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Sunday, August 1, 2004

WHY THE US HAS BEEN THE RICHEST COUNTRY SINCE THE 1880s: 9th in a Series

This is the latest article in a series about a month old now --- which deals with the various reasons why the US has been the richest country in the world now for 125 years, roughly half the total time since the industrial revolution of mid-18th century. This new installment extends the lengthy, stretched-out argument by probing a host of Schumpeterian concepts about capitalism, technological innovation, and long-term economic growth. Schumpeterian? The term refers to the work of Joseph Schumpeter, a Harvard economist in the early and mid-20th century, plus his recent followers . . . all of whom will be identified and explained later. Fairly marginalized in economics until the 1990s, the work of the Schumpeterians --- more and more numerous these days --- has moved toward the center stage of growth economics, and for reasons set out in parts two and three in this article.

...........................................................



(i.) America's Lead Is A Problem For Mainstream Economics

Of these Schumpeterian concepts, the most useful for our purposes postulates that there are different systems of national innovation across the countries of the world.

As previous articles in this series have hinted at, it's our chief explanatory variable to account for what stands out as a puzzle for mainstream economics: why the US continues to be the richest country in the world, and by far . . . these days, a good 35% richer than the Japanese or EU average in per capita income. In particular, superior American success here defies the predictions of both convergence catch-up theory and standard neo-classical market theories,

(i.) The former prediction argues that dynamic follower countries --- assuming they have good institutions and sufficient human skills to work with modern technologies, two things Japan and the member-states of the EU clearly have --- should grow faster than the lead country, thanks to a host of convergence processes that include the transfer of cutting-edge technologies from the leader and the swift diffuse of them throughout their economies. Over time, in consequence, they should fully close the gaps between them and the leader in per capita income and labor productivity: hence the term, catch-up growth . . . something that was occurring as Japan and Germany drew within 85-90% of the US level by 1990, only to fall way behind since then. These days, the gaps between them and the US in per capita income are where they were in the mid-1960s.

(ii-a.) Neo-classical economics, for its part, predicts that any best practices of one firm or another in competitive markets will be quickly emulated by rival firms, either in the home country or abroad: whether they're cheaper production costs, better products, or newer products. Otherwise, the rival firms will lose customers to the more go-ahead firms and eventually go bankrupt.


In the previous article, the dominant neo-classical growth model --- pioneered by Robert Solow of MIT back in the 1950s and still very much influential today --- gives a twist to this best-practices prediction.

(ii-b.) Assume that the superior performance of one or several firms turns out to derive mainly from better technology. In that case, their technological advantages should all the more quickly adopted by rival firms in competitive markets . . . whether in the home country or abroad. Why? Because, so the argument goes, technology is embodied knowledge that shows up in as new or better production machines, and knowledge --- no matter how innovative --- is a public good; it's not exhausted whether used by 2 firms or 2000 or 2 million of them around the world.


 

(ii.) What The Previous Argument Showed

For reasons that the previous article set out, none of these mainstream predictions holds up when it comes to explaining the huge gap, now well over a century old, that separates American living standards from those abroad. In particular,

  • Best practices aren't quickly adopted by the firms in other countries, not always.


  • Most markets aren't perfectly competitive; they reflect various degrees of monopolistic competition.


  • Technology isn't strictly a public good; rather, it's protected by patents and trademarks for a good reason --- to reward innovative risk-taking.


The upshot? It's multi-sided.

Above all, even when technological transfers do take place across countries --- note that the same applies to other emulated best-practices like statistical quality control in manufacturing, or just-in-time inventory delivery, or superior marketing, to name just a few --- they almost always have to be carefully adapted to a bevy of local national conditions: among them, 1) specific managerial practices, 2) regulations surrounding labor relations (think of affirmative action in the USA or restrictions on lay-offs in the EU), and 3) trade union influences. Nor is that all. 4) The dominant ways corporate firms raise capital for investment purposes --- say, stock markets in the English-speaking countries vs. bank credit in the EU and Japan --- will influence the speed with which managers switch to new technologies. Not to forget the 5) impact of very different cultural attitudes toward change and the costs of altering the status quo, all of which have politically charged consequences for electoral outcomes in democratic countries.

 

(iii.) Some Key EU Countries As An Illustration

Recently, to take just one instance, even the fairly modest efforts in both France and Germany to let market forces operate more effectively have generated raw vocal backlashes in both countries. The governments in both, one on the right and the other on the left, have had to retreat under pressure of electoral outcomes in local or regional elections . . . especially when it comes to withdrawing government aid to giant uncompetitive firms and forcing them to restructure or go bankrupt. The outcome? Both governments are now back to the self-defeating practice of subsidizing such firms. In Schumpeterian terms, the politicians in these and most other EU countries are futilely holding back the inevitable forces of creative destruction . . . a key insight of Schumpeter's, explained later here. The longer they seek to dam them, the longer it will take to rejuvenate their overall national competitiveness by exploiting the bountiful promises of the latest breakthrough technologies in information and communications.

With rapidly aging populations supported by state pensions, at best slow-growing work forces, and high long-term unemployment --- not to forget increasing spread of industrial prowess in Pacific Asia and India and East Europe --- these EU laggards don't have that many years left before the tasks of restructuring and reviving their economic vigor become politically next-to-impossible . . . any reform-minded government liable to be rejected in the next election by an unhappy, increasingly aged and ultra-cautious electorate. Fortunately, the tiny Scandinavian members of the EU, plus Ireland and to an extent Britain and Holland, show that it isn't impossible as things stand to rejuvenate their economies.

The American response has been far different than most of the EU's or Japan's. The gales of creative destruction have been allowed to work their impact, dislocations and all to the previous economic status quo. The outcome here? As the previous article in this series showed, the rate of growth in the US's labor productivity began to more than double after 1996 . . . almost all of it due to the effective diffusion of ICT throughout the American economy. Not only has the EU suffered a decline in its rate of productivity growth since the same year, it has hardly reaped any benefits whatever from the huge financial investments in ICT in the 1990s and early part of this decade.

 

PART TWO:
JOSEPH SCHUMPETER AND RADICAL TECHNOLOGICAL CHANGE


We'll explain who Joseph Schumpeter, the Austrian economist at Harvard, was in a few moments, along with the other key Schumpeterian insights into capitalism and its inevitably dynamic, dislocating nature. For the time being, fix your attention on these introductory comments --- especially about different systems of national innovation, a concept that Schumpeter's recent followers have developed and elaborated on.

 

(i.) Our Main Explanatory Task

If used properly, the Schumpeterian concept of different systems of national innovation does what mainstream economics, whether micro or macro, can't effectively account for: why, if your country's firms are doing something better than those in other countries --- in the US case, being more innovative --- those foreign firms don't quickly emulate these superior American techniques or best practices: whether 1) higher levels of R&D, or 2) better managerial know-how, or 3) greater levels of overall investment, or 4) better training of the work-force, or 5) or greater mobility of workers, or what have you.

As you'll see in detail in the next article in this series, the concept refers to an interwoven cluster of institutional, political, and cultural influences that vary across countries.

 

(ii.) The Payoff

Taken together, these interwoven influences shape how their national economies cope with and perform in a wider environment of restless globalizing forces on one side and repeatedly disruptive waves of technological change on the other . . . especially radically restructuring technologies. Think of electrification and automobiles around 1900 --- or airplane travel, mass tourism, credit cards, synthetics, the mass media, and consumer electronics in the mid-20th century --- or computers, information, and communications breakthroughs more recently. These breakthrough technologies, which appear to erupt every 50 to 60 years in clustered waves since the industrial revolution, alter the very ways we work and live and spend our leisure or fight our wars.

Consider just some of these revolutionary changes that pop to mind, all threatening to the status quo when they materialized --- even as they eventually transformed the basic fabric of human societies --- that have occurred since the late 19th century:

  • Will we live on farms and work the land for a living, or in cities and labor in factories, or in suburbs and commute by train or car to office buildings in urban conglomerations?


  • Will we tell stories to one another in villages or isolated farms at night, or go to films and theater or watch TV for hours at a time?


  • Will we need only basic literacy and traditionally handed-down knowledge of farming or have to spend 16-20 years in formal education to carry out complex, highly specialized tasks in our professions?


  • Will it take months for news from Europe to reach American shores --- which is what happened when the Treaty of London that ended the war of 1812 arrived weeks after the battle of New Orleans won by Andrew Jackson and the Americans --- or will we communicate instantaneously thanks to the Internet with anybody, anywhere, whatever the day or hour, around the world.?


  • Will half our children die before the age of 10, requiring large farming families, or will child mortality rates drastically decline in rich industrial countries, with the large extended family reduced to a much smaller two-child family, the parents living into their late 70's on an average?


  • Will we . . . well, you get the idea; no need to belabor it.


 

(iii.) Something Else

As it turns out, big breakthrough technologies also have a radical impact elsewhere --- no less far-reaching, no less disruptive. In a word,

  • They directly influence the distribution of global power and change the basic ways wars are fought.


Is it accidental, to elaborate briefly, nothing more at this point, that the two most successful great powers of the 19th and 20th centuries --- the British and American --- share a similar overall model of national capitalism, are democratic, have a firm rule of law, and are firm believers in the value of free trade and markets? Is it only an accident, inversely, that their main challengers --- Napoleonic France, Imperial Germany, militarist Japan, Nazi Germany and its fascist allies, or the Soviet Communists --- were all state-dominated systems, with no firm rule-of-law, no democracy, a contempt for commercial values and free markets, and a rule by militarized, power-crazy elites?

Questions only, though the answers are probably self-evident.

 

PART THREE:
SCHUMPETER'S WIDER WORLD-VIEW OF CAPITALISM: AT ODDS WITH MAINSTREAM ECONOMICS IN ALL ITS THEORETICAL VERSIONS


(i.) Creative Destruction and The Schumpeterian Outlook :

Note what's inherent in this Schumpeterian view of capitalism, first formulated by him in the early decades of the last century: the capitalist economy is revolutionary in nature . . . inherently dynamic and unstable, so full of flux and often uncertainty that radically restructuring technological innovations repeatedly disrupt the economic status quo around the world and transform our lives for good. As Schumpeter and his followers see it, these disruptions and unruly challenges to the economic and social status quo are essential to technological and economic progress. Schumpeter called them these destabilizing changes the gales of creative destruction.

When the forces of creative destruction pound the economic status quo in a country, they divide the population into winners and losers . . . always a matter of degree in each camp.

 

The Losers . . .

. . . are those hurt by the status quo's changes, and they will invariably resist them. Chief among the losers will be established firms and industries; maybe guilds and crafts workers; almost certainly --- if you go back to European and Asian and Latin American history in the 19th century --- aristocratic landlords, peasants, and traditional urban upper-class elites like doctors, lawyers, bankers, merchants, and top civil servants. In the EU these days, the employees of highly subsidized or protected enterprises --- private or public --- will be among the staunchest opponents of change too. The same is true in Japan. Trade union leaders will almost always back resistance to corporate restructuring as well, with lots of support from left-wing politicians. Many regions within a country will also suffer an economic downturn, the dominant business firms in their localities threatened by obsolescence and the loss of subsidies and other forms of protection.

Then too, whether on the left or right, there are the intellectuals in universities and the media . . . those anyway who specialize in pontification about the world, usually delivered ex cathedra. As in the past, so these days: they will rant against vulgar commericalizing innovations and the greedy, pushy entrepreneurs who bring them to the market-place, increasingly identified in Europe these days as Trojan Horses of American casino-capitalism.

What follows? In such an atmosphere, social strife is a constant threat in most of the EU and even in Japan.

Japan? Isn't that an exaggeration? Nope. Those who think that the natural condition of labor relations in that country is harmonious know little about Japanese history in the 20th century. From WWI on into the 1930s, the country was repeatedly jolted by strikes and occasional armed conflict of a limited sort. Most of labor opted to join the socialist or communist party in that period and again immediately after WWII. And despite the PR-fluff pushed by admirers of Japanese corporate enterprise in this country and Europe during the 1980s, when Japanese management and workers were portrayed as being on kissy-kissy terms, repeated survey data showed that Japanese workers were in fact the most discontented in the industrial world.

 

And The Winners?

So much for the losers. Who are the likely gainers from far-reaching economic and social change?

First and foremost, the innovative pioneer firms that succeed in the market-place; and also --- once new industries are created and their productivity diffused elsewhere around the national economy, with the dislocations to existing forms of work and livelihood absorbed --- the average person, whose standard of living will continually improve.

Yes, contrary to the claims of left-wing ideologues --- in the 19th century, then the 20th, and again nowadays it seems, especially in Europe --- and for that matter contrary to reactionaries and fascist ideologues in the past, the average person in the industrial rich countries, man or woman, lives longer, better, with more education and far more choice in their lives --- including sexual orientation, various forms of family relationships, far greater freedom to choose careers --- than ever before. Now people worry whether the rich might not drive a Lexus or a Mercedes compared to a Ford or a Nissan. Four generations ago, the gap here was between a peasant who had to walk a muddy path around his village and a landlord or a rich urban bourgeois or king who was driven in a coach with six horses.

 



(ii.) Schumpeter's View of Intellectuals: Invariably Anti-Capitalist



Even if the average person in rich industrial societies lives better than almost all wealthy aristocrats or urban elites ever did before the industrial revolution, most intellectuals will denouce the system --- on economic grounds, on social and cultural grounds, on environmental grounds, and even on political ones.

After all, won't inequality increase if the forces of creative destruction work their impact? That's if the intellectuals are on the left, as most are. If they're on the right --- as frequently the case historically in Europe, Japan, and Latin America and now in the Middle East --- their fretful worries will be of the opposite: dynamic capitalist change a l'americain will narrow inequality and the gaps in life-styles within existing countries; the more leveling Americanizing tendencies spread, the more they'll spell the doom of a traditional way of life. Won't a cheapened form of vulgar affluence and atomistic acquisitive pursuits ensue then? What will happen to the left's hope for a New Man? Or the right's hopes to preserve the traditional heroic artist or warrior or religious zealot or adventurer as the mass man, his brain manipulated by mass-advertising and flattered in the mass-media, takes over and leads his one-dimensional existence . . . the enslaved denizen of the iron-cage of capitalist rationality?

 

Schumpeter's First-Hand Disillusion with the Ideologies of the Intellectuals

Schumpeter --- and hardly him alone --- was puzzled life-long by the invariable hostility to free-market capitalism and bourgeois society and democracy that he himself initially encountered in Austra, first as a professor and then, after WWI, as the Finance Minister of the new Austrian Republic. The hostility flourished on the left and right. By the late 1920s as Austria slid into clerical fascism --- it would later enthusiastically embrace Hitlerian Nazism and unification with Germany --- he decided Europe was no place for the likes of him, and he packed up and fled to the United States, where he flourished as a Harvard professor until his death in 1950.

Schumpeter treated them at length in an influential book of his that appeared on the eve of WWII, Capitalism, Socialism, and Democracy. We'll discuss its themes in a few moments, including his own view of the intellectuals' inevitable hostility to dynamic, entrepreneurial capitalism, whether on the Marxist left or the reactionary and outrightly fascist right.

No need to elaborate here about the intellectuals and their constant woe-is-me assauts on capitalism and bourgeois society, along with their flights into dreamy abstract schemes of a better world --- left-wing Marxisms or right-wing reactionary or fascist in nature. It's not that their hostility isn't important. It is, but it deserves a full-dress analysis of its own . . . exactly the task of the next article in this series, the 10th.

 

(iii.) The Key Figure In Capitalist Change: The Manic, High-Pulsating Entrepreneur

The major engine of innovation is the bold, risk-taking entrepreneur, men and women who dream of wealth and glory, their manic ambitions no different psychologically speaking than those that animate great artists and athletes: their determination to be world-class, known as the best . . . maybe ever. They're invariable mold-breakers, these obsessively focused, hyperkinetic innovators: often mocked and despised by traditional elites --- whether in social, business, or intellectual life --- and often set back by one initial failure after another.

Few of them will ever succeed. Those who do will almost always fail at first.

If a few do succeed, the boldest innovators among them will create dynamic start-up firms and entirely new industries that will invariably jar, jolt, and transform the existing economic status-quo. What does that mean, play out fully? Essentially this: only when these disruptive forces that challenge the established order are allowed to play out fully --- Schumpeter's stormy gales of creative destruction --- will enough well-established industries and firms be rendered obsolete or at least lose market-share. Only then will enough capital and labor, enough managerial talent and scientific, engineering, and technical skills, be freed up to sustain the pace of revolutionary change and diffuse the pioneer, radically restructuring innovations on an economy-wide basis: the diffusion occurring first in the new industry itself --- say, to take one example, Henry Ford and his Model-T car in 1907 --- then in sweeping force across whole sectors of the national economy.

 

(iv.) By way of illustration, dwell on the Ford example briefly.

After Henry Ford's initial innovations --- a car for the masses, standardized assembly-line production, a high wage to his work-force --- the automobile industry was never the same. All successful rival firms had to emulate his techniques; some --- for instance, G.M. by the late 1920s or Toyota in the 1980s (lean production) --- would improve on them. On a wider scale, after 1907, American life was never the same. Suburbs sprawled; highways, then freeways had to be built; gasoline stations, repair shops, new car dealers, tire makers, and the like soon sprawled the landscape. Banks had to reorganize to make loans on cars; credit agencies were required to check on customers. Drive-in restaurants, motels, mass-tourism, drive-in movie theaters, Greyhound bus-service, the trucking industry, and delivery vehicles were all soon spun-offs too. So was the need to deal with the environmental pollution and traffic jams by the 1970s. In the meantime, first the horse-and-buggy industry, then the passenger railway system, then the existing locations of manufacturing firms and office buildings were all left obsolete or had to change drastically too. By the 1960s, roughly one quarter of the US GDP was directly or indirectly related to the automobile business.

Enter Japanese competition in the 1980s, and the automobile business was further revolutionized even if not to the same extent. American automobile manufacturing either did have to emulate Japanese best practices, adapted to American habits --- lean production, better quality cars, better gas mileage --- or go out of business. It did respond, fairly quickly if reluctantly. In the process, it has been modernized; Chrysler has merged with Mercedes; SUVs dominate the market; and the Japanese now have 30% of US sales.

The main beneficiaries? The American consumer, the American worker, and our standard of living.

 

Are cars exceptional? No.

The best recent example is again American in an era of revolutionary ICT innovations, one after another; bio-tech too now; and in the future, just on the horizon, nano-technology and new high-tech energy systems. Tersely put, a good 75% of the US Fortune 500 companies by the mid-1990s hadn't even existed two decades earlier. In Germany and Japan, by contrast --- the two countries widely touted to outclass the US economy by the century's turn, then leave it in the dust --- the equivalent hierarchy of giant firms had scarcely changed.

 

Was Henry Ford an admirable moral figure?

Finally, just to make sure there are no misconceptions left in any reader's minds, the buggy prof wants to add that he isn't an adoring admirer of Henry Ford as a person --- just the opposite.

Ford was a bigot, an anti-Semite, who created a large following when he funded an anti-Semitic newspaper in the 1920s. But if Ford's the worst thing that can happen to America, we've little to fear. By the start of the 1930s, he had recognized his error; he fired the newspaper's editor, stopped its publication, and issued apologies. Yes, all under duress; and yes again, no doubt fearing a loss of sales --- not to Jews alone, they were only 2-3% of the US population then, as they are today, rather to liberals, unions, and average decent Americans of all stripe offended by the bigotry. Eventually, to be more precise, he had to settle a libel suit when it turned out to be a disaster for him personally. (The best book is Neil Baldwin's recent book, Henry Ford and the Jews: The Mass Production of Hate

Meanwhile, at the start of the 1930s, Italy had Mussolini, Germany had Hitler, Portugal had Dr. Salazar, Spain would soon have General Franco, Japan would have mad-men militarists who were willing in WWII to fight to the last Japanese man, woman, and child, China had Chiang Kai-Shek and Mao Tse-Tung, and the Soviet Union had Stalin. By contrast, Ford's innovative legacy lives on; it also lives on in the Ford Foundation, just as the Stanford and Rockefeller ones live on in great universities, and Andrew Carnegie's in the US public library system. The legacies of these other wild-eyed zealots in Europe and Asia --- or their tin-pot imitators in Latin America or the Middle East --- are found in the cemeteries of hundreds of millions of human victims.

 

PART FOUR:
SCHUMPETER'S UNSPARING VIEW OF CAPITALISM'S DYNAMIC NATURE
MARGINALIZED UNTIL RECENTLY


(i.) Schumpeter Marginalized Until Recently

In espousing this view of capitalism inherently dynamic and unstable, a constant threat to the status quo --- within a national economy, including its dominant social and political hierarchies, and across countries and the distribution of power in the world --- Schumpeter and his followers were and remain at odds with dominant mainstream economics, whether in its macro- or micro- versions.

How so?

Well, whatever else may separate economists --- plenty does; but at bottom, it's mainly a matter of how they view the proper relationship between the public and private sectors of the economy: between states and free markets --- they agree on one thing: implement their policy prescriptions that deal with this relationship, and the national economy will then show a clear tendency toward a stable economic equilibrium. Whether liberated or regulated, operating freely or fine-tuned, the capitalist economy will be stabilized and fully efficient: on the Pareto frontier, fully productive and fully employed. At that point --- as opposed to wars or natural catastrophes that might disrupt the equilibrium from outside the economy --- no drastic changes from within the economy will then ensue. Changes will occur, but at the margin . . . in incremental and generally predictive ways. Most economists, to be blunt, are only happy when dealing with change of this sort: marginal, predictive, with fairly easy to calculate costs-and-benefits attached to the alternatives.

Agreed: these points deserve to be clarified, and they will. In a moment or two. First though, a question prompts itself:

 

(ii.) Who Was Joseph Schumpeter?

An Austrian by birth in 1883, Schumpeter served a brief stint as the new Austrian Republic's finance minister right after WWI, and then as the country slid rightward toward a clerical-fascist dictatorship, fled to the United States in 1930, where he taught at Harvard until near his death in 1950. Until recently --- roughly the last 15 years --- his influence on the economics profession was confined to the margins, with his reputation mainly surviving for his work on the history of economic thought and a book on the future of capitalism and democracy, Capitalism, Socialism, and Democracy, published at the start of WWII.

In that latter book, read more by sociologists and political scientists than economists, Schumpeter --- a champion of capitalism and bourgeois society --- thought that both were doomed, much to his regret. From one side, capitalism and money-making were sneered at by the intellectuals of both the left and right, whether Marxist or reactionary or outright Fascist. From the other side, the emergence of the modern giant corporation had separated management from ownership; the owners of GM or Mercedes aren't one family as in the entrepreneurial tradition, rather hundreds of thousands of anonymous stock-holders. What's more, with the introduction of systematic R&D, the giant corporation --- so Schumpeter went on to argue --- had routinized technological progress: Henry Fords or Thomas Edisons were no longer needed.

Add in the mass discontent with capitalism that existed in Europe, and what would follow?

According to Schumpeter, assuming the allies won --- not the fascists or a Communist world --- it would be something like the highly expanded regulatory- and welfare-state of the EU continent, with the public sphere greatly enhanced, bureaucratic tête-à-têtes with the heads of big industries and trade unions setting policies affecting the giant corporate firms in those industries, and with wealth-making by innovative types not only not needed but scorned daily in the newspapers and other media. It might be called capitalism, but to Schumpeter, it would be a far different kind of economic and social system for all the claims made about the need for a vigorous private economy. In his view --- remember, this was 1940 --- it would be a form of socialism, albeit one able to sustain a democratic polity. And it wouldn't be to his liking, however inevitable it was.

 

(iii.) Was Schumpeter Too Pessimist?

No need to elaborate on the book's central argument. The answer to the question just posed is a straightforward, yes; way too pessimistic.

In particular, though he was essentially right about EU Continental capitalism's future as it's evolved since 1945 --- which the vast majority of EU citizens seem content with, however much it isn't generally grinding out much economic growth or job-creation these days --- Schumpeter, it turned out, was wrong about capitalism's future in the English-speaking world. The US has still been very hospitable to entrepreneurial capitalism; it remains dynamic and open to energetic if unpredictable change --- hence the dominance in the Fortune 500 of firms that didn't exist a generation ago; its intellectual critics of capitalism, even in the modified welfare-state form that exists here (and elsewhere in the English-speaking world except for Canada), have little echo in political life; and it keep itself open to talent and new ideas from around the world, whether in the business, intellectual, or artistic spheres. On top of that, most Americans accept change as desirable, not just inevitable; and most are found in survey data not to resent or envy material success and see it as greed-in-action, but instead to respect and even admire those who create great fortunes for themselves by improving vastly our standard of living.

Moreover, despite the problems of entrepreneurship in Australia or New Zealand or Britain or Ireland, the English-speaking countries elsewhere are moving back away from the European dominant-form of regulated and welfare-state capitalism and toward the US model.

Yes, Canada remains something of an exception --- mainly because its political system has been dominated the last four decades by the Liberal Party, its main strength found in French-speaking Quebec. Even so, its Liberal governments have recently begun following the trend in the English-speaking countries, which is to bring government spending under control and reduce it. The following table brings this all out. Though Canada's public spending is closer to the EU's than to the USA's, it is still noticeably lower than the European average.

Government Spending 1999,
% of GDP






  1999
EU Average 50.9
France 53.6
Germany 48.8
Italy 48.9
 
Australia 36.1
Canada 42.3
Ireland 34.7
Japan 38.1
UK 39.1
USA 33,7
 


Source: OECD

 

(iv.) What Caused Schumpeter's Neglect Until Recently?

In barebone terms, as we briefly noted earlier, the Schumpeterian view of capitalism's inherent instability and tendencies toward radical change and creative destruction brings it into direct conflict with the dominant three approaches to explaining the workings of the capitalist economy that flourished after 1900. Whatever their differences --- clarified briefly in a few moments from now --- all three postulate tendencies of the capitalist economy toward a stable equilibrium: efficient, fully employed, and fully productive. We'll clarify these three approaches shortly. Right now, note only that until 1990 or so, Schumpeter and his small band of followers in the US and West Europe were generally marginalized in the economics profession.

All that has changed in the last decade and a half. Why?

In effect, it's the dynamic upheavals of the last decade and a half or so ---

  • The rapid spread of industrialization to China and India beyond parts of East Asia,


  • The currency and financial meltdown in East and Southeast Asia, dislocating what were thought to be highly successful developmental systems despite the doubts of others about their institutional structures: call these, if you want in over-simple terms, forms of crony capitalism.


  • The end of the cold war and the global spread of capitalism to the entire world, the first time a fully integrated capitalist system has emerged, along with the speed-up nature of globalizing forces.


  • The failure of the Washington consensus on proper market-oriented policies --- sound money, fiscal discipline, de-nationalization of industry, and freer trade --- by themselves to spark sustained economic development in Latin America.


  • Above all the rapid impact of ICT breakthroughs in accelerating American economic dynamism at a time when the purportedly better organized Japanese and Germans fell into stagnation, reinforcing the need --- along with these other changes --- to look at the institutional base of national economies, especially when it comes to fundamental innovations and change.


 

(v.) The Schumpeterian Revival

In an era of unprecedented global change and noticeable technological flux and tumult, small wonder, then, that a host of Schumpeterian concepts has been embraced by more and more economists concerned with economic growth and the roles of technology, entrepreneurial start-ups, and wider institutional influences as the engines of long-term economic growth across countries. Capitalism, it turns out, may not be something that invariably leads to a stable economic equilibrium, either by itself or with proper governmental policies. Far from that, it emerges as a dynamic, ever-changing system, itself operating within a wider environment that is political, socio-cultural, intellectual, and institutional . . . frequently at odds with the forces of creative destruction.

Among Schumpeter's most creative followers these days are Richard Nelson of Columbia, Phillipe Aghion (a Frenchman at Harvard), and Philip Howitt, a Canadian, at Brown. In particular, they and other growth theorists take for granted now in their work the following Schumpeter-views of capitalism:

  • Its inherent dynamism, full of flux and uncertainty, with no clear tendency toward a stable equilibrium;


  • The impact of radically restructuring technologies that transform the ways we live and work in fundamental manner and alter the global distribution of power;


  • The ways in which these revolutionary technologies occur in clustered long-term waves, roughly every 50-60 years;


  • The risk-taking nature of revolutionary technological breakthroughs that depends on bold, mold-breaking entrepreneurs . . . hard to ignore at a time when 75% of the Fortune 500 companies in America hadn't even existed in 1975;


  • The disruptive gales of creative-destruction, which shock the economic status quo when entrepreneurial innovation materializes and put a premium on flexibility and cultural adaptation to radical changes in the underlying techno-economic system of a country.


  • Differing systems of national innovation, an interwoven complex of institutions, political policies, and cultural attitudes. These include attitudes toward dislocating change and toward entrepreneurial risk-taking and wealth-making . . . the latter brought out by whether a society is pervaded by envy or admiration for wealth-makers, resentment or support.




 

PART FIVE:
HOW SPECIFICALLY SCHUMPETER'S VIEWS OF CAPITALISM CONFLICT WITH MAINSTREAM ECONOMICS


(i.) The conflict, as we noted earlier, shows up in all three dominant approaches to mainstream economics these days:

1. Neo-classical economics, which explains the working of the capitalist economy by looking at how markets operate from the bottom up in micro terms: the activities of individual firms, individual workers, individual investors, and individual consumers, coordinated through the price mechanism.

Ultimately, the discovery of market failures --- public goods that individual self-interest can't produce; degrees of monopolistic competition; information and transaction-cost problems; and externalities --- led to liberal versions of neo-classical approaches, which required more active governmental regulatory activities to offset the failures. That, in turn, as the government's regulatory intrusions multiplied, spun a reaction that stressed government failures: erratic and costly behavior by self-interested politicians and bureaucrats. The former seek votes by rewarding special interest groups or spending more and more on a variety of welfare programs irrespective of long-term costs; top bureaucrats are interested primarily in expanding their budgets, employees, and the scope of their programs irrespective of whether they are achieving their alleged goals or not.

2. New classical economics --- note, new; not neo --- which began to dominate economic thought from the mid-1970s on, and in a host of variants related to this paradigm: monetarism (really, a macro-economic approach); rational expectations; supply side economics; real business cycle theory; and neo-Ricardian views (the work mainly of Robert Barro of Harvard) that reinforce monetarist doubts about fiscal policy's stimulative effects on short-term GDP growth.

 

3. Macro-economics, born in the Great Depression of the 1930s, mainly the work of John Maynard Keynes, then reconciled to neo-classical economics in the work of a young American follower, Paul Samuelson --- also the pioneer, if one can be singled out, of modern quantitative analysis in economics. A little clarification will help put this in rounded perspective:

In effect what separates the liberal and conservative (new classical) approaches to macro-economics is, once more, the role of the government in the economy: in particular, whether the use of fiscal or monetary policies is needed or not for the market economy to stabilize at or near full-employment and arrive and stay on its path of long-term growth.

For new classical theorists, the national economy is generally flexible and self-adjusting. The only role for macro-economic policymaking is monetary, and that role very limited: the Central Bank should aim at keeping the price level stable, nothing else. Any efforts beyond that to stimulate short-term growth across the business cycle will destabilize the economy in the long-run, keeping it from adjusting to its potential output quickly.

Will fiscal policy work at all, even in the short-run, to stimulate an economy's revival out of recession? Monetarists have always doubted this. Until the 1980s, by contrast, liberal followers of Keynes insisted that fiscal stimuli --- deficit-spending --- was essential to such a revival. The new classical economists in the conservative camp, oddly, are largely divided on the issue.

On one side, according to neo-Ricadians like Robert Barro --- David Ricardo was the great 19th century theorist of comparative advantage in explaining free trade --- individual households know that future taxes will have to be raised at some point to pay for the increased public debt that arises whenever government spending exceeds government revenue: that is, whenever a fiscal deficit emerges. Knowing this, rational households immediately increase their savings to pay for future increased taxes; hence no stimulative effect on GDP, even short-term, can occur from fiscal policies. On this view, only if the government reduces its public spending will the public increase its own level of private spending.

On the other side, by contrast, supply-siders --- not, mind you, the publicists and journalists who are known to the public; but instead very respected economists like Martin Feldstein of Harvard (the head of Reagan's Council of Economic Advisers, and a big influence on the current Bush administration) --- think that deficit spending is not only needed to deal with a recession, but also that, if the tax cuts fueling the increased federal deficit are carefully crafted to expire once the economy is back at full employment, will be self-paying . . . the increased rate of GDP growth that follows bringing in enough new tax revenue to keep the deficits from rising and even shrinking them to manageable levels. Who knows? The tax cuts could even be made permanent, all depending.

Interestingly, President Bush's current chairman of the Council of Economic Advisers --- a colleague of Feldstein's at Harvard, Gregory Mankiw --- is himself a New Keynesian Republican, an advocate of such deficit spending as well.


 

(ii.) Equilibrium Thought Vs. Capitalist Change

All three dominant approaches to explaining the capitalist economy postulate tendencies toward efficient market-equilibrium, provided policymakers followed the right prescriptions: keep government spending low or increase it; avoid fiscal deficits or increase them; don't worry much about market-failures or worry a great deal about them; don't worry much about government-failures or worry a great deal; fine-tuned monetary policy or rule-based monetary policy; and so on.

In whichever guise mainstream economics is found, the Schumpeterian notions of inevitably dynamic, unstable capitalism --- in flux and buffeted by the gales of creative destruction and radical technologies --- are at odds with its assumptions of the market economy's tendencies toward stable equilibrium. And hence Schumpeter's marginalized reputation until recently.

 

(iii.) Schumpeter's Reputation Revived

All this has changed in the last 15 years or so, a point made earlier and worth re-emphasizing at the end here. More and more, growth theorists have incorporated key Schumpeterian concepts into their mathematical modeling of long-term economic growth: the forces of creative destruction, the pivotal influence of technological innovation in shaping long-term economic growth, the crucial role of entrepreneurial start-ups in bringing bold innovations to the market place, and the extent to which institutions, policies, and even culture create different systems of national innovation across the countries of the world.

 

A Quartet of Overlapping Concepts

In the next article in this series, we will directly focus on these Schumpeterian concepts, starting with what is meant by the system of national innovation --- including some variants that economists use, such as Moses Abramovitz's influential and closely related concept of social capability. A variant is social infra-structure.

Yet another variant --- directly dealing with socio-cultural influences that vary noticeably across countries --- is the concept of social capital: the extent to which the social norms of trust and cooperation within a national society have a wide or narrow radius.

If such civic norms are widely diffused in a society, then the country is blessed; it can count on a great deal of civic discipline and spontaneous cooperation for collective purposes, carried out within specific institutional and organizational settings. If, oppositely, the radius of trust is narrow and fragmented, confined to limited groups, the wider society is likely to be dominated, even torn, by rife suspicions, mistrust, and even fear across the lines of social class, ethnicity, and client-patron networks. In such societies, the political and economic systems are likely to be rife with corruption, nepotism, and personal advancement that is based on mutual services within Mafioso-like clientele networks . . . not on hard-work and professional accomplishment. Cynicism will mark people's outlook. Tax evasion will be a national sport. An underground economy of huge proportions will flourish alongside the formal, rule-based economy.

The larger result?

Such societies --- rampant in the Arab Middle East or Iran or tropical Africa, to an extent in much of Latin America too --- will invariably generate institutions, policies, and social behavior that will notoriously hold back economic development.

 

WHAT'S NEXT

Enough said for now in this lengthy article. In the ones that follow in the series, the buggy prof will deal directly with the meaning of these various concepts --- systems of national innovation, social capabilities that differ across countries, social-infrastructure, and social capital --- then apply them directly to the U.S.'s economic performance, comparatively viewed with Japan and the EU countries. When we're through, you should have a pretty good working idea of why the US --- the most innovative economy since the 1880s --- is also the richest . . . and the implications that follow, not least for its global position.

First though, as promised earlier, there's a need to tease out and clarify the nature and sources of intellectual discontent and edgy hostility toward capitalism, whether on the left or right . . . a state-of-mind that was prompted almost from the day the industrial revolution began in the latter part of the 18th century.