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Wednesday, June 2, 2004

WHAT EXPLAINS ECONOMIC DEVELOPMENT? 3rd of a 8-Part Mini-Series

This is the 3rd of a 8-article mini-series on economic development, the mini-series itself part of a much longer series that began at the end of April and deals with the democratic prospects of the Arab countries.

The argument in the first couple of articles on economic development, you might recall, unfolded in a trio of major divisions --- Part One, Part Two, and Part Three. The current article begins with Part Four. Naturally. And though you can follow the argument here pretty clearly without having read the first three parts, your grasp of its main points will be all the more sure-footed if you've worked your way through them.

More specifically, the current argument is something of a summary statement of what we've learned in the first two articles about economic development. It seeks to distill the necessary changes that any country's policymakers need to undertake --- institutional, cultural, and policy-oriented --- if they hope to launch their country onto a growth-path of out of poverty and sustain it over the long-term, for decades or even generations, narrowing the gap with the rich countries in the process. The summary will uncoil in a set of simple, straightforward theoretical propositions --- exactly four in all, each then clarified and illustrated with concrete examples. Grasp those four theoretical propositions and their implications, and you'll be well situated to make sense of why the world is divided into rich and poor countries, with fortunately several others rapidly growing and converging toward the levels of productivity and per capita income in the rich countries.

Keep in Mind Something

Observe that the convergence doesn't have to be complete. To be blunt, that outcome is unlikely for most countries in the world --- now or in the future.

Come to that, it's even true of the group of rich countries themselves. Despite their wealth and talents, none of the West Europeans or Japan has fully converged with the levels of productivity and per capita income in the US . . . the country with the highest income of this sort for the last 125 years, roughly half the time since the industrial revolution of the late 18th century erupted full-tilt. Japan and Germany aren't exceptions, just the opposite. As recently as 1990, they had closed the gap with the US to around 90% each. By then, lots of observers predicted that they would both match the American level of per capita by 2000, then go on to exceed it.

The reality? Over the decades by 1990, a small mountain of market inefficiencies had cumulatively piled up in each of their economies. Huge vested interests protected the status quo in both Germany and Japan; in each, it has proved stubbornly resistant to change. In the upshot, neither country has adjusted effectively to the dramatic changes in global capitalism, caused by new breakthroughs in information-and-communication technologies and rapid shifts around the world in economic dynamism. Small wonder that right now, half way through 2004, their levels of per capita income have fallen back to less than 70% of the USA's.

That's also true of per capita income in Britain, Italy, and France compared to the USA's. Two or three of the tiny EU countries, plus Singapore, peak around about 75-85% of the American level.

Still, all these countries --- not to forget Israel, Taiwan, and South Korea --- are justly regarded as affluent industrial democracies. By any standard, they're rich. A generation ago, these latter three countries were poor and struggling to develop. South Korea was even described by the World Bank in 1959 as something of a permanent basket-case, unlikely to do without lavish foreign aid for decades on end.

Could anyone have been more wrong?

Something Else Too

Narrowing the gap with the US and other rich countries is still going on. Take China and India, the two together numbering 2.3 billion people --- roughly half the total in the developing world. Starting from a very low level of per capita income only a couple of decades ago, they have been outgrowing the US and West Europe and Japan ever since. In the process, poverty has fallen in China to around 10-20% of the population, and in India it's been halved since 1980 to 25%.

Agreed: the gap with the rich countries is still large. Even so, it might be far less for these two countries in another generation, exactly as Japan had been able to do in the first generation or two after its Meiji Revolution of the 1870s or what South Korea, Taiwan, Hong Kong, and Singapore did after 1960. It all depends on their ability to overhaul their institutions and cultural habits --- not to forget their economic policies --- in innovative or creative ways that do not stray too far from the logic of long-term development enshrined in the four propositions about to unfold here, even as the reforms are adapted to their own specific national conditions.


 

PART FOUR:
LONG-TERM SUSTAINED GROWTH REFINED THEORETICALLY: FOUR SUMMARY PROPOSITI0NS


If the various strands of the argument are pulled together now, the following four theoretical propositions --- with some added clarification --- capture, it appears, the essential conditions of successful long-term development.

First Though, A Series of Clarifyhing Remarks Are In Order.

First Clarification: Three of the four propositions that follow --- 1, 2, and 4 --- are borrowed from a book by Charles I. Jones, Introduction to Economic Growth (Norton, 2nd ed., 2002), especially chapter 10. His model is sketched out in a suggestive way in one page, nothing more --- a barebones model if you want. And though the borrowing from Jones' work needs to be underscored, the elaboration of the model and the extensive comments that follow are strictly the responsibility of the buggy prof's cogitations, for good or bad. As for Jones' book, it's well worth buying and working your way through his clearly written analysis of various growth models, with one proviso in mind: the book's ordinarily used in upper division courses in economics --- possibly even in first year grad seminars --- and so to make sense of Jone's analysis, you need to have a good basis in statistics and multiple regression modeling --- the heart of econometrics. Some basic calculus would also help.

Second Clarification: After writing the previous paragraph, the buggy prof went to Prof. Jones' web site at UC Berkeley, where it turns out that he and Robert Hall of Stanford have published a lengthy, fully mathematical treatment of the first three propositions , "Why Do Some Countries Produce So Much More Output per Worker than Others?" Quarterly Journal of Economics, February 1999, Vol. 114, pp. 83-116.

In line with the buggy analysis that is about to begin here, the two writers find that the huge differences in productivity and per capita income across well over 100 countries in the world can be overwhelmingly explained by the quality of their institutions and governmental policies. One big difference though: Jones and Hall do not deal with culture. Not even one reference to it.

The Third Clarification: No surprise really, this lack of reference to culture as part of institutions . . . the two concepts defined carefully in both the 2nd and 3rd articles in this buggy mini-series.

Almost all economists shy away from the concept. For one thing, it's hard to find quantitative measures for it, something essential to formal economic modeling these days. For another thing, economists prefer to look at how concrete incentives --- the benefits or costs of alternative courses of behavior --- shape the decisions of rational economic agents like workers, consumers, firms, and even government policymakers in situations of choice, irrespective of cultural influences, between alternative courses of behavior. Incentives, rationality, and self-interest do all the explanatory work.

In Jones' and Hall's case, though --- as with more and more economists specializing in economic growth these days --- institutions also pay a role in shaping the incentives and choices of policymakers and economic agents. All the more curious, then, is the failure to deal with cultural influences. After all, the actual choices made within an institutional context by economic agents will be shaped not just by formal rules and formal enforcement mechanisms --- the latter meaning courts, the police, constitutionally specified elections, or private organizations legally authorized to hire, fire, promote, and reward (such as firms, banks, schools, universities, chuches, medical, legal, or other professions accrediting their members, trade unions, and so on) --- but also by informal social norms. Defining what is appropriate behavior in specific social contexts, they may even prove more powerful than formal rules and enforcements.

But note: social norms are part of inherited culture, reinforced by actual or anticipated group pressures to conform to them. What else could they be?

Like the basic beliefs and values and world-pictures that are widely shared in a society --- in short, a community-sanctioned culture that distinguishes, say, the average Chinese from the average Japanese or Egyptian --- social norms are the products of learned forms of behavior from early infancy on. In particular, they are transmitted across generations by a host of socialization mechanisms like the family, schools, churches, peer groups, the media, professions, and what have you. In the process, an individual learns what is appropriate behavior in specific situations. They are then maintained by group pressures within specific instititutional contexts, legal, political, administrative, economic, religious, and so on. More to the point, in most developing countries, prevalent social norms will even likely trump formal rules --- say, laws that make corruption, nepotism, and tax evasion illegal --- whenever the two are in conflict.

How so?

In plain English, the failure of an individual to act in conformity with group expectations can lead to a loss of face, severe shame and dishonor, ostracism, dismissal from a job, or even violent retaliation. It all depends --- on the nature of the social norms, plus the sanctions that groups will use by way of punishment.

Consider some examples. In societies where Islamic law prevails informally, extra-marital sexual relations by a woman can even lead to death by stoning; a sister or daughter raped by a stranger might have to be killed to save the family's honor. In societies where tax evasion is a national sport, anyone who pays taxes voluntarily will be considered a fool --- a sucker. As a third example, consider what goes on in the crony clientele-networks that dominate the political and economic life in most developing countries whether they're formally democratic or not. Anyone who refuses to cooperate with the higher-ups in the crony network --- say, by engaging in lavish corruption for mutual benefit whatever the law says --- will likely be regarded as wholly undependable; he can count on being quickly elbowed out of any position of influence within the larger society. No other form of social advancement may exist. In an outright Mafioso-like network, needless to add, the punishment will likely be far severer.

It's the prevalence of such informal social norms in well over a hundred or even a hundred and fifty countries these days that undermine a rule-of-law. By comparison, formal rules like constitutions, statutes, or regulations --- or the courts and police (themselves likely to be entangled in corruption) as enforcement mechanisms --- count for little.

Oppositely, as we'll now see, the gap between social norms and formal rules like the law is much narrower in rich industrial countries . . . mainly because the wider community-sanctioned culture that gives meaning to social life within specific national contexts is more friendly to a rule-of-law --- to less corruption, nepotism, and tax evasion. If there are group pressures at work, they are likely to work as incentives to obeying the law. True, pressures of this sort are greater in Denmark or Holland, traditionally, than in Italy or France. What's more, changes can occur that harm civic discipline and obedience of the law. Even in Holland or all the Scandinavian countries, high taxes have encouraged a big underground economy --- roughly twice as high as in the US with its lower taxes (15% of GDP vs. 8.0% in the US), and only slightly higher than in the Latin countries of the EU at around 20%.

It's an example of how misguided policies, over time, can backfire in even the most law-abiding of civic-minded countries.



What Explains Why Rich Countries Are Rich and Others Aren't?

And now, with these clarifying remarks under your belt, shift your attention to the four major propositions that are the heart of our explanatory endeavor here.

1. Rich countries are rich, first off, because they have invested high rates of their GDP in both physical and human capital over several decades or even centuries, and they have done so efficiently (productively). In the upshot, they benefit from cumulatively impressive sums of skills and physical capital --- plants, machines, office buildings, laboratories, infra-structure, and schools and universities, not to forget the high levels of systematic spending on R&D.

Several countries, note quickly, have mobilized high levels of capital investment for decades, but without much to show for it. Their investments weren't made efficiently; the money was largely wasted or diverted to unproductive ends. The Soviet Union is the classic example here; Maoist China down to 1978 is another; the same is true of every other Communist country. Nor is that all. State-directed capitalism in India until the 1980s had roughly the same outcome; so too did the import-substitution developmental strategy of Brazil, Mexico, and the rest of Latin America until then, their economies hobbled by inefficient nationalized industries, runaway regulations, and extravagantly high tariff levels and exchange rates, not to forget excessive money creation and hence galloping inflationary trends.

What happened in the end was fully predictable.

In particular, over several decades, all these countries had relied mainly on quantitative growth, subject to ever greater diminishing returns in their investments. They couldn't switch to qualitative economic growth, driven by ever greater levels of productivity and technological progress. In the upshot, their rates of GDP growth tapered off over time, then plunged toward zero and a stationary state, overwhelmed by self-inflicted burdens of diminishing returns and Himalaya-high market inefficiencies.

A question immediately prompts itself: what will determine whether investment in physical and human capital any one country are used efficiently or productively --- raising the levels of labor, capital, and total factor productivity (a technical concept, shorthand for technology broadly viewed in interacting with labor and capital)?

 

2. The answer: essentially a combination of good institutions and good policies. For the time being, think only of good institutions that operate in a clearly beneficial manner. In particular, when countries have successfully grown over the long haul, then you will likely find that to a large degree (with of course variations here across these countries) . . .  

Business institutions in them ---corporate governance, start-up firms and other entrepreneurial enterprises --- have been encouraged by formal and informal rules to operate with transparency and accountability. Poor performances is therefore easy for share-holders or banks or other outside investors to monitor and try to correct. If the corrections aren't timely, then market competition should sooner or later bring about either faster reforms or lead to bankruptcy.



Financial institutions --- banks, brokerage houses, stock and bond markets, insurance companies, and venture capital --- have themselves been carefully monitored in order to encourage transparency and accountability too. If they have operated this way and there is competition present in the financial sectors, then these institutions will likely perform their key function effectively: to allocate capital in productive ways by bringing savers and investors together.

If, oppositely, they aren't monitored and quickly punished for transgressions, then scandals galore will likely mark the financial sector in any country's economy. Just recently, we Americans have learnt this lesson anew for the upteenth time in our history.

Legal institutions have been created that operate with widespread public approval and enforce statutes and regulations that are generally followed spontaneously by most people in the country. Honest and impartial judges, good prosecutors, and a police force that is respected are essential here.

The upshot if these conditions hold? Corruption in both the public and private sectors is likely to be quickly discovered and punished. Nepotism in the corporate, financial, and administrative worlds has been limited or non-existent. Advancement up their hierarchies has been increasingly determined by performance, not by crony clientele-contacts.

If cultural beliefs and social norms turn out to be dysfunctional and hold back sustained economic growth, then they have been vigorously encouraged over time in the rich countries to change in more socially desirable ways --- by the educational system, churches, the media, political dialogue, voluntary associations, and the like. Meanwhile, to enforce socially desirable behavior, it will usually be necessary to toughen formal rules in any society --- legal or otherwise.

Note though: formal rules and enforcement mechanisms --- including statutues, courts, prosecutors, and the police --- can only do so much here if prevalent culture-based beliefs and social norms collide with them. The legal system itself may be shot through with corruption, nepotism, and the use of double-standards in applying law to the rich and powerful. Even if it isn't, the courts and the police will likely be overburdened. Meanwhile, lawless behavior of various sorts will continue to flourish.

Nor is that all. Even if political or religious or educational authorities push for cultural change, hoping to alter dysfunctional beliefs and social norms, such change will almost always occur slowly. That's true of all countries. If "cultures" could change rapidly --- deeply ingrained beliefs and values, transmitted from one generation to another --- they wouldn't likely be what we mean by culture.

Political institutions have been created that remain flexible while encouraging overall stability and oblige politicians to operate in ways that are accountable and transparent to the electorate and the media. When this condition prevails, then poorly performing leaders can be removed in the next election.

One of Japan's problems, to cite just them, in adapting its economy since the late 1980s lies precisely here: for a half century, except for a few months in the early 1990s, the country has been ruled by the same political party, the Liberal Democrats. A disillusioned Japanese public hasn't had the choice of a unified Opposition party to elect in the LDP's place and ensure that newer, bolder policies would be implemented. The status quo keeps marching along, powerful vested interests the only beneficiaries.

A merit civil service has emerged in the rich countries, not one that operates according to patronage and crony connections. Something else too. All bureaucracies are prone to certain kinds of predictable pathologies: expanding budgets, mushrooming missions, and ever more personnel irrespective of performance . . . not to forget endless red tape. In successfully developed coutries, various corrective mechanisms have been created that limit the impact of such pathological behavior.

In most developing countries, oppositely, the civil service is little more than a milk-cow for patronage on the part of dictators or demagogic democratic leaders. More generally, advancement up organizational ladders in any institutional domain that counts --- the legal system, the military, education, the financial system, big business, whatever --- will usually take place by means of clientele networks, not performance.

Good educational institutions at all levels have been fostered. So too has solid on-the-job training by business firms and public agencies. Both are essential to economic vigor over the long haul. So too, don't forget, is advancement to positions in both the private and public sectors by means of achievement, not crony clientelism and mutual backscratching services.

 

A Key Qualification

No one country, it should be quickly added --- certainly not the US --- can boast of unqualified success in all these institutional matters. Consider them, if you want, formulated in idealized ways. Still, it's not hard to recognize when a country is afflicted with dysfunctional institutions and maladapted cultural habits.

In particular, poorly designed institutions --- including cultural hinderances such as widely practiced social norms that encourage contempt for the law in any one institututional sector, never mind all sectors --- will produce huge inefficiencies in capital and labor investments, all marked by massive diversions of scare resources or outright wastage through various forms of predatory or incompetent behavior by the dominant elites in a society. If, to be more precise, the following culture-based practices prevail in the social life of any developing country, then it's hard to see how sustained long-term economic growth could occur until these dysfunctional practices and the social norms underlying them are changed:

 

The Likely Outcomes of Dysfunctional Institutions --- Including Cultural Influences That Work
Against A Rule of Law and a Vigorous Civil Society


Widespread corruption and nepotism will flourish.

Clientele crony-networks as we noted, will dominate the major institutions of the economy --- and very likely those in the political and legal systems. In that case, people advance to positions of authority and hence power and wealth through mutual back-scratching of a personal sort, rather than by means of clear performance and hard-work. What counts are family and personal contacts, little else. Call it Mafio-ism on a large scale, sometimes more violent, sometimes less. Either way, massively detrimental to effiicency and the long-term development of any country.

Very likely, political despotisms and other authoritarian systems have governed the country for long periods of its modern history, the leaders milking the population for their own benefit. No matter how wretched and exploitative their rule, they can't be removed except by violence, and as in the Arab world, the new rulers who emerge through a coup or revolution may be no better.

Even in electoral democracies without a solid rule of law and transparency and accountability of office-holders, politicians and top bureaucrats will regard public life as largely a means to self-aggrandizement and enrichment.

At all levels of the state bureaucracies, even the lowliest, officials will demand bribes from the public in order to do what they are supposed to anyway. Even then, red-tape will envelope almost every action of any agency. The pettiest of bureaucrats will love lording it over ordinary citizens without influence and the means to pay the necessary bribes.

More broadly, there may well be widespread tax-cheating, rife forms of gangsterism, and a lack of effective protection for private property and human rights. Demagogy will likely be a typical form of political activity. Cynicism and various degrees of fatalism will probably mark the outlook of most of the citizenry.

To top it off, a large underground economy will invariably emerge that is all the greater because of tax-evasion. Hernando de Soto, a Peruvian economist with a Ph.D. from the University of Chicago, found in the late 1970s that the underground economy in Lima was 125% the size of the official economy that, in principle, was being taxed.

From one angle, that's encouraging: it shows how much initiative and enterprise even a single small-time entrepreneur --- say, a driver of an unlicensed taxi or owner of a tiny laundry --- might manifest in order to earn a living for himself and his family. Hernando de Soto's findings were illuminating here. Even to set up a small one-man business of the sort just mentioned, the typical Peruvian owner would have to get official approval from 11 or 12 different bureaucracies; not only was this time consuming, months and months of wrestling with arrogant, nitpicking bureaucrats, it also required 11 or 12 different bribes to be made. Is it any wonder that most business people --- including larger, more important business firms --- simply ignored the law, then passed one or two bribes to the police and tax collectors?

From another angle, though, any large underground economy drastically reduces tax-revenue for a decent social security safety-net, education, and other essential social services. It also signifies a contempt for the law that further holds back a rule-of-law over the powerful and wealthy and obstructs progress toward effective institutionalized democracy. Both consequences can be disastrous. In Mexico and Brazil today, the underground economy is over 50% of GDP! Even in Holland and the small Scandinavia democracies --- traditionally cohesive, law-abiding countries --- high taxes have engendered a flourishing underground economy . . . around 15% of official GDP: not much lower than in Latin Europe, and about double the percentage in the USA.



 

3. Over time, the policies a government implements for the economy should approach the Washington consensus on integration into the global economy and the creation of sound money, fiscal solvency, enhanced market competition, effective tax revenues, and an effective social security network.

No country has even grown rich --- say, a per capita income of over $18,000 (the EU and Japanese average is about $26,000, the US around $38,000) --- without implementing such policies against a background of effective institutions.

Even here, though, there is clearly room for different cultural and political contexts: the Anglo-American free-market model, EU welfare-state capitalism (effectively adapted in Scandinavia and to an extent in Holland to the new global context, but not in Germany, France, Belgium, Spain, Portugal, or Greece), and a Japanese-like model that --- pruned of excessive governmental subsidies and regulations --- does emphasis social order and solidarity.

About all one can say is that there are trade-offs: the EU countries and Japan that have excessively interfered with free-markets have experienced a marked slow-down in growth since 1990 --- essentially when the new advanced technologies in information, communications, and bio-tech were paying off in growth here in the US (and elsewhere). Still, Sweden, Finland, Holland, and Denmark have adapted pretty well as small, cohesive countries --- their cohesion being challenged by large numbers of immigrants these days (hence a populist government in Copenhagen on the conservative side, and for a while in Holland) --- have done generally well. Possibly so will Germany, France, Italy, and Spain --- even if the changes needed risk setting off social conflicts and strife.

 

4. If a country is able to enjoy decent institutions and leaders (political, business, financial, bureaucratic, legal, and educational), then long-term development will be sustained by TECHNOLOGICAL PROGRESS:

More concretely, technological progress means a combination of:

  • Innovations that create new products or improve on the ways existing products (goods, services) are produced. Such innovations can be generated by home-based R&D, or as Singapore and the other East Asians have done so well --- through swift importation (technological transfer) that diffuses the innovations created abroad quickly through its own industries.


  • The most radical technologies create whole new industries of a revolutionary sort that change the ways people work and spend their leisure time: computers, telecommunication satellites and wireless connections, air travel, automobiles, entirely new forms of credit (credit cards), and so on. Ever since the industrial revolution of the late 18th century, they come in clusters every few decades and have these dramatic effects.


As a twist here, when you hear about technological progress, think of

Advances in knowledge that can be embedded in newer, better machines or lead to new and better management, marketing, and work within enterprises and bureaucracies. And remember: as the previous buggy article in this mini-series showed, the most dramatic advances are those that entail radically restructuring changes for entire societies and then --- through globalizing processes --- are diffused elsewhere to other countries.

By spawing entirely new industries in clustered waves of innovation every few decades, these revolutionary technologies dramatically alter the way we work and spend our leisure time. As we'll now see, they have another dramatic impact. They immediately influence the global distribution of power, military, diplomatic, and economic.


 

PART FIVE:
THE REVOLUTIONARY NATURE OF THE NEW KNOWLEDGE-BASED ECONOMY:
SOME FINAL COMMENTS


The Military and Diplomatic Consequences of Technological Breakthroughs:

So far, we haven't mentioned of the most radical outcomes of boldly new technological breakthroughs: their impact on the distribution of global power, economic and military, between countries. The pioneer countries are largely the beneficiaries, their power strengthened. The laggards are those whose relative power declines.

Hence a major cause of the rise and fall of great powers over the millennia and especially since 1500 . . . the beginning of the modern era, subject to the continued shockwaves of modernizing and globalizing forces out of Europe on a world-wide scale. At any rate, to clarify, out of parts of West Europe: it was in those parts that the industrial revolution would be born, the nation-state and nationalist revolution, the scientific revolution, and democratic revolution . . . as well as the ideological backlashes against all four.

 

America's Pioneering Role in Modern Technologies

It's these radically restructuring technologies --- which create whole new industries of far-reaching significance --- that have largely originated in the US since the 1880s or so, the decade when per capita America income surpassed Britain's to top all other countries ever after. Three waves of clustered revolutionary innovations have erupted over the 120 years that have uncoiled since then. Each time, the US has been the pioneer country with politically charged consequences for the distribution of global power:

-- First came the radical changes introduced by electrification and the internal combustion machine, along with mass production of the modern assembly-line sort pioneered by Ford Motors after WWI.

-- Then starting in the late 1920s a new era began: airplanes, mass travel, dramatically new forms of warfare, the modern mass media and consumer electronics (radio, movies, TV, the VCR), the nuclear bomb and nuclear energy, synthetics, and new credit facilities for buying durable goods on the installment plan.

-- And since the start of the 1970s, we're experiencing a major shift toward a knowledge-based economy driven by all the revolutionary changes that mark information-and-communication technologies (computers, the Internet, satellite telecommunications and so on), bio-tech, and now nano-technology . . . maybe the most revolutionary of all, the ability to work with materials at their molecular levels. Probably, in the near future, wholly new forms of energy as an alternative to carbon-based sources will materialize as well.


We are still in the midst of the epochal changes wrought by these dramatically new advances in knowledge, whether embedded in machines or not. And something else may be already taking shape all around us --- a knowledge-based economy may never run into the kinds of slowdowns that marked all earlier stages of clustered revolutionary technologies.



Over time, to clarify briefly, the new technologies of the steam engine and the factory system, or railways and steam ships and the telegraph and the modern corporation --- in effect, the first two waves of clustered breakthroughs that marked the modern industrial revolution from roughly the 1780s until the 1880s --- became standardized and were quickly diffused to most of Europe and the English-speaking countries, with parts of Latin America and Pacific Asia (Japan especially) recipients as well toward the end of the 19th century. What happened then? As standardization set in and the once radical technologies were imported elsewhere, technological progress in the innovating lead-countries would invariably slow down . . . usually, we can now see, about half way through each of the initial two waves of breakthrough innovations.

By then, such progress would be mainly confined to incremental improvements in the production processes within the industries that the initial bursts of innovation had created.

The same was true of the next two waves of clustered cutting-edge techologies: those of electrification and the internal combustion engine from the 1880s on, and those starting in the 1930s that we mentioned earlier --- airplane travel, new weaponry, the modern mass media, consumer electronics, and synthetics. Once again, about half way through each long wave of cutting-edge technologies --- 50-60 years in duration --- bold innovations in these new industries either fell off or disappeared, and the firms in them concentrated on incremental improvements that cut the costs of production and improved the quality of the standardized products, little else. At some point, a 36 inch Sony Wega TV is only slightly different from a 24 inch Panasonic or RCA TV.

The invariable loss of innovative momentum in each wave of breakthrough technologies had a predictable effect on economic growth, at any rate in the pioneer lead countries --- the UK, France, and later the US. Tersely put, as technological innovation slowed in the pioneer lead countries toward the middle of the 50-60 year cycle of clustered breakthroughs, so too would the pace of economic growth. It was a classic case of Robert Solow's diminishing returns setting in.

 

Enter Convergence Theory and Catch-Up Growth: The Subjects of the Next Article

Elsewhere, despite the slow down in innovation and economic growth in the lead countries, economic dynamism would continue in those developing countries that had imported the once radical technologies and diffused them throughout their own economies . . . always assuming, mind you, that their policymakers had initiated sufficient institutional and policy changes to launch themselves onto a path of sustained long-term economic growth. The reasons are simple and straightforward. Since convergence catch-up growth is the subject of the next article in this mini-series, we'll only single out one such reason.

Specifically, in the 19th century and throughout most of the 20th, the follower countries with adequate institutional and policy adaptation could not only import the most recent technologies in an era of standardization, they could frequently out-compete the rich leader countries in both price and quality in many of the more advanced industries that relied on them. At any rate, they could do so if their lower wages in manufacturing were significant in the costs of the final product. In that case, even lower productivity levels in the dynamic follower countries' industries could be offset by low-cost labor. Rapid German and then Japanese convergence on the British and later the Americans was largely propelled this way, both before WWII and afterwards.

Nor was that the end of their advantages.

Thanks to very good engineering and managerial talents, German and Japanese manufacturing often improved on the quality of the end products that were innovated by the British or Americans. The traditional discipline of their work-forces and social norms that promoted widespread cooperation also counted here. And because Japanese and German R&D specialized in incremental improvements to existing production processes, manufacturing firms would generally experience a steady improvement in their overall levels of productivity that eventually closed the gap with, say, their American counterparts in these standardized industries.

Think of television, stereo equipment, railway systems, automobiles, ship-making, steel, and various kinds of machine tools. In automobile production by 1990, Japanese car-makers even enjoyed higher levels of productivity; the same was true of steel. In some of these industries, American manufacturers had simply abandoned production. They were no longer competitive.

The outcome?

Convergence catch-up growth looked like working completely, at any rate for the Japanese, Germans, and some smaller countries in Europe and Pacific Asia. Even as the pioneer lead countries were experiencing a slowdown in long-term economic growth, the best situated follower countries could continue to grow faster --- as predicted by convergence theories of catch-up growth (explained in the next article in this mini-series) --- and close the gap in the levels of productivity and per capita income that were once very marked across these countries in the 1880s or throughout much of the 1900's. Japanese and German levels of overall national productivity in labor were about 50% of the US levels in 1950, by which time postwar reconstruction was over. By 1990 or so, they had closed the gap here, remember, to around 90%.

A question prompts itself quickly: what happened then?

 

Well, A Radical Break With This Historical Pattern May Mark The Current Era
of Technological Innovation


How so? To put it boldly, a knowledge-based economy where almost all the breakthroughs in cutting-edge technologies are largely dramatic changes in information and the ideas they embody may never slow down in the same ways as before.

In particular, the eruption and then invariable petering out every 50-60 years in each wave of radically new technological innovations may be drawing to an end, replaced by endless knowledge-driven changes whose impact will be extended in revolutionary ways that we cannot as yet do more than glimpse. Think of space exploration, dramatic new metals or substitutes, radical medical breakthroughs of a far-reaching sort, bold new sources of energy far more benign for our environment, revolutionary forms of weaponry that have already begun to be diffused and applied in the US military, and entirely new forms of genetically altered foods to feed a global population that will likely top its growth in mid-century at around 11 - 12 billion people.

Nor is that all.

By the same token, even as the process of catch-up growth is bound to continue in those developing countries that undertake the necessary changes in their institutional structures and their policies --- India now joining China here as two examples, with almost 40% of the world's population within their borders right now --- the rich leader countries may never experience a slow-down in their own pace of economic growth. These revolutionary innovations may continue to be generated by them, on and on into the future. If so, then given the speed with which new innovations continue to pile up and create whole new industries --- not without social dislocations, of course --- the US, to stay just with it, may never lose its lead in per capita income even if, over time, the actual gap between certain follower countries with a good set of institutions and flexibility continue to close the gap and converge towards it.

Towards it: that's the operational word --- not necessarily on it.

 

Will the US Lead Continue Way Into The Future?

Say, to be more concrete, will it last through the 21st century as it did throughout the 20th? The honest answer: no one can say for sure. Such is the high-octane pace of change these days that any predictions about the future more than three or so decades on will likely resemble science fiction more than good social science.

What can be said with more certainty is that a hefty premium will be placed on the social and cultural flexibility within each advanced lead and follower country as they're buffered by globalizing and technological changes . . . along with continued commitments by their governments to keep their economies open to global competition. Any clear retreat will likely backfire in growing rigidities within their economies over time: witness Japan, Germany, France, and Italy over the last decade and a half, unable to restructure their economic policies and institutions fast enough to keep pace with the pounding-ahead rate of shifts in technological dynamism and globalizing forces.

Will any of them regain full-tilt economic vigor again? Right now, no safe bet on the outcomes either way can be made.