Thursday, July 2, 2009

Book Review: Technological Revolutions and Financial Capital

I just finished reading "Technological Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages" by CarlotaPerez. This is a book I decided to read because I had heard senior IBMexecutives talk about it in the pasts. Two things struck me: one wasthat the IBM executives clearly valued what she had to say. The otherwas that her work made predictions about the current economiccrisis. While it is dense in part, overall I enjoyed the book andfound the model it contained quite compelling.

The basic idea of the work is that since the industrial revolutionthere have been 4.5 great surges of technological advances, eachlasting around 50 years. These surges were: the industrial revolution,the age of steam and railroads, the age of steel, the age of oil,cars, and mass production, and the information age. Each surgeoverlaps with the previous surge and goes through 4 distinct phases ofapproximately 10 years each: irruption, frenzy, synergy, and maturity.

The irruption phase begins with some big bang (identified inretrospect) identifying the new technology. The technology quicklygrows, while the old economy stagnates. In the frenzy stage, thefinancial capital that has invested in the new technology and newcompanies gets used to the staggering returns from the new technologyand expects them to continue. All businesses are expected to givelofty returns, more people enter the market, and there is assetinflation as the paper value of companies and other assets separatesfrom there productive value. As this continues, financial capitalstarts to invent ways to make money from money.

The frenzy phase ends with a market crash and correction. The crash isactually a very important part of Perez's model. The crash isnecessary to implement the new regulations needed for the newtechnological paradigm, and for the worlds of production capital tocome back into harmony with production capital. If this is done well,it can lead to a golden age in the synergy phase. The synergy phaserepresents the extension of the new technology to the rest of theeconomy, with the related increases in productivity.

At the end of the synergy phase, the new technology is starting tosaturate in its growth. This marks the beginning of the maturityphase. There are fewer and fewer parts of the economy to spread thenew technology too. Because of this, growth slows. As growth slows,there is a lot of idle capital looking for good things to investin. Additionally, the producers look into new areas and technologiesto prop up their now stagnating business. The idle capital and therenewed interest from established companies will provide theopportunity for the next technology to emerge, and the cycle repeats.

There are a few key themes and ideas in the book. One of them is theroles of financial capital and production capital through thecycle. Financial capital is the money, while production capital arethe people who make things. Financial capital can quickly move fromone technology to the next and is crucial in the creative destructionof old technologies and the emergence of new ones. However, productioncapital is key to successfully deploying the new technology throughoutthe economy. Additionally, production capital is very slow tochange. Production capital represents the people actually running thebusinesses. They have to have a very detailed understanding of thetechnologies, and need such an understanding to besuccessful. Therefore, they will stay with what they know as long aspossible.

Another key idea is the 50 year cycle. Perez argues that the 50 yearcycle is inherently human. Each of the great surges represents aparadigm shift in the technology and how people live. The ideasconsidered common sense are different in the different paradigms. Ittakes the first half of the 50 year cycle for the population tointernalize the new paradigm. This internalization is key to itscomplete exploitation in the synergy phase. Once the paradigm isinternalized, the new technology dominates everything and there isreal and good growth in the economy. It then takes another 20-30 yearsto fully exploit this internalization, before most gains have beenexploited. The force of this internalization is what really driveseverything. And the internalization inherently forces out any ideasthat do not fit within the paradigm. There very well may be wonderfultechnological advances that happen throughout the cycle. Incrementaladvances will be included within the new paradigm. Radical advanceswill be shunned, except in the maturity face. The new, radical ideasare just too risky for financial or production capital to invest inwhen the old paradigm is still providing good returns. It is only whenthe old paradigm stops providing good returns that the idle capitalshows up, allowing the next revolution to occur.

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