keeps economic engines rolling By 1918, Tokyo had established a traffic and a society progressing, as illustrated police squad, instituted traffic police uni- by the following cases. forms, and provided traffic stations for these new government employees. At first Japanese Transportation the enforcement of these laws was hap- Regulations hazard, but standardization improved over time. Today Japan finds itself in the Today, Japan has more than one million enviable position of having one of the kilometers of paved roads and thousands safest traffic systems in the world. of traffic laws that help manage the 69 Low- and middle-income countries million motor vehicles operating in the would do well to study the effect on country. These roads and laws not only Japanese society of the proliferation of regulate traffic in Japan, they also help motorcycles and other vehicles before the

16 innovations / Blockchain for Global Development II The Third Answer country developed institutions to enforce Parliaments were created to be insti- traffic laws and regulations. The innova- tutions that could negotiate with tions came first, then the institutions that investors, manage the public purse, and helped to manage the impact of the inno- provide guarantees on the debt taken up vation. by monarchs. The era of bullying gave way to an era of seduction because, all of European Parliaments and Courts a sudden, citizens could move their assets A lack of rule of law, corrupt judiciaries, (innovations) more easily. A new type of and untrustworthy parliamentary bodies economy had emerged, from one that are the hallmarks of many low- and mid- plundered wealth to one that sought to dle-income countries. Rich and prosper- create it. A similar sequence of events ous nations in Europe boast much better happened with the establishment of the systems, at least relatively speaking. How European courts. Originally established did they get these systems? In Prosperity to resolve disputes expeditiously, the and Violence: The Political Economy of courts became more relevant as they Development, Robert Bates describes the resolved more and more disputes. The sequence of events that led to the develop- fees they charged in time caused the ment of Europe’s distinctive political courts to become profit centers for many institutions.16. Consider, for example, how European monarchs. When first estab- our understanding of the risks associated lished, parliaments and courts did not sat- with sovereign debt has changed over the isfactorily represent the will of the people. past few centuries. Today we may see sov- Over time, however, as the citizenry ereign debt, especially that of prosperous became more prosperous, these institu- European nations, as less risky than pri- tions became more effective and repre- vate debt. However, that was not always sentative. We must remember that inno- the case. Hundreds of years ago, when vation and prosperity came first, and the most of Europe was made up of individ- institutions—at least the well-functioning ual monarchies where rulers could take, ones—followed. plunder, and kill at will, investors grew Once again, the innovation of mov- increasingly unwilling to lend money to able currency resulted in the creation of kings and to those subject to these social new economic features and, subsequently, conditions. As measures of wealth more institutional stability in the region. expanded from royal landholdings U.S. Food and Drug (unmovable assets) to include precious Administration metals and currency (assets more easily moved), investors became more powerful Consider the emergence of the U.S. Food and selective in choosing the monarchs to and Drug Administration (FDA). Because whom they loaned money. This led mon- of the nature of foods and drugs and how archs to figure out new ways to extract they are integrated into our lives, fewer resources from their subjects. Bates writes industries are more important when it that “monarchs innovated new ways of comes to protecting public health and tapping the private wealth of their citi- safety. History provides too many exam- zens. Among the most significant was the ples of how allowing “bad foods” into the creation of parliaments—fora in which market can be fatal, often with little or no they could trade concessions in public warning. A similar case could be made for policies for the payment of public rev- drugs. If any industries made it necessary enues.”17. to force regulations on them in order to innovations / volume 12, number 3/4 17 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald protect the population’s health and safety, improved regulatory environment, it is it was food and drugs. But, in fact, even also clear that regulations and the enforc- the FDA did not push regulations onto ing institutions can stymie innovation these industries before entrepreneurs had and new entrants. discovered market-creating innovations In each of these circumstances, inno- that impacted millions. The innovations vation preceded regulation. It was only came first. after an innovation was introduced into In his short paper, “History of Food the market, thereby reducing costs and and Drug Regulation in the United expanding product availability, that regu- States,” Marc T. Law, an economist at the lations began to take hold. Even for University of Vermont, notes that from industries as sensitive as food and drugs, colonial times to the mid-19th century it is hard to make the case that regulations most food and drug regulations in the preceded innovation. In fact, the decision United States were enacted on the state to create the FDA was made only after and local level and focused on limited events led the U.S. Congress to pass the types of food.18. At that time, a majority of 1906 Pure Food and Drugs Act and the U.S. households grew their own food, 1906 Meat Inspection Act.20. thus it would have made little sense to enact sweeping food production regula- Nollywood tions when most foods were not produced Most of the world is unaware that Nigeria for the mass market. Regulations at the has a thriving movie industry, largely time focused on products produced and because Nigerian movies are primarily distributed by industry, such as beef, created to entertain Africans and Africans pork, fish, bread, wine, etc. It wasn’t until in the diaspora. Nollywood’s production the second half of the 19th century that of 1,500 movies annually is second only to the scale and scope of regulation India’s Bollywood—a surprising statistic increased considerably. Law notes that in a country where fewer than 60 percent regulation increased for three reasons: of the population has access to electricity specialization and urbanization, techno- and only 40 percent of households have a logical change in food manufacturing, television. Nollywood has been able to and the average consumer having difficul- thrive precisely because many in the ty detecting foods gone bad. industry focused on creating a new mar- Again we see that as innovation ket that targeted non-consumers. Before improved production it also increased the the rise of the Nigerian movie industry, variety of foods available to millions of most Africans viewed movies produced in people. At the same time, it led to greater Hollywood and Bollywood. Few movies negative consequences from tainted foods from these markets reflected the lives of or unintended reactions to drugs. As the average Africans or considered their cul- technology and complexity of food and tures and collective experiences. As such, drug production increased, it became although Western and Indian movies more difficult for the average observer to were interesting, they were not relevant. detect harmful products. This created a Nollywood changed that. growing perception that regulation by Nollywood’s annual revenues have experts was necessary.19. Meanwhile, in reached $1 billion and the industry cur- order to increase barriers to market entry, rently employs more than one million traditional manufacturers disadvantaged people, second only to the country’s agri- new competitors by calling for more reg- culture industry. Nollywood’s success in ulations. While these events led to an democratizing access to Nigerian movies

18 innovations / Blockchain for Global Development II The Third Answer and entertainment is a win for everyone First, a definition: a Blockchain is a legitimately participating in the industry. public, decentralized, distributed digital As a result, Nollywood has been able to ledger that is used to record electronic pull in better governance as it relates to transactions. Each “block” in a piracy and copyright laws. Appreciating Blockchain contains specific information the industry’s importance as a major that cannot be altered, due to the distrib- source of employment and potential uted nature of the technology. For exam- income from the sale of movies, the ple, your personal bank account contains National Export Promotion Council, the information about deposits, withdrawals, Nigerian Copyright Commission, and the and other transactions such as bank fees. National Film and Video Censors Board These transactions are either stored on a are now collaborating on programs to server that is managed by the bank in a reduce piracy in Nigeria’s film industry. central location or, increasingly, distrib- Governments clearly have a role to uted among servers in “the cloud.” The play in ensuring that their nations bank spends millions of dollars on securi- become prosperous, but our experience ty to reduce the likelihood that bad actors suggests that a government’s enabling can steal your account information by role often follows the success of innova- getting into its systems or accessing its tors. And thus the classic chicken-or-the- cloud-based resources. However, even egg question arises: What comes first— with these massive and ever-growing building institutions or investing in inno- investments in cybersecurity, instances of vations? Our view is that market-creating large-scale intrusion (most of which are innovations act as a magnetic force that never known to the public) continue to pulls in the institutions that have the increase. When successful, the bank’s capacity to trigger further investment and ability to keep your information and innovation. Without market-creating transactions safe and secure builds trust innovations, it is incredibly difficult to between you and the bank. When not suc- build and sustain such institutions. When cessful, this mode of service points out the we put the proverbial cart before the inherent vulnerabilities of large-scale horse, neither the cart nor the horse can scale centralized databases. Trust is move forward. expensive to earn and even more costly when lost. BLOCKCHAIN-BASED A similar thing happens with the reg- INNOVATIONS TO DRIVE istries that manage most of our personal ECONOMIC DEVELOPMENT information, from property to healthcare records. The “managers” store this infor- Blockchain technology has garnered sig- mation, and how we transact with it, in a nificant attention as of late because it is centralized location. And, of course, they the foundation on which cryptocurren- strive to protect it; their ability to protect cies are based, and the foundational tech- our information impacts how much we nology on which many applications aside trust them. In many poor countries, from cryptocurrencies can be built. In this where governments are often under- section, we strip Blockchain technology resourced, there is a lack of trust in the down to its elemental functions by pre- institutions that manage these registries. senting use cases in which Blockchain Land disputes are particularly common. drives economic development by Disputes may arise over overlapping enabling market-creating innovations. ownership claims, tenancy-based and use-based assertions of rights, deliberate innovations / volume 12, number 3/4 19 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald land grabs, and a simple lack of proper More fundamentally, Blockchain recordkeeping, among other causes. The technology dramatically reduces the gap prevalence of such disputes results in a between market-creating innovation and systematic lack of confidence in the insti- the institutions that evolve in response to tutions of land administration. Absent those innovations. In a Blockchain-based reliable institutions, investors have little economy, the market-creating innovation assurance that their property rights will and the institution governing it are fun- be registered accurately and subsequently damentally intertwined. The following protected. This in turn adversely impacts two use cases serve to illustrate. investment not only in real estate but in other related asset classes. Blockchain Use Case #1: Converting Land Occupancy to Land Ownership Blockchain technology Decades ago, acclaimed Peruvian econo- mist Hernando De Soto wrote, “Without has the potential to an integrated formal property system, a modern market economy is inconceiv- reduce uncertainty able. The inefficiencies of non-Western markets have a lot to do with the frag- around land ownership mentation of their property arrangements and other property and the unavailability of standard repre- sentations.”21. In line with institution-cen- claims by providing tric theories of development, De Soto argued that the key to unlocking the verified records, and latent potential of development in poor thereby strengthening places is for governments to improve the systems that enable citizens—particularly institutions. the poor—to assert and defend property claims of all types, especially those related to land. Decades later, economists generally Blockchain technology has the poten- recognize that De Soto’s dream remains tial to reduce uncertainty around land far from a reality in most of the world. ownership and other property claims by Many fail to appreciate two additional providing verified records, and thereby facts. First, inadequate land administra- strengthening institutions. The likelihood tion systems undermine development for of corruption, misunderstanding, and all actors in society, not just the poorest. administrative errors is significantly Second, realizing De Soto’s dream is far reduced when a transparent, distributed, more likely to be achieved through mar- and immutable system is used to manage ket-creating innovation than through the transfer of assets from one party to international donor-driven institutional another. The clarity and reliability of reforms. claims and the increased strength of insti- One coauthor of this essay (Gabrielle tutions that follows from the introduction D. Gay) oversaw the later stages of the of Blockchain-based data systems can construction of the Ensign College of dramatically reduce the frequency of dis- Public Health, a $15 million private col- putes and accelerate the adjudication of lege campus in Kpong, Ghana, some 45 disputes when they do occur.

20 innovations / Blockchain for Global Development II The Third Answer miles outside Accra, only to discover that Blockchain Use Case #2: Ensuring the title to the land on which the campus the Integrity of the Pharmaceutical was built was tied up in a dispute involv- Supply Chain ing at least three other parties. The col- Sadly, and with tragic results, the African lege’s effort to secure a clear land title continent has become a dumping ground turned into three-year process that for counterfeit pharmaceuticals. A 2017 involved hiring legal teams on both sides World Health Organization report esti- of the Atlantic and frequent journeys mates that at least one in ten drugs in low- between continents, courthouses, and or middle-income countries is either sub- various government agencies. All the standard or fake. The organization also while the college operated under a threat found that, in Nigeria in 2007, at least 64 of property seizure and the revocation of percent of antimalarial medications were its accreditation. After the disputes were fake or substandard. A former director resolved, the college purchased the land general of Ghana’s National Health with a full and legitimate title. Due to Service estimated that up to two-thirds of remaining concerns about institutional the drugs on the shelves in that country weakness and the ongoing and unre- are either degraded or counterfeit, noting solved threat of expropriation through that making a more precise estimate is squatting, Ensign College did as most difficult due to the lack of accurate sup- Ghanaians do to signal their indisputable ply-chain data. claim to land—it erected a mile-long wall The market for drugs has long around the perimeter of the 50-acre cam- attracted bad actors. The pharmaceutical pus. industry is particularly vulnerable to Scenarios like this one illustrate why fraud, due to the high markup associated property rights are foundational to socie- with pharmaceutical products, the com- tal development and are the reason many plexity and increased fragmentation of well-intentioned and even well-funded pharmaceutical supply chains, and the endeavors in sub-Saharan Africa end in almost total inability of consumers— failure.22. Unclear property ownership many of whom are poor and have few and property registration not only deter options—to assess the authenticity of foreign investment, they also curb the pharmaceutical products. entrepreneurial initiative of citizens. If The distributed architecture of one cannot clearly lay claim to land, what Blockchain technology has the potential incentive does one have to build on and to enable traceability and transparency in invest in that land? Moreover, how can the pharmaceutical supply chain. A one use one’s land as a verified asset and chain-of-custody log can trace a drug’s employ that asset for the purposes of provenance, not only to its manufacturer finance and investment? but to the source of its raw ingredients. This story illustrates that demand Individual permissioned logs can trace exists in the private sector for improved the drug through raw material sourcing, land administration services. While the manufacturing, packaging, registration, source of that demand in this case was an procurement, and the end stages of distri- organization focused on social invest- bution. This means that a drug’s authen- ment, in many other cases the source of ticity can be determined with confidence. the demand is purely commercial. The transformational potential of this technology is enormous: millions of lives

innovations / volume 12, number 3/4 21 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald could be affected and thousands of lives mentally new data architecture, to the saved. societal and behavioral uncertainties that In this case, again, the market-creat- underlie the introduction of any major ing innovation and the institution that new innovation. Despite these real chal- manages it are essentially the same, as the lenges to its implementation, there is innovation is related to improved gover- every reason to believe that Blockchain nance. technology will pull a whole new category of innovations into existence—as has THE BEST WAY TO PREDICT been the case with market-creating inno- THE FUTURE IS TO CREATE vations for centuries. IT CONCLUSION: SHIFTING Technology alone rarely solves social FROM AN ASSET-CENTERED challenges; however, the application of TO A VALUE-CENTERED technology through innovation has often ECONOMY done so. Blockchain is no exception. Blockchain’s potential to transform many Governments around the globe are look- sectors of the world’s economies—espe- ing for opportunities to create robust and cially in low- and middle-income coun- inclusive economic development for their tries—is immense. The two examples citizens. The rapid development of above demonstrate that Blockchain can machine-learning technology—and the advance development through better new generation of artificial intelligence recordkeeping, particularly in economies that machine learning has enabled— where systems either don’t exist or the makes the challenge of sustaining inclu- systems that do exist are untrustworthy. sive development all the more urgent. Blockchain technology also has the Some governments, inspired by institu- potential to spark a whole new set of tion-based theories of development, have entrepreneurial activities we can barely focused on improving their ranking in the fathom today—much as it was difficult to World Bank’s “Doing Business” indica- imagine 15 years ago that a company such tors and signaled in other ways that their as Facebook would emerge and grow to jurisdictions are structured favorably for have a valuation of nearly $400 billion (at external investment. Others, inspired by the time of writing). During the early days ideas-based theories of development, of the Internet, there were many skeptics have focused on increasing the intensity who neither understood what the World of their investment in academic infra- Wide Web really signified nor believed structure and basic research. As laudable that any significant economic value could as these efforts are, history has shown come from it. Blockchain is in a similar that, without a firm commitment to phase, but we believe that Blockchain investing in market-creating innovations, technology has the potential to transform many of these programs will not result in how we engage with the world and the sustained economic growth and authentic global economy in as fundamental a man- development. ner as the Internet. As famed Austrian economist Joseph The challenges faced in realizing the Schumpeter wrote in his foundational potential of Blockchain technology are work, Capitalism, Socialism, and abundant and increasingly well under- Democracy, stood. They range from the cost of transi- tioning from legacy systems to a funda-

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Queen Elizabeth [I] owned silk take the lead in building market-creating stockings. The capitalist achieve- innovation on Blockchain ledgers. The ment does not typically consist in process will be halting and unpredictable. providing more silk stockings for As has always been the case with emer- queens but in bringing them with- gent technologies, the alignment of public in the reach of factory girls in interest and business purposes will not return for steadily decreasing follow from any single plan or directive amounts of effort. The capitalist but will be shaped over time by millions process, not by coincidence but by of individual choices. virtue of its mechanism, progres- sively raises the standard of life of the masses.23. Blockchain provides a In his 2007 Harvard commencement address, Bill Gates stated similarly that vehicle for reducing “humanity’s greatest advances are not in its discoveries but in how those discover- inequity not through a ies are applied to reduce inequity.”24. The innovations that matter most are temporary and not those that provide marginal improve- contentious ments in offerings for the already well- served but those that open up entirely redistribution of new possibilities for otherwise excluded market majorities. The greatest discover- income but through a ies will be those that, when rightly more fundamental and applied, enable entire populations to enjoy healthier lives, greater freedom, and sustainable expanded opportunities for self-defini- tion. redistribution of value. Unlike the current generation of plat- form-based business models that concen- trate the ownership of information and drive value to the center, Blockchain- What is more, as this process unfolds, based business models are structured to the limiting factor will not be the volume distribute the ownership of information of new ideas available to Blockchain inno- and drive value to the edges—where cus- vators—it will be the capacity of each of tomers and citizens are located. By intrin- us to embrace our true identity and to sically linking market-creating innova- benefit from new forms of social contri- tion and the evolution of institutions, bution. Just as the sewing machine and Blockchain provides a vehicle for reduc- the mobile phone opened up new modes ing inequity not through a temporary and of human creation and connection, contentious redistribution of income but Blockchain-based business models will through a more fundamental and sustain- require us to leave behind the 20th-centu- able redistribution of value. ry mindset in which our identities are As we have illustrated with the above defined by jobs and our wealth is defined examples, Blockchain will realize its by our assets. We will be challenged to potential to drive development only to the embrace an emerging world in which our extent that entrepreneurs and innovators identities are once again anchored in our relationships and our wealth is defined by innovations / volume 12, number 3/4 23 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald what we have the capacity to offer. Assessing and responding to Malawi’s Now, as in the past, the pathway to history of institutional reform. Policy progress will be blazed not by ideas or Research Working Paper No. 8289. institutions but by market-creating inno- Washington, DC: World Bank. vations. https://openknowledge.worldbank.org/ handle/10986/29111. REFERENCES Christensen, C. M. (1997). The innova- tor’s dilemma: When new technologies Agwara, H., Auerswald, P., & cause great firms to fail. : Higginbotham, B. (2013). Algorithms Harvard Business School Press. and the changing frontier. In The Coase, R. (1937). The nature of the firm. changing frontier: Rethinking science Economica, 4, 386-405. and innovation policy (pp. 371-410). DeSoto, H. (2000). The mystery of capital: Chicago: University of Chicago Press. Why capitalism succeeds in the west and Alexander, J. (2008). Japan’s motorcycle fails everywhere else. New York: Basic wars: An industry history. Vancouver, Books. CA: UBC Press. Gay, G. D. (2018). The business of giving. Andrews, M. (2013, March 8). Why Innovations online. https://innovation- institutional reforms in the developing sjournal.net/the-business-of-giving- world aren’t working. The Guardian c73968909855 online. Gates, Bill (2007). Address at Harvard: https://www.theguardian.com/global- Commencement, July 7, 2007. development-professionals- Innovations: Technology, Governance, network/2013/mar/08/institutional- and Globalization, 2(4), pp. 3-9. reform-international-development Hounshell, D. (1985). From the American Auerswald, P. (2007). The simple eco- system to mass production, 1800-1932: nomics of technology entrepreneur- The development of manufacturing tech- ship: Market failure reconsidered. in D. nology in the United States. Baltimore: B. Audretsch, I. Grilo, & R. Thurik Johns Hopkins University Press. (Eds.), The handbook of entrepreneur- Law, M. T. (n.d.). History of food and ship policy. Northampton, MA: Edward drug regulation in the United States. Elgar. EH.net. http://eh.net/encyclopedia/his- Auerswald, P. (2008). Entrepreneurship tory-of-food-and-drug-regulation-in- in the theory of the firm. Small Business the-united-states/ Economics, 30, 111-126. Romer, P. M. (1986). Increasing returns Auerswald, P. (2010). Entry and and long-run growth. Journal of Schumpeterian profits: How technolog- Political Economy, 94, 1002-1037. ical complexity affects industry evolu- Romer, P. M. (1990). Endogenous tech- tion. Journal of Evolutionary nological change. Journal of Political Economics, 20, 553-582. Economy, 98, S71-S102. Auerswald, P. (2017). The code economy: Schumpeter, J. A. (1942). Capitalism, A forty-thousand-year history. New Socialism and Democracy. New York: York: Oxford University Press. Harper and Brothers. Bates, R. (2001). Prosperity and violence: Schumpeter, J. (2005). The theory of eco- The political economy of development. nomic development: An inquiry into New York: W. W. Norton. profits, capital, credit, interest, and the Bridges, K., & Woolcock, M. (2017). How business cycle. New Brunswick, NJ: (not) to fix problems that matter: Transaction. Originally published as

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Schumpeter, J. A. (1912). Theorie der 3. For the purpose of this article, we will witschaftlichen Entwicklung. Leipzig: designate high-income countries, as Duncker & Humblot. Original English defined by the World Bank, as prosperous. translation, O. Redvers. (1934). The the- 4. Romer (1986, 1990), among others. ory of economic development. Oxford, 5. Christensen (1997). UK: Oxford University Press. 6. Winter, S. G. (1968, March). Toward a Those changes can be exogenous (for neo-Schumpeterian theory of the firm. example, institutions created to manage periodic flooding) or endogenous (for RAND Working Paper P-3802. example, institutions created to manage traffic in cities). 1. Properly, the Sveriges Riksbank Prize in 7. This definition is consistent with Economic Sciences in Memory of Alfred Schumpeter (2005/1912), who defines Nobel. innovation as taking an invention and 2. This view, quite understandably and often placing it firmly into a market, a process with the best of intentions, causes us to that leads to development or the push the “right” institutions onto poorer production of new combinations. In nations. But many of these institutions not Chapter 2, Schumpeter writes that “to only cost billions of dollars to operate, they produce means to combine materials and also fail to bring about lasting change in forces within our reach. To produce other the regions where they are being brought things, or the same things by a different in. Andrews (2013) reports that “as many method, means to combine these materials as 70% of [institutional] reforms seem to and forces differently” (p. 65). This is have muted results.” Perhaps what’s worse important because innovation is often is that the “success” of many institutional mistaken for invention, or something reform projects, according to World Bank entirely new. For the purpose of economic specialist Kate Bridges and World Bank development, this isn’t the case. According social scientist/ lecturer to Schumpeter, one illustration of this Michael Woolcock, is measured by how process of combination is “the opening of a much the new institutions resemble those new market, that is a market into which the in wealthy countries, rather than whether particular branch of manufacture of the the institutions actually solve a problem country in question has not previously (Bridges & Woolcock, 2017, p. 7). Bridges entered, whether or not this market has and Woolcock (2017) document that, existed before” (p. 65). In essence, it does between 2006 and 2011, institutional not matter that something existed in reform was a feature of more than $50 another country; if it is new to the country billion worth of World Bank-sponsored where it is being introduced, it is bound to projects and accounted for about a quarter have an impact on development. of the cost of these projects. Other major 8. Hounshell (1985, p. 67). development organizations, such as the 9. In the deliberately over-simplified model of Department for International Development the world known as “perfect competition” and the Asia and Africa Development in economics, trade exclusively refers to Banks, are also increasing the number of goods that are rivalrous and excludable. “institutional reform” projects they fund. Exchange occurs without any frictions. It is The trend is growing rapidly with no signs in contrast with this toy model that of slowing down, and the view that economists use the term “market failure” institutions are the primary problem in to refer to an array of ubiquitous frictions poor countries has even become that can occur in exchanges, including mainstream. Ask any layperson what some transactions costs, monopoly power, of the major reasons are that poor asymmetry of information, and imperfect countries remain poor, and they will soon appropriability. Imperfect appropriability mention a lack of functioning institutions results directly from a lack of excludability, innovations / volume 12, number 3/4 25 Clayton M. Christensen, Efosa Ojomo, Gabrielle Daines Gay, and Philip E. Auerswald

not from rivalry. It is a general concept, as laissez faire can be applied. Not so with applicable to the dredging of a river to many of the adulterations of food. minimize the risk of flooding as it is to the Scientific inspection is needed to detect the creation of a nursery rhyme. In the case of fraud, and scientific inspection is beyond dredging, the lack of excludability results the reach of the ordinary consumer. In from the diffuse impact of the investment. such cases, the Government should In the case of the nursery rhyme, the lack intervene” (Congressional Record, of excludability results from the ease of 49th Congress, 1st Session, pp. 5040-5041). copying. Activities subject to imperfect 20. The Pure Food and Drugs Act was passed appropriability are, generically, those for in 1906, thanks in part to the public which private and social returns to outrage at the shockingly unhygienic investment diverge. The creation of new conditions in the Chicago stockyards that ideas is widely thought to be subject to were described in Upton Sinclair’s book, imperfect appropriability for reasons of The Jungle. both diffuse impact and ease of copying. 21. De Soto (2000, p. 164). Each use of a new vaccine, for instance, will create lower susceptibility to contagion for 22. Gay (2018). an entire population. Thus, while a 23. Schumpeter (1942). particular dose of a vaccine is both rival 24. Gates (2007). and excludable, its benefits are neither. Price will not reflect marginal social benefits (or costs, as the case may be). 10. Winter (1968, p. 9). 11. Winter (1968); Agwara, Auerswald, & Higginbotham (2013); Auerswald (2017). 12. Auerswald (2007, 2008, 2010). 13. More fundamentally, the greater the intensity of market failures, the stronger the motivation for the creation of new firms. See Coase (1937) and Auerswald (2007). 14. Romer (1986, 1990). 15. Alexander (2008). 16. Bates (2001). 17. Bates (2001, p. 52). 18. Law (n.d.). 19. Law (n.d.) notes that this rationale for regulation was articulated by a member of the 49th Congress (1885): “In ordinary cases the consumer may be left to his own intelligence to protect himself against impositions. By the exercise of a reasonable degree of caution, he can protect himself from frauds in under-weight and in under- measure. If he can not detect a paper-soled shoe on inspection he detects it in the wearing of it, and in one way or another he can impose a penalty upon the fraudulent vendor. As a general rule the doctrine of

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