We’ve not done one of these for a while so here goes.
Dan Davies’ Lying for Money is an economic history of fraud which emphasises its relationship with the social trust necessary for civilisation. Practices like accounting, auditing, and record-keeping are in some sense technologies that permit us to manufacture artificial trust, and of course so is fraud. If you read this blog you’ve probably read about eight reviews of this book, so I’ll be brief and say that it makes sense and the frauds themselves are fascinating. (I like the detail that Reggie Kray’s accountant tried to get him to stop keeping a ledger of bribes he paid to the police.) One of D^2’s recommendations is that you should be suspicious of anything in a set of accounts that suddenly starts growing dramatically, which leads naturally to the next book I read.
John Carreyou’s Bad Blood is a closely reported history of Theranos, unicorn startup and massive fraud.
One of the telling details is the utterly vicious feud and lawsuit that broke out between the Holmes family and one of their closest friends, a patent lawyer who encouraged Holmes to start the company in the first place, over Theranos’ patents. You can’t cheat an honest man, they say, and the savage thirst for both easy money and sheer Trumpesque winnership this subplot displays explains a lot about how people were willing to buy the dream.
The wider problem, though, was that the whole idea of patented Theranos innovations was ridiculous, and the idea of trying to sneak in a vaguely similar patent filing in the hope of getting paid off even more otiose. There were none.
By the time Theranos became known to the general public, they had already repeatedly changed their mind about what the invention even was, how it worked, and who might use it. Far from being a lab-on-a-chip system, the inside of a Theranos device was a very ordinary assay panel with a toy robot arm clattering about, and in any case, as they tried to keep the show on the road they moved from deploying the gadgets to pharmacies or doctors’ surgeries to bringing samples back to headquarters where they were processed on entirely normal and very expensive Siemens instruments, just badly and with terrible standards of quality control.
In some ways Theranos was a fraud against the Valley innovation system, the combination of university and government research, patents, and venture capital financing. Carreyou repeatedly points out how Holmes seemed to be more interested in the idea of a startup than the thing. This is today’s version of the famous South Sea Company articles of association that said it would “carry on an enterprise of great advantage, but no-one to know what it is”. But big frauds often drift into fraudulence, and I think you can make a case that the Valley itself was an important driver of the drift.
Considered as a real business, Theranos never really got to the stage where it needed large-scale venture capital funding. Rather, it needed a bit of money to get a prototype going and work out exactly what it was aiming to do. This used to be a large part of how Silicon Valley investors worked. These days, however, the Valley VC business has become so big that it can substitute for the public stock market, largely through its successes with extremely fast-growing Internet companies like Facebook, the so-called unicorns. These firms use venture capital money for much longer and on a much bigger scale, and they aim for extreme growth very early on. This is possible, for example, if your product is likely to spread by social diffusion, following the famous Bass curve, if it is immaterial, for example, software, media, or digital services of some sort, and if it isn’t subject to heavy regulatory requirements.
Theranos was a medical instrument manufacturer and a biochemical laboratory; it wasn’t planting potatoes or building oil tankers, but it was not very much like Facebook. None of the three conditions were satisfied. Yet they plunged in much as they would for the latest app unicorn, pouring cash and hype on the company and encouraging it to aim for extreme growth rates early and to do so using the kind of practices you might for a cat video app. I think it is fair to say that the combination of a huge pool of private, autocratic funding and very high growth expectations is potentially criminogenic in Dan Davies’ sense.
In many ways, I got the impression that Theranos was a classic affinity-group fraud, with the twist that while Charles Ponzi mulcted his fellow Sicilian immigrants, Elizabeth Holmes specialized in duping fellow scions of the elite. Your chances of launching a Valley startup are after all significantly better if you literally grew up as Draper of Draper, Fisher, Jurvetson’s daughter’s best friend and next-door neighbour. And this seems to have macro-economic consequences!
That said, Bad Blood should give us an illuminating new angle on Bell, Chetty, Jaravel, Petkova, and Van Reenen’s paper.
Like essentially all economists they insist on using counts of patents as a measure of innovations, but the behaviour of Elizabeth Holmes’ relatives and their friends should remind us that patents might be better seen as a financial asset-class, while Holmes herself reminds us that they are frequently filed for non-existent inventions or for spurious reasons. An alternative reading of Bell et al is that the patent-innovation ecosystem is a fraud on everyone else, and Holmes’ mistake was to burn the locals.