Riding out the storms on Kondratiev's waves

Sunday Herald, The, Jun 18, 2000 by George

Ihave on my desk a tattered old article I used to give my economics students as a handout nearly 20 years ago. Rereading it now - when I'm teaching their children - makes my thinning hair stand on end. For, with almost supernatural insight, the article correctly forecasts that the 1990s would enjoy a global economic boom sparked by a huge wave of investment in as yet undreamed of technologies. Scary? And the said article also forecasts what happens next.

To better understand what a gobsmacking prediction this was, think back to the early 1980s. The economic scene was grim. The industrial relations mayhem of the 1970s had just given way to Mrs Thatcher, but with no discernible improvement. Inflation was running at 17%, interest rates were in double digits and one-fifth of UK manufacturing capacity was heading for the dustbin. Across the Atlantic, post-Vietnam America was still drifting in the Carter doldrums.

Predicting then an impending millennial capitalist nirvana seemed, at first sight, to rival von Daniken's alien visits for respectability. But the whole point of the article was neither magic nor - its contemporary equivalent - the unveiling of a new econometric forecasting model. Rather, it was a reprise of a very old idea in economics - the Kondratiev Long Cycle of economic growth dating from the 1920s.

Nikolai Kondratiev was an obscure Soviet statistician who claimed to have detected the existence of long waves of economic expansion and contraction triggered, for the most part, by the advent of new technologies. Each wave, upswing through downswing, lasted roughly 50 years.

Using a statistical analysis of price data from the British and other economies, Kondratiev identified his first upswing as being detonated by steam power in the 1790s, and climaxing in the 1820s. This boom then turned into the downswing of slow growth and the relative economic decline of the Dickensian hungry 40s.

The second Kondratiev wave began with a mid-19th century economic recovery based on the new chemical and steel industries, peaking in the 1860s and sliding into recession as capacity outgrew markets after 1873. His third cycle began in the 1890s, sparked by the introduction of electrical power and peaking during the first world war. Writing in 1926, Kondratiev predicted the third cycle would enter recession in the 1930s. The Wall Street crash occurred in 1933.

Alas, Kondratiev himself did not live to see his predictions borne out. A former minister in Kerensky's provisional government, before the Bolsheviks seized power, he disappeared into Stalin's gulags.

But history rolled on and a fourth Kondratiev wave happened after the second world war based on motorcars and mass production techniques, peaking in the 1960s then faltering through recession in the 1970s and stasis in the 1980s. At which point I began giving students my Kondratiev handout and telling them to invest long term in IBM and wait for a fifth Kondratiev wave. I got the computers bit right, but missed Microsoft.

Before we see what happens from 2000AD onwards, we need a few caveats. Does the Long Cycle of capitalist development really exist, or was Kondratiev merely being selective about the data he chose to highlight? And if the Kondratiev waves do occur, what causes them and their uncanny periodicity?

I'm reasonably convinced that, historically, waves of investment in new technology clusters have caused periodic bursts of high growth, high productivity and high profit. It also seems to be the case that falling profit margins, investment returns and, especially, the inevitable end of bull stock markets will lead to periods of slower growth as technologies mature and investment markets get back into synchronisation.

I'm more sceptical that this cycle can be given a precise periodicity la Kondratiev. It's also the case that some downturns, the great depression, for instance, were the result of calamitous human policy errors rather than the investment cycle. For example, the ill-informed contraction of US money supply in the 1930s was wholly avoidable and the Wall Street crash could have been as much an economic hiccup as the 1987 crash.

So what will the fifth Kondratiev wave hold for us? If it sticks to its "schedule", we'll see good times continuing in the 2000s as net technology matures. We might even see another burst of capital investment in optical distribution systems that will make the recent B2C share bubble look minor league.

But then we get the lean years stretching out through the late 2010s, 2020s and 2030s. A time of slower investment growth, slower productivity growth and, therefore, slower economic growth.

So retire to a remote Highland glen, invest in Treasury bills and play with your PC till the sixth Kondratiev wave around 2040. And what will power the sixth wave? Genomics.