Thursday, April 10, 2014

Capacity focus, 81: Technological innovation, diffusion, shocks, creative destruction, the Kondratiev - Schumpeter long wave and understanding the economic signs of our times

Series: 78, 79, 80, 81, 82, b/g

Shakespeare, putting the following words in the mouth of Brutus as he discusses an about to be missed pivotal opportunity in the civil war with Mark Anthony and Octavian [later, Augustus Caesar], put it well:

 There is a tide in the affairs of men.
Which, taken at the flood, leads on to fortune;
Omitted, all the voyage of their life
Is bound in shallows and in miseries.
On such a full sea are we now afloat,
And we must take the current when it serves,
Or lose our ventures.

 [Julius Caesar Act 4, scene 3, 218–224]

Just so, the pivotal question before us today is how to understand economic signs of our times, and thus how to surf the waves of innovation rather than be swamped by them and swept away by the forces of creative destruction. Where, too, as the ANC's motto counsels, we must understand the past, act in the present, build the future.

This brings the Kondratiev-Schumpeter long wave to the focus of our attention (here pictured by plotting the Standard and Poor's 500 percent shifts):

The pivotal idea here, is that for hundreds of years, a cycle of maybe 40 - 70 years (one to two generations) has decisively shaped economic and global history.  In Schumpeter's words in his classic 1939 Business Cycles, as edited and abridged by Fels:

Historically,  the  first  Kondratieff  covered  by  our  material  means
the  industrial  revolution,  including  the  protracted  process  of  its  ab-
sorption.  We  date  it  from  the  eighties  of  the  eighteenth  century  to
1842. The second stretches over what has been called the age of steam
and steel. It runs its course between 1842 and 1897. And the third, the
Kondratieff of electricity, chemistry, and motors, we date from 1898
on. These datings do not lack historical justification. Yet they are not
only tentative, but also by nature merely approximate. A considerable
zone of doubt surrounds most of them, as will be seen more clearly
later on [p.178] . . . .  From the standpoint of the transactions which carry a
fluctuation  of  short  span,  the  sweep  of  the  longer  waves  constitutes
the long-time conditions of doing business, although full equilibrium
could, even theoretically, exist only in the points in which all cycles
pass  their  normals.  This  accords  well  with  the  attitude  toward  eco-
nomic fluctuations of the business community. What the businessman
sees, feels about, and takes account of are the relatively short waves.
In our three-cycle schema they would be the Kitchins. Waves much
longer than these he does not recognize as such, but only as good or
bad  times,  new  eras,  and  so  on.  He, therefore,  acts  as  a  rule  on  the
conditions of a phase of longer cycles as if these conditions were per-
manent. This is obviously so in the case of the Kondratieff [p. 181]

 Thus, while it may be hard to assign specific dates, we can identify wavelike phenomena linked to various driving forces, and so it is highly advisable for us to pay attention and draw lessons for our own response to the signs and tides of our times here in the Caribbean and beyond.

For first instance, the historian and geopolitical thinker George Modelski has tabulated a parallel series of Kondratiev waves and long cycles associated with key technologies and the dominance of a chain of great powers:

 In the longer haul:

Fr: Robert W. Fogel, Catching Up with the Economy, March 1999, The American Economic Review

We may follow Korotayev and Tsiril (2010) and further highlight the recent waves:

 These waves were first seriously studied in our time by Russian Economist Nikolai Kondratiev, whose academic integrity led him to point out that Capitalist civilisation underwent multi-generational cyclical phases of:
 P: prosperity [upswing above the trend-line],
R:  recession [downswing from the peak],
D: depression [hitting rock bottom] and
E: improvement [turnaround towards new upswing] 

. . . which meant that the time of troubles from the end of the 1920's on was not terminal. This implication of a recovery was not welcome to Stalin, and he sent Kondratiev to the Gulag in 1930. Then, on that brutal Communist dictator's orders, Kondratiev faced a firing squad on 17 September 1938 (aged 46) at the
Kommunarka firing range, Moscow Oblast, USSR.

 A martyr to academic integrity.

Schumpeter, from the 1930's, termed these long waves associated with technological innovations and diffusion, after the martyr.

However, it is a matter of controversy as to whether the waves and associated "business cycles" are "real" and "useful."

Statistical studies of various types of economic data say, yes. For instance, Korotayev and Tsiril (2010) have used modern techniques based on the Fourier Transform for pulling frequency domain data out of time series, and have presented several convincing spectra. 

For example, we may snip:

The mere credible existence of these cycles is already significant, even before we address causes, for, if we can spot the signals, their amplitudes and phase relationships, we can at least roughly sketch in patterns and so may be able to judge tides. 

But of course, in the real world, such forecasting efforts -- just like weather prediction and its extension into projecting climate trends -- must be taken with a grain of salt, and we must not underestimate the significance of unpredicted shocks or surprise breakthrough innovations. Where, a sobering facet of this is that these K-waves are plainly strongly associated with great power rise and fall, thus with associated geopolitical, ideological and military conflicts.

When elephants get to fighting, smart worms, ants and mice get well out of the way.

Now, also, the long cycles are associated with innovation and diffusion of technologies, so it is helpful to picture that with the help of Knell and Robertson, and get a rough idea of how long the phases might take:

That S-curve is very familiar to strategic marketers, a product life cycle curve: birth, growth, maturity, decline.

And of course, this invites the expectation of the next wave as is also pictured, leading to a chain of cycles.

That opens up the question of analysis, and here we may introduce the Solow per capita production function as summarised by  Thomas McGahagan of Pitt University:
The Solow per capita production function:

q = A k 0.5
indicates that an economy can increase output per worker or q by
  1. increasing the amount of capital per worker or k. See the previous web page for a study of growth by capital accumulation.
  2. increasing multifactor productivity or A. An increase in A will come from innovation in methods of production, due to improved technology or improved organization -- including improved transportation and infrastructure under technology, and a decrease in social friction under organization.
Growth in output due to capital accumulation, as previously pointed out, will slow down and approach a steady state. [--> Thus, the S-curve tends to plateau as investment is attracted and pushes the technology towards a limit where growth tends to plateau . . . ] While this is a major source of growth -- it probably accounts for three-quarters of US growth, according to Dale Jorgenson ( Journal of Economic Perspectives , Spring 1988) -- it is not the entire story.

Increasing multifactor productivity due to innovation is necessary for continued rapid growth; that growth however will be less steady and less predictable than growth by capital accumulation. Indeed, changes in the rate of innovation may be one of the main causes of business cycles , as the economist Joseph Schumpeter (Austrian, taught at Harvard 1930-1950) maintained in his Theory of Economic Development (1912) and his Business Cycles (1939). This position has been developed in many ways by the so-called Real Business Cycle school (representative members: Finn Kydland, Carnegie-Mellon University; Edwin Prescott, University of Chicago) . . . 
In short, we here have a reasonable model and mechanism, where obviously generation-dominating technologies make very good candidates for cycles of 40 - 60 or so years. And, where also, we see the pivotal role of steady, long term investment in not just capacity but innovation and underlying research, exploration and development.

Feed such impulses into the leaky tyre model from last time:

. . . and we easily see a strong tendency of the economy to be oscillatory, at different scales. 

Thus, the different, superposed cycles:

Where does this catch us here in the Caribbean, in 2014?

For thought-provoking starters:

1 --> Here in Montserrat, we need a crucial infrastructure push to put in place effective access. That points to the current sea port project, to the development of the identified source of Geothermal Energy, and to the upgrading of our airport to at least capacity to take 40 - 50 seat regional carriers as before the volcano eruption. The restoration of fibre optic connexion would also help.

2 --> Across the region, similar investments can easily be identified.

3 --> But we still have not hit the focal spot, we need to lift our attention to innovations based on generation-dominating technologies.

4 --> For instance, we have largely participated in the digital technology revolution as consumers, not so much as producers. Starting with educational transformation to build computer programming and science into core primary and secondary education, that has to change.

5 --> We need to go high tech with agriculture and target profitable niches. That suggests drip irrigation and mulching, hydroponics, fish farming, and other innovations.

6 --> Since bio-technologies and nanotechnologies are evidently a coming wave, we need to strengthen our education base to catch that wave as it comes in. Now, not "too little, too late" as usual.

7 --> Water is a pivotal issue, and we need to look to water resources management.

8 --> We need to think and begin to act towards energy transformation. And in so doing we should at least bear in mind possibilities such as pebble bed modular reactors, molten salt thorium reactors, Bussard electrostatic potential well fusion, and broader fusion. 

9 --> Where for transportation, hydrogen and fuel cells look to be serious candidates.

10 --> And more, just add to the list (and place on a timeline compared to the S-curve chart) . . . 

11 --> Which then brings up the Hayek investment triangle and the issue of what sort of future are we already investing in now, based on business as usual:

12 --> Thence, where is that likely to end up given trends, and what credible alternatives can we put in place to head to a better outcome?  As in:


The thing is, we need to look at the innovation S-curve wave, with its credible timing, and then begin to play three to five moves ahead of events on the ground.

Which -- in a region prone to lurch, caught off guard, from reacting to one crisis to another --  is maybe the biggest challenge of all.

So, we are back to the Mordecai challenge: If not now, when? If not here, where, if not us, who? END