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An Explanation of Economic Change and Development

Fusari, Angelo (2014): An Explanation of Economic Change and Development.

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Abstract

The contribution to the explanation of economic change that this paper sets out is centered on a core of interconnected endogenous variables, mainly innovation, radical uncertainty and entrepreneurship, which current economic analyses consider only in part and separately, sometimes as endogenous but for the most as exogenous. The article (and the formalized model) suppose that the functioning of the economy is not disturbed by the operation of pathological factors mainly concerning public sector, as largely happens in current time, for instance: excessive public debt and public deficit; great inefficiencies and wastes in public sector and administration, and hence high taxation; inefficiencies, slowness and arbitrariness of judicial power; diffused organized criminality; financial capital operating, mainly at the international level, as master instead of servant of production, that is, largely devoted to speculation. A proper and efficient operation of the economy needs that those anomalies are absent. We attempt to explain economic change and development with regard to modern dynamic economies where the above pathologies have been removed. This supposition would be strengthened by the reduction of the model to only ‘necessary’ variables, as devised in sub-section 3.1.2 The theoretical frame of the proposed explanation is a dynamic competitive process: that is, a competition based not merely on prices but also put into action by entrepreneurs’ search for opportunities of profit attached to successful innovations, which generate profits through temporary monopolies and also engender disequilibria and radical uncertainty that will provide additional opportunities of profit. This dynamic competitive process is a great agent of economic change and evolutionary motion. As a first stage approximation, it can be thought of as a combination of Schumpeterian innovative entrepreneurship and action with the neo-Austrian market process and entrepreneurship: a combination describing the advent of innovations and the subsequent adaptive push enacted by the imitative diffusion of innovations and the search for other opportunities of profit allowed by rising disequilibria and uncertainty; a push that leads towards the reduction of the inconsistencies and radical uncertainty caused by innovation and (hence) towards a reorganization and re-equilibration of the economy on new structural bases. The understanding of the process of change and development is greatly obscured by the current separation of the two theoretical perspectives above. But it must be added that the explanation of such processes requires more than the simple combination of the two perspectives. In particular, it is essential that the notion of radical uncertainty – of which the Schumpeterian theory of economic development gives no explicit importance – is deepened. For its part, the neo-Austrian analysis of the market process, while attributing a great importance to radical uncertainty, thinks of it simply as a fog, an exogenous variable. We shall see that the explanation and measurement of radical uncertainty is a crucial – albeit very controversial and delicate – element of the understanding of the process of economic change and development. Moreover, we shall underline that the two theoretical perspectives (Schumpeterian and neo-Austrian) lack an adequate explanatory analysis of both the main agent of the whole process, that is, entrepreneurship (mainly its availability) and innovations. 1 It must be underlined that the notion of profit relevant with regard to the envisaged dynamic competition process does not include interest on the employed capital; it concerns only true profits, the so-called extra-profits resulting from entrepreneurial gains from successful innovations and the profit opportunities attached to the consequent disequilibria and uncertain perspectives. The ratio between those profits and the capital employed, expressed as the profit rate, is relevant mainly in that it is the only reliable indicator of the degree of success of an entrepreneur’s decision making, primarily in introducing innovations and meeting disequilibria and uncertainty. However, here we are not interested in the distribution of profits, that is, whether profit takes on a capitalist nature or is yielded by public or self-managed firms, etc. Such distributive characteristics express simply a choice of civilization, which is incidental to the mere question of economic change and development. Our model is not limited to the explanation of the core variables (that is, various kinds of innovation, such as radical and incremental process innovations and innovations of product, the demand and supply of entrepreneurship, and radical uncertainty) crucial in the representation of the whole process of change and the inherent disequilibrating and re-equilibrating evolutionary motion. The specified model also includes (and explains) other important variables such as output, employment, investment, prices, and wages. It refers to the maximum level of sectoral disaggregation, a sector for each specific good, and describes long waves. A specification with a restricted number of sectors is used for simulations. The structure of the paper is as follows: Section 1 concerns the introduction, while a second section is dedicated to a literary presentation of the theoretical construction, concerned mainly with the main variables enacting dynamic competition (entrepreneurship, radical uncertainty, innovation, profit) and long waves. A third section presents the formal specification of the model. This section is divided into five blocks. Block 1 concerns the explanation of radical process innovations and the advent of new products (that occur as soon as their explanatory functions reach some specified trigger values) and incremental innovations, while some Gamma distributions describe the diffusion of the radical process innovations across the economy, that is, the adaptive process following the innovative breakthroughs. Block 2 includes the equations explaining uncertainty, the availability of entrepreneurship, its demand and hence the excess of entrepreneurial skills. Block 3, which includes the equations of prices, wages and profits, has a conventional content, with the exception of some explanations of mark up and the definition of the rate of true profit, which excludes interests on capital. Block 4 concerns consumption and, in particular, the diffusion of new goods. Block 5 concerns capital and investment. A fourth section presents three simulations of the model that suppose different degrees of intensity of dynamic competition. A final section exposes some reference to a previous micro-specification of the model at the level of the firm. 2.

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