Towards Another Canon of Contemporary Economic Thought

1. Towards Another Canon of Contemporary Economic Thought Erik S. Reinert The Other Canon Foundation Moscow, January 19, 2010

2. Things economics does not explain well: Why are there so few middle income nations? Korea (Rep.)-Somalia, GDP per Capita 1950-2001 Korea (Rep.) Somalia 16000 14000 12000 10000 8000 6000 4000 2000 0 1950 1952 1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2001 Source: original data extracted from Angus Maddison, OECD, Paris, 2003

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

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

5. Latvian Ministry of the Economy 1994:

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

7. De-industrialized countries have a worsened income distribution

8. Forces set in motion: • De-industrialization • De-agriculturalization • De-population Examples: Southern Mexico, Moldova, Caribbean states

9. 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.

11. 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.

12. The Knowledge- and Production-Based Other Canon of Economics Tudor Economic Policy in England 1485+ Realökonomisch Mercantilism: Growth as Activity-Specific Alexander Hamilton US 1791 Daniel Raymond US 1820 M. & H. CareyUS 19. Century US Industrial Policy E. PeshineSmith Veblen and the Institutional School Japan + Asian Tigers 1945+ Giovanni Botero 1588 Antonio Serra 1613 Friedrich List 1841 Japan 1860+ Evolutionary Economics Renaissance Schumpeter Barthélemy de Laffemas 1597 Jean Baptiste Colbert 1651+ SchmollerSombart Classical Devp. Econ. 1945+ The Other Canon Von Hornick Germany 1684 German Cameralism & Anti-Physiocracy German Historical School 1848+ Verein für Sozial-politik 1872-1932 Marx Keynes

13. Joseph Schumpeter (1883-1950)

14. The Circular Flow of Economics The real economy Financial/money economy ”Black Box” Production of goods and services Money/capital

15. 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

16. 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.

18. ”David Ricardo’s economic theories are excellent, they lack nothing but sense”. Joseph Schumpeter.

19. Economics is a cyclical science, and crises determine the turning points in the cycle! So now is a turning point.

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

21. 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.

22. 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. 1895 Economics Neoclassical Samuelson 1948 1990s NOW! Synthesis

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

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

27. How the wage differentials between rich and poor nations were created through sequences of ’productivity explosions’ translated into wage rents. Malthusian activities Textiles Shoes Radio TV Schumpeterian activities Electronics 1750 2000

28. This type of sophisticated understanding disappeared with a simplistic dichotomy with the fall of the Berlin Wall’s, either • The market is the enemy and the state solves all problems, or • The state is the enemy and the market solves all problems. (like: you must agree either with George Bush or with the Taliban)

30. Institutions that made economic growth possible:Patents and modern tariffs were created at about the same time, in the late 1400s. Patents: Promoting new knowledgeTariffs: bringing new knowledge to new areas.

31. 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.

32. 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

33. Characteristics of Wealthy Countries: A Large Number of Economic Activities all Subject to Increasing Returns = Synergies between Industry, Agriculture and Advanced Service Activities.

34. The Circular Flow of Economics The real economy Financial/money economy ”Black Box” Production of goods and services Money/capital

35. SINCE 1990 THE WASHINGTON INSTITUTIONS HAVE PROVIDED A STRING OF RED HERRINGS ‘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’

36. Résumé of 500 years of History of Economic Policy • A nation is better off with an inefficient industrial sector than with none at all. • Industrialization must be accompanied by competition

37. Culprits: ’The Terrible Simplifiers’ Jacob Burchardt

38. Delft, Holland, 1650s: An Innovation System Based on Diversity NAVY & MERCHANT MARINE Supply: new species from afar to study Supply: canvas, linseed oil Demand: artists for drawing new specimens ART SCIENCE Supply: lenses and brass for binoculars + maps Supply: lenses for camera obscura Demand: luxury painting Supply: lenses + brass for microscopes INDUSTRY Textile production uses glass lenses Printing: copper for printing plates Pottery: tiles for export

39. 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.

40. 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 productinnovations, Ford & Microsoft. (dynamic, Schumpeterian imperfect competition, ‘market failure’ (?)) New products based on ICT.

41. 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.

42. East Asian: ‘Good’ Latin American: ‘Bad’ Temporary protection of new industries/products for the world market Permanent protection of mature industries/products for the home market (often very small) Very steep learning curves compared to the rest of the world Learning that lags behind the rest of the world Based on a dynamic Schumpeterian view of the world – market-driven ‘creative destruction’ Based on a more static view of the world – planned economy Domestic competition maintained Little domestic competition Core technology locally controlled Core technology generally imported from abroad/assembly of imported parts/‘superficial’ industrialization Massive investment in education/industrial policy created a huge demand for education. Supply of educated people matched demand from industry. 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 Meritocracy – capital, jobs and privileges distributed according to qualifications Nepotism in the distribution of capital, jobs and privileges Equality of land distribution (Korea) Mixed record on land distribution Even income distribution increased home market for advanced industrial goods Uneven income distribution restricted scale of home market and decreased competitiveness of local industry Profits created through dynamic ‘Schumpeterian’ rent-seeking Profits created through static rent-seeking Intense cooperation between producers and local suppliers Confrontation between producers and local suppliers Regulation of technology transfer oriented towards maximizing knowledge transferred Regulation of technology transfer oriented towards avoiding ‘traps’ Two Ideal Types of Protectionism Compared

44. 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. .

45. 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.

46. 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).

47. 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

48. Résumé of 500 years of History of Economic Policy • A nation is better off with an inefficient industrial sector than with none at all. • Industrialization must be accompanied by competition