Nobel Prize Implies Open Source is A Perfect Market

October 16th, 2007 Stacey Schneider

I have a degree in Economics, however, I have never actually worked as an Economist. I am still interested though, and religiously read all the reports on the Fed, the business section of the newspaper, and once a year, the winners of the Nobel Prize for Economics.

This year, Leonid Hurwicz, Eric Maskin and Roger Myerson won the award for something called Mechanism Design Theory. This theory attempts to answer this central question of how markets become efficient citing that:

As it turned out, the market implements fully efficient outcomes only under very stringent (unrealistic) conditions such as perfect competition, freely available information, private goods, and the absence of any environmental effects of production and consumption.

Specifically, they go on to discuss more on how double auctions, where both buyer and seller reveal a price for an indivisible object (in this case, a piano) to a central auctioneer at the same time. This is the only way to optimize value and ensure resources are allocated appropriately.

However, since for some reason auctions bore me, I decided to look into the other areas of their research on why all these unrealistic conditions occur hoping to find something exciting. Looking at Maskin’s CV, I found it. A paper titled: “Sequential Innovation, Patents, and Imitation” (with J. Bessen), Rand Journal of Economics (forthcoming).

I wondered how forthcoming it was and found that it came. The summary of this paper highlights that:

“…when discoveries are “sequential” (so that each successive invention builds in an essential way on its predecessors) patent protection is not as useful for encouraging innovation as in a static setting. Indeed, society and even inventors themselves may be better off without such protection. Furthermore, an inventor’s prospective profit may actually be enhanced by competition and imitation.”

Now, their premise is on patents and closed source license models. It would be interesting to extend that to Open Source licenses, which grant authors credit and some control, but encourage reuse, extension and innovation. As long as lawyers exist, I am sure Intellectual Property rights will not die. However, as the software market expands and accelerates, we most assuredly have seen the beginnings of the death throes of innovation in a closed source model. People jealously hide their inventions from other developers as well as customers. This process slows their time to market, masks their true value and creates artificial barriers to entry through what essentially amounts to scare tactics.  The market stagnates and dies.

Open Source develops code out in the open, encouraging reuse and improvement. This is an open economy of ideas, development and invention. Customers typically test and use products and understand its value faster and more completely, shortening sales processes. Feedback, through contributions and forum discussions happen openly and in real-time, correcting and improving product direction. Competition also occurs openly, where the vendors backing projects have an open view of their competition’s activities and it is really up to the vendor to push themselves to “one-up” the rest of the market. This open competition spurs faster economics, which means better products at a better price.

I think as long as vendors manage to stay away from the whole “environmental effects of production and consumption” issue, we have a pretty good argument that Open Source is software’s solution to creating the perfect efficient market.  

Entry Filed under: IT Industry