For quite a number of years, Carlota Perez has been predicting the inevitability of the financial crisis that ultimately engulfed us. An expert on the historical links between technology and socio-economic development, she is Visiting Senior Research Fellow at the Judge Business School of the University of Cambridge, as well as being affiliated with the University of Sussex and a number of other institutions,
I first met Carlota - a friend whom I therefore feel comfortable calling by her first name - when she visited IBM several years ago, shortly after the publication of her book: Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages. In her book, articles and lectures, she eloquently explains (see this excellent video, for example) how the combination of new, disruptive technologies and financial capital looking for the next big thing come together from time to time to usher massive new changes in society. These changes are always accompanied by a financial bubble and subsequent massive crash.
She believes that the present financial crisis is indeed a “once in a half century event”, but an event that she argues has happened four times before in the last 200 years or so. While each such technology-based revolution has its own unique dynamics, a lot can be learned by examining their common characteristics. If you look at the historical big picture, patterns begin to emerge, which serve as a very good guide for thinking about and planning for the future.
Over the past couple of centuries years, we have had a technology revolution every 40 - 60 years, starting with the Industrial Revolution in 1771. This was followed by the age of steam and coal, iron and railways which started in 1829; steel and heavy engineering (electrical, chemical, civil and naval) starting in 1875; and the age of the automobile in 1908. Our present information technology and telecommunications age, whose starting point Carlota pegs at 1971, is the 5th such major revolution in that span.
Each such revolution takes about half a century to spread around the world, and is characterized by two distinct periods: installation and deployment.
The installation period is a time of creative destruction, when new technologies emerge from the lab into the marketplace, entrepreneurs start many new businesses based on these new technologies, and venture capitalists encourage experimentation with new business models and speculation in new money-making schemes. Inevitably, this all leads to the kind of financial bubbles and crash we are now quite familiar with
After the crash, comes the deployment period, the time of creative construction and institutional recomposition. The now well accepted technologies and economic paradigms become the norm; infrastructures and industries start getting better defined and more stable; and production capital drives long-term growth and expansion by spreading and multiplying the successful business models.
I first heard Carlota speak shortly after the implosion of the dot-com bubble. I assumed, as did most of those who attended her lecture, that given the dot-com financial crash, we would soon be entering the deployment period. She argued vehemently then, and in subsequent conversations, that the real financial crash had not yet taken place. After a meeting in 2005, where we once more discussed where we were in the cycle, I posted this entry where I wrote that
“Carlota Perez believes that we may not yet have entered the deployment period, as the crash phase doesn't seem to have resolved itself. She mentions three particular structural tensions that we need still to work out in order to move on: investments continue to be focused on short-term gain, not on long-term production and growth; the social system continues to foster an unstable environment in which the rich get richer and the poor get poorer; and there is too much idle money chasing and inflating assets like housing and not going into expanding the demand needed to soak up all the excess supply being produced.”
Think how remarkably prescient her words are, especially when you consider the number of top economists who were at the time advocating the notion that the world was now safe from cataclysmic financial crises, because of the ability of derivatives and other new financial instruments to effectively distribute risks.
In this recent article, After Crisis: Creative Construction, she explains that
“this time we have had the boom and crash in two episodes. The first was the Internet mania which was truly fuelled by new technology and ended in the NASDAQ collapse of 2000. The other was the set of easy credit bubbles of 2003-08, when investors were pushed by an abundance of quasi-free money into finding anything but technology as an object of speculation (from commodity futures to securitized sub-prime mortgages). The enormity of this financial bubble was facilitated by the process of globalization and the capacity for computer-aided financial "innovation" acquired during the NASDAQ boom. It is because regulation did not follow after 2000 that free-wheeling finance was able to reach such astonishing levels of systemic risk. It is only now, when all the crooked doings of the casino have been revealed and their painful consequences for the real economy are being suffered, that there is enough political pressure for regulation and institutional recomposition.”
Carlota believes that the financial excesses that keep coming to light are an integral part of the concept of creative destruction popularized by Austrian economist Joseph Schumpeter to describe the process of transformation that accompanies radical, disruptive innovation. The new technologies and innovations advocated by entrepreneurs and venture capitalists are the force that ultimately sustains long term economic growth, even as this same powerful force destroys the value of established companies. As Carlota writes
“Historically, [the Installation Period] has been the time when financial capital shapes the economy, while the ideology of laissez faire shapes the behaviour of governments. It is a grand experiment when unrestrained finance can override the power of the old production giants and fund the new entrepreneurs in testing the vast new potential. Finance then helps the new giants emerge, enables the modernization of the old industries with the new techno-economic paradigm and facilitates the necessary overinvestment in the new infrastructures (so coverage is enough for widespread usage). Thus the extreme "free market" ideology has a role to play in the early decades of each surge.”
Everything changes after the inevitable crash. “The collapse reveals the need for regulation to restrain financial excesses and to favour the real economy, usually under political pressure for reversing the income polarization and other negative consequences of the bubble times.”
And she adds, “Once installation has been achieved, however, there is a vast innovation and growth potential that the economy is ready to tap. Unrestrained markets then become a very blunt and brutal instrument; yet markets guided by policies that implement common visions arrived at through a social consensus orchestrated by modern, well informed, realistic and socially responsible governments are more likely to achieve the best results in these circumstances.”
The focus has to now be on the real economy, that is, the economy of production capital, long-term investment, job creation. Individual pursuit of wealth and power has to now be balanced with achieving the common good. Her parting words offer a good prescription for what we must do to help bring about this new period of creative construction
“Ultimately, the length and depth of the global recession (perhaps depression) will depend, not on the financial rescue packages but, to a much greater extent, on whether the wider measures taken are capable of moving the world economy towards a viable investment route with high innovation potential. The technological transformation that occurred during the past few decades has already provided the means for unleashing a sustainable global golden age. The environmental threats offer an explicit directionality for using that creative potential across the globe in a viable manner. The major financial collapse has generated the political conditions to take full advantage of this unparalleled opportunity. It is everybody's responsibility to make sure this possibility is not missed.”