An out-of-equilibrium approach to innovation and growth

M.Amendola

‘The Innovative choice’ B.Blackwell 1988

‘Out of Equilibrium’ OUP Clarendon Press 1998

‘The Market Way to Riches: Behind the Myth’ E.Elgar 2006

Standard Analysis of Innovation and Growth

• Dominant analyses of Innovation and Growth are consistent with the standard definition of the process of Production and Technology.

• This relates inputs and output on the basis of a given relation defined ex ante by technical conditions, and hence determines returns and productivity as the expression of these conditions.

• In this view both productive capacity and its adequate utilisation are the automatic (immediate or delayed) result of the availability of given

productive resources, and of the way they are combined, which also determines the efficiency with which these resources are used in the process of production.

All this comes about as the result of a simple choice, a choice that becomes the main object of policy.

This view of production and technology has the following policy implications:•The right investment - the choice of innovative technologies - is the main source of growth.•This choice calls for favourable market conditions, reckoned as perfectly competitive markets.

Monopolistic distortions - with focus mainly on the labour market rigidities- appear as a main obstacle to the working of competition, and hence call for structural reforms to remove them.

Macro interventions to assure stability (identified with price stability and balanced public budgets), are a preliminary step, once stabilised the economy, to the required structural reforms, and hence is a pre-condition of the process of innovation and growth.

Equilibrium in the background

The production theory underlying this approach is consistent only with an equilibrium context.Only in equilibrium we can count on an established relation between the basic magnitudes (output, capitalemployment) of the production process.This established relation supposes the functioning of agiven productive capacity - defined in terms of givenproduction coefficients - that brings about a regularbehaviour of the economy.

Only in equilibrium, then, we can relate inputs and output on the basis of a given relation defined ex ante by technical conditions, and hence determine returns and productivity as the expression of these conditions

Co-ordination problems, which might hamper the effective appropriation of the potential returns of technology, are excluded by assumption.

The production process is then synchronised: inputs and output are analytically contemporaneous in thatthere are always proceeds agains which costs canbe set and a ‘current’ productive activity out of whichthey can be financed.

Innovation as an out-of-equilibrium process

Innovation is by definition the modification of a given productive capacity, and hence the breaking of a regular behaviour of the economy.

Production processes are no longer synchronised: as a consequence co-ordination problems arise in the economy

Innovation is then a process (in real time) that can be successful or not; technological opportunities do not imply productivity gains as the result of a simple choice.

•Actually obtaining the returns of innovationdepends not so much on the intrinsic characteristics of technology as on the co-ordination, both at the micro and the macro level, required to make the innovation process viable.•Innovation implies in the first place a restructuring of productive capacity. However, co-ordination problems arise not only in the production process itself, due to the distortion of productive capacity resulting from innovation, but extend to the whole economic activity.•New goods imply new types of production processes and hence new activities that in turn call for new types of interaction among the existing agents and institutions or even the appearance of new actors and institutions.

The main problem is then to re-establish a regularbehaviour of the economy, which, we shall see, Depends on re-establishing a balanced structure of productive capacity and eliminating market imbalances.This is what makes the innovation process viable and allows to reap the gains of technology.

In this light technology no longer appears as the precondition of the process of innovation but as the result of the latter, interpreted as an (essentially economic) co-ordination process.

ProductionThe way we look at production is the watershed betweenan equilibrium and an out-of-equilibrium analytical approach.In an equilibrium context, we have seen, production is kept in the background, and its results are disposed of by assumption.Out of equilibrium we need a definition of production stressing its time dimension and sequential articulation.(Neo-Austrian)Production is a scheme for transforming a sequence of primary labour inputs into a sequence of final output.The production process is fully vertically integrated, whichmakes it possible to bring into light the construction phase of productive capacity and its articulation over time with its utilization phase (intertemporal complementarity).

Capital goods are internal in that they cannot be transferred from one process to another embodying adifferent technique. In this ex ante view capital appears as a fund of (financial) resources that allows to employ a human resource to carry out production.At each moment the productive capacity of the Economy is represented by a population of production processes.A steady state is sustained by a constant age distribution of production processes, representing a given way of working of an established productive capacity. This implies a perfect synchronization of production.

The age distribution of production processes is characterized by a horizontal dimension consistent with its vertical dimension

Then not only the phases of construction and Utilization of productive capacity, but also investment and consumption, saving and investment, and supply and demand of final output are fully harmonized.

The analytical context

Neo-Austrian production ProcessProduction of Processes Production of CommoditiesIntertemporal Complementarity

Decision ProcessConstraints - ExpectationsIntertemporal Complementarity

Sequential ContextIntra-period Sequence Inter-period Sequence

Intertemporal Complementarity of Production Process interaction withIntertemporal Complementarity of Decision Process

Sequence Constraints - Decisions - Constraints

Evolution of the Economy

Construction Horizontal dimension

Structure consistent

Utilization Vertical dimension ( Productive capacity with a given age structure)

Balance Intertemporal complementarityAt each moment Production processesOver time

Investment/Consumption Intertemporal Co-ordinationSupply/Demand Decision process

Equilibrium of the economy

Structural changeSHOCK(change in technique-innovation-growth acceleration,….throws the economy out of equilibrium)

Distortion of Productive Capacity(affects the age structure, the equilibrium balance of productionProcesses)

Problems of intertemporal complementarityProduction Process Construction utilization(Dissociation in time of inputs from output, costs from proceeds)

Problems of Intertemporal Co-ordinationDecision process(investment consumption, supply demand, market disequilibria)

Out-of-equilibrium ProcessDistortion of productive capacityMarket imbalances

Reaction and adjustment mechanisms determineStrong erratic Fluctuations (more amd more distortions ofproductive capacity

Viability problem Complementarity (Prod.Proc.)Re-establish Intertemporal Co-ordination (Dec.Proc.)

Focus on the Adjustment Process, not on the Point of Arrival

No distinctionLONG TERM (Equilibrium-Adjustments realizedSHORT Term (Disequilibrium)

LONG TERM (Sequence of Short terms Process

Exogenous vs Endogenous

No FUNDAMENTALS (Change according to evolution path)

Technology ≠ Its Ga

CREATION vs ALLOCATION of resources

SIMULATIONS vs ANALYTICAL SOLUTIONS

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Co-ordination mechanismsCo-ordination problems are associated with the distortion of productive capacity due to a structural shock affecting the way of functioning of the economy.

Inflationary pressures and the appearance of unemployment are the likely outcome of the attempt to carry out innovation processes

The main problem is then to re-establish a balanced structure of productive capacity and to eliminate market balances, thus containing inflation and re-absorbing unemployment.

The availability of productive (financial and human)resources,and the constraints that these may impose on production processes,together with the allocation of these resources, through the equilibrating (or disequilibrating) role performed by price and wage regimes, are the essential elements of the co-ordination mechanism required for economic changes that involve Structural modifications to be successfully brought about.Contrary to the current policy consensus, macroeconomic stability,far from being regarded as a pre-condition of growth - seen as a set of rules aimed at guaranteeing monetary stability and fiscal discipline - will result from a process that requires discretionary interventions to assure its viability.The rationale of these interventions may be quite the opposite of that presiding over the measures making up the prevailing consensus.

CONSENSUS

Structural properties of the economy (technology andinstitutional rules)govern behaviours and the workingof markets

Institutional mistakes prevento the access to Innovative Technologies

Hence: macroeconomic interventions are required toassure stability as a preliminary step, once stabilisedthe economy, to the necessary structural reforms

Structural reforms aimed at favouring innovation: torealize perfectly competitive markets and minimize monopolistic distortions - focus on the labour marketwhose rigidities are a main obstacle to the working ofcompetition

SUMMING UP

Macro stability is the precondition of the process ofinnovation and growth, assimilated to the realizationof structural reforms, Macro stability regarded as a set of rules and behaviours aimed at achieving monetary stability and fiscal discipline,given once and for all and efficient whatever the context and the moment considered

Monetary policy Innovation implies a restructuring of productive capacity that brings about co-ordination problems (inflation, unemployment).We can try to curb inflation as son as possible (restrictive monetary policy). In this case the investment necessary to carry out the restructuring process cannot be realised.This exacerbates the initial negative impact on output and employment.Alternatively an accomodating monetary policy accepting a transitory inflation will enhance the growth process, thus allowing to re-absorb both inflation and unemployment.

In conclusion:

Monetary policy should be aimed at promoting banking behaviours and financial structures that sustain necessary investment instead of maintaining a devastating constraint on firms’ behaviours in order to maintain full price stability.

The labour marketFlexibility, actually coming down to hiring and firingconditions and free wages fixing is a main structuralreform reckoned as a strong incentive favouring innovative choices,growth and employment.Innovations that introduce new products and, if successful, have higher returns are risky and are characterised by a strong turnover and a pronounced creation and destruction of employment.Dismissal costs (employment protection) and rigid wages reduce the incentive for investment in risky, although very productive, technologies and help to retain human resources in low productive sectors.

Creating jobs vs. matching demand and supply of labour.

To create jobs we have to create productive capacity as employment is a part, an aspect of productive capacity.

Innovation (restructuring of productive capacity) is not the simple result of a choice, favoured or hampered by the existence of given conditions. It is a process implying the appearance of imbalances and thus needing the working of co-ordination mechanisms for its viability.

The working of labour markets (flexibility/rigidity, wages policy, employment protection…) must be looked in the perspective of the viability of the innovation process.

In this light:

Learning is a main aspect of innovation.

Flexibility (as absence of employment protection) rather discourages long-term investment in human capital by employers since the worker may not remain in the firm. It also discourages investment in firm-specific skills by workers since these skills may not be a fair return for thatinvestment in the absence of job security.

Restructuring depends on learning and learning obtains notbecause turbulences are systematically favoured but because, although inevitable, they end up in stabilised structures

Flexibility (as referred to wage determination)

Innovation implies a distortion of productive capacity thatresults in disequilibria all over the economy. Due to the attempt to react to these disequilibria we have an alternationof excesses of supply and demand that amplify thedistortions of productive capacity resulting in ever increasing fluctuations that are a threat to the viability ofinnovation. The prevailing wage regime has an essential role in reducing these fluctuations. Price flexibility interpreted as quick and full adjustment feeds over-reactions in one direction or the other.A certain wage rigidity, also by preventing strong incomeredistributions, prevents instead the fluctuations from becoming too violent.

Competition

•Competition policy defined with respect to a given market structure (perfect competition) presumed optimal = privatisations, deregulation of all markets, extreme flexibility and fight against so called monopolistic distortions.•Competition as a process, which is in the nature of a co-ordination mechanism. In this light imperfect competition must be distinguished from market failures. It is a characteristic of any market process and cannot be removed nor systematically corrected

Insofar as successful innovation requires a breaking up of themarket structure in an early phase followed later by a stabilisation of this structure, it may also call for a change in the prevailing rules and institutions. Fast growing markets and changing regulations act as an incentive for initiatives that result in strong changes in industrial structures. But the stabilisation of a new industrial structure may require monopolistic practicesand new forms of regulation, commanding the new inter-industry relationships.

Rivalry and complementarity are both essential elements of aprocess of innovation. Competition fosters rivalry that providesa stimulus to innovative choices; market connections make possible the construction process that allows the effective realization of innovation.

Market and StatePrice stability, budget equilibrium, market flexibility, are not likely by themselves to engage people in risky innovative processes.Decisions are effectively taken on the basis of expectations given the existing constraints. This calls for he presence of an authority capable of sending the strong signals required to actually push the economic actors to engage in a process of innovation, and to help them co-ordinating the actions along the way so as to make the process viable.