6 – The Role of Technology – Competitiveness


We saw in the previous chapter, Transition to a New Paradigm, that a strategy to ‘exit’ Neoliberalism should involve three stages: a) forgiveness of the debts achieved by restarting and inflating the real economy; b) going back to a more correct (= more balanced and equitable) management of the economy by making new institutional arrangements, both national and international; and c) making the previous changes sustainable for the long run by re-acquiring, maintaining and upgrading an industrial structure fit for the twenty-first century.   

Stage a, restarting and forgiveness of the debts, is a ‘transition issue’. It is a problem of wiping the slate clean and restarting the real economy. Stage b is a more permanent concern: resetting the economic rules and institutions (both at the national and the international level) so that they can ensure a more correct and balanced running of the economy for the longer-term.  Both a) and b), restarting and resetting, are questions concerning the ‘software’ of the economy.  Now we need to deal with what can actually sustain this software, that is, the hardware that allows the economy to run. We will start by making the case that the backbone of a viable economy is made up of its industrial structure, something that runs contrary to common wisdom, as people in the West tend to think that we live in a post-industrial age. To make the case that industry is still very relevant, I will use Ha-Joon Chang’s essay ‘Why we don’t Live in a Post Industrial Age’, then I will further clarify the subject by exploring in more detail one of the two problems raised by Chang: the relevance of industry for trade deficits and the balance of payments, which are at the centre of the fatal neoliberal imbalances leading to unsustainable debts; (the other problem raised by Chang, the relevance of industry for long term growth, will be dealt with in the next chapter).  Finally I will draw the conclusions relevant for stage c): what needs to be done in order to back up the new software (or new economic paradigm) with a proper industrial structure.  

Unfortunately implementing part c) is much more difficult than it seems.  Technology gets ever more complex and expensive as time goes by, and countries get more interdependent; as a result, reacquiring and maintaining industrial competitiveness is increasingly a difficult issue, yet it needs to be first understood and then tackled.  Running away from it by compensating industrial decline with financial overgrowth is not the answer, as highlighted by the 2008 financial crash.

Part I – Ha-Joon Chang: ‘Why we don’t Live in a Post-Industrial Age’

This part that follows is an abridged version of Chapter 9 (titled: ‘Why we don’t Live in a Post-Industrial Age’) of the book “23 Things they don’t Tell you about Capitalism” (2010), by the South-Korean economist Ha-Joon Chang.  He explains this point in a most simple and conclusive manner, and I have added very little to it.  Ha-Joon Chang makes the point that, contrary to popular belief, the advanced countries don’t live in a post-industrial age, as industrial goods are still an important part of what we consume (although not of what we produce) and therefore they still shape the way we live and our standards of living.  In addition, he explains that national economies are now interlocked in a way that they did not use to be in the past, hence the necessity for each country to keep a very close eye on its industrial dynamics as they affect very strongly its balance of payments, with very serious consequences for the long term viability of its whole economy.

This is his argument in a nutshell:

‘We may be living in a post-industrial society in the sense that most of us work in shops and offices rather than in factories, but industry has not become unimportant.  Most (although not all) of the shrinkage of the share of manufacturing in total output is not due to the fall in the absolute quantity of manufactured goods produced but to the fall in their prices relative to those for services, which is caused by their faster growth in productivity (output per unit of input).  Now, even though de-industrialisation is mainly due to this effect and thus it may not be negative in itself, it has negative consequences for economy-wide productivity growth and for the balance of payments, which cannot be ignored.  An economy in which services play a more important role than industry (as is the case in most advanced countries) presents two problems: a) the limited scope for productivity growth makes services a poor engine of growth; b) the low tradability of services means that a more service-based economy will have a lower ability to export.  Lower export earnings means a weaker ability to buy advanced technologies from abroad, which in turn leads to ever increasing balance of payments problems, as well as slower growth.

This is the ‘longer’ explanation in Chang’s own words – I have only added some comments, which will be in square brackets:

‘Having successfully launched the Industrial Revolution, Britain was the unquestioned dominant industrial power in the nineteenth century.  [Due to the rise of rivals, mainly Germany and the United States] by the time of the First World War Britain had lost its leading position in the world’s industrial hierarchy, but the dominance of manufacturing in the British economy itself continued for a long time afterwards.  Until the early 1970’s, together with Germany, Britain had one of the world’s highest shares of manufacturing employment in total employment, at around 35 percent.  At the time, Britain was the quintessential manufacturing economy, exporting manufactured goods and importing food, fuel and raw materials.  Its manufacturing trade surplus stayed consistently between 4 percent and 6 percent of GDP during the 1960’s and 70’s.  Since the 1970’s, however, the British manufacturing sector has shrunk rapidly in importance and now accounts for only 13 percent of GDP (against 37 percent in 1950).  These days, Britain runs manufacturing trade deficits in the region of 2-4 percent of GDP per year.  What has happened?  Should Britain be worried?  Many people actually celebrate the rise of services.  According to them, the recent expansion of knowledge-based services with rapid productivity growth – such as finance, consulting, design, computing and information services, R&D – means that services have replaced manufacturing as the engine of growth, at least in the rich countries.  Manufacturing is now a low-grade activity that developing countries such as China perform.

Have we really entered the post-industrial age? The answer is no. Today’s rich countries have become post-industrial societies in the social sense, as most of their people are no longer employed in industry (in Britain only just over 10 percent of the labour force are).  However, they have not become post-industrial in the economic sense.  Manufacturing still plays the leading role in their economies.  In order to see this point, we need to understand why de-industrialisation has happened in the rich countries.  A small, but not negligible, part of de-industrialisation is due to optical illusions, in the sense that it reflects changes in statistical classifications.  One such illusion is due to outsourcing of some activities that are really services in their physical nature but used to be provided in–house by manufacturing firms and thus classified as manufacturing (e.g. catering, cleaning, technical supports).  When they are outsourced, recorded service outputs increase without a real increase in service activities.  In addition to the outsourcing effect, the extent of manufacturing contraction is exaggerated by what is called the ‘reclassification’ effect (some manufacturing firms, seeing their service activities becoming predominant, applying to the government statistical agency to be reclassified as service firms).  [Aside from these two effects which are small] one cause of genuine de-industrialisation is the rise of manufacturing imports from low-cost developing countries, especially China.  However dramatic it may look, it is not the main explanation for de-industrialisation in the rich countries. Most estimates show that the rise of China as the new workshop of the world can explain only around 20 percent of de-industrialisation in the rich countries that has happened so far.  The remaining 80 percent of de-industrialisation can be explained by the decline of the prices of industrial products, and not by a decline in their demand.  We are spending ever higher shares of our income on services not because we are consuming ever more services in absolute terms but mainly because services are becoming ever more expensive in relative terms.  If you adjust the changes in relative prices the decline in manufacturing in the rich countries has been by far less steep than it appears to be.  For example, in the case of Britain the share of manufacturing in total output fell from 37 per cent to 21 per cent between 1955 and 1990.  However, when taking the relative price effects into account the fall was much smaller, only from 27 per cent to 24 per cent.  The relative prices of manufactured goods have been falling dramatically because manufacturing industries tend to have faster productivity growth than services.  In manufacturing, where mechanisation and the use of chemical processes are much easier, it is easier to raise productivity than in services.  In contrast, by their very nature, many service activities are inherently impervious to productivity increases without diluting the quality of the product.  There are some service activities, such as banking, which have greater scope for productivity increase than other services.  However, as revealed by the 2008 financial crisis, much of the productivity growth in those activities was due to ‘financial innovations’ which obscured the real risk’ [rather than genuinely reducing it, therefore amounting to fraud]. 

‘To sum up, the fall in the share of manufacturing in total output in the rich countries is not largely due to the fall in (relative) demand for manufactured goods, as many people think. Nor is it due mainly to the rise of manufactured exports from China and other developing countries, although that has had big impacts on some sectors.  It is instead mainly due to the falling relative prices of the manufactured goods due to faster growth in productivity in the manufacturing sector.  Thus, while the citizens of the rich countries my be living in post-industrial societies in terms of their employment, the importance of manufacturing in terms of production in those economies has not been diminished to the extent that we can declare it a post-industrial age’. [In other words, we consume as much and more manufactured goods than in the past, and some of them are produced abroad, but the largest part of the decline in manufacturing as a share of total GDP in the rich countries has to be attributed to the decline in the relative prices of manufactured products compared to services, and not to de-localisation].

[Now the bad news is that unfortunately, although the relative increase in productivity in the manufacturing sectors is in itself a good thing, it can have bad consequences]. 

‘If a country’s manufacturing sector has slower productivity growth than its counterparts in other countries, it will become internationally uncompetitive, leading to a) balance of payments problems in the short run and falling standards of living in the long-term.  Even a manufacturing sector that is very un-dynamic by international standards can be (and usually is) more dynamic than the service sector of the same country’ [but this is not good enough, a country needs to be competitive by international standards if it wants to avoid balance of payments problems].  [In addition, there is another problem quite aside from international competition]:  b) ‘as the economy becomes dominated by the service sector, productivity growth for the whole economy will slow down.  Unless rich countries think that they are rich enough and don’t need to increase their productivity, this is a situation that they should worry about, or at least reconcile themselves to’. 

Balance of payments problems: ‘de-industrialisation has a negative effect on a country’s balance of payments because services are inherently more difficult to export than manufactured goods. [At the root of the low ‘tradability’ of services lies the fact that they cannot be shipped around the world].  Of course, a country can plug the deficit through foreign borrowing for a while, but eventually it will have to lower the value of its currency, thereby reducing its ability to import and thus its living standards. Given this, a rising share of services in the economy means that the country, other things equal, will have lower export earnings.  Unless the exports of manufactured goods rise disproportionately, the country won’t be able to pay for the same amount of imports as before.  If de-industrialisation is of the negative kind, accompanied by weakening international competitiveness, the balance of payments problem could be even more serious, as the manufacturing sector then won’t be able to increase its exports [then the country will fall further and further into debt and, to avoid this predicament, will have to implement austerity measures to reduce its imports]. [in addition, this has a compounding effect as lower export earnings make  more difficult to buy the very technologies which would help the country to improve its competitiveness]

[A possible objection to this argument is that ] not all services are equally non-tradable.  The knowledge services – banking, consulting, engineering and so on – are highly tradable.  For example in Britain since the 1990s, exports of knowledge-based services have played a crucial role in plugging the balance of payments gap left behind by de-industrialisation.  However, even in Britain, which is most advanced in the exports of these services, the balance of payments surplus generated by them is well below 4% of GDP, and hardly enough to cover the country’s manufacturing trade deficits.  In the aftermath of the 2008 financial collapse, it is unlikely that Britain can maintain this level of trade surplus in finance and other knowledge-based services in the future.  In the case of the US, the trade surplus generated by knowledge-based services, at 1%, is even less, and nowhere enough to make up for its manufacturing trade deficits, which are around 4% for GDP.  Moreover, it is questionable whether the strengths of the US and Britain in the knowledge-based services can be maintained over time.  In services such as engineering and design, where insights gained from the production process are crucial, a continuous shrinkage of the industrial base will lead to a decline in the quality of the service and a consequent loss in export earnings.  If Britain and the US [by far the most advanced countries in the knowledge-based economy] are unlikely to meet their balance of payments needs in the long run through the exports of these services, it is highly unlikely that other countries can.

Another aspect to consider in this negative dynamic inherent in an economy with a prevailing services sector is that, in order to develop or to upgrade its technology, a country has to import superior technology from abroad, but if the country has a balance of payments problem its ability to buy this superior technology will be hampered.  Some may point to the case of Switzerland or Singapore, two economies that appear to have developed on the basis of services.  However, these economies have a lot more manufacturing than it is commonly believed.  We don’t see many Swiss manufactured products because the country is small and because its producers specialise in producer goods, but in per capita terms, Switzerland has the highest industrial output in the world. Singapore is also one of the five most industrialised economies in the world, measured in terms of manufacturing value-added per head (Japan, Finland and Sweden make up the rest of the top five). 

To sum up, the rich countries have not become unequivocally post-industrial.  Once we take into account the relative price effects, the manufacturing sector’s importance in their production systems has not fallen very much.  However, the problem is that even if it is mainly due to this relative price effect, de-industrialisation has negative effects on the balance of payments and long-term productivity growth, both of which need reckoning. “ [here ends the part that I have copied form Ha-Joon Chang’s book]

One cannot help to think, following Ha-Joon Chang’s reasoning, that technology seems to be creating a situation similar to a thread-mill: one has to run simply to remain in the same place.  There are two aspects to this problem: the first one, of a relative nature, has to do with all the issues related to the balance of payments – the other has more of an absolute nature, and has to do with the imperative of growth inherent in a capitalist economy.  

The first order of problems arises from the necessity that technological development creates for each country to keep up with the general pace of it – in economic jargon to ‘remain competitive’- otherwise a chain of negative reactions will set in (trade deficits, growing foreign debt, necessity to do austerity or to devalue the currency in order to reduce the trade deficits, resulting in lesser ability to develop/buy more advanced technologies, leading to further loss of competitiveness and the dangerous slipping into a vicious cycle).

We will now try to understand in more depth the issues related to the balance of payments and their relevance to what we called stage c), ensuring the long-term sustainability of a post-neoliberal economic arrangement (or paradigm). We will be dealing with the other issue highlighted by Chang in the next chapter, which will explain the crucial role played by industry and technology in generating long-term growth and will reveal that technological development is central for the long-term evolution and survival of capitalism.

Part II – The Balance of Payments and the imperative to maintain international competitiveness

In the following paragraphs I have conflated and adapted a few posts found in the blog ‘Goofynomics’ by Alberto Bagnai (professor of economics in the University of Pescara – Italy) dedicated to balance of payments issues.  I will look at the issues related to the balance of payments in general terms.  However, as these issues are greatly affected by the different positions that countries have in the international monetary system (i.e. the position of their currency as an international means of exchange and reserve of value), I will highlight mainly the point of view of the United Kingdom.

In a globalised economy such as the one we live in, most countries rely heavily on goods, services and capital produced or generated in other countries.  As a consequence, they need to export their own resources to earn international means of exchange, so that they can pay for their imports. By exporting, a country acquires foreign currency.  This money flows into its banking system and eventually to its central bank and can be used to pay for its imports. A country which constantly imports more than it exports, eventually runs out of foreign currency reserves and, if it wants to keep on importing, it will have no other option but to get into debt. This constraint is more relaxed for some countries, first and foremost the USA, but also other countries whose currencies have a special place in the international monetary system, that is, the currencies with international reserve status. Although the USA is by far the most privileged country in this respect, the UK as well enjoys a considerable advantage, as its currency is accepted as an international means of payment and, in addition, foreign investors are willing to put considerable amounts of money in the City of London (and in the UK housing market) in pound denominated assets. These two aspects (the status of the currency as international means of exchange and reserve, as well as the appeal of the UK financial and housing market) allow the UK debt to be more sustainable (= less expensive to service) than it would be for other countries.  This also implies that the UK can get away, at least in part, with repaying its foreign debt by simply creating more money, as it’s been happening since 2008.  However, even privileged countries like the UK still have to keep their trade deficits under control, otherwise their currencies will lose credibility and will tend to be replaced in their privileged role.  Therefore we can say that for all countries, although with various degrees of stringency, the rule applies that trade deficits and the resulting foreign debt cannot be allowed to grow indefinitely. Eventually, when the debt appears to be unsustainable and many creditors/investors start to pull out, the country will run into a balance of payments problem.  

we now need to understand what a balance of payments is and how it is composed – we will look at the UK in particular.


The balance of payments is an accounting document recording all the transactions of a country (more specifically of its residents) with the rest of the world (more specifically with non resident people and institutions).  It is divided into four sections:

1) Current account – its transactions show how a country ‘earns its living’, and they are divided in four different sections:

a) goods

b) services

c) payments of income (interests, dividends, profits) to capital provided by non-residents

d) unilateral transfers (mainly from resident foreign workers to their home countries)

2 Capital account: (less important)

3 Financial account: measures inflows and outflows of capital, both short term (purchase/sale of securities by foreign investors) and long term (direct investments/divestments by foreign investors)

4 Errors and omissions: self explanatory

The two most important sections are 1) the current account, which shows the health of a country’s economy by measuring its dependency on foreign goods, services and capitals and 2) the financial account, which shows how a country finances its current account deficits or where it invests its current account surpluses.

The most important thing to understand is that the balance of payments, like all accounting documents, must balance out (= the total sum of the various sections must be equal to zero).  Therefore, at the end of an accounting period, a current account deficit must be matched by a surplus in the financial account, which constitutes an inflow of foreign capital. In other words, the country in deficit must find somebody willing to finance it. The capital thus acquired will flow into its financial account, thus balancing the balance of payments. But this will come at a cost, which will show year after year in the current account as passive interests and dividends (in section c, payments of income).

We will now do a closer analysis of the UK current account as it evolved in the 20 years between 1993 and 2013, analysis which can be enhanced by a quick comparison with the Greek and German current accounts in the same time span.

UK – Current account 1993 – 2013

Greece – Current account 1993-2013

Germany – current account 1993-2013


The balance of payments is an accounting document recording all the transactions of a country (more specifically of its residents) with the rest of the world (more specifically with non resident people and institutions).  It is divided into four sections:

1) Current account – its transactions show how a country ‘earns its living’, and they are divided in four different sections:

a) goods

b) services

c) payments of income (interests, dividends, profits) to capital provided by non-residents

d) unilateral transfers (mainly from resident foreign workers to their home countries)

2 Capital account: (less important)

3 Financial account: measures inflows and outflows of capital, both short term (purchase/sale of securities by foreign investors) and long term (direct investments/divestments by foreign investors)

4 Errors and omissions: self explanatory

The two most important sections are 1) the current account, which shows the health of a country’s economy by measuring its dependency on foreign goods, services and capitals and 2) the financial account, which shows how a country finances its current account deficits or where it invests its current account surpluses.

The most important thing to understand is that the balance of payments, like all accounting documents, must balance out (= the total sum of the various sections must be equal to zero).  Therefore, at the end of an accounting period, a current account deficit must be matched by a surplus in the financial account, which constitutes an inflow of foreign capital. In other words, the country in deficit must find somebody willing to finance it. The capital thus acquired will flow into its financial account, thus balancing the balance of payments. But this will come at a cost, which will show year after year in the current account as passive interests and dividends (in section c, payments of income).

We will now do a closer analysis of the UK current account as it evolved in the 20 years between 1993 and 2013, analysis which can be enhanced by a quick comparison with the Greek and German current accounts in the same time span.

The first thing that can be seen at a glance, is that the patterns of the UK current account components are not dissimilar from the Greek ones, while Germany presents opposite patterns. And this is no surprise, as both the UK and Greece are net importers, while Germany is a net exporter.

The black line represents the total sum of the four sections that make up the current account, and for the UK it shows a situation of persistent and growing current account deficits since 1998.

As for the individual components of the current account:

Blue line – Goods (also called trade balance) – as it is the case for most countries, it presents the same pattern as that of the total current account, because it is the most important of its components (for this reason, the trade balance is normally used as a proxy for the total current account).  The UK trade balance is persistently negative, as it is the case for Greece. This is due to de-industrialisation (only approximately 12% of the UK economy is classed as manufacturing) and it is indeed a problem, despite being largely ignored by the media.

Red line – Services – it presents the opposite pattern, a growing surplus both in the UK and in Greece. In the UK this is mainly due to financial and professional services (such as insurance, health, architecture, management consultancy, higher education and English law)  – for other countries such as Greece, it might be tourism, international transport etc.

Green line – Income payments – this line shows also a positive pattern, but it has been declining and even becoming negative, and this is a bad sign. Normally for a country in debt this balance would be negative (and this is the case for Greece), because it is made up of interests, dividends and profits on foreign direct investments, which are paid out to foreign (non-resident) investors. This is basically the remuneration for the foreign capital that finances our current account deficits.

In the case of the UK this balance has normally been positive because the UK tends to borrow money from foreign markets at very low rates (as it is considered a safe country for investors) while it tends to earn higher rates of return on its capitals invested abroad, especially on direct investments. Therefore, despite the fact that the UK has a net debt (of about 20% of GDP) with the rest of the world, the difference between interests and dividends received and interests and dividends paid tended to be positive until 2012.  This is because a substantial part of the UK debt held by foreigners is in the form of government bonds, which pay very low rates of interest. On the other hand, a substantial part of the money invested abroad by UK residents is in the form of direct investments, which tend to earn much higher returns.  For example, in 2009, while foreign investors had £600 billion worth of direct investments in the UK, British investors had £1000 billion  worth of direct investments abroad. The UK tends to lend money in the form of remunerative investments (direct investments) and to borrow money in the form of low interest government bonds, this is the reason why it manages to receive a positive income from a net debt position. But this situation is now deteriorating, and this is a bad sign. When a country (or any debtor) reaches the stage that it needs to borrow in order to pay interests on the existing debt, it is normally when creditors start pulling the plug.

Violet line – Transfer payments – these are mainly remittances made by immigrant workers to their countries of origin – the balance is negative for the UK, but fairly flat.

To sum up, the current account balance is the most important indicator of the state of health of an economy, and a persistent deficit signals an unhealthy dependence on foreign goods, foreign capitals or both. In the case of the UK the main problem is the dependence on foreign goods (due to de-localisation) while the dependence on foreign capitals is (or was), at least until recently, not causing serious problems in terms of high costs. A situation of persistent current account deficits normally ends in a balance of payments crisis.

Balance of payments crisis: it occurs when the current account deficit of a country can no longer be financed because the country in question is no longer attractive to foreign investors at affordable rates. The country will have to use its foreign currency reserves in order to buy imports and, at the same time, to prevent running out of them (and having to ask for a dreaded IMF loan), will have to devalue its currency and will have to slow down consumer spending on imports by curtailing the spending capacity of its residents, which can only be achieved by means of austerity measures.  As a consequence of implementing these measures, a balance of payments crisis will result in an abrupt reversal of the previous financial flows: the current account deficit turns into a surplus, and the inflow of capital in the financial account becomes an outflow as the country starts to repay its debts through exports or, if all comes to worse, by selling off its assets.  We can see such a pattern taking place in the Greek and UK current accounts in the aftermath of 2008.

The financial collapse of 2008 can be considered a balance of payments crisis.  It was not obvious because it was not treated as such by the media and the political establishment.  It was treated as a banking crisis due to malfeasance and recklessness, without further investigating what this really meant – i.e. without analysing the dynamics of the international creation and circulation of capitals within neoliberal globalisation (something that I have done in the chapter dedicated to the neoliberal economic paradigm). In addition, for what concerns the USA and the UK, these countries were able to bail out their banks by creating new money in the form of government debt, and there was no immediate effect on their ability to import.  In other words, they didn’t need a much feared IMF loan (and its accompanying heavy conditionality) as is normally the case with the balance of payments crises of ordinary countries, but the effects of the bail-outs (basically austerity measures) would be felt soon afterwards in a manner not dissimilar (although much milder) than what normally happens after an IMF loan.  

Post-balance of payment crisis measures. In order to avoid the repetition of a balance of payments crisis after it has taken place once, persistent austerity measures are necessary as the most effective and quick way to contain imports in the short term by reducing the incomes of the deficit country’s residents.  The other complementary policy choice is currency devaluation, which is much less damaging for the economy involved, but it can also be a lot less effective in the short term, depending on the structure of the economy in question; that is, on how sensitive  both its imports and its exports are to a devaluation of its exchange rate.  This policy poses a conundrum for a country (such as the UK) with a weak industrial base, and therefore unable to increase exports very much by means of a currency devaluation: it may not be very effective in reducing trade deficits while at the same time it tends to discourage (by reducing the value of their assets) the very foreign investors whose capitals are needed for as long as the deficit position persists.  Therefore, to avoid austerity, the only viable solution, in the longer term, would be making structural changes in the economy (re-industrialisation) in order to permanently decrease its dependence on foreign credit.  To sum up, austerity and currency devaluation are complementary measures.  Austerity is very effective to contain trade deficits but very undesirable for the economy.  Currency devaluation is much more desirable but it is only effective for a country with a good industrial base, able to increase exports and substitute imports with national goods.  Therefore the only practicable short term solution may be austerity in many cases, while the only desirable long term solution is a structural change in the economy.

As the status of countries and their currencies in the international monetary system varies, the mix of measures taken after the post-2008 bank bail-outs has been more or less harsh depending on the countries involved. But all in all we can say that, although in different degrees, since 2008 all countries with substantial trade deficits have had to implement measures aimed at containing them, at repaying the accumulated debts and/or at keeping themselves sufficiently attractive for creditors by keeping high the level of returns for them. 

We will now further analyse the problems faced by an economy dependent on foreign resources and demonstrate with a mathematical model that this dependency acts as a severe limitation on its ability to pursue expansive policies in order to promote economic growth and poverty reduction. 

Link between economic dependency and growth – a formal model explaining boom and bust cycles 

If for the moment we cast aside the possibility of making structural changes, and take the structure of a country’s economy as a given, we can build a formal model which shows how, for a country reliant on imports, there is a sort of ‘iron law’ which limits its possibilities for economic growth.  This is due to the fact that there is a direct link between economic growth of a country (regardless of whether it is financed by credit or positive money), the consequent growth of its residents’ incomes, the resulting growth of its imports not matched by an equivalent growth of its exports, a looming balance of payment crisis, and finally the need to adopt austerity measures to deal with it and to prevent its repetition.  This apparently inescapable chain of events tends to confine all import-dependent economies into a vicious (and by now familiar) boom and bust cycle, putting an upper limit to their economic development. We will now look at a simple formal model that puts the above mentioned chain of events into a mathematical relationship. 

The Thirlwall model – this model was formalized by the British economist Tony Thirlwall in an article published in1979, titled ‘The Balance of Payments constraint as an Explanation of International Growth Differences’.

Step 1): the model starts with a very simple equation. If we indicate exports of goods with X and imports of goods with M, the condition for long term financial sustainability (= no foreign debt) will be

X = M

This means that a country’s economy, in order to be on a sustainable path, has to have a trade account which is balanced in the medium/long term. In this simplified model we take the trade account as a proxy for the current account, and this can be done without problems because in most cases the two show the same pattern. 

Step 2: if we start from a balanced situation and we want to keep it that way, then imports and exports will have to grow at the same rate. 

Assuming that the initial value of export is 100, if X = M, then the value of exports will also be 100. If we assume that imports grow annually by 3% while exports grow only by 2% per year, then after one year the country would have the following deficit:

X – M = 102 – 103 = – 1

A situation of equilibrium can only be maintained if imports and exports grow at the same rate if, that is, the following condition is verified:

X* = M*

The letters with asterisks indicates the rate of growth of X and M.

Step 3: the growth of imports depends on income growth:  M* = πY*

This is an empirical relation: the demand for imports depends on the income of a country. This relation is very easy to understand: as the national income (or GDP) of a country grows, its residents will have more money to spend and, in a globalised economy, they will buy more imports. The relation between these two variables (π), called elasticity of imports to income can be seen from the table below (copied from the blog Goofynomics):

a) The first column represents the percentage variation of the GDPs of the countries in the sample between 2007 and 2013,

b) the second column represents the percentage variation of their imports in the same time interval

c) the third column is the ratio between the first two: column b divided by column a.

AVERAGE RATIO or π = 2.1

This ratio, called elasticity of imports to income and indicated with the Greek letter π, expresses an empirical relationship, tends to be constant over a given period of time, and it indicates the structural dependency of a country on foreign goods. It can only change when there are shifts in the structure of that country’s economy.  For example, it increases in presence of de-industrialisation, as it is happening in the periphery of the Euro zone at the moment. It is generally greater than 1 (with the exceptions, in our sample, of Austria, the United States and Finland, whose imports are relatively “rigid”) and its average is roughly 2.  For the UK this ratio is 1.3

To be noted:

* Each country has its peculiar economic structure and there are also cases which would appear absurd, such as Estonia or The Netherlands where GDP decreased but imports increased (in the case of the Netherlands this is due to the fact that from its ports German goods are exported to other countries, therefore its imports are mainly goods in transit).

* The concept of elasticity must not be confused with the similar concept of marginal propensity. Marginal propensity is the ratio between two increments, while elasticity is the ratio between two percentage increments.

Based on the above table, the elasticity of imports to income can be indicated as follows


In order to better highlight the dependence of imports from income, this equation can be re-arranged as follows:

M* = πY*

In other words, if Y (= income, or GDP) increases by 2%, M (imports) will increase by 2% multiplied by π  (the elasticity of imports to income).  Based on the average value of π (roughly 2 in our sample), if a nation’s income grows by 2%, the value of its imports will increase by 4%.

Step 4: as a result, the balance of payment constraint (or external constraint) will limit the growth rate of a county’s economy

To demonstrate this, we must go back to the original equation (X* = M*) representing the condition of equilibrium of the trade account measured in terms of its variations. We need to substitute M* with its equivalent πY*, as indicated above, and we get the following equation:

X* = πY*

Step 5: From this equation we can find out that particular GDP growth rate (indicated as Y*bp ) which is compatible with the condition of equilibrium:

Y*bp = X*/π

This formula will give us the GDP growth rate compatible with the external constraint (= compatible with maintaining a balanced trade account). 

If the actual growth rate is greater than the one indicated by this formula, then the country in question will get into a deficit position: we could say that its GDP is running too fast, causing its imports to grow too fast compared to its exports and the country will start accumulating foreign debt. Conversely, if its growth rate is lower than the one indicated by the formula, the country will tend to accumulate a trade surplus: this means that by repressing internal demand (generally by means of wage repression), the country will be able to run a current account surplus and to become a net creditor (Germany is an example of this policy choice).

To sum up: an increased GDP growth normally reflects negatively on the trade account, either increasing its deficit or reducing its surplus position, because increased income leads to increased expenditures and part of the increased expenditures will go into buying foreign products. As a consequence, the rate of GDP growth that a country can afford to have without worsening its trade account position is:

1) in direct proportion to the growth of its exports (because with exports growing fast, more foreign currency will be available to pay for increased imports)

2) in inverse proportion to π, the elasticity of imports to income, which is a measure of the structural dependency of a country from foreign goods. The higher this dependency, the higher will be the increase in imports resulting from any given GDP growth rate.

Therefore, countries with growing exports can afford to grow without problems, while countries with high structural dependency from foreign goods cannot.

What happens if a country disregards this constraint – boom & bust cycles – If a country’s GDP grows more than its ‘constrained’ growth rate, and this can happen for instance in the initial stages of a housing bubble-led growth (but it could just as well be a program of QE for the people, because the effect is the same, putting money in the hands of ordinary consumers, who are bound to spend a part of it on imported goods – on the other hand QE for the financial markets is not a problem, because it doesn’t result in increased imports), its foreign debt will increase due to increased consumption of imported goods.  When the creditors start to get nervous and sell their positions, there will be a credit crunch and a recession will follow. The lower rate of growth of the second part of the cycle, averaged with the higher rate of growth experienced during the initial stage of the cycle, will result in a long-term rate of growth which is compatible with the external equilibrium. What is the duration of the ‘long term’ in this context? (In other words: for how long will the financial markets be willing to finance the trade deficits of a country?) There is no straightforward answer, but normally by collecting data over a span of about 20 years you should be able to capture 2 or 3 cycles, and therefore be able to verify if the real average growth rates experienced by the sample countries over that period of time is in line with the growth rates predicted by the model.

If, on the other hand, a country grows at a slower rate than the one compatible with the balance of payments equilibrium, it will become a net creditor. This position is much more comfortable, as it causes no balance of payments crisis, therefore there is an asymmetry here. The literature on the subject is vast, but the conclusion that we can draw is that the rate of growth compatible with the external constraint works as an upper limit to economic growth, not as a lower limit.

Verification of the Thirlwall model – Actual growth rates over a 20-year period

Here we have a graph that compares actual long term growth rates (on the vertical line) of a sample of 177 countries with their ‘constrained’ growth rates (on the horizontal line). (Data taken from Goofynomics, originally taken from World Economic Outlook)

The 45° line indicates the points were the two growth rates (real and ‘constrained’) coincide. We can see that most countries are clustered near the 45° line, while a number of countries kept their actual growth rates well below the ‘constrained’ ones. There are also 9 countries with very crazy values (they are all very small oil rich countries with wars).  Once taken out these 9 outliers, the results are even more in line with the model. The predictive capacity of the model, once taken out the outliers, is 56%.  This means that the ‘external constraint’ explains 56% of the actual growth rates recorded by the 168 countries making up the sample.  We can see this from the second graph, which does not include the outliers.

We must add that, if we replace the ‘constrained’ income growth rate (Y*bp = X*/p) with the export growth rate ( X*) – that is, if we don’t divide the export growth rate by the elasticity of imports to income, the relation is a lot weaker.

The conclusion is that the rate of export growth taken on its own is not enough to decide how much an economy can grow without having balance of payments problems. Its dependence on imports is also crucial.

Consequences in terms of economic policy – the role of asset bubbles

The Thirlwall model is telling us that a country cannot sustainably grow its GDP unless a) it manages to increase its exports or, b) it manages to reduce its structural dependency from foreign goods by producing more at home. Both these objectives, in order to be achieved, require: a) devaluation of the currency, b) structural changes in the economy (re-industrialisation).

We have mentioned what happens when countries with persistent trade deficits ignore the external constraint and grow their GDP anyway: the UK did it before 2008 and so did the countries of Southern Europe. It ended up with a financial collapse, with the banks being bailed out by the governments, and with the public being made to pay to pay the final bill in the form of austerity measures.  It is true that the UK government has been reducing part of the debt by creating money (QE) and injecting it into the financial economy, and that this QE program could actually be diverted to the real economy (QE for the people).  Just as it is true that the UK government, being still in possess of its monetary sovereignty, could have adopted this policy of spending into the real economy right from the start of the last boom and bust cycle, rather than letting the banks create money in the form of private debt. There would have been no housing/financial bubble and no bank bailouts, but without inflating asset bubbles the housing/financial market of the UK would have been much less attractive to foreign investors, and a balance of payments problem would have occurred much sooner.  The UK having an international reserve currency, it would have been able to create money to pay for its imports; however, the following chain of events would have occurred:

We start with a situation of unwillingness to borrow ( or inability to borrow at reasonable interest rates) —-> decision to create money to pay for imports –> flooding the markets with too many GBPs pounds –> this would eventually result in excessive devaluation and consequent inability to buy necessary imports (this is called deterioration of the terms of trade) —> this would entail the necessity to implement austerity measures in order to contain imports.  

In other words, a country that tends to have trade deficits can either create money to pay for them, but this would lead to excessive devaluation of its currency and eventually the need to pay in hard currencies (i.e. US dollars) or can issue increasingly unsustainable (or ‘toxic’) debt titles in the international financial markets, this way attracting investors that effectively finance the trade deficits.  This allows the game to last a while longer, but eventually there will be a financial collapse and the necessity to obtain an IMF loan, and then to implement austerity measures.  If the country is at the top of the international hierarchy, it will have more leeway to create money, bail out its banks and carry on with business as usual, but eventually the creditor countries are likely to start to put pressure in different ways, such as stopping to buy toxic assets and buying real assets of the deficit country instead, or converting the government bonds of the deficit country into gold.  The most geopolitically independent countries could even start implementing more advanced solutions, such as creating their own payment networks and financial markets, thus displacing the ones of the countries which have been abusing their privileged positions in the international monetary system for too long.  This is precisely what is happening at the moment with the Belt and Road Initiative.  When this happens, resetting the international monetary system becomes a geopolitical matter that needs to be addressed with increasing urgency.

It should be obvious at this point that the real function of an over-inflated financial sector, with its largely fraudulent activities and the creation of asset bubbles serves to hide the economic un-sustainability of persistent trade deficits and prolong the neoliberal game as long as possible.  It should also be evident that the real purpose of austerity measures is to keep trade deficits from getting out of control, while nothing is done to solve the root cause of the problem, the structural dependency of the economy.

Strategies adopted over time to deal with the balance of payments constraint

Having said all this, the difficulty of overcoming structural dependency should not be underestimated.  First of all we need to highlight the fact that the problem of competitiveness and technological innovation can only be tackled if there is a major impulse at the national level by means of public funding, and only in a secondary way at the level of individual firms.  The reason for this will become clear in the next chapter (where I will trace the evolution of industry and technology in the last 200 years) but it is a fact that the main burden falls on the governments of each country to set up and maintain an economic environment which will help its industries to stay competitive at the international level. Keeping up with the technological race is achieved by means of state supported expenditures in R&D (including using state owned enterprises to carry out R&D), as well as expenditures in infrastructure, education and training, as well as a series of interventions designed to contain the costs of doing business.  All of this will ensure the basis for international competitiveness of the individual firms operating in each country.  In turn, it is only by making sure that its firms remain in business, that a nation-state can maintain an autonomous economic space, a vital condition in order to retain a meaningful degree of political sovereignty.  

As keeping up with technological developments is difficult and expensive, often countries choose (or are ‘induced’) to take a short cut and embark in alternative policies that allow them to balance their accounts without going through the trouble and expense necessary to acquire/re-acquire a state-of-the-art industrial structure.  We can say that there are two main directions that countries can choose – and the international setting is essential in determining these choices. One set are ‘virtuous’ ways, which allow individual countries to maintain as much as possible their competitiveness and preserve their economic base.  The other set are non-virtuous ways which cause the countries to fall behind in terms of competitiveness and to slide further and further into debt.  Countries normally adopt a combination of policies within one of the two sets:


a) constant upgrading of available technologies and therefore increasing the value added of exports – as noted previously, maintaining a good position at the frontiers of technology becomes ever more complicated and expensive as time goes by and new technologies become ever more complex; b) therefore protectionism is used in combination, in order to preserve a sufficient industrial base.  There are also some additional measures within SET A that are not quite as ‘virtuous’ because they rely on the willingness/ability of partner countries to absorb the exports of the country in question: c) increasing the quantity and therefore the total value of exports.  This is normally achieved by means of c1) currency devaluation and/or c2) wage devaluation, that is, competing by making exports cheaper.  These measures (c1 and c2) can work only if only one country does it (otherwise this will unleash a destructive race to the bottom) and if the country in question is relatively small, so that the adverse effects of this export led strategy (based on wage and welfare containment or on currency devaluation) on its internal demand (negatively affected by low wages) are more than compensated by increased exports, and the balance of payments of its trading partners are not substantially affected, as the size of its trade surpluses are small as a percentage of the partners’ economies.  If, on the other hand, the country in question is a large one, then this ‘mercantilist’ policy can only work for a while if its partner countries adopt neoliberal policies and accept to fall further and further into debt. All of the above measure are greatly facilitated by e) being part of an economic block in which the leading country is taking responsibility for the growth of the whole block by creating money and acting as the buyer of last resort (something that the USA was doing under the Bretton Woods system) or by creating debt and toxic titles and still acting as buyer of last resort – something that the USA was doing during the time of the neoliberal paradigm (1980’s up to 2008).  The problem at the moment is that the USA is no longer in a position to perform this role, as shown by the much criticised trade wars initiated by President Trump.  These ‘wars’ demonstrate that even for the mighty United States the time has come to start worrying about the balance of payments constraint.


Then there are the non-virtuous ways, which over time erode the economic base of a country:

a) increasing interest rates to attract enough capital in order to finance trade deficits with foreign debt – this is only a temporary measure as it soon becomes unsustainable; b) implementing austerity measures to keep trade deficits in check.  This eventually leads to a general impoverishment of the country and to its inability  to upgrade its technologies or buy new ones, so it is unsustainable as well, but over a longer period; c) being a deficit country within the neoliberal paradigm – which is based on attracting the capitals of the surplus countries into the international financial markets, and then redistributing them at low cost, often inflating asset bubbles.  This works for a while but eventually leads to disaster, because the neoliberal countries end up losing their industrial base and becoming structurally dependent.  Then what happens is that the geopolitically weaker ones will be driven into deflationary default and their assets will be gobbled up, while the stronger ones (i.e., the countries whose currencies are used as international means of payment) tend to try and survive with a combination of austerity and QE for the financial markets – basically attracting foreign capitals by inflating asset bubbles while at the same time containing all other expenditures.  This in terms of industrial competitiveness means that they slide into a situation of ‘managed decline’ as expenditures for R&D, infrastructure, education, etc. will dry up, until the hegemonic position of these countries is finally supplanted by new emerging ones.  

Policies associated with the above strategies

As mentioned before, these two sets os strategies are associated with different geopolitical arrangements and different economic paradigms.  Set A is associated with the Keynesian paradigm, based on economies that aim to pay their way in the world by keeping a healthy industrial base.  Some countries can also pursue these policies within the neoliberal paradigm, by carving for themselves a role as export-led or mercantilist countries within this arrangement.  For a country that chooses ‘set A’ all its economic policies (money creation, taxation, exchange rate policy etc.) will be geared at harnessing its public spending capacity both to upgrade its industrial structure and to contain the cost of doing business.  On the other hand, the countries that adopt set B, associated with the neoliberal paradigm, aim to pay their way in the world by attracting foreign capitals.  This means that they will avoid spending money into the real economy, and will pour it instead into the financial one, in order to give attractive returns to foreign investors that finance their trade deficits.  We can sum up the accompanying policies that go with SET A and SET B this way:

Policies associated with SET A strategies and ‘earning a living’ from the real economy

These are the policies necessary to favour re-industrialisation and maintain economic competitiveness.  They are also the same policies historically pursued by many states during the initial phases of industrialisation.

1) Taxation – government involvement in the economy is necessary to subsidise re-industrialisation and to keep down the cost of living and doing business by: building infrastructure, investing in research and development, curbing utility prices, keeping a high level of aggregate demand (in order to achieve economies of scale) and providing essential services such as health, education and social housing (which help to keep the costs of living and doing business low). Ideally taxation should fall relatively lightly on the productive economy, and should be shifted to unearned income (interests, rents, capital gains, monopoly profits).

2) Exchange rate – reasonably low

3) Interest rates – as low as possible, in order to finance investments in the real economy at low cost

4) Consumer price Inflation – contrary to common belief, the productive economy benefits from moderate price inflation, as it makes more likely that revenues (which take place at the end of the production cycle) are higher than costs (which are incurred at the beginning of the production process).

5) Asset price inflation – it damages the productive economy by increasing production costs and also the costs of living of its workers, therefore it needs to be kept low

6) Monetary policy – public control of money creation to finance government deficits at low cost – central bank not independent but serving government policies

7) Financial markets & capital mobility – it needs to be restricted, as it interferes with government ability to control monetary and fiscal policy

8) Foreign trade – some protectionism (especially in case of unfair competition from countries with no regulations and very low wages) is necessary

Policies associated with SET B strategies and ‘earning a living’ from the financial economy 

These are the policies necessary in order to please the financial markets:

1) Taxation – as low as possible, the financial markets don’t need public services, therefore they want a reduction in the size of government

2) Exchange rate:  as high as possible, so as to keep high the value of their assets in case they have to be sold

3) Interest rates:  as high as possible in order to produce attractive returns for the financial markets

4) Consumer price inflation: as low as possible because it reduces the value of the liquid assets held by investors in the financial markets

5) Asset price inflation on the other hand is very good as it implies capital gains.  However, periodic crises with bankruptcies and assets sell offs are also very good, as they make possible to sweep up more assets at bargain prices. Therefore financial bubbles and periodic crashes are good.

6) Monetary policy – privatised money creation with an ‘independent’ (= privately controlled) central bank

7) Financial markets & capital mobility – complete deregulation and complete cross border mobility to take advantage of opportunities everywhere

8) Foreign trade – free trade, no tariffs, no barriers in order to be able to take full advantage of globalisation (producing where labour is cheapest and selling everywhere in the world)

Policy adjustments associated with the current time of transition

Set A policies tended to prevail during the times of the Bretton Woods system, while the non-virtuous policies associated with set B strategies are the ones we are familiar with, prevailing in the last forty years of neoliberalism. How is the balance of payments constraint managed at the moment, in our post-2008 time of turmoil and transition?  Initially, up until 2016, with different combinations of austerity and currency devaluation and, for the sake of clarity, we can sum up the various policies into two extremes, which we have seen in action in recent years, option 1) austerity light (UK style) and option 2) heavy duty austerity (Greek style).  

Option 1 (austerity light) – this policy option aims at getting by with a mix of austerity and currency devaluation.  This is the option being pursued by the UK at the moment.  In the aftermath of the bank bailouts of 2008, the newly created money in the form of government debt pushed down the exchange rate rather sharply. The British pound lost about 30% of its value against the Euro, where austerity policies were being implemented instead. This loose monetary policy, if kept in place, could have made possible a long term improvement in the balance of payments by acting in two ways: 1) a permanently devalued pound would have the effect of giving foreign creditors a ‘haircut’ on their credits, as the value of their pound denominated assets would have permanently decreased and 2) this devaluation could have facilitated a rebalancing of the trade account by discouraging imports and making exports more competitive. 

However, this type of policy, in the presence of an import dependent structure of the economy, can just as easily backfire, as imports get more expensive, exports don’t increase in sufficient amounts, while at the same time disappointed investors start to sell their positions in the City of London.  For this reason, once dealt with the post-crash emergency, the UK government made sure that the economy would go back to business as usual and proceeded immediately to pass austerity policies (although very light compared to those taking place in some parts of the Eurozone) which had the effect of a partial re-valuation of the pound, indispensable to keep foreign capital coming to the UK. Later on QE for the financial markets and the ‘Help to Buy’ scheme have made sure that asset prices would keep on rising despite the non optimal state of the economy, thus keeping foreign investors reasonably happy.

Option 2 (heavy duty austerity) – this option allows for no currency devaluation (as this is impossible for a member state of the single currency) and it is based entirely on austerity policies, which reduce trade deficits by slashing residents’ incomes and thus containing imports, while doing nothing to increase exports.  This option implies continuing to rely on the financial markets as the foreign debt cannot be reduced (via currency devaluation) nor repaid (by increasing exports) but only stabilised at best, by reducing imports.  However, as austerity reduces the country’s GDP (and prevents the country from upgrading its technologies and its infrastructure) the burden of the debt increases, and eventually leads to escalating interest rates and the bankruptcy of the entire economy, so that gradually the country is forced into selling a large part of its assets, both public and private, just in order to manage the debt.  

If option 2 is a recipe for economic suicide (or debt slavery), option 1 leads to a slower death or what we could call ‘managed decline’: slowly crumbling infrastructure, inability to keep up with the technological race, gradual shutting down of productive activities and selling off of assets, all resulting in a slow but inexorable impoverishment of the population, as the real economy is unable to grow and ever more burdened with servicing the debt (not least via increased asset prices, i.e. increased mortgages).  This situation is likely to alert a part of the national elite to the necessity of initiating a transition out or neoliberalism – and this is the current state of affairs.

We can say that since 2016 (with the Brexit referendum, the election of Donald Trump and the rise of populism in Europe) an uncertain move out of neoliberalism has indeed started.  The question of the moment is:  what stands in the way of decidedly embarking upon a proper transition? The problem is first of all political – as highlighted in the previous chapter, part of the elite is unwilling to lose its privileged status granted by the current economic and geopolitical set up.  This set up translates into institutional arrangements which are very difficult to undo:  in the Euro zone a transition is impossible for as long as the single currency remains in existence, in the UK exiting neoliberalism is not even being discussed (for example as part of the Brexit debate) because it would be incompatible with keeping the City at its current, still thriving level of business.  In the USA the move towards re-industrialisation has started, but it is not an easy route to undertake.

For what concerns the UK, we can say that the main structural problem we face is that having to keep the City of London thriving (policy objective unfortunately very dear to all the UK elites) implies a massive influx of capitals which tends to distort the structure of the economy (via overvalued exchange rate) and which needs to be rewarded, thus imposing a continuous drain (= extraction of economic rent) on the rest of the economy.  In other words, the City needs an economic environment that rewards financial capital handsomely, but having to grant this level of financial returns would make the local industry non-competitive, and thus unviable. Therefore the current management of the consequences of the crash (QE for the financial markets + austerity for the rest of us) along with the inability to exit /Brexit this stalemate, derive from a choice made long time ago, to switch from an economy based on production to one based on finance, which unfortunately our elites seem to be totally unwilling to question and which, in any case, is difficult to reverse.

For what concerns other countries – as previously discussed many countries, faced with the current scenario of what has been called ‘secular stagnation’ leading towards slow irreversible decline (and actually in some cases to quick self destruction) are starting to consider the ‘exit’ option. This involves, as we have seen, stage a (restarting the real economy with injections of deficit spending – absolutely forbidden by the EU treaties) stage b, changing the software (this is being attempted in the EU by pushing for reform of the treaties) and rebalancing trade (this is most vocally advocated by the USA of Donald Trump) and then stage c), re-industrialisation.  At this point not only the political resistance of the neoliberal elite, but also the actual sheer difficulty of implementing re-industrialisation need to be considered, both aspects leading to the current stalemate.  If we overlook for the moment the political aspects of the problem and focus only on the economic ones, we can exemplify them by looking at the clumsy attempts that the Trump administration has been making to rebalance trade and re-onshore American industry (attempts known in the public debate as ‘trade wars’).  What we can see is that it is all very nice and well to advocate bilateral agreements to rebalance trade, but if all a country (the USA) has to offer are the likes of chlorinated chicken, outdated military equipment, mafia-style NATO protection and, as it would seem, also soon-to-be outdated IT technology.…..then short of exercising a considerable amount of covert and overt coercion, these so called agreements will not take place.  Likewise, it is nice and well to decide to ‘exit’ the EU (and with it the neoliberal economic paradigm) but if a country (the UK) is unable to reduce the importance of finance in its economy…..then it will not be able to implement any meaningful changes.  For the countries trapped within the Euro-zone the problem is, likewise both political (how to reach an agreement in order to reform the current burdensome and self-destructive economic management rules) and economic: are they able to rebuild a proper industrial structure?  The situation of structural dependency is different for the various countries, ranging from desperate cases such as Greece, to not so desperate ones such as Italy and to complicated ones such as France, which still maintains many hegemonic and colonial ties that are part of the current order and greatly help to prop up its economy – ties that would be seriously undermined, if not completely destroyed, if a new world order takes shape.  

Relevance of the above analysis for stage c – the difficulty of re-industrialisation in the 21st century

At this point we need to abstract from the various situations of each country, from their political and geopolitical entanglements (already analysed in Chapter 5) as well as from their actual economic structures – subject to great variations from one country to the other.  Our aim at this point is to address the possibilities of successfully implementing stage c (re-industrialisation and maintaining competitiveness) in the most general and abstract terms.  Therefore, the question that I will address next is: what are the available options, going forward, for an advanced economy that doesn’t want to compete in the international markets – especially not against Third World countries – by lowering wages and environmental regulations, but instead would like to compete by keeping its industry at the cutting edge of technology at least in a few key sectors?  (After this I will also address, very briefly, the question of technological catch-up for what concerns less advanced economies)

As highlighted before, any country can in theory (bar geopolitical constraints) implement stage a) creating money to restart the real economy (exiting the euro where it applies) by means of government spending, inflating wages and this way reducing the burden of the debt for the real economy; then it can proceed with point b (shrinking the financial economy and bringing it back in balance with the real one, then seeking trade agreements to rebalance trade).  All of this can and should be done but if the country in question is not able to pay for its imports, these measures will not be sustainable.  The only sustainable way to inflate the real economy, shrink the financial one and rebalance trade is to make structural changes that bring the economy up to the task of being able to produce enough desirable/sellable products to pay for its imports. 

Therefore the way forward for a hypothetical advanced country, is to build/re-build a viable economy by equipping it with a competitive industrial core, ideally positioned at the high end of the value added chain. 

Each country needs to decide the mix of productions (including services as well, but keeping in mind their lesser tradability) in which to specialise, bearing in mind that a diversified economy is more resilient.  A core of these productions needs to be in key advanced sectors that, with their potential for technological improvements, will be able to pay -with their exports- for the necessary imports and for the welfare state. Ideally all Western countries would need to phase out the current neoliberal globalisation and enact some form of protectionism that would allow them to re-onshore some key industrial sectors potentially capable of generating innovation and productivity growth and thus function as a traction engine for the rest of the economy. If Western workers don’t want to be forced to the current race to the bottom (competing by decreasing wages and environmental standards) they will have to protect their re-born industries in the more mature and low tech sectors from the competition of semi-slave labour in Third World countries, but at the same time enough productivity growth needs to be generated in high value-added, innovative sectors to pay for our imports and welfare state.  As wages grow in East Asia (they are going in this direction, as China is in the process of rebalancing its economy away from exports and towards developing internal demand and the service sector) the West could become competitive again in high tech sectors.  This would be a virtuous and sustainable way of rebalancing the world economy, as it would be a race to the top rather than a race to the bottom.  In a hypothetical ‘equilibrium’ of the system, which would be dynamic and not static (as technology keeps on changing and improving) all countries would have to rely on internal demand (and not on exports) to keep their workforce employed and would have to keep their trade balanced, at a level of prices (and technology) that would allow high wages and high standards of living.  This is not unrealistic because, before the advent of neoliberalism, this is how the capitalist system had been developing, in a progressive manner, by increasing productivity and thus making possible higher wages and more welfare.  The evolution capitalism as a result of the technological race will be analysed in depth in the next chapter, as this holds one of the major keys (along with politics and geopolitics) to understanding how our system really works.  For the moment I will address the issue of keeping up with the technological race only very briefly.

The question of how a country should equip itself with a high tech industry, is not an easy one.  As time goes by, producing cutting edge technology requires ever higher expenditures in R&D, education and infrastructure (including an innovation infrastructure, as we will see in the next chapter).  Developing cutting edge technology is very expensive nowadays because it requires pouring money into many ventures of which a good number is bound to fail.  Only a few will succeed and some of them will bring in very high revenues, of which a good chunk will have to be poured into further R&D to develop the next generation of inventions.  In other words, staying competitive is much more expensive and difficult nowadays than it was even just 50 years ago.  

These issues are analysed in depth by the economist Mariana Mazzuccato in her book ‘The Entrepreneurial State’ and part of the next chapter (the part relating to the more recent developments) will be based on it.  The book makes the case that nowadays, precisely due to the extremely high level of risk, expenditure, and long term vision necessary to keep up with the technological race, the states are by far the main players in the technological game, and it could not be any other way.  The contribution of private entrepreneurship is highly hyped up in the public discourse, but in reality most of the money, leadership and vision behind technological innovation come from the state.  This has been the case for at least over a century (the second industrial revolution at the turn of the previous century took place thanks to heavy state intervention), but since the end of WWII/beginning of the Cold War the role of the state has become absolutely crucial.  To quote directly from the book: 

‘Areas of high capital intensity, and high technological and market risk tend to be avoided by the private sector, and have required great amounts of public sector funding as well as public sector vision and leadership to get them off the ground.  The state has been behind most technological revolutions and periods of long-run growth. The state needs to engage in risk taking and in the creation of a new vision’.

The book explains the way technological innovation at the frontiers of knowledge works nowadays (and at least since the end of WWII):  the state must choose the direction of future innovations envisioning new promising fields in which to patiently start pouring money, until maybe after 20 years some concrete results start to be achieved. This is something that the Americans have been doing massively in past decades (although at the moment it seems that they are being overtaken by the Chinese – and by the Russians for what concerns military technology).  In the US this massive public support for R&D has always been hidden as part of the military budget. Quoting from the same book: 

‘The growth of the US biopharmaceutical industry was not, as is often claimed, rooted in business finance (such as venture capital), but rather emerged and was guided by government investment and spending. the knowledge economy did not spontaneously emerge from the bottom up, but was prompted by top-down stealth industrial policy; government and industry leaders simultaneously advocated government intervention to foster the development of biotechnology industry and argued hypocritically that government should ‘let the free market work’. P67-68

The high costs of technological innovation imply as well the necessity to repay them with large sale turnovers; in other words, the necessity to achieve economies of scale by capturing large enough markets.  This is easier for very large countries, everybody else will need very good political and economic management at the national level, in order to open up large potential markets.  The ability to make alliances and mutually beneficial trade agreements is in general very needed in a multi-polar world, but unfortunately good political management has become extremely rare, having been eradicated systematically by forty years of neoliberalism and seventy years of American hegemony.

For what concerns countries at lower levels of development, it is easier for them to take steps forwards, at least in theory, because they need to catch-up rather than to innovate, although in practice they face very heavy obstacles mainly of geopolitical nature. To get a general idea of the type of measures that countries at different levels of development should be taking (and what they should be avoiding), in order to move up towards advanced status, please see the last part of chapter 8 ‘Money and currencies’.

Going back to where we started from, the two issues raised by Ha-Joon Chang: 

de-industrialisation has negative effects on the balance of payments and long-term productivity growth, both of which need reckoning.

we have now analysed all the basic implications relating to the first question, the relevance of industry and technology for the balance of payments, and we have seen how managing this problem is central to managing both any national economy, and the world capitalist economy as a whole.  Not understanding this basic economic problem means not being able to understand the rise and fall of economic paradigms and, by extension, the rise and fall of countries as well as empires. Now we must address the second issue, the role of technology in producing growth.  We will see that analysing the implications of this apparently straightforward and common sensical statement, will unlock an entire world, even more so than the previous one.  We will see that technological development has been the driving force behind nothing less than the very survival (so far) of the capitalist system itself, via its mutation and evolution in a progressive manner.  Contrary to the gloomy predictions of its Marxist critics the system, which was expected to collapse under the weight of its own contradictions, on the contrary has managed to survive, precisely due to technological development (the ‘race to the top’) leading to increased profits as well as increased standards of living for the masses….until neoliberalism reversed the trend….

If you want to find out more, then go to the next chapter!

Go to Chapter 7 – The Role of Technology – Long Term Growth