Frans has an interesting little post concerning economics and particularly the question of how much real difference exists between decisions taken by state planners and those taken by the bureaucracies of large firms. This insight has a history in economics back to John Kenneth Galbraith’s The New Industrial State with its notion of the power of the technostructure, the influential amalgam of technical or scientific experts and bureaucratic managers that in Galbraith’s view vied with the classical profit-maximising motivation in explaining the behaviour of big companies. (Note that obviously no-one wants to minimise profit, but that there are other motivations that might conflict with this – for example, the pursuit of status, bureaucratic aggrandisement or personal enrichment at the expense of the owners.) The point may seem arcane, but it has important consequences for the balance of power between planning and the market. If the alternative motivations are relatively strong, this would imply a greater potential for market failure – if weak, a lesser, and hence a strong case for less state intervention.
One very interesting consequence of this is in our view of dynamic phenomena – that is, ones that change over time. Most economic theory is synchronic – it deals with simultaneous events at one point in time. In the accounting for growth, once the contributions of changes in the supply of labour, changes in the supply of capital, and the supply of land are stripped out, we are left with two factors. One of these is how far the economy is from its trend rate of growth – whether it is booming or in recession. In other words, how much of the economy’s capacity for production is being used and hence what is happening to aggregate demand. If we assume a balanced growth path (as you do) and that the economy is at its trend rate of growth – that is, that this factor equals zero – we are left with one factor that determines the slope of that growth function. This is called total factor productivity, the total value all the economic activity that went on created over the value of its inputs. Now, this is obviously a very important factor: if the economy somehow becomes better at using its inputs, the result is a multiple of the total input. Total factor productivity captures the effect of changes in technology, entrepreneurship, education, and in the allocation of resources.
Obviously, if you could explain the evolution of this factor over time you would basically have explained the growth phenomenon itself. But, unfortunately, economics isn’t good at diachronic comparisons (ones between points in time), for much the same reason as it hasn’t been very good with such things as the environment. The effects of a change now in terms of future developments are hard to capture in the equations, especially when the effects are indirect. For example, how do you bring the future (and only quantifiable now with difficulty) effects of burning oil into today’s cost-benefit analysis? It’s a similar problem when you come to technology. The theorists have made various attempts to pin down the issue. One try is a pure market argument – if a technical advance will enable you to charge higher prices, you’ll do it, and then so will everyone else. This, of course, runs into the problem of the two economists who find a fifty pound note but don’t pick it up because if it was there, someone else would have done. Demonstrably, technical advances aren’t evenly distributed, which is what the model suggests. Neither does technical progress maintain an even pace. This is where Joseph Schumpeter comes in.
Schumpeter was one of the brilliant wave of economists produced by Vienna University in the 1920s and then exiled. The Vienna school are usually thought of as a bunch of libertarian free-marketeers, largely because they were, but this does not fit Schumpeter terribly well. His distinctive contribution to economics was the paradox that monopoly, rather than competition, drives technical innovation. Innovators, in so far as they are motivated by money, do so because they might secure a monopoly of the new technology and hence get supernormal profits. What prevents this monopoly from ossifying is the motivation to render the monopoly obsolete. These two processes he described as the process of creative destruction. (Interestingly, it seems to me that sectors where there is little dramatic innovation tend to remain monopolistic.) Further, he argued that this is reflected in the long-term evolution of growth. At the time, a fashionable concern in economics was the cause of long-term business cycles (and indeed their existence) – long periods of either general prosperity or poverty. Explanations ranging from bank clearing procedures and the average time taken to complete major construction projects to sunspots and climate change have been put forward, but for my money Schumpeter’s is still the best.
Simply, it is observable that technological progress is uneven over time, or lumpy as Schumpeter put it. You wait years for a microchip to come along – then a whole raft of electronics turns up at once. Hence, long term cycles could be said to correspond to a sort of technological life cycle. First, the breakthrough, when a major enabling discovery is made. Then the upswing, as we get started on exploiting it. Finally, as the technology becomes baroque and we approach its limits, it becomes either obsolete or matures into ordinariness. We can all think of examples. Schumpeter’s analysis ends up by arriving at the conclusion that although pure capitalism would probably be the most efficient system, it might not be the best. After all, in a perfect competition world, that monopolistic incentive would be gone. And the process of creative destruction, like the short-term business cycle, might throw up severe social costs. Hence there was a need for a state role rather like the one Keynes envisaged with regard to the short term. The best answer would be a mixed economy with a partly planned core surrounded by a vigorous private sector. The challenge is, of course, to come up with the social arrangement that would produce it.