Wednesday, November 26, 2014

Financial Crisis or Innovation Crisis? Both!

NEW YORK  Former world chess champion and political activist Garry Kasparov and internet entrepreneur Peter Thiel, squared off with Harvard economist Kenneth Rogoff on the question whether advanced economies experience a financial crisis or an innovation crisis.

Mr Rogoff, who authored This Time is Different: Eight Centuries of Financial Folly (2009) with Carmen Reinhart, argues that the systemic financial crisis is the root cause of the prolonged economic slump in the western world. In their research, Mr Rogoff and Ms Reinhart found economic growth following a systemic financial crisis to be about a full percentage point below trend growth.

Mr Kasparov and Mr Thiel, on the other side, disavow Mr Rogoff’s claim that the collapse of advanced-country growth is the result of the financial crisis. In their view, the flailing western economies reflect stagnating technological development and innovation, and without radical changes in innovation policy, advanced economies are unlikely to see any prolonged pickup in productivity growth.

Robert Gordon of Northwestern University espouses in Is U.S. Economic Growth Over? an even more dire view, suggesting that the 250 years of rapid technological progress that followed the Industrial Revolution may prove to be the exception, rather than the rule.

A synthesis of the positions held by Mr Rogoff and Mr Kasparov and Mr Thiel is rather obvious. Most advanced economies are indeed suffering from a full-blown balance sheet recession in the aftermath of the worst systemic financial crisis since the Great Depression. Households, all too often saddled with mortgage debt exceeding the value of their home, are desperate to pay down debt and reluctant to spend money, let alone take out new loans.

In order to meet the requirements of the new regulatory environment, banks are assiduously trying to raise capital and hesitant to lend money to businesses. Both the lack of consumer demand and the credit contraction harms business activity in the western world, resulting in what may be a decade or more of subpar economic growth.

On the other hand, speculative bubbles in the housing market come with Dutch disease-like symptoms. The term ‘Dutch disease’ was coined 35 years ago by The Economist, and describes the observed relationship between the exploitation of natural resources and the decline of the industrial sector in a country.

The primary mechanism of deindustrialization is that a natural resources bonanza will lead to the appreciation of a nation’s currency, resulting in the nation’s other exports becoming more expensive for other countries to buy, thereby making the manufacturing sector internationally less competitive.

The other mechanism through which (indirect) deindustrialization takes place, is the so-called spending effect. As revenues from a natural resources boom are spent domestically, the demand for labor in the non-tradable sector increases, luring workers away from the tradable sector. We see something similar happening during a housing boom.

With residential housing prices on the rise, homeowners feel wealthier and are inclined to spend more, often with the help of a second or third mortgage. This in turn inflates the non-tradable sector. Since technological growth in the non-tradable sector is generally lower, compared with the tradable sector, a speculative bubble in the housing market harms innovation and technological growth.

The deindustrialization resulting from a housing boom could well explain the lack of technological progress and innovation in western economies, as observed by Mr Kasparov and Mr Thiel.

The Rogoff-Kasparov-Thiel synthesis is not compatible with the Keynesian view that the Great Recession is merely about a shortfall in demand, ie, that it is cyclical rather than structural. Through its adverse effect on the tradable sector, a housing boom does structural damage to an economy.

It is not a coincidence that Germany, the only western country that saw real housing prices decrease over the past decade, turned itself from the sick man of Europe at the end of the 1990s into one of the few advanced economies that seem globalization-proof.

The Dutch disease can’t account for Robert Gordon’s more pessimistic view that the era of rapid technological progress has come to an end altogether. But as the rise of China, India and other emerging economies poses tremendous challenges in terms of climate, food and other natural resources, I doubt his sobering outlook will prove true.

  • Contact us to secure rights


  • Hide Comments Hide Comments Read Comments (2)

    Please login or register to post a comment

    1. CommentedPaul Peters

      Although a very fascinating theory indirect deindustrialization does not so much smother innovation... it is optical illusion effect of a shift towards tertiary skillset due to times of significant service growth that has created an overvaluation of skills like financial analysts, marketeers, coaches.. as long as innovation wasn't even on the agenda, or you could buy regional exclusive rights, you could lean on your CFO and CMO.
      But maybe we can talk about a second "Dutch disease"..
      One third of the Dutch workforce is either a business owner, director, manager, coach or advisor.. if we correct this for the business owners we are talking about one quarter. This is some overhead... Not only that, it is the sheer amount and filtering effect of the organizational hierarchy where mostoften the most talented are pushed out as "overqualified". So, the innovators are there.. but they are crowded out by people who are now fighting hard to make themselves seemingly indispensable.

      It doesn't mean the road ahead is grabbing back to industrialization, or make entrepreneurs out of students for that matter, but if one understands the evolutionary nature of systemic automation, then one can reach forward to the future industrialization. If you want to know how that looks like, look at user communities in the Gaming industry. The emergent business model is truly amazing.

      Before the crises, banks simply were easy lenders.. but now with their risk-aversity what is exposed is their imcompetence in gauging viable businesses, the gut feeling factor. And while inventor/entrepreneurs would slip through the mazes and get a confidence vote in their benefit.. Now this is all gone. On top of that popular optimization methods like Six Sigma have made many business process so lean, mean and predictable that for the last two decades more and more work has been offshored but also did not allow any room for any potentially revolutionary pilot project. Many of the earlier inventons would piggyback along on the facilities of large companies. And with the increased formalization of this, these opportunities that seed and feed innovation are not there anymore, and nothing has replaced it.

      In the end it is about people, and there are very few mature scouting, mentoring and seeding networks available for the 40-50 year old has the highest likelyhood of success, as they have the maturity, experience, expertise, drive and tenacity to make things happen. None that i know of at least. At the moment most of the funding goes to bystanders, writers of subsidized reports, motivators and start up cheerleaders, who try to fill up their penny cup at the circus entrance while turning up the volume knob to set a new Tjakka density record.

      It takes courage to do so, but hopefully at some the cumulative prospect will reach a tipping point so that the perceived risk of change is less than falling victim to collective autocannibalism.

    2. CommentedShane Beck

      More likely it is just easier for the Western elite to milk the taxpayer by scams such as Savings & Loans, Junk Bonds, Internet bubbles, CDOs /CDS and bank their loot in off shore tax havens than compete in the global marketplace. Technological innovation in general is slowing down with many innovations being refinements of inventions from the 20th century. These days, corporations are engaged in Patent Wars to milk profit from the court settlement system