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

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1 The Economics of Ignorance, Slippery Concepts, and Diversity. With Reflections on China and the European Union. Erik S. Reinert The Other Canon Foundation, Norway & Tallinn University of Technology, Estonia

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

3 Ignorance: The Worst Kind? It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so. Mark Twain, Hucleberry Finn (1884). The first world war also destroyed the foundations of the 19th century economy: free trade and the gold standard. Martin Wolf, Financial Times, January 14, 2015.

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

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

6 The two types of economics: One of the nice things about economics is that it is only a way of thinking, factual knowledge does not exist. Victor Norman, Norwegian economist, (based on Friedman 1953) The root of everything we can call theory is to observe things as they are. Hans-Georg Gadamer, Lob der Theorie. Reden und Aufsätze, 1991.

7 The persistent Myth of Free Trade: «Although it looks as though free market fundamentalism has been relegated to the dustbin of history, the second pillar of neoliberalism free trade is not only still standing but has been reaffirmed as «indispensable» by political and economic elites around the world». Manfred Steger & Ravi Roy, Neoliberalism. A very short Introduction, Oxford University Press, 2010, p. 137.

8 European and US economic strategy since 1485 First EMULATION: emulate the economic structure of the leading nation(s) And only then: COMPARATIVE ADVANTAGE In other words: the TIMING of free trade is a crucial variable.

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

10 Competetiveness. OECD Definition 1992: Competetiveness may be defined as the degree to which, under open market conditions, a country can produce goods and services that meet the test of foreign competitions while simultaneously maintaining and expanding domestic income (italics added). In Technology and the Economy, page 237. OECD Definition 2015: Competitiveness is a measure of a country's advantage or disadvantage in selling its products in international markets Context: The OECD Secretariat calculates two different measures of competitiveness based on the differential between domestic and competitors unit labour costs in manufacturing and consumer prices both expressed in a common currency (webpage).

11 Productivity I The potential for productivity increases are highly activity-specific: How much productivity increase you can achieve largely depends on what economic activity you are in. Verdoorn s Law: The key link between growth in output and growth in productivity. Baumol s Law: In some economic activities productivity increases are virtually impossible without reducing quality (symphony orchestras)

12 Source: Solomon Fabricant, Employment in Manufacturing, , New York, National Bureau of Economic Research, Inc, pp

13 Productivity II. The fruits of increased productivity will spread in the economy in two different modes: The Classical Mode: as lower prices to the consumers (in perfect competition markets as in agriculture, process innovations) The Collusive Mode: as higher profits and higher wages to the producers («The Fordist wage regime»). In high barriers to entry/ increasing returns activities (manufacturing), product innovations. Reinert 1994, Catching up from way behind

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

15 Innovations & new technologies Dynamic imperfect competition (high quality activity) Shoes ( ) Golf balls Automotive paint House paint Shoes (2009) Baseballs Perfect competition (low quality activity) The Quality Index of Economic Activities Characteristics of high quality activities new knowledge with high market value steep learning curves high growth in output rapid technological progress high R&D content necessitates and generates learning by doing imperfect information investments come in large chunks/are divisible (drugs) imperfect, but dynamic, competition high wage level possibilities for important economies of scale and scope high industry concentration high stakes: high barriers to entry and exit branded product produce linkages and synergies product innovations standard neoclassical assumptions irrelevant Characteristics of low quality activites old knowledge with low market value flat learning curves low growth in output little technological progress low R&D content little personal or institutional learning required perfect information divisible investment (tools for a baseball factory) perfect competition low wage level little or no economic of scale /risk of diminishing returns fragmented industry low stakes: low barriers to entry and exit commodity produce few linkages and synergies process innovations, if any neoclassical assumptions are reasonsable proxy

Source: Solomon Fabricant, Employment in Manufacturing, 1899 1939,

16 Source: Solomon Fabricant, Employment in Manufacturing, , New York, National Bureau of Economic Research, Inc, pp

17 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

19 Giovanni Botero, 1580s. Wealth is concentrated in the cities because only there you find a large number of different economic activities which all add value to the raw materials of nature. Botero: Diversity as a key element in explaining wealth + synergies.

21 Antonio Serra s two key dichotomies useful for understanding wealth, poverty, and crises Financial Economy vs. Production Economy (i.e. the need to control finance) Increasing Returns vs. Diminishing Returns (i.e. increasing returns, manufacturing, as key to wealth)

22 The Cecchini Report (1988) - Economic gains from the 1992 programme could rise to 200 billion ECU or more, together with a substantial boost to employment. - Most of the benefits were seen as coming from increasing returns to scale (in manufacturing). - BUT: It was never considered that manufacturing could die out in certain EU countries, so that the benefits of the single market WOULD ACCRUE ONLY TO THOSE COUNTRIES WHERE A SIZABLE MANUFACTRUING (INCREASING RETURNS) SECTOR SURVIVED.

23 Economic structure and population carrying capacity Hunting and gathering soc. 1-2 persons / km2 Agricultural societies 40 persons / km2 Industrial soc (ex. Holland) 400 persons / km2 OR, Antonio Serra at Lampedusa: If the wish is to make it possible for as many Africans as possible to live well in Africa, the only viable way forward is to (re)introduce manufacturing.

24 Understanding the link between lack of industry and religious extremism. From manufacturing you may expect the two greatest ills of humanity, superstition and slavery, to be healed. Ferdinando Galiani ( ), Italian economist.

25 Two types of metaphors for Economics Metaphors from physics The invisible hand of the solar system (from the Enlightenment) The equilibrium metaphor (from physics of the 1880s) Metaphors from biology The human body as a metaphor for society (Ancient Greece, Roman Law from about year 400, through the Renaissance to German economist Albert Schäffle (1880s) Darwin s and Lamarck s theories evolutionary (Schumpeterian) economics,

26 Nature: A system of Increasing Diversity

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

28 Diversity as an insurance policy High Andes: Potatoes. Far Northern Europe: Reindeer herding.

29 Diversity and Competition between states as the source of Europe s success Werner Sombart: War and Capitalism (1913) Luxury and capitalism (1913)

30 Diversity as source of freedom Christian Wolff (1723) Ousted from University of Halle under death penalty, received with honours in the University of Marburg

31 Will we be able to maintain a highdiversity system? Low Complexity vs. High Complexity Evolutionary Systems. Source: Gould, Stephen Jay, Full House. The Spread of Excellence from Plato to Darwin, p. 171.

32 Europe: checks and balances Florence: members of la signoría elected for two months. Venice: administrators elected for 6 months. Mario Draghi elected until 31/

33 Russia serves as an example of the risks of an overvalued exchange rate. Compare to the Euro in the EU peripehery.

34 250 Russia: Exchange rate (right axis), real wages and production, Index of Industrial Production, seasonally adjusted, 2000 = Index of agricultural production, seasonally adjusted, 2000 = 100 Real average monthly accrued wages (based on CPI), seasonally adjusted, 2000 = 100 Real exchange rate (against US), DEC 95= 100

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

Objectives ECONOMIC GROWTH CHAPTER

Objectives ECONOMIC GROWTH CHAPTER 9 ECONOMIC GROWTH CHAPTER Objectives After studying this chapter, you will able to Describe the long-term growth trends in the United States and other countries and regions Identify the main sources of