The Economics of Ignorance, Slippery Concepts, and Diversity. With Reflections on China and the

European Union.

Erik S. ReinertThe Other Canon Foundation, Norway &Tallinn University of Technology, Estonia

Forgotten economic understanding: important for the EU periphery

‘There is the illusion that the New Germany left after the annexations can be reduced to a pastoral state (i.e. without industry). It cannot be done unless we exterminate or move 25,000,000 people out of it’.Herbert Hoover, Report from Germany to President Truman, March 18, 1947.This was probably the key argument that created the Marshall Plan. How could Hoover know this and how did he arrive at the number 25 Million??

Ignorance: The Worst Kind?“It ain't what you don't know that gets you intotrouble. It's what you know for sure that just ain't so”.Mark Twain, Hucleberry Finn (1884).

“The first world war also destroyed the foundations of the 19th century economy: free trade and the gold standard.”Martin Wolf, Financial Times, January 14, 2015.

Martin Wolf ignores a monumental case of «theoriestörende Empirie»: The 19th Century was a period of massive industrial protectioneverywhere!

Hayek’s ’overshooting’ mechanism.

’Never will man penetrate deeper into error than when he is continuing on a road which has led him to great success’Friedrich von Hayek, 1952.Compare Hyman Minsky’s ’destabilizing stability’ as a mechanism behind financial crises.

The two types of 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. (based on Friedman 1953)’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.

The persistent Myth of Free Trade:

«Although it looks as though free marketfundamentalism has been relegated to the dustbin of history, the second pillar of neoliberalism – free trade – is not only still standing but has been reaffirmed as «indispensable» by political and economicelites around the world».

Manfred Steger & Ravi Roy, Neoliberalism. A very shortIntroduction, Oxford University Press, 2010, p. 137.

European and US economicstrategy since 1485

First EMULATION: emulate the economicstructure of the leading nation(s)And only then: COMPARATIVE ADVANTAGE

In other words: the TIMING of free trade is a crucial variable.

Three «slippery concepts»

• «Competetiveness».“Merkel pushes for boost to Greek competitiveness” • «Productivity».“Productivity isn't everything but in the long run it is almost everything”, Paul Krugman• «Innovation».“Our objective is to develop policy initiatives aiming at the modernization of the EU industrial base through accelerating the uptake of innovation.”

Competetiveness.OECD Definition 1992: “Competetiveness may be defined as the degree to which, under open market conditions, a country can produce goods and services that meet the test of foreign competitions while simultaneously maintaining and expanding domestic income” (italics added). In Technology and the Economy, page 237.

OECD Definition 2015: “Competitiveness is a measure of a country's advantage or disadvantage in selling its products in international markets Context: The OECD Secretariat calculates two different measures of competitiveness based on the differential between domestic and competitors’ unit labour costs in manufacturing and consumer prices both expressed in a common currency” (webpage).

Productivity IThe potential for productivity increases arehighly activity-specific: How much productivityincrease you can achieve largely depends onwhat economic activity you are in.Verdoorn’s Law: The key link between growth in output and growth in productivity.Baumol’s Law: In some economic activitiesproductivity increases are virtually impossible without reducing quality (symphony orchestras)

Source: Solomon Fabricant, Employment in Manufacturing, 1899‐1939, New York, National Bureau of Economic Research, Inc, 1942. pp 90‐91.

Productivity II.The fruits of increased productivity will spreadin the economy in two different modes: The Classical Mode: as lower prices to the consumers (in perfect competition markets as in agriculture, process innovations)The Collusive Mode: as higher profits and higher wages to the producers («The Fordist wage regime»). In high barriers to entry/ increasing returns activities (manufacturing), product innovations.

Reinert 1994, Catching up from way behind…

Innovation.As with productivity increases, the windows of opportunity for innovation will vary vastly from one economic activity to the other.It is entirely possible for a nation to locked intotechnological dead-ends bereft of anypossibilities for increasing returns and innovations. Haiti: Baseballs. US: Golf balls.Systemic effects: Haiti & Moldova vs. Germany

Characteristics of high‐quality activities•new knowledge with high market value

•steep learning curves

•high growth in output

•rapid technological progress

•high R&D‐content

•necessitates and generates learning‐by‐doing

•imperfect information

•investments come in large chunks/are divisible (drugs)

•imperfect, but dynamic, competition

•high wage level

•possibilities for important economies of scale and scope

•high industry concentration

•high stakes: high barriers to entry and exit

•branded product

•produce linkages and synergies

•product innovations

•standard neoclassical assumptions irrelevant

Characteristics of low‐quality activites

•old knowledge with low market value

•flat learning curves

•low growth in output

•little technological progress

•low R&D‐content

•little personal or institutional learning required

•perfect information

•divisible investment (tools for a baseball factory)

•perfect competition

•low wage level

•little or no economic of scale /risk of diminishing returns

•fragmented industry

•low stakes: low barriers to entry and exit

•commodity

•produce few linkages and synergies

•process innovations, if any

•neoclassical assumptions are reasonsable proxy

Shoes (1850‐1900)

Golf balls

Automotive paint

House paint

Shoes (2009)

Baseballs

Perfect competition (low‐quality activity)

Innovations & new technologies

The Quality Index of Economic Activities

Dynamic imperfect competition(high‐quality activity)

Source: Solomon Fabricant, Employment in Manufacturing, 1899‐1939, New York, National Bureau of Economic Research, Inc, 1942. pp 90‐91.

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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’.

Giovanni Botero, 1580s.

Wealth is concentrated in the citiesbecause only there you find a largenumber of different economic activitieswhich all add value to the rawmaterials of nature. Botero: Diversity as a key element in explaining wealth + synergies.

Antonio Serra’s two key dichotomiesuseful for understanding wealth, poverty,

and crises

Financial Economy vs. Production Economy(i.e. the need to control finance)

Increasing Returns vs. Diminishing Returns(i.e. increasing returns, manufacturing, as key to

wealth)

The Cecchini Report (1988)- “Economic gains from the 1992 programme could

rise to 200 billion ECU or more, together with a substantial boost to employment.”

- Most of the benefits were seen as coming from increasing returns to scale (in manufacturing).

- BUT: It was never considered that manufacturing could die out in certain EU countries, so that the benefits of the single market WOULD ACCRUE ONLY TO THOSE COUNTRIES WHERE A SIZABLE MANUFACTRUING (INCREASING RETURNS) SECTOR SURVIVED.

Economic structure and populationcarrying capacity

Hunting and gathering soc. 1-2 persons / km2Agricultural societies 40 persons / km2Industrial soc (ex. Holland) 400 persons / km2

OR, Antonio Serra at Lampedusa: If the wish is to make it possible for as many Africans as possible to live well in Africa, the only viable way forward is to (re)introduce manufacturing.

Understanding the link between lackof industry and religious extremism.

“From manufacturing you mayexpect the two greatest ills ofhumanity, superstition and slavery, tobe healed”.Ferdinando Galiani (1728-87), Italianeconomist.

Two types of metaphors for EconomicsMetaphors from physics

• The invisible hand of the solar system (from the Enlightenment)

• The equilibrium metaphor (from physics of the 1880s)

Metaphors from biology

• The human body as a metaphor for society (Ancient Greece, Roman Law from about year 400, through the Renaissance to German economist Albert Schäffle (1880s)

• Darwin’s and Lamarck’s theories – evolutionary (Schumpeterian) economics,

Nature: A system of Increasing Diversity

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

Diversity as an insurance policy

High Andes: Potatoes.

Far Northern Europe: Reindeerherding.

Diversity and Competition betweenstates as the source of Europe’s

success

Werner Sombart:• War and Capitalism (1913)• Luxury and capitalism (1913)

Diversity as source of freedom

Christian Wolff (1723)

Ousted from University of Halle under death penalty, received with honours in theUniversity of Marburg

Will we be able to maintain a high-diversity system?

Low Complexity vs. High Complexity Evolutionary Systems.Source: Gould, Stephen Jay, Full House. The Spread of Excellence from Plato to Darwin, p. 171.

Europe: checks and balances

Florence: members of la signoría elected for two months.Venice: administrators electedfor 6 months. Mario Draghi elected until31/10-2019.

Russia serves as an example of the risks of an overvalued exchangerate.

Compare to the Euro in the EU peripehery.

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250Russia: Exchange rate (right axis), real wages and production, 

1992‐2001

Index of IndustrialProduction, seasonallyadjusted, 2000 = 100

Index of agriculturalproduction, seasonallyadjusted, 2000 = 100

Real average monthlyaccrued wages (basedon CPI), seasonallyadjusted, 2000 = 100

Real exchange rate(against US), DEC 95=100

Felix Somary (1881-1956) The main projects of the West have produced exactly the opposite effect of what was intended:• The Crusades• Religious Freedom• The French Revolution• The Euro + Globalisation (?)