Schumpeterian Heterodox Economics: Attempting to Define an

Alternative Approach to Development Theory.

Erik S. Reinert

Aalborg, May 6, 2008

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

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‘get the prices right’‘get the property rights right’ ‘get the institutions right’ ‘get the governance right’ ‘get the competitiveness 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

Not necessary to reinvent wheels: much useful theory in now forgotten history of

economic policy:

’Lack of Conceptual Novelty’ (1485-1947): continuity of principles and

toolbox with varying degrees of sophistication

Important Continental criticism of (English) Classical Economics:

- deals with quantities void of any qualitative characteristics

(qualitätslose Grössen)- blind to structural connections/

synergies (Strukturzusammenhänge)

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).

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+

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 ????synthesis

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

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

Synergy (e.g. manufacturing/agriculture)

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.

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

The Circular Flow of Economics

”Black Box”Production

of goods and services

Money/capital

The real economy Financial/money economy

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

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Ave annual increase in

productivity

YearsSource: Carlota Perez, Calculations from Jenkins 1994

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

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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

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

Capitalism is about rent-seeking

The trick has been to make capitalism

a) into dynamic (Schumpeterian) rent-seeking that increases the size of the pie.

b) insure a ’fordist wage regime’, i.e. that dynamic rents are divided between

entrepreneur (higher wages), workers (higher wages), government (larger tax

base).

The ’Mechanics’ of Economic Development

Activity-specificDynamic imperfect competitionSynergy-based (within labour market) Induces institutionsEmulation, then Comparative Advantage

Industrial Policy: Ideas from Europe.

Renaissance Economics (1200s-1600s).• Wealth as a product of urban synergies• Switching the meaning of innovations • ‘Schumpeterian’ institutions: ‘getting the prices wrong’ • Maximising diversity and division of labour• The real gold mines are not the gold mines Enlightenment Economics (1700s).• Productivity explosions and activity-specific growth• Synergies between industry and agriculture• Taxonomies: ‘Good’ and ‘Bad’ Trade

Creating rent-seeking institutions by ‘getting the prices wrong’

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.

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

Institutions as agents of change

‘It is not sufficient to inquire whether an institution of the state is attested to have

been founded by our ancestors. Rather it is necessary that we understand and explain

why it was instituted. For it is by knowing a cause that we gain knowledge of a thing’

Leonardo Bruni (1369-1444), 1413.

Manufacturing as the real gold mines.

“..such is the power of industry that no mine of silver or gold in New Spain or Peru can compare with it, and the duties from the merchandise of Milan are worth more to the Catholic King than the mines of

Potosí and Jalisco.

Italy is a country in which there is no important gold or silver mine, and so is France: yet both countries

are rich in money and treasure thanks to industry.”

Giovanni Botero, Ragion di Stato, 1588

Wealth as a product of synergies:

Wealth as a ben comune or ’common weal’Brunetto Latini (ca. 1210-1294),

Chancellor of Florence.‘… il ben comune fa grandi le città.’

Niccolò Machiavelli ( 1469-1527 )

Policy: Maximize the division of labor.

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.

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.

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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

Peru: Increasing Exports and Falling Wages

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Export of raw materials and import of manufactured goods is ‘bad trade’ for a nation (King 1721)

Export of manufactured goods and import of raw materials, but also exchanging manufactures for other manufactures, is ‘good trade’ for a nation (King 1721).

Only farmers who share a labour market with manufacturing activities are wealthy: market for products, market for excess labour, access to technology (US/Europe 1800s)

Important synergies between city and countryside: Only farmers near manufacturing cities produce efficiently (Europe 1700s to George Marshall 1947) 

Increased population a problem because of diminishing returns and no new land (Malthus)

Increased population a necessity in order to create scale/markets for manufactures (European pre-Malthusian population theory)

Specialisation will meet the flexible wall of diminishing returns and increasing costs/falling productivity (From Bible’s Genesis to Ricardo and John Stuart Mill).  

International specialisation leads to increasing returns/ economies of scale, producing falling costs, barriers to entry and higher profits (Serra 1613)

Traditionally only a minimum of diversity and very little division of labour.

Generalised wealth caused by a large diversity/large division of labour/maximising the number of professions (Serra 1613)

Few windows of opportunity for innovation (until very recent history)

Windows of opportunity for innovation concentrated in few activities (all urban: Botero 1589) (Perez and Soete 1988)

The experience of 1500s Spain: de-industrialisation and return to agriculture creates increased poverty: a nation is better off with a relatively ineffective manufacturing sector than with none

The experience of 1500s Spain: The real gold mines are the manufacturing industries, because the gold from the Americas ends up in the manufacturing cities outside Spain (generalised knowledge 1600s)

Traditionally very little systemic effects, no ben commune (common weale)

Generalised wealth only found in cities with artisans and manufacturing, and explained as a systemic effect: il ben comune (Florence 1200s).

‘Agriculture’‘Manufacturing’

Theorising by Inclusion: The qualitative differences between manufacturing and agriculture as perceived over time as ideal types or stylised facts.

Creates few synergiesCreates large synergies (linkages, clusters)

Terms of Trade tend to deteriorate over time compared to industrial products

Terms of Trade tend to improve over time compared to agriculture

Technological change leads mainly to lower prices in the consuming countries (Singer 1950)

Technological change leads to higher wages, profits and taxes in the producing countries(’a Fordist wage regime’)

Dominated by process innovations, product innovations for agriculture are made outside the agricultural sector (Ford’s tractors, Monsanto’s seeds, biotechnology)

Dominated by product innovations which, when products mature, turn to process innovations

Reversible wages and payment in kindCreates bargaining power for labour and irreversible wages: ‘stickiness’ of wages in money  

Generally creates a feudal class structureCreates a middle class and conditions for democracy (‘City air makes free’)

Large price fluctuations. Timing of sales often more important for income than production skills

Stable prices

Cyclical production/overproduction (no possibility of storing semimanufactures)

Stable production that can be fine-tuned to demand. Overproduction avoided by storing raw materials and semimanufactures.

Slow growth in productivity until after World War II. Subject to ’productivity explosions’ since the 1400s

Activities with low income elasticity of demandActivities with high growth in demand as income grows/Verdoorn’s Law ties increase in demand to increase in productivity

‘Agriculture’‘Manufacturing’

Perfect competition (commodity competition)Dynamic imperfect competition

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’

What is a technological revolution?

A powerful cluster of new and dynamic

technologies, products and industries

Change in techno-economic paradigm(New best practice “common sense”)

An interrelated set of generic technologies and organisational principles

Explosive growth and structural change

Quantum jump in potential

productivity for all

‘The invention of innovation’.

1277: Roger Bacon arrested in Oxford for ‘suspicious innovations’. Innovations = heresy.

1605: Francis Bacon writes ‘An Essay on

Innovations’. Innovations becomes the essence of progress.