Great Technology Surge Cycle – Section two

Joseph Schumpeter’s work on Business Cycles

Schumpeter’s life work in macroeconomics has placed him in the Pantheon of their most renowned thinkers. Albeit he remains outside of the neoclassical economist canon. Some of his more famous students were John Kenneth Galbraith and Alan Greenspan (Fed Chairman 1987 – 2006). Schumpeter researched technological innovation and business cycles amongst many other topics. He was a prolific thinker and we touch only on his Long Cycle theories here.

Schumpeter’s theory was not generally accepted in mainstream economics. Some of this was just bad timing. His book Business Cycles was selling very well until Keynes eclipsed it three years later with his own book. The General Theory of Employment, Interest, and Money. Keynes book quite literally become the text book for macro-economics. Keynesian theory are the tools which all central bankers use to this day to manage market economies. Keynes theory provided the monetary tools for the management of interest rates to balance inflation against unemployment. Those tools all came form Keynes. Though the two disagreed with one another on several major topics, they did respect and even influence one another. Let us now focus purely on the work he did on long cycles.

In the 1930s Schumpeter took up the role of technical progress in the great technology surge cycle. He argued that basic innovations like the steam-engine and the railway came from more than just their invention. Rather it was together with the ‘swarming’¹ of smaller, secondary inventions which were the forces that launch a long cycle. In many ways Kondratiev’s work received its greatest expression not by Kondratiev himself, but through Joseph Schumpeter. His book Business Cycles of 1939 is inconceivable without the foundations laid by Kondratiev. Earlier in Schumpeter’s first models there were only two phases: prosperity and depression.

In his monumental book Business Cycles Schumpeter restated and expanded his earlier theory. Later, he concluded that there were four phases in the longer “Kondratieff cycle.” He had embraced Kondratiev work later.²  Schumpeter, like Garvy was working with translated documents. He made the same error Garvy would later. They both had called the cycles with interchangeable names: Long Cycles or Long Waves.

The Great Technology Surge Cycle charts from Schumpeter and Kondratiev

The chart (above left) shows a single cycle featuring both Schumpeter’s and Kondratiev’s labels for the cycle. On the chart (above right) is from Schumpeter’s book Business Cycles page 213. This is the image one encounters most often incorrectly attributed to Kondratiev. Altogether he wrote that the cycles have four phases pretty much along the lines of Kondratiev’s four seasons. Schumpeter went on to describe Long Cycles as “Kondratieff’s” in honor of the Russian economist. Schumpeter decided to call the long cycle ‘Kondratieff waves or cycles’. His work was full of terms such as ‘the Kondratieff depression’, ‘the Kondratieff prosperity’, and ‘the Neomercantilist Kondratieff’. Referring to the entire third great technology surge cycle of steel and technology cores. He also named the sequence of long cycles the first, second, and third Kondratieff’s.³

Where the misrepresentations originated

There was significant maturation of the core technology surges modelling which will continue to be outlined following this paragraph. In order to provide some clarity as to why Long Cycles are not only misunderstood but mislabeled as well. We need to touch on two events. The first error occurs during WW2 when George Garvy, working for N.B.E.R.⁴, wrote a paper⁵ reviewing Kondratiev’s theory. Garvy used the now infamous mistranslated 1926 article as his source. Garvy’s paper was widely read in the academic community, including by Schumpeter. The N.B.E.R. had a significant following at that time.

Garvey’s paper was correct in the critical assertion that Kondratiev’s model contained errors as Kondratiev’s dating did not align. Data Garvy had in 1943 showed this. At the end of the 3rd section there is visual further proof for this. However as he was correcting one error he propagated another. Throughout the paper he interchangeably referred to the cycles as long cycles and errantly, long waves. An example to clarify why this distinction is important. Every wave rises and then falls. A long cycle contains two waves and therefore he missed one of Kondratiev’s most salient points. Schumpeter would subsequently also continue propagating this verbiage. He also interchangeably referred to them as either Kondratiev’s or long waves. The theory was overly simplistic back then. The great news is the refinement of the model would continue despite this mistake which still continues to plague us.       

Schumpeter builds on Kondratiev

The two major contributions Schumpeter made building on Kondratiev’s work was first in correctly identifying what starts the long cycle. Making a parallel to physics it was in the 1960s that Higgs theory of how mass accumulates in sub-particles. This was critical for understanding how the universe forms. Schumpeter theorized that ‘Kondratieffs’ began as clusters of innovation, swarms that densely packed together to launch the Long Cycle.

These technology “swarms” delivered through step refinement and imitators of the new technologies. They produced the energy to create the core which would launch the new Long Cycle seemingly from nowhere. An example of this was when personal computers (PCs) were first invented by IBM. There were hundreds of companies which made clones of the IBM PCs. Not to mention the other hardware products such as modems, monitors and printers. Schumpeter predicted this with his model for long cycles a half a century before the PC swarming actually occurred.

Swarms

The second thing which Schumpeter correctly theorized was that the technology surge cycles featured “swarms” delivered through step refinement. The imitators of the new technologies unleashed the economic force termed Creative Destruction. Creative Destruction is the process where new innovations replace and obsolete older innovations. Coined by Schumpeter in 1942, he stated that business cycles operate under cycles of innovation. Specifically, markets are disrupted by new innovations. We see this all too clearly today. The Internet killed off printed Newspapers and a radically impacted the retail industry. Retail” brick and mortar stores” struggle against online stores. These are quick examples in Creative Destruction.

A very unusual source

Schumpeter actually got the concept for this from Karl Marx. In The Communist Manifesto of 1848, Marx and Engels described the crisis tendencies of capitalism. They used terms of “the enforced destruction of a mass of productive forces.” Correspondingly within modern economics, creative destruction is one of the central concepts. In Why Nations Fail, Acemoglu and Robinson make the case why creative destruction is beneficial. They argue the major reason countries stagnate and go into decline is due to creative destruction being blocked. Either by ruling elites or monopolies. Creative destruction promotes innovation.

The ensuing postwar Keynesian revolution put Schumpeter’s work on innovation and the business cycle very much into the background. Schumpeter’s work tended to be axiomatic. Meaning that he worked under the assumption that Long Cycles existed. It would not be till the 1970s when the work started to document the assumptions for proving the theory began. In fact he had left some fairly major questions unanswered, such as why did these cycles reoccur. Nevertheless, his works would remain a rich source of inspiration. Indispensable for anyone who, like Schumpeter was puzzled by the alternation of phases in prosperity and depression. These have been manifest since the onset since The Industrial Revolution.

1970s A Renaissance for the Great Technology Surge Cycle – NeoSchumpeterian theory

In the 1970s Schumpeterian economics were revived as a potential post-Keynesian alternative to neoclassical economics. The neoclassical canon did not even consider innovation, entrepreneurship, and unbalanced growth. The feel of economic stagnation starting in the 1970s served as the fuel for Schumpeter’s revival. The drumbeat of the dreary daily news showing the closures in steel mills and auto plants. Along with the rising tide in unemployment was something which was palpable. It wasn’t theory. It was visceral. The major role technological change plays in generating economic growth spurred academia. The reasons for the revival was due to the increasing realization innovation cycles.

He saw the economic process as part of the larger social and historical frame of reference. Schumpeter had a complex vision of economic processes. Neoclassical macroeconomics had never attempted to address these processes.⁶  Some economists had taken up looking at the Long Cycles again. This did not mean they produced great scholarship right out of the gate.

Gerhard Mensch was a German economist as a disciple of Schumpeter who worked on innovation research. He stated that Schumpeter’s swarms of technology were imitators who in jumping on the “bandwagon.” That these imitators of the technology cores pushed the cycles forward. The problem was Mensch was looking at the wrong swarms. The technology innovations Mensch referenced turned out to be unrelated. Chris Freeman working at the Science Policy Research Unit (SPRU) in 1983 said he couldn’t find the bandwagon effect. At least not where Mensch had said they are located (in depressions). It was Mensch who made an early attempt at revival.⁷ 

Mensch would stimulate thinking and that was key at that time to get the cycle research moving again.

The French regulation school⁸

Next up were the members of the French Regulation School. The crash of 1929 and the ensuing Great Depression was the reason why regulations were put in place. The 1933 Glass Steagall Act effectively separated commercial banking from investment banking. It also created the Federal Deposit Insurance (FDIC) at the same time. The Regulation school was working in France where the economic instability and stagflation had ran rampant in the 1970s. France was not unique as this was the case in most industrialized nations. The Regulation school sought to apply systems theory to economics in order to bring regulations to address stagflation. Such as the kinds passed in wake of the Great Depression to address the economic woes of the 1930s.

Unwinding The Great Depression regulations

Most of the West however would move in the polar opposite direction. Later in the 1980s the Reagan administration began punching holes in Glass Steagall. Under a political construct pushing for deregulation. That plan failed in the USA as well under Thatcher in the UK. The removal of Glass Steagall and other banking deregulation were the direct cause of the 2009 banking crash. The commercial banks had become investment houses creating new toxic financial products such as derivatives. Derivatives enabled the investment houses and banks to increase their leverage to a jaw dropping ratio of 40 to 1. For every real dollar on hand in the banks, their bets were 40 times greater. This meant they were not even close to liquid and could not cover what they owed as the market collapsed. Governments worldwide were forced to intervene and inject capital to keep the markets afloat.

The needs for cycle insights

This short history of why wanton deregulation was an awful idea is to underscore the criticality in understanding technology cycles. That is without mentioning the additional debt burdens ladled on to Western economies. The result of cash injections and liquidity required to keep the economies afloat. Finally the School’s research would influence other economists who were working to evolve Long Cycle theory.

Impacting neoclassical economics

Evolutionary economics began to gain traction in academia. Innovation and technology had hardly been even mentioned in classical macroeconomic textbooks. Measurements such as GDP were only adopted as an official measurement for the first time in 1944.⁹ The US embraced GDP to measure bomb and bullet production at the end of WW2. It will take quite some time to change the ingrained neoclassical model of macroeconomics.

Variables value and placement matter

In reading several histories of this period I summarize them as follows. They looked at the wrong time frames to scientifically. They did this to try and prove the existence of these economic cycles. Some simply used the wrong model/template. An example for this was the MIT Systems Dynamic National Model. MIT attempted to unfold the progression of policies and structure as the cause for the national economy within their model. They described the cause of depressions were due to the capital plants as being over built and therefore worn out. Pretty well known today that the crashes in reality come from the formation of overvalued investment bubbles. These form due to over investment and not the economy “wearing out.”¹⁰ 

As you would suspect from MIT – their math was correct. The assigned variables were wrong because they were using the wrong dates to model. But they were now taking economic, mathematical and scientific approaches to techno-economic paradigms which had never been done before. The basic academic blocks had to be recorded first. This began in the 1970s with the documentation in the causes for the economic factors. These were shown to be the effects for the cycles recurrences.

Evolutionary economics takes a fresh look

One of the central tenants in evolutionary economics approaches of looking at all sources. These even included Marxists. They picked out the good bits and simply discarded the bad ones. The old approach was in tossing out 100% of any thinking judged to have been circumspect. I would like to mention that I read several Marxist historians such as Eric Hobsbawm and Tony Judt. I read almost everything they published because at the very least they addressed economic drivers and history. They did this when almost no other historians had taken that approach.

When I undertook documenting technology cycles, I found that almost every economic source I read quoted historians like Hobsbawm. The economic interpretation of history is what the common thread is. To be very clear I do not endorse communism as it is based on an enormous philosophical error by Marx. In the table at the top is a link which explains Marx’s mistake.

Christopher Freeman brings the great technology surge cycle into academic economic studies

Freeman was recognized as one of the founders of the post-war school of Innovation Studies. He was the founder and the first Director, from 1966 to 1982 for a new unit. The Science Policy Research Unit of the University of Sussex, England. Freeman as the founder and first Director of SPRU is an uncanny historical parallel. Kondratiev founded the Conjecture Institute 40 years earlier. They both did so to study what was considered to be academically out of bounds.

Freeman made pioneering contributions to innovation studies in a number of respects. First he helped to shape a tradition of research into firm-based innovation during the early 1970s. Secondly the research yielded from his book The Economics of Innovation. This at a time when academically macro-economics did not study innovation at all. Third he influenced international trade through a series of commissions from governments to advise them on innovation policies. His reflections were informed on the notions put forward by the two economists with interpretations of Marx’s ideas on capitalism. The economists were the Russian Nikolai Kondratiev and the Austrian American Josef Schumpeter.

Freeman’s contributions

Freeman and SPRU, played an essential role in recognizing the historic significance of the emergence of microelectronic based technologies. This matured into the development of what has come to be called the Techno-Economic Paradigm theory in Long Cycles. He co-authored As Time Goes By in 2001 with Francisco Louçã.¹¹ 

In it the authors put the Internet revolution in the perspective of the four prior cycles in technical change. Steam-powered mechanization, electrification, and motorization (internal combustion engine). The book argues for a theory of reasoned economic history which assigns a central place to these successive technological revolutions. 

As Time Goes By is where my reading intersected with what was the latest cycle theory thinking. He would also collaborate with Carlota Perez. She went on to became the titan of the Techno-Economic Paradigm for innovation cycles. Carlota’s insights in how innovation periods and phases integrated to continually power the repetitive cycle. Freeman however, brought innovation into academic macroeconomics as a discipline. One can’t underscore how import Freeman’s work was at every level.

Christopher Freeman’s Critical Collaboration

Let’s move onto section three of the evolution in technology cycle theory. To see where the current thinking now is. In section three we introduce the remarkable economist Carlota Perez. Carlota delivers on Box’s maxim. A model that is very useful for the great technology surge cycle.

The Great Technology Surge Cycle – Section Two – Footnotes Follow

1. Hansen, A. 1951. “Schumpeter‟s Contribution to Business Cycle Theory‟ The Review of Economics and Statistics  ↩︎
2. Long Wave Theory. Elgar Publishing 1996. Volume 69, The International library of critical writings in economics. Edited by Christopher Freeman. Page 299 Cycle Theory‟ The Review of Economics and Statistics  ↩︎
3. Kondratiev and the Dynamics of Economic Development. Long Cycles and Industrial Growth in Historical Context. By Vincent Barnett. Publisher Palgrave Macmillan; 1998. Page 136.  ↩︎
4. The National Bureau of Economic Research still exists today: nber.org/ ↩︎
5. Kondratieff’s Theory of Long Cycles. Article by George Garvy. The Review of Economics and Statistics. MIT Press, Vol. 25 No. 4 (Nov., 1943), pp. 203-220 ↩︎
6. Technology and the Human Prospect. Published by Frances Pinter Ltd, England 1986 Edited by Roy M. MacLeod. Page 197.  ↩︎
7. Long Wave Theory. Elgar Publishing 1996. Volume 69, The International library of critical writings in economics. Edited by Christopher Freeman. Pages 133 – 134.  ↩︎
8. Members of the Regulation School: Alain Lipietz, Jacques Mistral, Robert Boyer, and Michel Aglietta ↩︎
9. The Bretton Woods conference in 1944 ↩︎
10. Long Wave Theory. Elgar Publishing 1996. Volume 69, The International library of critical writings in economics. Edited by Christopher Freeman. Pages 313 – 320.  ↩︎
11. As Time Goes By. Oxford University Press. From the Industrial Revolutions to the Information Revolution. By Chris Freeman and Francisco Louçã. 2001  ↩︎