Towards a better understanding of convergence and divergence: or, how the present EU strategy – at the expense of the economic periphery – neglects the theories that once made Europe successful

8450135745_78cfa66567_b

This new working paper attempts to address some of the main problems of the European Union today. The main thesis is that the Weltanschauung and the economic narrative on which the European project has been based have changed radically since the inception of the European Project, from one conducive to convergence and cohesion to another which is conducive to divergence and, in the last instance – I shall argue – to a form of internal colonialism towards the economic periphery.

The field of Science and Technology employs the term sociotechnical imaginary [1] about the collective narratives and visions of social futures and of the common good. I shall argue that the European Union has moved away from the sociotechnical imaginary, or narrative, that dominated after World War II. I shall argue that this post WW II Marshall Plan Narrative (MPN) gave way to an equilibrium-based Neo-Classical Economics Narrative with an added innovation rhetoric, which I shall argue is based on a fairly shallow understanding of innovation (which I shall call NC+I).

Key economic features of the Marshall Plan Narrative were leftovers from the crisis of the 1930s. Important points were:

  • Economic structure matters (=manufacturing matters).
  • The financial sector must be strictly controlled, so that money can only be made by helping economies to grow and not by shrinking them [2]
  • A strong focus on employment.

The Marshall Plan Narrative dominated in the late 1940s when the institutions appeared that were later to develop first into the European Coal and Steel Community and then into the European Economic Community. The German term Wirtschaftsgemeinschaft even more emphasizes the communal feeling which, as I see it, slowly got lost after 1992 as the Marshall Plan Narrative disappeared. I shall argue that the last time the Marshall Plan Narrative (MPN) dominated, was in the 1980s with the slow integration of Spain – gradually lowering tariffs – in order to save its manufacturing sector. The change in the European socio-economic narrative was accentuated by the 1989 fall of the Berlin Wall, so the European Union’s birth in 1992 to a large extent coincided with the change in economic narrative.

The present EU narrative and the so-called evidence-based policy backing it up suffer from some basic weaknesses. First of all most of the underlying theories all suffer from what economics Nobel Laureate James Buchanan called the equality assumption: ‘Any generalized prediction in social science implies at its basis a theoretical model that embodies elements of an equality assumption” [3]. Since the time of David Ricardo (1817) international trade has been based on the barter of qualitatively identical labor hours. Common sense tells us that if a neighboring country has moved from the Stone Age into the Bronze Age, maybe it would be a good idea for your own country to follow? But no, the economics profession will almost unanimously insist that the backward country should stick to its “comparative advantage” in the Stone Age. The meaninglessness of this theory was fully understood in the Marshall Plan Narrative until the 1980s, but was subsequently lost to the European Union. David Ricardo’s comparative advantage was once used by England to defend the prohibition of manufactures in the colonies. Now the same theory impoverishes the EU periphery.

The present EU narrative and accompanying ‘evidence based policy’ [4] are based on dramatic simplifications, Ricard’s trade theory being one of them. Close parallels exist between the criticism of neo-classical economics and modern criticism of other sciences. A classical critique of the “physics envy” of economics is Phillip Mirowski’s More Heat than Light (1989), a critique he has renewed ever since. The theories used and supposed evidence are based on dramatic simplifications and compressions of available perceptions of the state of affairs and possible explanations. Hypocognition is the term now being used for this oversimplification phenomenon. [5] Another term used to describe this state of affairs is ‘socially constructed ignorance’. This ignorance is not the result of a conspiracy, but of the sense-making process of individuals and institutions:

To make sense of the complexity of the world so that they can act, individuals and institutions need to develop simplified, selfconsistent versions of that world. The process of doing so means that much of what is known about the world needs to be excluded from those versions, and in particular that knowledge which is in tension or outright contradiction with those versions must be expunged. [6] 

This type of problem has been discussed earlier by Jerome R. Ravetz under the term ‘usable ignorance ’[7].

It should be noted that this document is written more based on my studies of industrial dynamic at Harvard Business School than on standard economic theory. The document is also written in a different language than most modern economics, in English rather than in mathematics. This was also the case with what I have labeled The Marshall Plan Narrative – that economic structure is the key factor explaining wealth – ever since its 1588 inception with Italian economist Giovanni Botero’s bestseller Sulle Grandezze delle Città (1607) [8]. Languages have different strengths and different uses. I have argued for a long time that using mathematics in order to qualitatively understand economic development is like writing a thesis on snow in Swahili, where there are likely to be few words to distinguish between types of snow. On the other hand, the Saami language in Northern Fennoscandia has more than 300 different terms that describe different qualities and conditions of snow [9].

Through its equality assumption, neo-classical economics kills our understanding of the importance and profound consequences of diversity. This is extremely serious for our perception of the world around us, not only because diversity has been and is a central feature of European nature, culture, and political history, but also because understanding economic development and its absence – understanding convergence and divergence – requires a profound understanding of diversity. [10]

Combined with the use of mathematical symbols, the equality assumption carries with it an unconscious – but artificial – feeling of being an objective observer. In spite of perhaps having observed reality from only one of many possible angles and having unconsciously made sweeping generalizations – assuming that things which are very different are in fact alike – the modern economist is easily trapped in a false belief in his or her own objectivity, into hypo-cognition. I find that Friedrich Nietzsche warned against this lack of perspective over a hundred year ago:

The only seeing which exists is a seeing in perspective, a seeing with perception; and the more feelings we allow to get involved about an issue, the more eyes – different eyes – that we mobilize to observe one thing, the more complete will our concept of this thing, our objectivity, be. Would not eliminating the will….be the same as to castrate the intellect?

In other words, we must attempt to perceive the complex realities behind simple numbers.

The document contains a brief description of the long-term political background for the shift in the European socioeconomic narrative. This story necessarily starts in the 1840s, with the coming of age of two cosmo-political economic theories: Communism and what was then called Manchester liberalism (now neoliberalism). The contrasts and conflicts between these two politically extreme theories – communism and extreme liberalism – and above all the compromises which were forged between them formed what Europe finally became. A key point here is how the two cosmo-political philosophies – called the irrational twins by German economist Gustav Schmoller – came to lose their glitter towards the end of the 19th century, yielding to theories which, because they understood the links between economic structure and economic wealth, argued against both cosmo-political economic theories. I argue that the 1989 death of one of the irrational twins – communism – led to a totally unwarranted resurrection and domination of the second irrational twin in the form of neoliberalism – completely overshadowing the sensible compromises that had been worked out over time. The death of one irrational twin led to the triumphalism of the second, and equally irrational, twin, i.e. neoliberalism. This heavily influenced the Maastricht process and the Maastricht criteria leading to the demise of the Marshall Plan Narrative. As I see it, decisions made in the age of partly irrational market triumphalism from 1989 to 1992 are the core of many of the present problems of the EU. I would argue that the present economic divergence process within the EU would have been much better understood and preventable by the economic understanding of 1947, and I shall try to rebuild my narrative on neo-classical economics + shallow innovationism in that spirit.

A brief note on how the innovation narrative was introduced in the European Union appears as a necessary part of the introduction. After he passed away, the economic theories of Austrian-born Harvard economist Joseph Alois Schumpeter (1883-1950) – the “prophet of innovation“ [11] – declined into obscurity. However, Richard Nelson and Sidney Winter’s 1982 An Evolutionary Theory of Economic Change launched a neo- Schumpeterian narrative that revived the importance of innovation. In the late 1980s this narrative reached the institutional level with OECD’s TEP (Technology-Economy) program (1988-92). In 1993 the narrative was picked up by what was then called The European Economic Communities with Jacques Delor’s White Paper on Innovation [12]. Two years later, the new narrative was published by what in the meantime had become the European Community, as EUs Green Paper on Innovations [13]. Richard Nelson is an American, but the other important scholars in the new field of innovation studies were all Europeans: Richard Freeman, Giovanni Dosi, Bengt-Åke Lundvall, and Luc Soete. The two latter founded an international network, Globelics, dedicated to innovation studies, which has held international conferences since 2003. More recently the idea of “open innovations” has apparently brought the innovation process closer to a neo-classical model, but as I see it such “open innovations” [14] – while very useful in some industries, like IT – are not representative of the economy at large.

This report – which criticizes the European Union’s innovation narrative – is written by a convinced Schumpeterian, a person who thinks that innovation indeed should be put at the centre of the economic narrative. I am, however, convinced that the present EU narrative of innovation fundamentally is a neo-classical narrative, not reflecting the context- and industry-specific nature of the innovation process. Since my student days at Harvard in the mid-1970s – thanks to being taught by one of Schumpeter’s best friends at Harvard [15] – I have considered myself a Schumpeterian economist. Schumpeter’s understanding of the world – his techno-economic narrative – satisfied both my queries as a businessman – I had started a manufacturing company at the time – and my queries on uneven economic development which I had tried to understand during my work in Peru. I therefore enthusiastically joined the neo-Schumpeterian tribe and Globelics. But I soon saw what was coming. Already at the First Globelics conference in Rio de Janeiro in 2003 I warned that “by integrating some Schumpeterian variable to mainstream economics we may not arrive at the root causes of development. We risk applying a thin Schumpeterian icing on what is essentially a profoundly neoclassical way of thinking” (i.e. a neoclassical cake). [16] The next year I published an alternative Schumpeterian narrative, where economic activities were seen as being qualitatively different. [17]

Perhaps I should also add that I consider myself a convinced European, who twice voted in favor of Norway joining the community. It is easy to pinpoint when my enthusiasm for the European Union turned to deep skepticism, it was in the evening of April 30, 2004 – the night before many former Soviet Republics joined the EU – and the place was the Tallinn Opera House, where next day’s accession was being celebrated. I was suddenly struck with the thought that what I was attending was essentially the funeral of the European welfare state as we had known it. A virtually instant integration between a recently de-industrialized group of countries, involving millions and millions of people, where the “winners” were making 1 Euro an hour, and a wealthy Europe where the “losers” were probably making 10 Euro an hour would have to wreck at least some welfare in the European Union. That same year, with an Estonian colleague, we predicted the Latin-Americanization of Europe: falling wages and larger economic differences. [18] In 2007 we followed with a paper called European Eastern Enlargement as Europe’s attempted suicide? [19] In 2013 we published an article arguing that the roots of present European crisis long preceded the financial crisis. [20] I have previously applied the same type of narrative as used here on poor countries. [21]

A recent working paper by the German Bundesbank produces the following conclusion regarding EU convergence: “Our main findings suggest no overall real income per capita convergence in the EU, however, we identify subgroups that converge to different steady states using an iterative testing procedure….. The empirical evidence suggests a clear separation between the new and old EU member states in the long run”. [22] It is my hope that the qualitative economic aspects discussed in this paper may shed some light on this lack of convergence.

Table of Contents of the report:

1. Introduction – the two Socio-economic Narratives.
2. A Brief Background for the Irrational 1989/1992 Triumphalism: The 1840s and the Birth of the Irrational Twins.
3. EUs Three Slippery Concepts: an Overview.

3.1 Competitiveness
3.2 Productivity.
3.3 Innovation.

4. The Alternative Sociotechnical Narrative: How Innovations Differ in Occurrence and Diffusion.

4.1 The “Quality of Economic Activities” as a determinant for Economic Welfare.
4.2 The Classical and Collusive Modes of Diffusion of Technological Gains.

5. Key Mechanisms of Economic Retrogression; De-industrialization, the Ratchet Wheel that Collapsed, and Overvalued Exchange Rates.
6. Separating the Real Economy from the Financial Economy.
7. Diversity as the forgotten dimension: Kant vs. Fichte.
8. The Killer Apps of Capitalism: Ferguson (2011) vs. Reinert (2015).
9. Conclusion. Jean Monnet’s own metaphor as the EU being like the Kon-Tiki raft.

Download the full report here.

Footnotes

[1] For an explanation of the term see here.
[2] Presently the financial sector makes huge amounts of money by effectively shrinking the Greek economy. A basic rule of capitalism since the 1700s has been that the private interests in making money must coincide with the public interest of seeing economies grow rather than shrink. I shall return to this later.
[3] Buchanan, J. (1979). What Should Economists Do? Indianapolis, Liberty Press, p. 231.
[4] Saltelli, A., and Giampietro, M. (2015). The fallacy of evidence based policy.
[5] Lakoff, G. (2010). ‘Why it Matters How We Frame the Environment,’ Journal of Environmental Communication 4:1, 70-81.
[6] Rayner, S. (2012). ‘Uncomfortable knowledge: the social construction of ignorance in science and environmental policy discourses’, Economy and Society, 41:1, 107-125,.
[7] Ravetz, Jerome., R., (1987). ‘Usable Knowledge, Usable Ignorance, Incomplete Science with Policy Implications,’ Knowledge: Creation, Diffusion, Utilization 9(1), 87-116.
[8] English translation: On The Greatness of Cities.
[9] Eira, Inger Marie (2012). The Silent Language of Snow. Sámi traditional knowledge of snow in times of climate change, PhD Thesis, University of Tromsø.
[10] For a discussion of diversity which may be seen as an integral part of this work, see Reinert, Erik and Ting Xu, ‘Declining Diversity and Declining Societies: China, the West, and the Future of the Global Economy’, The Uno Newsletter, Vol. II, No. 13.
[11] This is the title of Harvard professor Tom McCraw’s biography of Schumpeter.
[12] Growth, Competitiveness, Employment. The Challenges and Ways Forward into the 21st Century (1993). This White Paper starts with the phrase: “Why this White Paper? The one and only reason is unemployment. We are aware of its scale, and of its consequences too. The difficult thing, as experience has taught us, is knowing how to tackle it”.
[13] European Commission (1995). Green Paper on Innovation.
[14] See e.g. Hippel, Eric von (2011). “Open User Innovation”. In Soegaard, Mads and Rikke Friis Dam, Encyclopedia of Human-Computer Interaction. Aarhus, Denmark: The Interaction Design Foundation.
[15] Australian economist Arthur Smithies (1907-1981).
[16] Reinert, Erik S. & Sophus Reinert (2003). Innovation Systems of the Past: Modern nation-states in a historical perspective. The role of innovations and of systemic effects in economic thought and policy, Paper prepared for the 1st Globelics Conference, Rio de Janeiro.
[17] Reinert, Erik S. (1994). ‘Catching-up from way behind – A Third World perspective on First World history’ in Fagerberg, Jan, Bart Verspagen and Nick von Tunzelmann (eds.) The Dynamics of Technology, Trade, and Growth, Aldershot, Edward Elgar, pp. 168-197.
[18] Reinert, E. S. and R. Kattel (2004). “The Qualitative Shift in European Integration: Towards Permanent Wage Pressures and a ‘Latin-Americanization’ of Europe?’, Praxis Working Paper no. 17, Praxis Foundation, Estonia.
[19] Reinert, E. S. and R.  Kattel, ’European Eastern Enlargement as Europe’s Attempted Economic Suicide?’, WP No. 14, TOC-TUT WP series, 2007.
[20] Reinert, E.S. and R. Kattel (2014). ‘Failed and Asymmetrical Integration: Eastern Europe and the Non-Financial Origins of the European Crisis’, in Sommers, Jeffrey & Charles Wolfson (eds.), The Contradictions of Austerity. The Socio-Economic Costs of the Neoliberal Baltic Model, London, Routledge, pp. 64-86.
[21] Reinert, E. S. How Rich Countries Got Rich… and Why Poor Countries Stay Poor, London, Constable, 2007.
[22] Borsi, Mihaly Tamas and Norbert Metiu (2013). “The Evolution of Economic Convergence in the European Union” Deutsche Bundesbank Discussion Paper, No 28/2013.

Erik Reinert is Professor of Technology Governance and Development Strategies at Tallinn University of Technology.

Photo: European Parliament

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s