Technological Revolutions and Financial Capital is a slim (171 pages of text) book with a hefty punch. In it Carlota Perez charts major technological changes over two centuries that drew in massive amounts of speculative capital, created a bubble that then burst, and then continued in a quieter fashion to spread through the world drawing on production capital. She is Visiting Senior Research Fellow at the Judge Business School of the University of Cambridge and is also affiliated with the University of Sussex and a number of other institutions.

She says hers is the first account of bubbles and panics to link technology innovation to capital. Joseph Schumpeter, in his accounts of business cycles, devoted a lot of attention to financial capital, but his followers “strangely” seem to have missed this, she adds.

Her examples of technological innovations are:

• The Industrial Revolution, Britain, 1771
• Age of steam and Railways, Britain, spreading to America, 1829
• Age of Steel, Electricity and Heavy Engineering, USA, Germany, Britain, 1975
• Age of Oil, the Automobile and Mass Production, USA, Germany then Europe, 1908
• Age of Information and Telecommunications, USA, spreading to Europe and Asia, 1971

They move in roughly 50-year segments, similar to Kondratieff long waves, but she brings the technology revolutions into the account, while he is completely economic.

(I looked for the telegraph, which was sometimes mentioned as a world changer bigger than the Internet – she has it with the Age of Railroads, which makes sense because the lines ran along the rails and were often used to coordinate train schedules.)

Each new surge of innovation dramatically lowers cost and has a widespread impact on the economy, society and politics. Until the 1980s, she says, the best form of organization to support mass production was the centralized pyramid, but with the advent of computers and the Internet, that structure appeared rigid and clumsy. And along came Michael Hammer and James Champy with their books on how to re-engineer the corporation.

Configuring institutions around the technology advances often takes a decade or more and is accompanied by a lot of turmoil, she adds.

“The full unfolding of its wealth-creating potential at first has rather chaotic and contradictory social effects; it later will demand a significant institutional re-composition.” The Big Bang, a period of years or decades which she calls Installation, pulls in money through market frenzies. It is often followed by a recession which leads to demands for change – sometimes violent — which in turn leads to a calmer Golden Age she calls Deployment with new regulation, business practices and standards adapted to the new technology. Once a technological surge is widely adopted and spreads out globally from its source, the way is open for the next wave of innovation.

This is a densely written book that will make your head hurt – first from trying to keep pace with how the pieces are tied together and then from slapping yourself on the forehead at how obvious some of it is. Once electricity is adopted and houses have wires, the way is open for all sorts of electrical appliances to be developed and sold. Railways were first designed just tot move coal from mines – then they started moving passengers. The initial impact was to put long distance stagecoaches and inns out of business, although initially they increased the business for horse-drawn carts to carry passengers from terminus to ships. They attracted huge investments and often went bust, especially in America, leaving English investors with substantial losses while creating a network of rail lines for the US.

At any given time, says Perez, many powerful ideas exist, but to produce a wave of change they require the right social and economic conditions. They are most apt to win support of capital when other innovations have been tapped out and are generating simply normal returns; speculative capital, accustomed to the huge returns of an innovative area, is searching for the next big thing. While waiting for the next highly profitable opportunity, financial capital turns to real estate, paintings, pyramid schemes and hostile takeovers.
Financial frenzies are good for innovation, if not necessarily for investors, because they help build out valuable infrastructure. The huge investment in fiber optics led to outsourcing since so much dark fiber was available at prices far below the cost of laying it.

Nor is the investment always good for the home country. Britain’s financial capital supported transcontinental infrastructures like rails, ships, telegraphs, mining and agriculture around the world while neglecting the home markets.

Concluding in 2002 as the world was going into a post bubble recession, she said the time required institutional imagination and quotes Keynes on the Grand Slump of 1930…”there cannot be a real recovery until the idea of lenders and the idea of productive borrowers are brought together again,” which is what Perez means by moving from financial capital to production capital.

IBM’s Irving Wladawsky-Berger notes that her theory was remarkable in understanding the timing of the dotcom crash.
“I first heard Carlota speak shortly after the implosion of the dot-com bubble. I assumed, as did most of those who attended her lecture, that given the dot-com financial crash, we would soon be entering the deployment period. She argued vehemently then, and in subsequent conversations, that the real financial crash had not yet taken place. After a meeting in 2005, where we once more discussed where we were in the cycle, I posted this entry where I wrote that
“Carlota Perez believes that we may not yet have entered the deployment period, as the crash phase doesn’t seem to have resolved itself. She mentions three particular structural tensions that we need still to work out in order to move on: investments continue to be focused on short-term gain, not on long-term production and growth; the social system continues to foster an unstable environment in which the rich get richer and the poor get poorer; and there is too much idle money chasing and inflating assets like housing and not going into expanding the demand needed to soak up all the excess supply being produced.”
“Think how remarkably prescient her words are, especially when you consider the number of top economists who were at the time advocating the notion that the world was now safe from cataclysmic financial crises, because of the ability of derivatives and other new financial instruments to effectively distribute risks.”

In her book she explains that “The tensions between the growth of paper values and real wealth creating capacity, which was partly relieved by the collapse, can only be overcome by strict and decisively enforced regulations to restrain the practices of the casino economy,” she said, while warning that the financial collapse of 2001-2 may not have been spectacular enough to wipe out excess self-confidence.
The massive amounts of low-priced technology demand expansion into new markets such as China and Eastern Europe, she added.
“…the tasks are complex and wide-ranging: designing an adequate and enforceable regulatory framework, devising ways of effective intervention to reshape the demand profile to extend the Information Revolution; and decisively acting on both sides of the world divide to stimulate a truly global economy, expanding wealth generation across the planet.”
Perez encouraged readers to avoid nostalgia and look forward. Her look back with its extensive and detailed links between technological innovation, capital, frenzies, bubbles and recessions lays out a pattern that decision makers can benefit from.
For some more recent commentary by Perez:

Steve Hamm of BusinessWeek caught up with her in 2008 on the issue of immigration
“Capitalism is founded upon the principle of the common good resulting from the private pursuit of profit. Yet, much more often than not, it is governments that have to make sure that the principle works.
“But when governments don’t act intelligently, economic forces hit back hard and brutally. Just as the reluctance to regulate the “free” financial markets brought on the sub-prime crisis and a likely recession, letting the unrestrained markets continue to shape globalization is likely to bring social unrest and an energy and environmental crisis.

Art Kleiner in the Booz & Company publication strategy+business in 2005 got this from her:
“Finance capital has done its job; it’s brought forth the resources to pave the way for the next wave of technology. Along the way, it’s created an environment in which companies like Microsoft, Intel, and Google could emerge and flourish. Now we need to spread out the new paradigm of our era through all the economies of the world, just as in the past.
S+B: We’ve been here before?
Perez: Yes, and more than once. There are historical regularities in the way technological revolutions form and become assimilated into society. You and I both have seen the changes wrought by information technology, and we think it is uniquely momentous. Yet previous technological revolutions made equally momentous changes. When you go back and read contemporary accounts of life in the 1880s and ’90s, you could replace the words steamships and telegraph with computers and Internet and the text would sound completely modern.
The dinosaurs have to be replaced.
“The industrial giants have reached limits to growth and innovation, but most of them still can’t give up their old practices, even when they see the need to. The electric refrigerator and the vacuum cleaner had been truly fantastic innovations, but by the 1970s innovation had devolved down to the electric knife and electric toothbrush. The appliance companies were still producing a lot of money, but they didn’t know how to invest in or design the new types of appliances that semiconductors would make possible.”
“For each technological revolution to flourish, you need a lot of new investment in infrastructure. If you don’t have railroads, who can build locomotives? If you don’t have roads or electricity, how can you sell cars or refrigerators? But if you don’t have enough cars or refrigerators, you can’t justify the roads or power plants. The solution comes through asset inflation.”
What the future demands:
“First, finance needs to be adequately regulated. Every time some forward-looking CEO tries to implement a three-year plan, he gets ousted in three quarters. The finance world still expects the easy profits of the bubble, but what is needed now is long-term investment. If capital gains were taxed more stringently when assets were sold before five years, for example, then more investors would “marry” the companies they own and focus on maximizing longer-term returns. Similar measures for all assets would discourage the current massive deviation of investment money toward housing bubbles and derivatives. And, obviously, regulation of global finance must be enforceable at the global level. Quite a tall order!
“Second, prices have to come into line. During Installation, there is always strong asset inflation (both in equity and in real estate) while incomes and consumption products do not keep pace. This creates a growing imbalance in which the asset-rich get richer and the asset-poor get poorer. When salaries can buy houses again, we will be closer to the golden age.
“Third, as Deployment gets closer, you will see increasingly stable industry structures. Look at the mad price wars of the airline industry; it has a lot of restructuring to do to segment its markets and develop a sustainable set of practices.
“Fourth, there need to be innumerable investments and business innovations to complete the fabric of the new economy. Here’s one small example: Millions of self-employed entrepreneurs work from home with uneven sources of income. Where are the financial instruments to smooth out their money flow so they can work and live without anxiety? For them, that innovation could be the equivalent to installment credit in the 1950s, which made possible the consumer base needed for mass production.
“Finally, I’m not sure we’ve understood the causes of fraudulence at companies like Enron, nor how to avoid them by means other than excessive bureaucratic controls. The key decision makers, in government and business, do not seem ready to make the changes that could get a golden age under way.”
IBM’s Irving Wladawsky-Berger has an appreciation of her, with links, here:

He links to a 10-minute video presentation she made to an audience in Rome. It is well worth watching for its concise explanation of her ideas and her forceful presentation.

She contends that globalization has great potential for providing a better life around the world but it is being better life but it is being resisted by those who are being hurt by it, which calls for imaginative government response in education and individual protection.
“Governments have to become as modern and agile as business firms.” She calls on governments, businesses and NGOs to collaborate for a better world.

In a presentation University College London apparently posted in March 2009, she explains more about the role of governments and finance in developing the future:

“What is needed is the redesign of the financial architecture so that the system will go back to its basic role of reallocating resources, smoothing the flow of money from savers to investors and making its profits by sharing in the wealth it helps create and acquire. Of course, there will always be special instruments that take advantage of imbalances or misjudgments, and that is part of the legitimate workings of the market. But the idea that money can “work” and make you a millionaire in no time and with no risk has to be clearly ruled out if the global economy is to get the full growth and profits benefit from the potential of the current paradigm.
“There are many regulatory directions to follow, but there are two that define whether finance will be constructive or will continue to be decoupled from the real economy, playing its own game. One is transparency, the other is global reach. The need for transparency is obvious. One of the main strengths of the synthetic instruments, hedge funds, default swaps, derivatives and other supposedly sophisticated innovations in recent times was precisely their opacity. Without full information there is no accountability, no protection for investors and no proper supervision or regulation is possible. To achieve effective disclosure rules, only the truly savvy financiers could help define effective disclosure rules -quite a few are willing- and only very determined political will can effectively set and enforce them. “

This is not merely a financial crisis; this is the end of a period. As Stephen Roach puts it: leaders must have “the wisdom and the courage to shift the policy debate away from tactics and toward strategy”.

On the value of industrial policy during the deployment stage:

“Once installation has been achieved, however, there is a vast innovation and growth potential that the economy is ready to tap. Unrestrained markets then become a very blunt and brutal instrument; yet markets guided by policies that implement common visions arrived at through a social consensus orchestrated by modern, well informed, realistic and socially responsible governments are more likely to achieve the best results in these circumstances. “

Filed under: Technology