Thursday, 13 November 2008

Book Review: Economic Transformations by Richard Lipsey, Kenneth Carlaw & Clifford Bekar

In this time of economic hardship and financial market woes, it is heartening to read a book from which one can take a positive message. Though it was not written to be so, the content of this academic brick of 595 pages gives me much confidence that the long term bodes well for our material success.

Why so? In short, because our prosperity rests on factors with considerable strength, resilience and flexibility. Their durability is born of decades, even centuries of development and though they can never be assured to continue forever, they have power of momentum. It will take a lot of screwing up for the machine to fail entirely.

This book examines the sources of the West's economic prosperity through historical and model (both textual and mathematical) analysis of General Purpose Technologies, those developments whose strength and pervasiveness transform and energize the economy and society. Examples include writing, iron and steel, the waterwheel, the three-masted sailing ship, electricity, railways, the airplane, mass production and the factory system, the computer, the Internet, lean production and biotechnology. They identify (p.132) twenty-four such technologies in the course of history and one - nanotechnology - which they expect will prove to be so this century. An accelerating flow of such GPTs promises future growth. This does not mean it all will go steadily and easily upward with no hickups along the way. However, in the very long historical perspective of this book, our current recessionary climate is not even a blip.

One of the interesting and possibly controversial conclusions of this book (see pages 426-431) is that indefinitely sustained economic growth is entirely possible due to the effects of GPTs.
"... if there are limits to future growth, they are far less likely come from limits to innovative activity than from other sources, such as failures of human will, human institutions, or human inaction." (p.428)
The authors are academic economists, with no evident ax to grind and indeed, they take pains to review contrary views and explain why they think they are wrong, or partly right. The book contains a lot of academic economic-speak and some sections are mathematical. Evidently targeted at fellow academics most of it is still highly readable for the layman.

Among the major issues examined in the book and the authors' answers :
  • is growth sustainable? - as above, yes, unless we screw it up
  • why did prosperity historically happen in the West, specifically in Britain, and not elsewhere like in Islam or China? - because they failed to develop mechanistic science, which in turn was due to impediments or reversals in those societies from religion, institutions, laws, education systems, habits of thought and attitudes of free enquiry
  • can technology and growth winners be predicted? - no, the situation is too complex because of the effects of inter-relationships amongst differing political, social, economic and institutional factors and of human decisions on outcomes; each situation is unique, what they call the "arrow of time"; much of technological innovation is truly uncertain "... in which it is impossible to either to delineate all the possible outcomes or to match the probabilities to the outcomes..." and not merely risky, in which the possible outcomes and a probability distribution can be attached to each. The implication for individual investors are that we truly cannot ever predict which companies or countries will succeed and by how much. Moreover, there are only a few big winners who take a vastly disproportionate share of the spoils ( I think of Microsoft) and a lot of losers. This process of having winners and losers is necessary to sort out the good from the bad.
The discussion of population and its relation to economic growth in the appendix to chapter nine is delightful and shocking. From Roman times to the present, family size, birth and marriage rates have been intimately inter-connected with economic growth as people decided how many children to have to optimize their well-being. People knew how to control family size, both to increase and and decrease it, they acted upon that knowledge and attitudes and laws accommodated themselves to the reality of what people did. Today we use such gentle solutions as the birth control pill but in the past some practices to accomplish the same thing were routinely done and were seen to be perfectly ok:
  • one birth control method in the Ancient world was a "pessary made from crocodile dung" (p.335)
  • "Sexual practices that did not result in conception, such as as oral, anal, and homosexual intercourse, were also common throughout the ancient world." (p.336)
  • in Medieval times, "Although the Christian Church opposed infanticide as a method of controlling family size, 'if the the excuse of poverty was given, the penance was not very heavy'. Russell argues that the choice of infanticide was conditioned on economics: ... unlike today, the 'right to life' was not as important as the right to a good life."
  • infanticide was routinely practised in ancient Rome, in Japan, in Medieval times
  • when having more children was desired, "Couples seeking to enter marriage sought to get pregnant as a precondition of the marriage." (p.339)
The tell-it-like-it-is analysis continues throughout and there are many thought-provoking details to ponder. For example, on pages 422-423 they discuss one effect of the new technologies of the ICT (information and communications technology) revolution as being a widening of income disparity, the difference between the haves and the have-nots. If you doubt the reality, check out this great You Tube video at Economist's View The Coming Collapse of the Middle Class by Elizabeth Warren, a Harvard University professor. In addition to creating a big social problem, the phenomenon is believed by some to be constraining the recovery of US stock markets - see this Nov.14th article in the Globe and Mail by Fabrice Taylor.

The general value of this book is that one understands the world a bit better and the specific value for investing and personal finances is to know better the trends and forces at work which can potentially be turned into profitable investing.

The first and most powerful lesson is that one should stay the course and not abandon the stock market. There is so much powerful momentum from GPTs that recovery, though it may take several years, will almost surely occur. The ICT and Internet have a long way to go before their wealth creating effects peter out.

Second, owning a position in broad-based market funds is a smart way of avoiding the truly uncertain and thus near-impossibly difficult task of picking the rare winners. Even if nanotechnology takes off as the next GPT, trying to pick the one or two or three winners amongst all the inevitably numerous losers will be more a matter of luck than skill, even if one buys a diversified ETF such as PowerShares Lux Nanotech ETF (symbol PXN). Motley Fool writer Jack Uldrich pegged it correctly in this 2006 review of PXN when he says "Nanotechnology, however, isn't your typical field. It is a common mistake to think of it as an industry. It isn't. Nanotechnology is more of a general-purpose technology, like electricity or the Internet. Because of this, I have always encouraged investors to think of nanotech's potential less from the perspective of what it is and more from the perspective of what it will allow existing businesses to do."

Perhaps superfluous to mention for an academic book, there is a lengthy (14 page) bibliography with many further books and articles to entice follow-up reading.

Economic Transformations is worth every penny of its price of £24.99 in paperback from Oxford University Press (the Chapters hardcover version is $169.95!). Five out of five stars.

For an economist's review of the book, see this one by Joel Mokyr.

In this ITIF video, Lipsey discusses the implications of the book's ideas for the US economy and US public policy. The download slides summarize key ideas from the book using ICT as a case study.

The main author, Richard Lipsey has his own web page here. It has a number of downloadable working papers; there are several on ICT.

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