STWR - Share The World's Resources

Do countries have a choice in their economic systems? In the past, countries could choose between capitalism and communism, but today the choice is smaller if we are to take the failure of socialist states at face value.

Neo-liberals asserted that democratic capitalism had emerged as the clear winner in the competition for promoting human happiness, a conclusion summed up in the memorable phrase “the end of history”. But economics is a difficult subject to predict, and there have been a cascade of papers in the last two decades showing that current democratic capitalism is not the only possible system and perhaps an unlikely bet for long-term survival. The source of these threats is surprising given that it has, in the past, promoted capitalist development: human knowledge.

The classical representation of knowledge’s effect on growth is through technology and technological innovation. Advances in technological knowledge may become more productive over time. When today’s scientists invent something such as a new power source, a cure for disease, or a new material, it is often not just better than before; its improvement over past science is bigger than all past improvements. The implications of accelerating technological productivity were heavily investigated in the endogenous growth theory from the early 1990s. Two of the most striking implications are that growth can continue at a high rate indefinitely, and incomes in poor countries may never catch up with rich countries, even if they follow exactly the same policies and savings behaviour. The balance of current thought is that at the moment technology is good but not that good, and developing countries can catch up with developed countries. The more startling predictions of endogenous growth theory were not incorrect, but the technology has not reached a stage where they come into effect.

In fact, there is evidence that transfers of technological knowledge around the world significantly increase the growth rates of developing countries and sharply reduce the time countries take to obtain their economic potential. Dowrick and Rogers [1], for example, find that technological transfers account for around 40 percent of the total catching-up by developing countries on developed countries’ incomes. Their calculations are that a developing country which is open to technological transfers would reduce the gap between its current and potential income by half in twenty years, with no other changes in capital or labour structure. Such development may well create frictional unemployment as new technologies are adopted, but otherwise would be reasonably painless.

Knowledge impacts on growth not solely through the medium of technology innovation but also through human capital, an individual’s capacity to increase economic output by virtue of their own abilities. Education is often used as a substitute for human capital in measurement. It is true by definition that production is boosted as a result of human capital, and it is unsurprising that empirical evidence finds that a more skilled workforce tends to attract higher investment from overseas. The result that national education affects the pricing of equities is less obvious but the conditional Capital Asset Pricing Model, probably the most widely accepted current pricing model, has indeed been shown to function best in the presence of a human capital measure. The mechanism is that asset returns are determined by variability of asset prices with respect to total wealth growth, which has human capital as an important determinant.

The substantial effects of technology and education on growth and related quantities are not unsurprising in a capitalist system, and with the exception of the possible effect of future endogenous growth, do not challenge that system. Physical and intangible capital, with its comparatively well-defined personal and geographic ownership, and its risk-bearing and accumulating character, remain prime sources of growth. It also maintains in broad terms the qualitative ownership relations of capital and labour. However, the distributional consequences of modern technological and educational developments alter the quantitative relations to a substantial extent. To be fair, some radical writers see recent changes in income distribution as largely dictated by shifts to a more neo-liberal political agenda globally. Whilst accepting the plausibility of this hypothesis, it is difficult not to accept the theoretical and empirical validity of at least some of the claims about knowledge’s distributional effects.

For example, it is doubtful whether developing countries can afford to fund transfers of technology and the training necessary to use it, which has led some commentators to throw a spotlight on the financial systems in developing countries. Below a certain level of financial development, they argue, developing countries could find themselves stuck with obsolete technology, and will not be able to reach world income standards. The same argument is often advanced to explain why the poor within a country may invest less in education than its financial rewards would warrant. They may become locked into poverty with low prospects for future earnings. Employers are likely to find it difficult to discriminate between lack of education and lack of ability, lowering the wages of the uneducated still further.

Opinions are divided on the relation between knowledge, growth, and inequality. One hypothesis is that during a country’s early stage of development, physical capital accumulation is the primary engine of growth which is associated with the enrichment of a comparatively small entrepreneurial class and rising inequality. As countries become richer, the principle source of growth becomes human capital, and so this stage of development is typically associated with more education and greater equality. The conjecture is believable, but should not be viewed as presenting developing countries with a single neo-liberal path to development. Small developing countries, for instance, may choose to educate their population to a high degree at the expense of promoting a minimal government, pro-capital economy, with the skilled workforce able to seek employment in other countries or acting as a magnet for international investment. In terms of production growth, the domestic economy may not prosper to the same extent as a more plainly capitalist country, but in terms of the future income and happiness of its current population, the choice is a viable one.

An alternative hypothesis [2]on knowledge and inequality proposes that economic growth occurs through productive innovations within companies. These innovations are subject to delays before they reach other companies. In this model, not merely is technology associated with increased inequality between educational groups as education has a high association with growth, but also within groups as only a selected few will be able to work with the growth enhancing innovation. The proposed mechanism explains some aspects of inequality occurring in the United States and United Kingdom over the last twenty years. However, in other countries the empirically observed association of inequality with growth and technological innovation is very mixed, and it is likely that no single hypothesis can be considered dominant.

In view of the connections between knowledge and inequality, it is a natural step to consider political activity to be a function of education. In the model of Bourguignon and Verdier [3], economic growth increases as people are educated. It may be in the interest of a political elite to provide free education to the poor so as to increase the elite’s own income. However, increased education brings increased demands for political representation by the poor, and possible redistribution from the elite to the poor. The demand for redistribution presumably does not increase markedly as human knowledge and education become increasingly advanced, whereas it is to be expected that economic production will continue to increase. It is likely in this model that the value of an educated population increases to the elite, and democratic power is reinforced. However, the impact depends on the relative values of technology and human capital. If the productive value of technology is considerably higher than that of human capital, which could conceivably occur, then the elite may view an educated population with its redistributive demands, to be bad business.

Human knowledge may accomplish quietly the aim of revolutionaries the world over, a sustainable economy where physical capitalism is not the prime ordering principle, but the outcomes are not necessarily any nicer.

James Waters ~ STWR Member

James Waters is a research fellow at the Westminster Buisiness School, University of Wesminster

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