Volatility and crisis in catching up economies: industrial path-through

under the stickiness of technological capabilities

“The Red Queen Effect”.

Mario Cimoli (CEPAL)Gabriel Porcile (UFPR)

The questions 1• Economists agree that intervention in the financial system is legitimate so as to avoid the destruction of the system

• But why avoiding the destruction of capabilities in the industry and agricultural sectors is not a legitimate policy objective as well?

• Why is the destruction of a financial assets more important than the destruction of human capital?

• In times financial crises, even Nixon and Bush became Keynesians. But why industrial policy always need to be carefully justified? Why do economists have to apologize when they defend industrial policy?

The questions 2

• In times of instability and crisis economists focus on inflation and financial vulnerability

• But how instability affects the real sector and long run growth? Are the effects just a transitory slowdown have they persistent effects on growth?

• Is the real sector flexible and then after a negative shock it comes back to its initial shape or could it be transformed in a direction which could be more or less efficient than the former?

The real sector

• We are interested in technological capabilities in the industrial sectors

• These capabilities are related to productivity, diversification and competiveness

• The evolution of capabilities are in close interaction with investment and the growth of effective demand

• There are virtuous circles in which learning, investment, demand growth and economic growth reinforce each other

Financial and real sectors

• The relationship between the financial and real sectors, a rich tradition in economic thinking: Marx, Hilferding, Keynes and Minsky

• Hilferding noted sector distortions associated with price instability

The Lord’s Words• In Keynes, speculation with assets may divert capital from building new wealth

• Lord Keynes: “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. The measure of success attained by Wall Street, regarded as an institution of which the proper social purpose is to direct new investment into the most profitable channels in terms of future yield, cannot be claimed as one of the outstanding triumphs of laissez-faire capitalism”

What explain this crisis…

“Ponzi finance” plus “liquidity trap”

Minsky

• The development of a sophisticated financial system may endogenously lead from conservative finance (hedge) towards speculative and “Ponzi finance” (eventually generating a financial crisis);

“There therefore are systemic conditions that need to be satisfied for a financial crisis to occur: the financial structure needs to be heavily indebted, involving a large element of either Ponzi finance or speculative finance which can become Ponzi. We can characterize a financial structure which is predominantly hedge financing as robust and a financial structure that is heavily speculative and Ponzi as fragile.” (Minsky, 1991)

“The potential loss to society from a financial crisis will be great if it leads into a deep and long depression. If all that followed from a financial crisis is some redistribution of the wealth or a shift of production from investment to consumption economy, then some concerns goods within a full employment about equity and the impact upon the losers in this process may arise…Intervention is ordained if it is believed that a free market resolution of a financial crisis requires doing time in a deep depression.” (Minsky, 1991)

Real and financial “assets”

• Why can technological assets be dilapidated and financial assets protected?

• Indeed, one may argue that protecting real assets is the best form of protecting financial assets in the long run

• We may sometimes pick the (technology- based) winners in industry and try to prevent the financial system from picking the winners, the loosers and the chantas (malandro, imbroglione, deceitful)?

Picking the chantas (Charles Ponzi, born in Ravenna, 1882; died in Rio de

Janeiro in 1949)

Consequences…

• Under recession…the: • Injection of liquidity increase demand for liquidity….

• Increase the restriction of real sector and the effective demand is continuously reduced…

• Volatility of prices…exchange rate….

The microeconomics of price and financial

instability• Atkinson-Stiglitz: punctuated technological change (localized learning)

• Hysteresis and path-dependency in learning (Arthur, Dosi, Cimoli&Dosi, Cimoli&Porcile)

• Technological capabilities are real assets that cannot be easily rebuilt once they have been destroyed

Stickiness of technological capabilities• Require real time• Accumulation• Path-dependent• Complementary• Irreversibility

Price shocks and the firm´s response

• A price shock obliges the firm to readapt and redefine its capabilities by reorganizing the production process, investing in R&D and moving towards a new mix of production

• But these changes require time and resources; the velocity with which the firm responds is crucial to remain competitive in the market

• During this re-adaptation process there will be a slowdown in productivity growth; some activities may disappear (and the firms exit the market), and others will attain higher efficiency at the end of the adaptation period

A systemic impact..

• The shocks will have an impact on productivity growth; the may show hysteresis as the ability of the firm to respond gradually weakens

• Changes in the terms of trade, real exchange rate and increasing uncertainty: mounting challenges to the firm

• There is a process of recurrent readjustment which implies a loss of capabilities and a fall in productivity (or a slowdown in productivity growth)

Sectoral implications: evolutionary microeconomics and

economic growth• Structural and technological change sustain productivity growth and international competitiveness

• This redefines market shares and the distribution of international effective demand

• When price instability destroys capabilities, it also affects the basis for growth in the long run

• The real sector will not recover initial shape: a negative shock changes the growth potential in a persistent way

Summing up the effects

• Technological rigidity leads to a loss in capabilities expressed in two inter-related forms: the productivity slowdown and the loss of technology-intensive sectors (lesser diversification)

• What are the costs of loosing technological assets? There are as well systemic implications: lower learning by interacting, less complementarities, lower increasing returns at the industrial level

• The industrial and technological systems are no less systemic than finance…

• In the long run, productivity and structural change are the drivers of economic growth and development. Therefore both the microeconomic and sectoral consequences of the loss of capabilities are lower economic growth

t

Re-adaptation of technological capabilities and productivity slowdown

50

60

70

80

90

100

110

Indi

ce d

e P

rod

uctiv

idad

Rel

ativ

a

0

20000

40000

60000

80000

100000

120000

140000

160000

Pro

duct

ivid

ad E

EU

U

AL (promedio simple) USA

From a positive shock to …

• Lets imagine that the price shock is a temporary rise in the price of commodities

• This may be due to the normal fluctuations in the market…or may also reflect a period of strong speculation in commodities, heightened by increasing uncertainty

• A shock of this type favors sectors which are less technology-intensive implies a loss of capabilities

• When relative prices return to their pre-shock levels, technological capabilities lost in the adjustment process could not be easily recovered

• The economic structure that emerges after the adaptation process may have in the aggregate less capabilities and less sectors (a loss of diversification) that it had before.

0

10

20

30

40

50

60

70

80

90

100

0.00 0.20 0.40 0.60 0.80 1.00

Technological Specialization Index 2001-2003 (share of technology intensive sectors in each geographical area versus

the share of technology intensive sectors in the US)

Latin American CountriesSouth Africa

Australia & New Zeland

European Countries

J apan

Canada

Emerging Asia

US

New paradigms in production and technology

Summing up...

1) It is more than an aggregate impact (it affects the recomposition of the microeconomic structure).

2) Firms and sector readapt learning, capabilities and production

3) Destruction of production capacities and technological capabilities

4) Industrial and technological systems are no less systemic than the finance

5) From a positive shock to long term loses in productivity and growth…of LA?

6) New paradigms in production and technology will led the resurgence from the current crisis (the US dominates relevant knowledge in biotech and nanotech + control of IP-intellectual property)

7) Competing policies and the need “more than ever” of active industrial and technological polices.

8) Policies to avoid the destruction of production capacities and technological capabilities; and, furthermore, incentive the accumulation and adoption of new technologies

9) A process of technology foresight to have a comprehensive overview of future productive paradigms bringing together in partnership scientists, engineers, industrialists and government officials

What is to be done?

• The policy set defined above is still more valid in the present crisis/uncertainty context. They should be adopted or reinforced

• It is necessary to avoid the destruction of capabilities that were costly accumulated by generations.

• One must protect capabilities. Some of them should be reshaped, transformed or should evolve towards new directions, but should not be dilapidated