Towards Another Canon of Contemporary Economic Thought Erik S. Reinert The Other Canon Foundation...

Towards Another Canon of Contemporary Economic

Thought

Erik S. Reinert

The Other Canon Foundation

Moscow, January 19, 2010

Things economics does not explain well:Why are there so few middle income nations?

Source: original data extracted from Angus Maddison, OECD, Paris, 2003

Korea (Rep.)-Somalia, GDP per Capita 1950-2001

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16000

Korea (Rep.) Somalia

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1990

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1998

2001

Growth rate of GDP per capita of selected world regions; regional average in selected periods between 1820 and 2001; annual average

compound growth rate.

-2

-1

0

1

2

3

4

5

1820-1870 1870-1913 1913-1950 1950-1973 1973-2001

A fric a

A s ia (J apanexc luded)

L atin A meric a

E as tern E urope

F ormer US S R

Per capita GDP in BRIC countries 1950-2008:USSR/Russia, Brazil, China, and India.

Latvian Ministry of the Economy 1994:

Peru. Increasing Exports and Falling Wages:The break in the mid-1970s

-100 %

-75 %

-50 %

-25 %

0 %

25 %

50 %

75 %

100 %

1960 1970 1980 1990 2000

0

1

2

3

4

5

6

7

White collar wages

Blue collar wages

Export

De-industrialized countries have a worsened income distribution

Forces set in motion:

• De-industrialization

• De-agriculturalization

• De-population Examples: Southern Mexico, Moldova,

Caribbean states

Falling Real Wages:• In small Latin American countries from the mid

1970s.• Stagnating wages in the US from about the same

time. • Root cause: De-industrialization of The Second

World starting in 1990 (from Latvia to Mongolia). • Argentina late 1990s (real wages down by 40 per

cent from peak) + Asian crisis. • Western Europe is being hit now.

The Problems with Ricardian Economics:

• Overly abstract

• When he created economics, Ricardo forgot to create ’money’ as a category

• Ricardian trade theory sees all economic activities as being qualitatively alike for promoting development

• Does not recognize the importance of entrepreneurship and innovations.

The Knowledge- and Production-Based Other Canon of Economics

Ren

aiss

ance

Tudor Economic Policy in England 1485+

Realökonomisch Mercantilism:Growth as Activity-Specific

Alexander HamiltonUS 1791

Daniel RaymondUS 1820

M. & H. CareyUS 19. Century

US Industrial Policy

Giovanni Botero 1588Antonio Serra 1613

Barthélemy de Laffemas 1597Jean Baptiste Colbert 1651+

Von Hornick Germany 1684

German Cameralism & Anti-Physiocracy

German Historical School 1848+Verein für Sozial-politik 1872-1932

Friedrich List1841

E. PeshineSmith

Japan1860+

The Other Canon

Veblen and the Institutional School Japan +

Asian Tigers1945+

EvolutionaryEconomics

Schumpeter

SchmollerSombart

Marx

Keynes

Classical Devp. Econ. 1945+

Joseph Schumpeter (1883-1950)

The Circular Flow of Economics

”Black Box”

Production of goods

and services

Money/capital

The real economy Financial/money economy

Importance of Entrepreneurship

‘The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian, nations into civilization’.Karl Marx and Friedrich Engels, The Communist Manifesto, 1848

Classical economists (including Marx) did not understand that there was not only ONE industrial revolution, but that the whole process of economic growth consists of subsequent waves of large-scale innovations (Schumpeter’s ’Gales of Creative Destruction’) that each needs a new set of entrepreneurs.

Economists’ trade-off: ‘The general reader will have to make up his mind, whether he wants simple answers to his

questions or useful ones – in this as in other economic matters he

cannot have both’. (Joseph Schumpeter 1932).

”David Ricardo’s economic theories are excellent, they lack

nothing but sense”.

Joseph Schumpeter.

Economics is a cyclical science, and crises determine the

turning points in the cycle!

So now is a turning point.

The impact of financial crises on the publication of economics books.

From fact-less to empirically based economics:

’One of the nice things about economics is that it is only a way of thinking, factual knowledge does not exist’.

Victor Norman, Norwegian economist, 1994.

’The root of everything we can call theory is to observe things as they are’.

Hans-Georg Gadamer, Lob der Theorie. Reden und Aufsätze, 1991.

Three Times Rise and Fall of ’Physics-based’ Economics

School Starting point Peak Death Physiocracy Quesnay 1758 1760s ca. 1770(’Rule of Nature’)

Classical Ricardo 1817 1840s ca. 1895Economics

Neoclassical Samuelson 1948 1990s NOW!Synthesis

The need to bring non-Ricardian elements back in simultaneously:

Novelty (innovation)Diversity (heterogeneity)Scale (increasing returns)

Synergy (e.g. manufacturing/agriculture)

How economic growth happens.(why growth is activity-specific)

Activity-specific Economic Development:The mechanization of cotton spinning during the First Industrial Revolution.

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1750 1800 1850 1900 1950 2000 2050

Ave annual increase in

productivity

YearsSource: Carlota Perez, Calculations from Jenkins 1994

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1850 1900 1923 1936

USA: Learning Curve of Best-Practice Productivity in Medium Grade Men’s Shoes’

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1850 1900 1923 1936

Man-Hours Required by Best-Practice Methods of Producing A Pair of Medium-grade Men’s Shoes at Selected Dates in the U.S.

Year Man-Hours Per Pair

1850 15.5

1900 1.7

1923 1.1

1936 0.9

USA: Learning Curve of Best-Practice Productivity in Medium Grade Men’s Shoes’.

How the wage differentials between rich and poor nations were created through sequences of ’productivity

explosions’ translated into wage rents.

1750 2000

Textiles

Shoes

Radio

TV

ElectronicsSchumpeterian activities

Malthusian activities

This type of sophisticated understanding disappeared with a simplistic dichotomy with the fall of the Berlin Wall’s, either

a)The market is the enemy and the state solves all problems, or

b)The state is the enemy and the market solves all problems.

(like: you must agree either with George Bush or with the Taliban)

Institutions that made economic growth possible:

Patents and modern tariffs were created at about the same time, in the late 1400s.

Patents: Promoting new knowledge

Tariffs: bringing new knowledge to new areas.

Russian Strategists who got it right:

• Peter the Great: Diversifying the economy and industrialization. Emulate Holland.

• Sergei Witte: Diversifying the economy, industrialization and infrastructure. Emulate Germany. Theories of Friedrich List.

Russian Economists who Understood Capitalism well:

• Michael Tugan-Baranowsky (1865-1919)

Capitalism, industrialism and crises.

• Nicolai Kondtratiev (1892-1938)

The cyclicality of capitalism.

• Alexander Chayanov (1888-1937)

Agriculture and the peasant economies

Characteristics of Wealthy Countries:

A Large Number of Economic Activities all Subject to Increasing Returns

= Synergies between Industry, Agriculture and Advanced Service Activities.

The Circular Flow of Economics

”Black Box”

Production of goods

and services

Money/capital

The real economy Financial/money economy

‘get the prices right’‘get the property rights right’ ‘get the institutions right’ ‘get the governance right’ ‘get the competitiveness right’‘get the innovations right’‘get the entrepreneurship right’‘get the education right’ ’get the climate right’’get the diseases right’‘get the culture right’

Missing dimension:‘GET THE ECONOMIC ACTIVITIES RIGHT’

SINCE 1990 THE WASHINGTON INSTITUTIONS HAVE PROVIDED A STRING OF RED HERRINGS

• A nation is better off with an inefficient industrial sector than with none at all.

• Industrialization must be accompanied by competition

Résumé of 500 years of History of Economic Policy

Culprits:’The Terrible Simplifiers’Jacob Burchardt

Delft, Holland, 1650s: An Innovation System Based on Diversity

NAVY & MERCHANT MARINE

ART

INDUSTRYTextile production uses glass lensesPrinting: copper for printing plates

Pottery: tiles for export

SCIENCE

Supply: canvas,linseed oil

Supply: new species from afar to study

Supply: lenses + brass for microscopes

Supply: lenses for camera obscuraDemand: luxury painting

Supply: lenses and brass for binoculars + maps

Demand: artists for drawing new specimens

Colonialism as a Technology Policy.

‘That all Negroes shall be prohibited from weaving either Linnen or Woollen, or spinning or combing of

Wooll, or working at any Manufacture of Iron, further than making it into Pig or Bar iron: That they be also prohibited from manufacturing of Hats, Stockings, or

Leather of any Kind… Indeed, if they set up Manufactures, and the Government afterwards shall be under a Necessity of stopping their Progress, we must not expect that it will be done with the same Ease that

now it may’.

Joshua Gee, Trade and Navigation of Great Britain Considered, London, 1729.

How innovations spread: • Classically: as lowered prices to the

consumers. Typically in agriculture and process innovations (perfect competition) Using ICT

• ‘Collusively’: as higher profits, higher wages and higher tax base for the producing country. Typically in product innovations, Ford & Microsoft. (dynamic, Schumpeterian imperfect competition, ‘market failure’ (?)) New products based on ICT.

How the use of ICT reduces value added

• Tourism: internet bookings reduce margins for hotels in Venice and Costa del Sol, Spain.

• Used books: instead of finding books through catalogues, customers now find them on the web. Result a precipitous fall in prices for used books. Book descriptions on the web reduce need for high-skilled cataloguers.

Regulation of technology transfer oriented towards avoiding ‘traps’

Regulation of technology transfer oriented towards maximizing knowledge transferred

Confrontation between producers and local suppliersIntense cooperation between producers and local suppliers

Profits created through static rent-seekingProfits created through dynamic ‘Schumpeterian’ rent-seeking

Uneven income distribution restricted scale of home market and decreased competitiveness of local industry

Even income distribution increased home market for advanced industrial goods

Mixed record on land distributionEquality of land distribution (Korea)

Nepotism in the distribution of capital, jobs and privilegesMeritocracy – capital, jobs and privileges distributed according to qualifications

Less emphasis on education/type of industries created did not lead to huge (East Asian) demand for education. Investment in education therefore tends to feed emigration

Massive investment in education/industrial policy created a huge demand for education. Supply of educated people matched demand from industry.

Core technology generally imported from abroad/assembly of imported parts/‘superficial’ industrialization

Core technology locally controlled

Little domestic competitionDomestic competition maintained

Based on a more static view of the world – planned economyBased on a dynamic Schumpeterian view of the world – market-driven ‘creative destruction’

Learning that lags behind the rest of the worldVery steep learning curves compared to the rest of the world

Permanent protection of mature industries/products for the home market (often very small)

Temporary protection of new industries/products for the world market

Two Ideal Types of Protectionism Compared

Latin American: ‘Bad’ East Asian: ‘Good’

The United State as the Ideal Type of a Developmental State (about 1830):

‘Of course, free trade is the ideal, and the United States will proclaim the true cosmopolitan principles when the time is ripe. This will be when the United States has a hundred million people and the seas are covered with her ships; when American industry attains the greatest perfection, and New York is the greatest commercial emporium and Philadelphia the greatest manufacturing city in the world; and when ‘no earthly power can longer resist the American Stars.’ Then ‘our children’s children will proclaim freedom of trade throughout the world, by land and sea.’ (Joseph Dorfman)

First Listian Principle Abandoned:

Listian principle: A nation first industrialises and is then gradually integrated economically into nations at the same level of development. Symmetrical integration: win/win situations. Neoclassical principle: Free trade is a goal per se, even before the required stage of industrialisation is achieved. Risk of lose/lose situation & factor-price polarization.

.

Second Listian Principle abandoned:

• Listian principle: The preconditions for wealth, democracy and political freedom are all the same: a diversified manufacturing sector subject to increasing returns.

Neoclassical principle: all economic activities are qualitatively alike, economic structure does not matter.

Third Listian Principle abandoned:

Listian principle: Economic welfare a result of synergy. 13th century Florentine Chancellor Brunetto Latini (1210-1294) explains the wealth of cities as a common weal (‘un ben comune’).

Neoclassical principle: ‘There is no such thing as society’, Margaret Thatcher (1987).

Asymmetrical integration creates the Vanek-Reinert effect:

When two nations at widely different technological levels integrate, the first

casualty is the most advanced economic activity in the least advanced nation. This

in turn contributes to factor price polarization and migration of skilled labor

• A nation is better off with an inefficient industrial sector than with none at all.

• Industrialization must be accompanied by competition

Résumé of 500 years of History of Economic Policy