Technology and wealth creation: where we are, where we’re going

2155

The interrelationship of technology, economic advance, and social and political systems, has many ramifications. The last ten years, in economic terms, have constituted an American decade. But the way in which the American decade comes to an end is probably the most important issue for the world economy today.

Every twenty years or so since the Industrial Revolution, a group of new technologies has had a major impact on economic life. Steam power, canals, railroads, telegraph and telephone, electricity, road transport, radio, air transport, pharmacology, television, computers and information technology. Some of these have been general enabling technologies (such as steam power or electricity) which change the way production is organised; some (such as television) create new consumer goods which command a large fraction of household time or expenditure. Enabling technologies transform business life. Consumer technologies transform domestic life.

Some major new technologies have large effects of both kinds. Road transport both changed the organisation of business and gave households automobiles. The process of change set off by major new groups of innovation has typically taken half a century to work through. For enabling technologies, production systems have to be reorganised around them and this investment (sensibly) takes time. With consumer technologies it takes some time to establish which new goods have market appeal and devise methods that will enable them to be produced sufficiently cheaply for a mass market. The first answers are rarely the right answers.

In this long term historical perspective, there is nothing very extraordinary about the current phase of innovation based around information technology. Not in impact. It is hard to argue seriously that its effects are more wide-ranging than those of electricity or telecommunication. Not in pace of introduction and adoption. Computers were invented fifty years ago, were first commercial products in the 1960’s and became universal in business in the 1990’s. Against the expectations of most people in the early stages of the development of new information technology, the cost of processing fell faster than the cost of communication. The result is that everyone has an intelligent terminal on their desks, rather than, as with electricity, plugging into a gigantic central system. Instead of a handful of super computers, we have pc’s. It is now evident that networking will lead to a final shape of the business that is somewhere between the centralised and the distributed extremes.

Hyperbole associated with the adopt of new technologies is familiar to economic historians. It greeted the railways, electricity, automobiles, radio and television. Prophets proclaim the arrival of a new technologically driven era of peace and harmony. Bankers and business gurus anticipate the demise of traditional businesses and business models. These claims are always hugely exaggerated, although never entirely wrong. In the course of the resulting hysteria, gullible investors lose large amounts of money, promoters and some fortunate individuals make smaller amounts of money. There is a reckoning after which most people pick themselves up and start again: at the end of it all, some new real assets have been created., There are some special features of the current boom, but its general shape is familiar and predictable.

Simply to keep up the pace of economic growth which advanced countries have enjoyed over the last century, there needs to be a new technology of significance comparable to electricity or computers every twenty years or so. Since we are well through the process of applying information technology (if the normal cycle of development and implementation is fifty years, we are approaching the end of that cycle) it is time to ask what the next technology is going to be. There is one overwhelmingly strong candidate, and that is biotechnology. Modern life sciences have the potential to transform medicine, nutrition and agriculture in ways as radical as electricity or telecommunications transformed other areas of economic life. I started to write that biotechnology raises more political problems in its application and implementation than any previous technological shift. But looking at what was written and felt about the arrival of the railways, I am not so sure.

There was resistance to the introduction of steam power, as there was to the railways, and as there still is to the automobile: but in the West the introduction of available technologies has never in recent centuries been seriously delayed by popular or political objection. It is a moot question whether politics would have blocked the expansion of nuclear power if the technology had proved economically successful. Since it wasn’t, we will never know.

Experience shows that prediction of the specific commercial applications of new technologies is usually ludicrously bad. This is true at very general levels: no-one anticipated the range of domestic applications of electricity and for a long time few anticipated that there would be domestic uses at all – and at more mundane levels – no-one realised that ultimately the main use of video recorders would be to play pre-recorded movies. With hindsight we will laud geniuses like Henry Ford and Bill Gates who saw the future correctly: but in truth it is not clear that they see the future correctly in a manner different from the manner in which the people who put down the winning numbers on their national lottery ticket.

Biology is the exciting intellectual frontier today, and this has intriguing implications not just for the environment of economics and politics but for the way we think about economics and politics themselves. The claims of evolutionary psychologists that all human behaviour can be derived from our ancestors’ experiences on the African savannahs are way over the top, but should not blind us to the possibility that fundamental changes in the structure of social sciences are in prospect. It is entirely credible that within a few years we will have psychology which is firmly based in biology and neurosciences, and that such psychology will then form the basis for a more rigorous economics and sociology. These would be fundamental changes in the nature of knowledge as applied to political issues. I used to believe that the structure of economic reasoning which I learnt as a student was essentially set for all time. Today I am less sure.

If biotechnology is indeed the great new frontier, it seems likely to be a creator of new products – and the associated demand for new products – rather than a general enabling technology which enhances the productivity of all business. Moreover, government may well prove to be the main buyer, or at least financier of these products, as underwriter of the health care system.

The pace of change in information technology has rather overshadowed the disappointing progress of innovation in other areas of the economy. Imagine writing a similar paper to this in the 1960’s. In the previous two decades, commercial aviation had displaced sea transport for all long distance passenger traffic and much freight: America was putting a man on the moon. A modern pharmaceutical industry had been established almost from scratch. Drugs had eliminated mortality from infectious diseases among otherwise healthy adults and could induce controllable changes in moods. Other new compounds could interfere with the progress of other life-threatening conditions, such as hypertension and cancer. New materials synthesised from oil had greatly reduced the cost of manufacturing many household objects and made previously impossible construction, from buildings to aircraft, feasible The commercial application of nuclear power seemed likely to displace fossil fuels as a primary energy source and transform large scale construction, to be followed by fusion and fuel cells.

It was reasonable to project all these advances forward, and those who predicted technological futures at the time did: yet the outcomes have been disappointing. We still travel in essentially the same vehicles – cars, trains, planes – as in the 1960’s; the space programme produced nothing of economic significance; many new drugs have been produced, but the blockbusters have been anti-ulcerants and anti-depressants. Few of the more recent advanced materials have found commercial application. Nuclear power has failed to be commercially useful. We make electricity today by burning coal and gas and power our cars by burning oil, much as we did a century ago.

Thus there is a serious argument that rather than technological progress being unmanageably fast, it risks becoming worryingly slow. To find new enabling technologies for the next fifty years, we probably need to look at activities like transport, fuel or to further advances in communications. Or maybe future technological changes will be much more piecemeal, without discontinuities of the size produced by electricity, aviation or computers.

Wealth creation in firms

The most successful large firms of the twentieth century based their success on the management of large integrated processes. Oil companies exemplify this: so did the great manufacturing companies of the era, Ford and General Motors, Boeing and IBM.

By the end of the century, the list of leading companies looks different: Microsoft and Intel, Coca-Cola and Disney, Merck and Wal-mart. Very little of the value of these companies’ output is the cost of the physical resources that go into them. Almost all of it is value that they add.

This exemplifies what we mean by the knowledge economy, and illustrates how the sources of competitive advantage in it have changed. For some of these businesses – Intel, Merck – knowledge is technical knowledge, the product of advanced science. But more often it is not – Disney, Coca-Cola, Wal-mart. The competitive advantage of these latter firms is indeed found in knowledge management. But the knowledge they manage is not at the frontiers of human endeavour, and the distinctive mechanisms by which they manage it are not based on high technology.

In the case of Disney the company’s success is based on its ability to exploit, recycle and rejuvenate a historic repertoire (and that repertoire is reprised for the same reasons that Shakespeare or Mozart are reprised – it is very difficult to do better, even with all the advances in technology and knowledge that have occurred since the originals were created. Some kinds of knowledge become obsolete and are superseded (old physics and law textbooks), others do not.) In the case of Coca-Cola, corporate success is based on branding, and the emotional and informational associations that go with it. And Wal-mart is the modern successor to the large integrated manufacturing corporations, its success based on superior knowledge management along an extended chain from customer needs to supplier capabilities.

The claim that information and knowledge management are central to competitive success in the twenty-first century is entirely true, but many of the implications of that claim are misunderstood. The knowledge management which is the key skill of each firm I listed above is not based on information technology. The collection and transmission of data – which is what technology has transformed – is not the principal problem, or its solution. Information technology is changing the structure of some of these industries, but in indirect ways. For example, the hit and miss process of trying compounds to see if they work is no longer central to pharmaceutical research. Once underlying therapeutic principles are established, libraries of compounds can be searched mechanically. But it is not in that process that competitive advantage lies. Rather its mechanisation focuses attention on skills in fundamental chemistry and in marketing and distribution. In retailing, the ability to gather and analyse large quantities of data easily and quickly transfers power from the shop floor to the corporate centre. The store manager is deskilled and disempowered and retailing skills are found in organisations rather than in individuals. But in neither case is the competitive advantage of the business based on its information technology. It is the ability to manage information in a much broader sense that is key.

This secondary relevance of technology to the competitive advantage of firms is quite general. I sometimes tease business audiences by asking them to identify what Gablinger, Ampex, Berkey and Chux make. They were the first firms to engage in commercial marketing of low-alcohol beers, video recorders, handheld calculators and disposable nappies, respectively. The point is not just that none of these firms are there any more. It is that the market leaders in these businesses are now Philip Morris, Matsushita, Casio and Procter and Gamble – powerful, established firms with strong capabilities in related markets. They moved in and took over after others had pioneered the technology and the definition of customer needs. Microsoft’s rise to market dominance was not based on the technical superiority of its products. Glaxo became one of the world’s leading pharmaceutical companies on the basis of its marketing success rather than the superiority of its research. Leading edge technology is rarely the source of competitive advantage at the level of the individual firm. What matters is that firms have access to leading edge technology in the commercial environment within which they work and the complementary skills to absorb it within their organisations and transmit it to their customers.

These technological and organisational developments have implications for the structure of industries and for the nature of work. Some of these are general trends. The shift to the knowledge economy generally implies that firms should be smaller. A group of related factors is at work here: the decline of large manufacturing companies is a major part of it. But economies of scale are mostly physical – to do with the management of processes – diseconomies of scale human – to do with the management of people. As human factors become an ever larger fraction of value added, the cross over point at which these disadvantages outweigh the benefits fall. And knowledge based companies are able to subcontract large parts of the overall claim of production (Microsoft, Nike) retaining only the key value added for themselves.

Increasing concentration and a rise in the average size firms were a feature of most Western economies until about 1970. Since then, these basic changes in the nature of business I have described – which suggest that business would become more fragmented – have been at war with the efforts of investment bankers and ambitious chief executives to create larger companies. Until around the middle of the last decade, business logic seemed to be winning (firms were getting smaller) but more recently the deal makers seem to have gained the upper hand. All previous phases of intense merger activity (the turn of the last century, the 1920’s, the 1960’s) have ended in regretful mornings after and this does not seem likely to be an exception.

But many of the effects of changing technology, and of globalisation, on structures are industry specific. Sometimes technical change and liberalisation dictate large firms (airlines), sometimes smaller ones (telecommunications). Sometimes globalisation implies greater concentration (Boeing can make planes for the world from Seattle), sometimes less (neither BMW nor Hyundai could have achieved the market position they have – or any at all – if obliged to rely on their domestic markets). Sometimes technological change reduces vertical integration (as in pharmaceuticals, where the major companies take on a new role as finders and distributors (“publishers”) of other people’s research, or in media) – sometimes it increases the need for such integration (as in retailing, where shopkeepers exert an ever increasing influence over manufacturing processes).

There are also some general trends in the nature of employment. The knowledge economy and globalisation increase the differentials earned by those with specific and distinctive skills. So income inequality rises (or unemployment if the effects on differentials are resisted). And, where it is possible, unskilled jobs will be transferred to poor countries. But it is not universally true that the skill requirements of jobs rise. Disney’s hosts, or McDonald’s franchisees perform unskilled jobs to great effect in consequence of strong centralised knowledge management.

Wealth creation in nations

Advancing technology is the principal determinant of economic growth for the twenty or so rich countries of the world. However most of the world is well inside that technological frontier. For these countries, prospects of economic growth depend little on technology and principally on advances in their economic, political and social infrastructure.

The gap between those countries whose systems are able to accommodate extant technology to economic effect and those which cannot is stark and persistent. Loosely, we might identify the first group of countries as those whose levels of output per head are half or more of the levels achieved in Switzerland or the United States. At the other end of the spectrum – those with output levels less than 10% – 20% of this potential – countries are constrained by their economic and social organisation rather than by available knowledge and technology. The first group of rich states covers a little less than a billion people, the second group, in sustained poverty, four fifths of the world population The intermediate group – which covers a wide span of levels of national income and economic achievement – contains no more than a dozen states with a total population of only around 200 million (mainly in Spain, Argentina and South Korea).

Over the two centuries of rapid economic growth in rich states, the pattern has been for one or two countries to join the group of advanced states every decade or two. In the last fifty years or so these new members of the rich list include Italy, Finland and Ireland within Europe and the first Asian economies (Japan, Hong Kong, Singapore) to operate at this technological frontier. There is a striking geographical component within Europe, the countries joining the group have always been contiguous with, but peripheral to, the existing members (as with Italy, Finland and Ireland) This pattern is likely to be repeated in the next decade as the weaker EU members (Spain, Portugal, Greece) increase their living standards and, in the more distant future, other peripheral countries may aspire to follow them (Slovenia, the Czech Republic).

In Asia, there are some signs of precisely the opposite geographical phenomenon. In Europe, the economic effectiveness of a central core of states has gradually worked its way out. In Asia we may see the prosperity of a periphery burrow its way in to the centre. This rather speculative observation may in turn derive from what is perhaps the central fact of modern economic history: the economic success of North-West Europe, and the economic failure of China, over the last three centuries or so, from starting positions that in many respects looked extremely similar. That contrast is the most telling illustration of the fundamental interdependence of technological advance and economic and political organisation.

This is a reminder that despite globalisation, geography remains hugely important to economic performance. And history matters too: as a counterweight to facile beliefs about the ease of exporting western economic models to Eastern Europe or the third world. Successful market economies function in, and by virtue of, elaborate social and political institutions which cannot easily be reproduced without reproducing the historical pattern by which they came about.

The next decade

This interrelationship of technology, economic advance, and social and political systems, has many ramifications. The last ten years, in economic terms, have constituted an American decade. History “ended”: the combination of economic, social and political institutions found in late twentieth century America was appropriate for all countries and all time. The “new economy” arrived: the US was capable of sustained economic growth at a rate not previously experienced. (And provided they too understood the End of History, other countries could match the economic achievements of the United States.) The magic touch of Alan Greenspan would not only end the business cycle, but justify ever rising stock prices.

This is not all nonsense, but it is largely nonsense. There is no end to the debate about the appropriate form of political or economic institutions: indeed, as I have suggested, we may in a few decades conduct that debate in entirely new ways. The evidence for a permanent increase in America’s potential growth rate is thin, and it is worth remembering that only a decade ago the US productivity slowdown was a central theme of economic commentators. And even if everything said about the New Economy were true, it is not clear why it should lead to the huge increase in the share of profits in national income which is needed to justify a level of share prices whose relationship to earnings is completely out of line with historical experience.

This is why it is likely that the 1990’s will be identified as one of the great speculative bubbles of history. Although we talk melodramatically about stock market crashes, precipitate collapses have always been rare (what made the 1929 crash memorable was not that there was a ‘black Thursday’ : it was that shares continued to go steadily down for four years afterwards). Bubbles can burst, or they can slowly subside. In either case, the consequences are generally unpleasant. The 1929 crash brought about the virtual collapse of the American banking system. The most important speculative bubble of our lifetimes – the Japanese share and property boom of the 1980’s – ended in a ten year recession from which there still seems no substantial relief.

These two historic examples illustrate that the consequences of such booms and busts are not confined to financial markets. It is, however, virtually impossible to give specific predictions of how, or when, these consequences will evolve, even if it seems inevitable that they will occur. It has seemed reasonable (but been wrong) to anticipate an end to the American boom for three or four years now although there are much stronger indicators today than before that the end is in sight.

But the way in which the American decade comes to an end is probably the most important issue for the world economy today. Whatever economic developments of the next twenty years hold, they will be very different from the economic developments of the last twenty years, especially (but not exclusively) as far as financial markets are concerned. The American hegemony of that period, both in terms of intellectual influence on economic thinking and in dominance of world financial markets, will experience at least a temporary setback. And that will change both the economic environment in which we operate and the ways in which we work within it.

Print Friendly, PDF & Email