Old Mulled Wine

Still feeling lucky after procuring the much coveted leather sofa in the newly opened branch of Costa, I browse the weekend edition of The Times whilst waiting for my wife, son and mother-in-law to emerge from the depths of the Christmas crush. A multitude of passers-by, walking with intent, crosses the main street of the once-industrial Northern town. The current economic recession would seem to have been conquered, judging by the countless bulging bags carried by the shopping crowd. The noticeable number of empty shop units marked with ominous ‘To Let’ signs, however, contradicts my wishful thinking of recovery.

While sipping my steaming cup of tea, an article grabs my attention: “A quest for the road to growth”. In the national news section, Chris Giles reminds us that Britain has been on a relentless path towards de-industrialization, greater regional disparities and gradually rising social inequality for more than a generation. The main two questions posed in his article are: what combination of forces will drive Britain’s post-recession growth, and can manufacturing again be a key motor of our economy?

According to Gordon Brown, speaking at the CBI business leaders’ conference, amongst these forces for economic revival are innovations in sectors such as information and communication technology and low-carbon industries, revival of the transport infrastructure and ‘new economy’ skills. Giles thinks this could be just plainly wishful thinking, as the government plans to halve net capital expenditure in the next five years.

Opinions vary amongst interviewed experts, however. Some voices call for an increase in government-funded job-intensive renewable energy programmes, whilst others suggest that an increase in private-sector saving and decline in the sterling will ensure that manufacturing and net exports boost growth, while reducing Britain’s trade deficit.

My concern from the above thinking is that the current rhetoric is geared towards mainstream macroeconomics based on monetary policy. Monetary policy makers and economists have, so far, provided unsatisfactory explanations linking economic growth and technological change and innovation.

An abridged history of the thought on economic growth based on technological change seems pertinent here.

The contemporary study of technical change and economic growth starts with the work of Solow in the 1960s. Solow’s tradition produced estimates of exogenously-induced technical progress but this did not uncover the underlying causes. The 1980s saw the emergence of endogenous models. The most distinctive features of the endogenous genre has been the increasing importance of entrepreneurs’ discretion to allocate physical, financial and human resources to R&D and as well as their ability to manage (somehow) the processes contributing to technical progress.

Unfortunately, the above models operate at a high level of abstraction and make several simplifying assumptions. Also, the inherited neo-classical assumption of general equilibrium is increasingly being contested as erroneous, since entrepreneurs are always seeking to upset the conditions that are supposed to generate it, rendering economic models useless to business decision-making. William Baumol is amongst the economists that have criticized traditional assumptions such as perfect competition, and rational actors having complete information, amongst others. Unfortunately, the reality is quite messy.

More recently, Joseph Schumpeter’s thinking has started to gain interest in the popular media. The Economist started a column named after the famous Austrian economist not long ago. For Schumpeter, it is the ‘emergent patterns’ arising from the strategic choices and interaction between entrepreneurial firms that is of interest. In a symbiotic process, successful entrepreneurial ventures can change the configuration of the industry. Unsuccessful ventures will, however, fail to reconfigure the network of links in the production network.

Coincidentally, the FT weekend magazine brings us an interesting article about the rise and fall of MySpace. In a nutshell, Rupert Murdoch’s media conglomerate could not fully capitalize on the new technology because its executives, who were wearing old-thinking hats, failed to understand its potential to reconfigure a taken-for-granted business model. Needless to say, the time is ticking for this type of traditional business model.

On the same wavelength, economists wearing old-thinking hats are trying to find solutions using crippled thinking.

At a time, when even orthodox economists at the other side of the pond are publicly acknowledging the limitations of traditional neo-classical thinking applied to both supply and demand sides, it is important that here in Britain, our economic leaders also recognize the need for a paradigm shift.

New wine, rather than old-mulled wine in new bottles, is needed – urgently.