Saturday, 9 July 2011

The origin of long term growth

(Written at the time of the .com bubble 12 years ago,
but just as relevant in 2011)

                      On top of the traditional neoclassical understanding of the economy there have, during  the last 10 years, emerged an understanding of knowledge related growth. Although such an understanding, which originally was based on the work of Poul Romer, explains some of the observed growth phenomena. That understanding is still too superficial to explain why some countries over time become more developed than others.
                      200 years ago Denmark and Egypt were having equal size populations and equally developed agriculturally based economies. Today Denmark is on nearly all accounts except size among the world leaders, while Egypt is a developing country without very much development!
As it would be narrow minded and stupid to think, that the above stated difference is due to the different cultural and ethnic origins of the populations, there must have been something very different and very important happening to those two countries!
 For ¾ of those 200 years Egypt was ruled by foreigners, first by the Ottomans and later by the French and the English. None of whom had any interest in fundamentally changing the country, and for the last half century fundamental change has been impossible due to the up hill struggle against the population explosion.
Approximately 200 years ago Denmark too was a feudal agrarian country with virtually no manufacturing capability of its own. What happened was that some of the leaders within the nobility observed what was taking place in other parts of Europe, and in order to improve agriculture and avoid a local revolution, they decided to work for a smooth transition away from the feudal society. Denmark was lucky, because historic events especially the economic events helped the country to a development where the farm population prospered and consequently developed educationally and politically. Farm exports became the driving force leading to a gradual, but also rapid mechanisation of the agricultural sector and later to a mechanised production as such.  A process was started where the surplus product was distributed more and more evenly, eventually leading to an industrial society with a high and broad educational standard.
The ideological/political explanation for this Danish development was naturally the want of equality and justice, but in actual fact it was something quite different that was the fundamental driving force behind this remarkable development in a small country without any other resources than its population and its arable land.
Firstly protectionist behaviour by England and France forced the Danish farmers to develop their production methods while the farmers of those countries had no incentive to change, as they due to the import restrictions could keep their market share without making any changes. Then later competitive pressure from producers of grain in Central Europe hit the European markets by way of the new railways, and the same was the case with grain from the U.S.A. transported on rail and by steamships. This development forced the Danish farmers to abandon export of grain and instead use the grain to produce dairy products. The manufacturing of farm and dairy machinery led to a broader industrialisation, and as industry in a small country like Denmark cannot survive based on its home market, the only  possibility for the industry were to compete on the international markets.          
 The relative high wages of the well organised workers in Denmark, forced the manufactures to stay competitive by way of continuously developing and renewing the production apparatus, thus reducing the amount of costly labour.
Already David Ricardo wrote: "It is when the market price of labour exceeds its natural price that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family", but what David Ricardo did not anticipate was that  this good conditions for the labourers, when combined with the pressure from well organised labourers through their organisations and associated political parties,  led to a higher educated labour force capable of inventing and using more advanced production methods, leading to higher productivity, higher wages and still better educated labourers/employees! In other words the pressure resulting from high wages/taxes lead to a positive developmental spiral of business as well as of society.
With the emerging understanding of knowledge related growth, many politicians talk of improving education, and in some cases they even try to do something about it, but it is only when the parent generation experiences personal growth and prosperity and therefore also experience that education in actual fact leads to better living conditions, that their children are motivated to rise above their present social and educational level. In many countries including the U.S.A. where there are huge social and educational differences, very little is in actual fact done towards a broad improvement of the educational level.  
It was Adam Smith who defined that the surplus product was the motivation for the manufacturers to continue producing, Although already David Ricardo defined the extra surplus product as the economic surplus coming out of being technologically ahead of the competitors, this was more or less ignored as it was assumed of less economic importance because it only was of economic benefit to the leading producer until the other producers caught up.
When the employees and society acquires a greater share of the surplus product from the producers by way of higher wages and taxes, the producers are forced to innovate in order to stay in business. By educating the population and developing the infrastructure society establishes an efficient foundation for further development and competitiveness!
Northern Europe, where the above stated mechanism is most clearly at play, is improving living standards and infrastructure, at the same time as being competitive to the U.S.A.  
If we take a look at the development of other European countries than the Scandinavian, after “the second world war”, Germany, Switzerland and Holland prospered at the same time as they revaluated their currencies! Revaluation is in fact the same as raising the states and the citizens/workers share of the surplus product, at the expense of the exporting firms. Those firms are then forced to create extra surplus value by way of innovation in order to stay in business.
That general long term growth is driven by an economic pressure on the manufacturers by way of higher wages and taxation has great implications for the political strategies. The best way to help business grow is not to subsidise or protect any firm or work for lower wages, but to develop the infrastructure and make all public functions as efficient as possible, to optimise the educational system, to finance supplementary education of the workforce and to massively finance public research.    
The present perception of economic growth is “what is good for business is good for the country!” but that is not always the case. In the present situation American firms can stay profitable at the same time as society runs huge budget and balance of payment deficits and society are incapable of upgrading infrastructure and education sufficiently. When the American society is not capable of supplying enough experts and bright young people, such persons are just imported from other countries, thereby hiding the inefficiency of the educational system. In the present downturn a lot of these experts have gone home to their native countries, and the American firms have found out, that the citizens in those countries can do much of the work, brain work too, that has hitherto been done in the USA, and at much lower wages! 


Although the above statements are correct they are not functioning in the “Old Industrial countries” any more. The internationalisation of those economies has set the companies free to run away from high wages and taxation and leave their home countries behind.

Unfortunately it is not possible to turn the development back.

The only possibility is to speed up the societal, political and legal development towards an international economy based on the exchange of ideas.

The alternative (that regrettably by now is the most likely) will be conflicts and even war between the “Old industrialized countries” and the “New industrialized countries”.

The established economic powers and institutions will naturally be opposed to radical changes, but when they realize that the alternative will be the break down of the economic system as such, resulting in their loss of wealth, they might be willing to radical changes.


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