Of Interest

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Saturday, September 1, 2012

KONDRATIEFF WAVES


KONDRATIEFF WAVES (or, for short, K-waves) may be defined as a pattern of regularity characteristic of structural change in the modern world economy. Some 60 years in length, it consists of an alternation of periods of high sectoral growth with others, start-up periods of slower growth. The study of this pattern helps to trace the evolution of the global economy, and aids in politico-economic prediction.
One of my earliest introductions to the world of economics came from someone who was a true believer in the Kondratieff Wave – the idea that there is a much longer cycle, lasting approximately fifty years, which overlays the ordinary, and shorter business cycle. You'll be pleased to know that if the present crisis marks the start of a classic Kondratieff downswing, then we've got between five and thirty-six years of slump still to come.
In any case, it was a delight to have my attention drawn to an article, published back in October 1987, which postulated that the stock market crash of that month marked the crest of a Kondratieff Wave, ergo it would therefore be downhill from then on for the next 20-30 years. Well there was a recession shortly afterwards, albeit shallow and shortlived, but thereafter decent levels of growth resumed and continued but for another brief hiccup around the turn of the century right up to the present crisis.
Nor was this the only error in prediction. Kondratieff Waves tend to be associated with the eclipse of one world superpower and the rise of another, so it was logical to assume back then that the still apparently unstoppable rise of Japan would eventually dislodge the United States from its position of economic hegemony. How wrong can you be?
However, none of this disproves the Kondratieff theory. The mistake made in article may have been merely to misread the cycle. Kondratieff, a Russian economist who died in Stalin's Gulags, identied three distinct long waves, the dates of which you can see in the table below. The downswing in the last of these waves begins during the First World War or shortly afterwards.
Subsequent students of Kondratieff cycles have placed the end of this third cycle during or shortly after the Second World War, which seems logical enough, and have identified a further two cycles thereafter, with the fifth upswing beginning in the 1980s and ending with the current crisis. On past durations, we are now in a downswing phase lasting anything between ten and forty one years. Dating the beginning of the crisis from 2008, that's between five and thirty six years to go (See table below).
Part of the difficulty with Kondratieff is deciding precisely what the cycle is. Kondratieff himself observed the waves first in capital investment dynamics – high periods of investment followed by low periods – and then later in production of pig iron. Subsequent followers have observed the cycles in price indices, or relatively elevated periods of inflation followed by low ones. A further explanation connects them with waves of technological innovation. Kondratieff himself observed that "during the recession of the long waves, an especially large number of important discoveries and inventions in the technique of production and communication are made, which however are usually applied on a large scale only at the beginning of the next long upswing".
The Austrian economist, Schumpeter, was also a disciple of this latter explanation. Intuitively, it seems likely there is something in it. Periods of very high, transformational innovation are followed by rapid development and high investment as the new infrastructure is rolled out. The consequent increase in productively leads to big gains in living standards. But then the development phase comes to an end and there is a pause for breath before the next big thing comes along. In the modern age, there have been five or six great transformations, starting in Britain with the industrial revolution and then on to the transport revolution brought about by rail. Subsequently there was the era of electricity and the automobile, then came eletronics, air travel, and televisions. The present one, perhaps now largely over, is that of mass communications.
Oh come off it, If you are talking about the intermittent march of progress, that's one thing, but to connect it with a discernible, time specific wave of ebbing and flowing economic activity is quite another. Well maybe, but research by Andrey Korotayev and Sergey Tsirel published by the University of California on its eScholarship website suggests that there is indeed some correlation between the long K-cycle and world GDP.
However, somewhat confusingly, their analysis suggests two interpretations of the current global economic crisis. One is that it doesn't mark the start of the fifth Kondratieff downswing at all, but can be interpreted as a temporary depression between two peaks on the upswing, where the second peak may even exceed the first. On this interpretation, the big meltdown doesn't begin until 2018-2020 (memo to self: liquidate all positions by 2020).
However, there is also quite a bit of evidence to suggest that the current financial crisis does indeed mark the start of the downswing. Given that this is not a normal recession, but a downturn caused by an all-embracing banking crisis, 2008-2010 seems the more likely inflection point. It also correlates quite closely with the separate "40 year rule", an old piece of Wall Street folklore which has it that really serious banking crises only happen once every forty years because this is how long it takes for all institutional recollection of the last one completely to die out, allowing the new generation of banking hotheads to let rip once more.

Yet another good  way to expand your knowledge is check out the website of the Long Wave Group whose publications cover the global economy from the long-term prospective.  You will discover that over the past decade the company's President, Mr. Ian Gordon has accurately predicted the banking crisis , the housing crisis, the stock market crash, the pension crisis, the sovereign debt crisis and  the double bottom of the gold bullion market in 1999-2001. 

One last point worth adding, no school of Economics has a theory of technology, yet it is technology improvements that drive wealth improvements in general.
At the moment we are in a situations where an awful lot of easy gains over the past thirty years have stopped happening, due to the maturing of computer technology.  For example, an iPad is an innovation, but it is only a marginal one from a laptop and does not completely replace it.  It is a much smaller gain than from desktop to laptop, or from PC to multimedia PC and multimedia to Internet.
Now humanity is back in our usual position of having to find something new to do.  And greatly impeded by the metastatic growth of government that computerisation has allowed, effectively rendering further computerisation almost useless and economically harmful. 
So here we remain until something happens in someone's garage to open things up again, assuming their garage is located in a entrepreneur friendly jurisdiction, so nowhere in the West.
Something similar happened in the 1930s with the motor car.  All the easy gains from replacing horses over the previous 30 years stopped dead.  Suddenly it was all about marginal improvements and on the back of that change there was the most enormous recession.  Same thing in the 1840s about railway technology, and again in the 1870s.

If Kondratieff was right. If is the the key word here.  Because frankly a Soviet-era Socialist economist has probably very little to teach us.  
I use the term Soviet-era Socialist economist in the sense of schools of economics. Classical, Neoclaissical, Keynsian, Monetarist, Socialist, Fascist, and Austrian/Neo Austrian. 
The Fascist school is also known as Corporatist in modern parlance. Monetarist could also be called Neo-Keynesian. What is techically Neo-Austrian is usually just refered to as Austrian today. Of them all, the (Neo)Austrian school is the best, but there is much that is not explained by any school, such as the role of technological development.


Instead of parroting bien-peasant economic theories popular with those who don't actually think about it, why not take a look at Austrian economics.  The Austrian school is able to explain why there is a depression much more effectively than Kondratieff voodoo, and what to do to exit the recession - stop diverting productive resources by inflating the money supply and radically shrink back the metastatic state, and allow liquidation of bankrupt assets.
Austrian economists were predicting a major depression of unlimited duration since the early/mid 2000s,
Food for thought.   




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