Carl Menger, the founder of the Austrian School of Economics, had the ambition that economics should be a .map of the forces at workÿ. Standard textbook economics (.neo-classical economicsÿ) takes as its starting point a metaphor of .equilibriumÿ based on the state of the physics profession in the 1880s. This force towards equilibrium is, however, only one of many forces at work. The most fundamental feature of capitalism is change, and this change is only poorly reflected in standard economics. Financial crises are just one of the many things that happen in real life, but cannot happen in standard textbook economics. From the standpoint of Joseph Alois Schumpeter (1883-1950), Austrian economist and Harvard economics professor who spent much time at Harvard Business School, .equilibriumÿ is the opposite of economic development. Equilibrium theory therefore fails to reflect many of the mechanisms of industrial and economic dynamics that create economic welfare. This note attempts to outline some of these forces.

Erik S. Reinert

English

Research Papers in Economics

the other canon foundation, Norway
Tallinn University of Technology, Tallinn
CONTACT: Rainer Kattel, kattel@staff.ttu.ee; Wolfgang Drechsler, drechsler@staff.ttu.ee; Erik S. Reinert, reinert@staff.ttu.ee
Working Papers in Technology Governance and Economic Dynamics no. 26
TECHNOLOGY GOVERNANCE
August 2009
C Ca ap pi it ta al li is st t   D Dy yn na am mi ic cs s: :   
A A   T Te ec ch hn ni ic ca al l   N No ot te e
Erik S. Reinert, The Other Canon Foundation, Norway & Tallinn
University of Technology, EstoniaCarl Menger, the founder of the Austrian School of Economics, had the
ambition that economics should be a ‘map of the forces at work’. Standard
textbook economics (‘neo-classical economics’) takes as its starting point a
metaphor of ‘equilibrium’ based on the state of the physics profession in
the 1880s. This force towards equilibrium is, however, only one of many
forces at work. The most fundamental feature of capitalism is change, and
this change is only poorly reflected in standard economics. Financial crises
are just one of the many things that happen in real life, but cannot happen
in standard textbook economics. From the standpoint of Joseph Alois
Schumpeter (1883-1950), Austrian economist and Harvard economics pro-
fessor who spent much time at Harvard Business School, ‘equilibrium’ is the
opposite of economic development. Equilibrium theory therefore fails to
reflect many of the mechanisms of industrial and economic dynamics that
create economic welfare. This note attempts to outline some of these
forces. 
Productivity explosions
What from a long-term perspective may look as relatively smooth curves of
economic development are in reality the result of explosive productivity
changes in a small number of industries. Figure 1 shows an early such ‘pro-
ductivity explosion’ from a breakthrough innovation: that of cotton spinning
in the late 1700s when annual labour productivity rose with more than 25%
annually for a brief period.
2At the time the common sense of economics was for nations to attempt to
get industries behaving like this inside their borders. Productivity explosions
create a system of triple rents: profits are high, wages rise, and the gov-
ernment tax-base grows. In its essence colonialism was a system that pro-
hibited such production activities — industry in general — from being car-
ried out in the colonies. At the time of this early productivity explosion, this
prohibition of manufacturing was a main motive for the United States’ inde-
pendence in 1776. 
Today we are experiencing a similar productivity explosion in the computer
industry. Moore’s Law tells us that, since the late 1970’s, the capacity of
the computer chips doubles roughly every 18 months, creating an upward
curve like the one of the cotton industry in the 1700s.    
Also the activities, even technologically pedestrian ones, that are near the
productivity explosion may achieve triple rents. The task of cutting and
preparing cables to the computer industry grew up geographically close to
the computer industry itself when volume was low and prices not a big
issue. Based on the growing demand, however, even low-tech industries
may achieve economies of scale and run down the learning curve (see
Figure 2).
As German economist Friedrich List pointed out in 1841, English econo-
mists tended to explain economic progress as a result of free trade rather
than as the result of ‘productivity explosions’, thus ‘confusing the carrier
with the cause’. The trade theory disregarded the industrial revolution by
3operating only with labour hours, no capital, no skills, no technology, and
no entrepreneurship. List’s comment still applies to standard textbook eco-
nomics.      
Learning Curves and Experience Curves. 
One classical article in Harvard Business Review is called ‘Profit from the
Learning Curve’. The learning curve is a productivity explosion seen from
a different angle, measuring the explosive growth in labour productivity
as a declining curve in labour units per unit of output (Figure 2, and
Figure 3 middle).
Starting in the 1970s Boston Consulting Group (BCG) developed the same
concept using total costs, not labour hours, on the left axis, and called this
an ‘experience curve’. Learning curves and experience curves have very
important implications for competitive behavior between firms. 
Ray Vernon and Louis Wells, two professors at Harvard Business School,
developed a life cycle theory of international trade. One implication of this
theory is that rich countries export when the learning curve is steep, but
become importers when the learning curve flattens out. In other words,
within the manufacturing sector poor countries tend to specialize where the
learning curve is flat. Since the Terms of Trade (export prices compared to
import prices) between rich and poor countries often have stayed the same,
this means that the rich countries are able to take out as ‘triple rent’ most
of the fruits of technical change. Former industrial policy was based on the
idea that a nation was better off being slightly less efficient in an industry
subject to a steep learning curve than specializing in industries with limited
or no learning potential. 
Industry Concentration
The number of firms in an industry goes through a cycle as technologies
mature (Figure 3, top). Initially the number of firms in the market grows: at
one time there were more than 200 car manufacturers in the United States
and more than a dozen match factories in Norway. Some decades later
there were four (4) car manufacturers left in the Unites States and one
match factory in Norway (today none).
45Market Saturation Curve (S-curve)  
Normally a steep learning curve is associated with a sharp increase in
demand (Figure 3, bottom). When the mobile industry starts growing no
one has cellular phones and the market saturation curve takes on the form
of an ‘epidemic curve’ like in medicine. Flat to start with and flat towards
the end, but with steep growth in the middle. When the curve flattens out
the replacement market becomes the dominant segment, and product dif-
ferentiation increases (‘adding bells and whistles’).  
The close relationship between technical change and increasing demand is
called Verdoorn’s Law after a Dutch economist. 
The Quality Index of Economic Activities
Figure 4 attempts to make a fluid classification system for economic activ-
ities sorted according to their abilities to create triple rents (high profits, high
wages, large tax base). Black, on the top, marks a situation of temporary
monopoly from a new innovation. White, at the bottom, marks a situation
of ‘perfect competition’ which is the ‘ideal’ situation in neo-classical eco-
nomics with ‘normal’ or no profit. The problem is that economic theory only
defines well pure black (monopoly) and pure white (perfect competition),
while very few activities stay long in any of these positions. Industrial
dynamics take place in the various shades of gray areas where theory has
little precise to say. 
The gravity in the system (from black to white) is produced by imitators of
the original idea and general productivity developments, and under some
circumstances — as when a patent expires — the fall can be very fast (the
price of a medicine may suddenly fall by 90%). Some innovations, like the
container, are born towards the white end, but the container was important
to other industries because transportation costs were reduced. 
The various factors that create gravity and gravity-resistance are listed in
Figure 4. The position of a nation’s export activities, at what level (at what
shade of grey), in Figure 4 will be highly determinant for the real wages of
that nation. Baseballs for the US national sport have not experienced innova-
tion in the final assembly operations for a century. This is still 100% manual
work. The world’s most efficient baseball producers are in Haiti and
Honduras, where their wages are between US Dollars 0.50 and 1.00 an hour.
The wages in the national service sector, the librarians or the firemen of Haiti,
will have wages in line with the producers in the export sector. The world’s
most efficient producers of golf balls, on the other hand, are in New Bedford
6Massachusetts, where the average industrial wage is US Dollars 14 per hour.
Golfballs are a high-tech product that needs to be located near the engineers. 
When Haiti exports baseballs to the United States and imports golf balls,
the country exchanges 28 hours of labour (at 50 cents an hour) for one
hour of labour in the United States (at 14 dollars an hour). These mecha-
nisms are not captured in international trade theory, since this theory oper-
ates on the basis of bartering labour hours — all of the same quality —
alone. 
The case of baseballs and golf balls is an extreme one, but the very same
forces are at work with Norway’s relationship to the rest of the world.
Businesses — and nations — stay wealthy only through continuous inno-
vation, the welfare state must be a Schumpeterian welfare state in order to
survive. Remaining at the same level of profits or real wages requires con-
tinuous innovations. Or, as one of the characters in Alice in Wonderland
says: ‘This is how fast you have to run here in order to stand still’.      
Figure 5 (Chart 16) shows the ‘quality index’ of economic activities as it
looked in practice in 51 industrial sectors in the United States from 1899
to 1939. Note the fantastic productivity explosion in the automotive indus-
try and the miserable performance — e.g. of the glove and leather sector.
Note also Verdoorn’s Law at work: the relationship between ‘high growth
in output’ and rapid decrease in ‘wage earners per unit’ (i.e., the slope of
the learning curve).      
The Gestation Period for Innovations
Technologies differ on a variety of axis, and accordingly what US econo-
mist Moses Abramowitz called ‘the factor bias of economic growth’ also
varies. The building of railroads was extremely intensive in ‘capital without
skills’. The coming science-based techno-economic period is likely to be
extremely extensive in ‘knowledgeable capital’.
The factor bias of technologies also shows other peculiarities. The Fordist
mass production paradigm made national catching up with the leader
nations through reverse engineering (the Japanese pulling a US car apart
and creating an improved version) a viable option. The coming science-
based paradigm will be dominated by patents and copyrights and will make
reverse engineering impossible or illegal. Since few nations have positive
balances of payments in patents, royalties and copyrights, this is likely to
worsen world income distribution.
789The gestation period from invention to innovation (i.e., when the invention
reaches the market) also varies considerably from one techno-economic
paradigm to another. The IT-paradigm made relatively short times between
a conceptual idea and a ‘killer application’ possible. The coming science-
based paradigm will require large amounts of skilled and patient capital, as
in Figure 6. A typical product takes 15 years from inception to positive cash
flow. Here various forms of capital are needed, R&D capital, angel capital,
seed capital and venture capital.
Out of an initial pool of 20 projects, only one is likely to be a success after
15 years. Venture capital typically enters only 5 years before positive cash
flow, when there are 2 projects left of the original 20, when the success
rate is 50 per cent vs. the 5 per cent for the investor who starts in year 0
(positive cash flow) minus 15. 
Observers of US industrial policy noted that a growing public participation
in the national innovation system started already several years ago.
Sovereign Wealth Funds as well as the huge financial reserves that many
nations have accumulated are likely to become heavily involved in this new
version of capitalism. The state will no longer be the enemy it used to be
seen as during the Cold War years, but more like economic historians
1011
describe early capitalism in Venice 500 years ago: Venetian wealth was
built on a symbiotic relationship between private entrepreneurship and the
activities of the state. And as with Venice 500 years, national hegemonies
are unfortunately still going to be decided by ‘economies of scale in the use
of force’ as Venice’ foremost historian, Fredrik Lane put it. Economic power
and military power will continue to be two sides of the same coin.
Conclusion: Strategies in a Turbulent Capitalism  
In all its simplicity, Boston Consulting Group’s ‘Product Portfolio Matrix’
(Figure 7) provides a navigational map, a résumé of the forces at work,
which can be used by companies and nations alike. It was a key tool when
this author, as part of US consulting group Telesis, advised the Irish Prime
Minister’s Office on the country’s industrial policy in 1980. The core strate-
gic element consists of the flow of funds from the lower left corner, the
‘cash cows’, to the potential new winners, the ‘question marks’ of the
upper right hand corner. Ireland managed to ride down the steepest learn-
ing curve of our time, harnessing the productivity explosion of the IT-revo-
lution. The next one will be different. Figure 6, the former figure, represents
a description of what will be going on inside the upper right hand corner in
the next techno-economic paradigm. It is important to understand the many forces of capitalism. To a large
extent the wealth and poverty of nations are formed by the ‘forces at work’
— using Menger’s term — depicted in the graphs in this technical note. In
the tradition of Carl Menger and UK economist Nicholas Kaldor this note
sees ‘degrees of imperfect competition’, caused by technological change
and increasing returns, to be a determining element in explaining differences
in national wealth. If we wish to explain the difference in GDP per capita
between Somalia and Korea — where Somalia was a richer country than
Korea until this writer was a teenager (Figure 8) — the main explanatory
variables are found in these same forces.
1213 13
Working Papers in Technology Governance and Economic Dynamics 
The Other Canon Foundation, Norway, and the Technology Governance
program at Tallinn University of Technology (TUT), Estonia, have launched
a new working papers series, entitled “Working Papers in Technology
Governance and Economic Dynamics”. In the context denoted by the title
series, it will publish original research papers, both practical and theoretical,
both narrative and analytical, in the area denoted by such concepts as
uneven economic growth, techno-economic paradigms, the history and the-
ory of economic policy, innovation strategies, and the public management
of innovation, but also generally in the wider fields of industrial policy,
development, technology, institutions, finance, public policy, and econom-
ic and financial history and theory.
The idea is to offer a venue for quickly presenting interesting papers –
scholarly articles, especially as preprints, lectures, essays in a form that
may be developed further later on – in a high-quality, nicely formatted ver-
sion, free of charge: all working papers are downloadable for free from
http://hum.ttu.ee/tg as soon as they appear, and you may also order a free
subscription by e-mail attachment directly from the same website.
The first nine working papers are already available from the website.  
They are
1.
2.
3.
4.
5.
6.
7. 
Erik S. Reinert, Evolutionary Economics, Classical Development
Economics, and the History of Economic Policy: A Plea for
Theorizing by Inclusion.
Richard R. Nelson, Economic Development from the Perspective
of Evolutionary Economic Theory.
Erik S. Reinert, Development and Social Goals: Balancing Aid and
Development to Prevent ‘Welfare Colonialism’.
Jan Kregel and Leonardo Burlamaqui, Finance, Competition,
Instability, and Development Microfoundations and Financial
Scaffolding of the Economy.
Erik S. Reinert, European Integration, Innovations and Uneven
Economic Growth: Challenges and Problems of EU 2005.
Leonardo Burlamaqui, How Should Competition Policies and
Intellectual Property Issues Interact in a Globalised World?
A Schumpeterian Perspective
Paolo Crestanello and Giuseppe Tattara, Connections and
Competences in the Governance of the Value Chain. How
Industrial Countries Keep their Competitive Power14
Sophus A. Reinert, Darwin and the Body Politic: Schäffle, Veblen,
and the Shift of Biological Metaphor in Economics
Antonio Serra, Breve Trattato / A Short Treatise (1613) (available
only in hardcopy and by request).
Joseph L. Love, The Latin American Contribution to Center-
Periphery Perspectives: History and Prospect
Ronald Dore, Shareholder capitalism comes to Japan
Per Högselius, Learning to Destroy. Case studies of creative
destruction management in the new Europe
Gabriel Yoguel, Analía Erbes, Verónica Robert, and José Borello,
Diffusion and appropriation of knowledge in different organiza-
tional structures
Erik S. Reinert and Rainer Kattel, European Eastern Enlargement
as Europe’s Attempted Economic Suicide?
Carlota Perez, Great Surges of development and alternative forms
of globalization
Erik S. Reinert, Iulie Aslaksen, Inger Marie G. Eira, Svein
Mathiesen, Hugo Reinert &  Ellen Inga Turi, Adapting to Climate
Change in Reindeer Herding: The Nation-State as Problem and
Solution
Lawrence King, Patrick Hamm, The Governance Grenade: Mass
Privatization, State Capacity and Economic Development in
Postcommunist and Reforming Communist Societies
Reinert, Erik S., Yves Ekoué Amaïzo and Rainer Kattel. The
Economics of Failed, Failing and Fragile States: Productive
Structure as the Missing Link
Carlota Perez, The New Technologies: An Integrated View
Carlota Perez, Technological revolutions and techno-economic
paradigms
Rainer Kattel, Jan A. Kregel, Erik S. Reinert, The Relevance of
Ragnar Nurkse and Classical Development Economics
Erik S. Reinert, Financial Crises, Persistent Poverty, and the
Terrible Simplifiers in Economics: A Turning Point Towards a New
“1848 Moment”
Rainer Kattel, Erik S. Reinert and Margit Suurna, Industrial
Restructuring and Innovation Policy in Central and Eastern Europe
since 1990
Erkki Karo and Rainer Kattel, The Copying Paradox: Why
Converging Policies but Diverging Capacities for Development in
Eastern European Innovation Systems?
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.  
23.
24. 15
Erik S. Reinert, Emulation versus Comparative Advantage:
Competing and Complementary Principles in the History of
Economic Policy
Erik S. Reinert, Capitalist Dynamics: A Technical Note
The working paper series is edited by Rainer Kattel (kattel@staff.ttu.ee), 
Wolfgang Drechsler (drechsler@staff.ttu.ee), and Erik S. Reinert (reinert@staff.ttu.ee),
who all of them will be happy to receive submissions, suggestions or referrals.
25.
26.

Capitalist Dynamics: A Technical Note

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics