A new economic paradigm.

Author:Lent, Adam
Position::Essay
 
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Bringing history back in

Much of the commentary on the current economic crisis has been largely ahistorical. There have, of course, been the now common comparisons between this period and the problems of the 1930s, and there has been debate about when exactly the conditions for the crash were created, with various views pinpointing the policies of Nixon, Reagan, Thatcher, Clinton, Blair, Brown, or Greenspan.

None of this amounts, however, to a particularly sophisticated or detailed account of how the crisis fits into the broader sweep of historical economic developments. This is hardly surprising. History has been out of fashion in the discipline of economics for many years. The focus in the economics profession, with some notable exceptions, has been increasingly on economic modelling and econometrics informed by broadly neo-classical principles. Given, however, that these techniques have proved largely ineffective at predicting this crisis, there must, at the very least, be an obligation on those who are concerned with economics and economic policy to think much harder about what history might teach us.

Fortunately, there is a strand of economic analysis which has long laid a central emphasis on detailed historical analysis. This is the tradition of evolutionary economics as developed by thinkers such as Joseph Schumpeter (1975), Simon Kuznets (1953) and Christopher Freeman (1974). The approach is fundamentally different to the neo-classical style of economics which uses individual rational decision-making within the marketplace as the basis for developing complex and supposedly predictive economic models. Evolutionary economics, by contrast, is concerned with identifying and analysing the patterns that exist in economic history and understanding how fundamental tensions in capitalism, and the society and polity within which capitalism operates, shape those patterns.

One of the leading thinkers working in this tradition, Carlota Perez (2002, 2004a, 2009a), has written a great deal about the crash. Interestingly, and unlike most mainstream economists, she was writing about it before it happened. In essence, she knew the crash was coming and what its implications would be, not because she had developed a supremely complex model of the economy but because she had studied the tensions and patterns that prefigured major crashes and recessions in the past.

Using Perez, we can see that an understanding of economic history shows we are at a key social, cultural, political and economic turning point which could well favour the progressive outlook in the long term. Yet this understanding which also raises challenging questions about the policy framework offered by this outlook.

The tensions and patterns of capitalist development

Perez's understanding of history leads her to identify three fundamental features that drive the volatility of capitalism and its tendency to go through periods of boom, bust, stagnation and radical reinvention.

The first is the tendency of technological change to occur in rapid clusters of innovations which drive sudden surges of modernisation in commercial operations.

The second is the differing interests, preferences and constraints of the distinct agents who work in the spheres of mobile investment finance (what Perez calls 'financial capital') and those who work in the sphere of production (often referred to as the 'real economy' and what Perez describes as 'production capital').

And the third is the fact that the institutions of political, social and cultural life tend to be far more resistant to and slower to adapt to the paradigm shifts which occur in the commercial sector than the economic agents themselves following a cluster of technological innovations.

The upshot of these features is a broad pattern of development and volatility which has repeated itself four times since the birth of technologically driven capitalism in eighteenth century Britain. Perez argues that each of these four historical periods can be split into four phases:

  1. irruption when a new cluster of technologies and an associated business paradigm emerges and begins to spread;

  2. frenzy when finance capital invests ever more heavily in the new technology and linked businesses and greatly expands its political influence;

  3. synergy when the new technology and paradigm spreads more fully across all spheres of society leading to economic benefits;

  4. maturity when the technology and paradigm reaches the point at which it stops producing major productivity gains and achieves market saturation.

Between phase 2 and 3, there is the often troubled turning point created by a financial crash.

We are now at the crucial mid-way post-crash turning point in the current and fifth historical process which began with the emergence of new information technologies in the late 1960s and early 1970s. However, it is necessary to look in some more detail at each of the four phases identified by Perez before exploring the current crisis.

Irruption

As mentioned, each of the five historical periods has been kicked off by the rapid adoption of a family of related technologies by companies for commercial gain. The implications of those technologies, however, always prove more profound than simply the provision of new mechanical processes. They inspire radical alterations in the way companies think about and organise their activities; what Perez labels a new 'techno-economic paradigm'. Those companies which embrace both the new technology and the new paradigm discover major productivity gains and create new markets unavailable to their less fleet footed competitors who often suffer crises leading to insolvencies and unemployment.

Summarising the concept of paradigm is difficult--it is a certain 'common sense best practice' made up of a variety of more or less explicit principles and behaviours, learned and developed as the best way to apply the new technologies. Maybe the best word to describe them is the rather fuzzy 'ethos'. But for all their fuzziness, these new techno-economic paradigms are truly transformatory for business and, ultimately, wider society.

Although Perez does provide descriptions of all five paradigms since the late eighteenth century, for the sake of brevity and relevance, some clarity on this can be gained by comparing the techno-economic paradigm that shaped the period from the early 1900s to the 1970s and the new paradigm that has been reshaping our world since the early 1970s. The table below does this in a simplified form. The earlier paradigm is associated with the technological breakthrough in the production of automobiles and use of oil while the later is linked to the rapid development and use of ICT technologies beginning with Intel's launch of the microchip in 1971.

Previous paradigm Current paradigm mass production flexible production closed hierarchical structures open networks stable production routines continuous improvement employees as resources employees as creative capital fixed plans flexible strategies international trading globalisation classic three tier markets highly diverse markets One can see from this list that the broad ethos of the two paradigms is very different. While the earlier paradigm emphasises hierarchy, self-contained organisations, control and homogeneity, the later paradigm favours flatter structures, networks of organisations, autonomy and diversity.

With its success, the new paradigm begins to impact on wider thinking outside the commercial sphere, influencing civil society and government in rarely straightforward ways. However, as mentioned above, the implications of the paradigm are always much harder for the wider socio-institutional framework to adopt than the commercial world where resistance can often be great anyway.

Frenzy

The profit-making potential of the new technology and associated paradigm does not escape the attention of investors for long. Indeed, the excitement and returns generated by the new technology draws in increasing investment--an outcome which itself enables the new technology and techno-economic paradigm to spread far more widely than it would have without such significant capital backing. In turn, this changes the nature of the capital markets as a greater and greater emphasis is placed on bold investment with high returns. This also enhances the economic significance and political influence of financial capital, which becomes a dynamic driver of growth and innovation when compared to the far less vibrant pools of mature production capital. Over many years, this emphasis on the high returns from mobile financial capital turns into a competitive frenzy which results in over-investment and a manic search for high returns often found in financial engineering rather than productive investment itself. The inevitable crash follows.

Perez asserts that the five big financial crashes since the Industrial Revolution have been associated with the gradual build-up of a frenzy following the emergence of a new technology and associated paradigm some decades earlier.

Technology Crash Mechanisation and canals from 1770s 1797 Steam power and railways from 1830s 1847 Steel, steamships, chemistry and electricity from 1870s 1890-93 Mass production, oil and automobiles from1910s 1929 ICT from 1970s 2008 Synergy

Maybe Perez's most crucial observation is that the crashes that follow the rise of the new technology do not mark the end of the dominant business paradigm, but its mutation. The paradigm continues its march of transformation but almost entirely as a result of the imperatives facing production rather than financial capital. Production capital does not possess the extraordinary mobility of financial capital and as such has little choice but to explore every possible opportunity to increase productivity within the new techno-economic paradigm and develop every possible market for the products and services to which it is organically linked. It is for...

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