Sounds like the title is restating the obvious but I have been reading a number of very good diaries here on KOS from the likes of Jerome a Paris, Stirling Newberry, bonddad, and others on the current economic mess we are all in - here in the US and overseas. Everyone seems to have their own theory about what is going on and I think everyone is partially right and at the same time we are all missing things.
I am going to try to bring in a different take on what is going on... a macro-macro view if you will. I am not an economist, I was trained as an engineer - but was raised by an economist. And one of my siblings is also an economist (tax policy). So I grew up with these discussions ever since I was a child.
The area I want to discuss ECONOMIC EFFECTS OF INNOVATION affecting every facet of the socio-political events we discuss here - from the social safety net to schools and how we raise our young. It describes the dot.bomb boom and post-bubble world. It will effect SS and the hunt for PEAK OIL.
Innovation and the Economy
Economies appear like they are in steady-state and stable but they aren't. I think a lot of what is going on in the world economy is a result of where we are (all of us - not just America) in time on the cycle of innovation. Innovation is more than productivity numbers or the number of new patents. It is the way we live our lives and produce, move and consume goods and services. It is the way we live our lives. Studying innovation is more anthropology than either economics or engineering.
Back in the first half of the last century an Austrian economist named Joseph Schumpeter observed and then postulated that bursts of economic growth then subsequent collapse followed in regular waves. These waves lasted approximately a half to a third of a century. In 1999 the Economist magazine ran a splendid series of articles on the "New Economy" and discussed Schumpeters work here. An excerpt:
Godfather of innovation
All attempts to understand the effects of technological progress on economic growth pay homage to Joseph Schumpeter, an Austrian economist best remembered for his views on the "creative destruction" associated with industrial cycles 50-60 years long. Arguably the most radical economist of the 20th century, Schumpeter was the first to challenge classical economics as it sought (and still seeks) to optimise existing resources within a stable environment--treating any disruption as an external force on a par with plagues, politics and the weather. Into this intellectual drawing-room, Schumpeter introduced the raucous entrepreneur and his rumbustious behaviour. As Schumpeter saw it, a normal, healthy economy was not one in equilibrium, but one that was constantly being "disrupted" by technological innovation.
Others had noticed "long waves" of economic activity before him, notably a Russian economist, Nikolai Kondratieff, who drew attention to them in 1925, using data on prices, wages and interest rates as well as industrial production and consumption drawn from France, Britain and the United States. But it was Schumpeter, the economic radical, who studied them in depth.
In his view, each of these long business cycles was unique, driven by entirely different clusters of industries (see chart 1). Typically, a long upswing in a cycle started when a new set of innovations came into general use--as happened with water power, textiles and iron in the late 18th century; steam, rail and steel in the mid-19th century; and electricity, chemicals and the internal-combustion engine at the turn of the 20th century. In turn, each upswing stimulated investment and an expansion of the economy. These long booms eventually petered out as the technologies matured and returns to investors declined with the dwindling number of opportunities. After a period of much slower expansion came the inevitable decline--only to be followed by a wave of fresh innovations which destroyed the old way of doing things and created the conditions for a new upswing. The entrepreneur's role, as Schumpeter saw it, was to act as a ferment in this process of creative destruction, allowing the economy to renew itself and bound onwards and upwards again.
The article is subscription only but it can be bought from the Economist for a small fee. The chart they mention is found here... don't know if it loads for you but highlights the concept of waves pretty well.
Why this matters is that this Schumpeter Wave Model explains an awful lot of what we see going on in our economy today. I think we are just now `past peak' on one of the most massive Schumpeter innovation waves in history... the wave we are on now is the computer-telecomm-internet wave. Other huge waves in the past were the steel, coal-steam power wave of the late 1800s.and the internal combustion engine, petrochemical, automobile wave of the early 1900s to 1930s. These waves from earliest initiation to end-of-wave last approximately 30-50 years.
When I say `wave of innovation' - I mean the `rate of innovation' or `amount of innovation' not necessarily the amount of product or value of product. It is a measure of human activity of creating new ideas and products, activity that directly relates to incomes and margins and asset valuations. Also some waves are bigger and have more socio-economic impact than others.
It doesn't mean that when a wave `ends' the technology goes away... all it means is the innovation has returned to some steady-state baseline level and the industry no longer generates above normal activity and wealth as a result. People still make livings working in these industries but the profitability is marginal, wage growth is small or even declines. They are now part of everyday life. It is a commodity industry.
Another thing to understand is that these revolutions don't just affect the people working in that field. The social and economic effects of the automobile revolution from 1900 to about 1930 affected far more people than just those building cars or refining gasoline - it affected EVERYONE. Likewise the real effect of the IT revolution was felt by many more people than just the IT workers writing code and stringing fiber optic cable. The wealth spills over everywhere - just ask restaurant owners in San Francisco or Silicon Valley what it was like down there in the late 90s.
Phases of the Wave
Innovation is rapid and divergent in the early part of the wave. There are lots of ideas. People and firms are chasing these ideas everywhere. Prices for the products are very high but so are the costs. Product variety and choice is very broad. In the early 1990s there were hundreds (like more than 600) automobile companies in the US alone. Designs were all over the place - steam, electric, gasoline - you name it. A similar situation existed in IT in the late 1980s and early 1990s - many platforms and computer companies.
As acceptance of the product increases and volumes grow, companies use `economies of scale' to squeeze the least innovative and highest cost concepts out of the market. However overall market growth is so rapid and large the companies exiting the industry are hardly missed and the workers are quickly absorbed by their competition - often times at higher wages. Remember the tech workers jumping from job to job in the mid 90s? A similar situation occurred in the automotive industry in the 1920s.
Eventually the market gets saturated - both with products and with `ideas'. From this point on companies are as likely to compete on price as they are on innovation (enhanced product features). Product innovation tends to start to converge with fewer real differences. This is the waves `peak'. At this point employment, salaries, margins, profits and investment are at their maximum. Remember 1998-2000?
While new investment may slow at peak, it doesn't go away... more money pours in and more capacity and more price pressure results. The dominant firms are able to squeeze out or buy up the weaker ones. As they do, there are layoffs or plant closings (think how Micro$oft and HP were buying everything in sight). Companies that try to compete with the dominant ones do it on price and are forced to adopt `low cost production' strategies - find ways to under cut the dominant firms pricing by using lower cost labor or materials (think off-shoring).
The highly competitive nature of this environment means that few new firms can start and survive. Any new idea or product entry is quickly countered by a cheap alternative from one of the dominant players. The new entrant is either crushed or absorbed.
This downward grind can go on for years and years like this as the large companies consolidate and as products look more and more alike. These firms get set in their ways and stale. Eventually the cycle is broken when a new wave takes off, typically in a new industry and pushes the older industries aside. Schumpeter called this `creative destruction'.
Like Forest Ecology
A really simple analogy is to look at the economy like it was a forest. Forests also seem to be in steady-state and stable but they too are cycling. In the early years a whole lot of seedlings fight for space and water - trying to grow in all kinds of places and terrains. Most die and only a few make it to mature trees. Along the way there are small fires that clear out the brush and duff and keep the forest healthy. The mature trees grow and shade out the forest floor making it impossible for new saplings to grow.
As time goes on the trees get old and decayed. Eventually conditions are ripe and a super-fire comes along and burns the forest to the crown. In the ashes new saplings grow.
Financial Bubbles and Innovation Waves
There seems to be a relationship between financial bubbles and these waves. I am not 100% sure why that is - haven't read as extensively on this as on innovation. But my guess is the excess wealth from the front end of the waves creates VERY high returns and profitability... or at least POTENTIAL profitability (dot.bomb). Investors who were rewarded early keep plowing money back into the innovations trying to repeat. Likewise others see this success and do the same. They expect to get similar returns. As more and more money pours in they chase riskier and riskier investments. Equity prices go higher and higher. You have a bubble.
But as the industry passes peak and transitions from features based innovation phase to price based commodity phase, the margins dry up and can't support the high equity prices. Once that is realized by the market you see the `bubble burst'. The longer the bubble lasts into the unsupported `low margin' area of the curve the harsher the bust.
Implications For Us Today and Tomorrow
I think we passed peak on the IT driven wave around 2000. If Schumpeter was right and these waves are approximately 30-50 years long and we peaked around 2000 then we won't see another peak until 2030-2050. Many think the wave cycles are coming faster so maybe it is 2020-2025. Regardless there are going to be some crappy years in between. I think we see a lot of the symptoms now - jobless recovery, consolidation of companies, tight margins, etc.
I don't think government can `stop' a wave or create one out of thin air. But I know government can make the effects more gentle or severe depending on policy. To understand that all you have to do is look at how Hoover and FDR handled the Depression. It scares the crap out of me when I imagine Bush and his like in charge of the economy and social safety net through this period. And don't even get me started on bankruptcy reform... going into an economic down draft with this kind of legislation is asking for social upheaval. We need to continue the fight for a solid safety net - if this wave plays out like the others we will need it more in the years to come than we do now.
Lastly there are major Social Security implications. First off as the down beat accelerates and conditions get more `stagnant' - expect incomes and the resultant tax revenues to slow. This is going to put a lot more pressure on SS in the years 2010-2020. But as a new wave initiates (and my guess it will - probably in energy as `Peak Oil' needs drives innovation) this will generate an awful lot of additional wealth just in time as SS gets into the heaviest demand years.
The key to making sure the next waves benefits America is making sure we have good schools teaching basic science and liberal arts as well as business and engineering. There innovators can come from anywhere and we need to cultivate all kinds. Secondly the kids in school now and those yet to be born are the ones that will make this happen - they need nurturing environments and good schools now to deliver on their the promise. We can't wait until `then'. We need to redouble our efforts as progressives to see this happens - the conservatives will only take care of their kids.
There is no guarantee this `Next Big Thing' will happen in America. We have to make sure it does. And the forces of the established status quo won't make it easy.