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“Technology cycles and technology revolutions” by Luigi Paganetto and Pasquale Lucio Scandizzo University of Rome “Tor Vergata” 1. Introduction Technological cycles have been characterized as the basis of long and continuous periods economic growth through sustained changes in total factor productivity. While this hypothesis is in part consistent with several theories of growth, the sheer magnitude and length of the economic revolutions experienced by humankind seems to indicate that a fuller explanation than those provided by these theories may be in order. As Douglas North (1981) argues, the industrial revolution has been characterized by a first phase of technological advancements, followed by organizational changes that have primarily sought to exploit the scale economies in mass production. These changes, in turn , have caused a number of transaction costs internal to the firm to arise, mainly for what concerns the measurements of the quality of inputs and outputs devised to control the increasing division of labor. The rise of the transaction costs of the assembly line have eventually determined the demise of the Fordist model and the end of the main technological cycle in the second half of the twentieth century. According to this interpretation, the main industrial revolution thus mirrored, in a broad sense, the process of the emergence of the modern firm from the market, as described by Coase (1937), i.e. a process of development of large structures of command and control to reduce transaction costs external to the firm, long hierarchical chains of division of labor and growing internal transaction costs for supervision, measurement and quality control. Technology, in this respect, had long finished its leading role when the Fordist model entered in its post-industrial crisis in the 1970’s, while the new technological cycle, based on the joint development of the personal computer and internet, although in the making, was only slowly coming on stage. The role of technology in raising total factor productivity was, of course, essential in the industrial revolution, but, to a large extent, it was determinant only to establish the conditions for a spectacular increase in high speed throughput ( North, 1981; Chandler, 1977), i.e. both in an increase in output and in a decrease in inputs per unit of time. In fact, most of the technological advances throughout the 19th and the 20th century were of the incremental variety, both in the sense that they were perfecting discoveries which had already been known for long time (as was the case of the steam engine) and in the broader sense that they were feeding into a revolutionary new form of organization of the firm and of society itself, through mechanization, automation and other forms of vertical integration of technological processes. It is interesting to reflect on some of the crucial differences between this “second economic revolution”, as North aptly calls it, and the first one, based on the discovery and expansion of agricultural activities as a systematic exploitation of domesticated forms of plants and livestock. Two things immediately come to mind: first, the role of the technology is similar, even though the intensity appears lower. Second, the technology determines a development of the frontier of agricultural land, a process that can be compared only imperfectly to the process of urbanization. For the first point, it is notable that, as in the industrial revolution, in the agricultural revolution throughput also increased dramatically, both by increasing total output per unit of time and by decreasing the amount of land and labor necessary to produce a given quantity of output. For the second point, it has to be recognized that output expansion was mostly obtained by pushing outward the frontier of cultivation at the expense of forests, pastures and other forms of native destination of the environment. Productivity increases were, of course, the very product of systematic agriculture, through cultural practices, the management of water, the application of manure and other organic fertilizer and the selection of plants and livestock to improve performance. Compared to the industrial revolution ,in fact, one has the impression that the role of technology for progress in agriculture has been and continues to be perhaps more crucial, since the organizational changes that can be achieved by lengthening the value chain are much more limited and entail higher economic and social transaction costs. It is unclear whether the third economic revolution has occurred in the 1980’s or the sudden acceleration of productivity from ITC simply corresponds to a cycle within the second economic revolution. As Table 1 shows, an alternative way to look at technological change is provided by the Kondratiev - Schumpeter (K-S) view of long term cycles spurred by “waves” of innovation. Schumpeter, in particular, claimed that the fifty to sixty years business cycles observed by Kondratieff were determined by the fact that innovations tend to appear in clusters. According with this theory, peaks of economic prosperity are caused by waves of primary and secondary investments, stimulated by innovations, and followed by secondary technological changes and further investment. The inevitable slackening of the process, once the original momentum is lost, cause equally inevitable petering out of economic growth until another cluster of innovation materializes. Whether the K-S view of the business cycle is truthfully supported by the data or is just a suggestive narrative of economic history, what appears interesting in it as well as in North’s more sweeping account of economic revolutions, is the limited degree of endogeneity recognized to progress. In both cases, in fact, endogenous growth appears to settle in during the change, but in both cases the primary motion of the change appears somewhat mysterious, not fully endogenous and not fully exogenous, be it the technological shift at the basis of the “economic revolutions” or the original cluster of innovations that are described as the prime movers of the K-S cycle. In denying at once both the K-S theory and any simple idea of endogenous change, North (1981, p.172), for example, states: “…The important point is that the Second – as indeed the First – Economic Revolution was the inflection change in the supply curve of new knowledge, rather than the clustering of a set of innovations or any of the other characteristics used to describe the Industrial Revolution”. However, we surmise that more attention should be given to the origin of major technological and economic changes, with reference to one crucial question: the role of the production and use of energy in economic development. It is our contention that answering this question may provide the missing link to explain the possible rise of the next cluster of disruptive innovations in the K-S paradigm, or, alternatively, the next inflection in the supply curve of new knowledge. Figure 1 2. Energy: Some Stylized Facts Energy as an economic good has attracted the imagination of the economists because of its importance, but also because it is a very general concept, essentially borrowed from physics, very different in its immaterial nature and overarching scope from the more menial notions of men and machines of the dismal science. These characteristics invite sweeping generalizations and the search for fundamentals much beyond the usual attempts at theorizing of consumption and production economics. Indeed, if we go through the literature on energy economics, we witness a recurrent characteristic throughout the whole history of economic thought: the desire to capture in a few stylized facts the properties of an economic good which, in its immaterial and pervasive nature, appears to be a crucial determinant of our universe. In his “Three Laws of Energy Transitions” (2007), for example, I. Bashmakov claims that energy economics may be characterized by three basic laws: the law of stable long-term energy costs to income ratio; the law of improving energy quality; and the law of growing energy productivity. According to the author, these three laws are broadly the consequence of limiting thresholds in energy purchasing power, the asymmetry of the elasticity of energy demand, and the tendency to substitute lower quality energy forms with higher quality ones. A similar, less recent, attempt, performed by Georgescu Roegen (1971) and the so called “thermoeconomists”, sought to analyze the evolution of life and biological equilibrium through the joint use of the laws of thermodynamics and the cost benefit principles. In their approach they define “exergy”, as the measure of the useful work energy of a system, and they suggest it as a measure of value. They also characterize the economic systems as networks of production, distribution and exchange, which are dissipative in terms of matter, energy and information, and ultimately problematic in terms of sustainable development, complexity, biodiversity and ecological balance. Some of the generalizations appear to be based on the idea that factor substitution is only a short run phenomenon and that it tends to obscure the fact that what is really at work is the attempt to utilize energy under a more efficient form. For example, Welsch and Ochsen (2005), using German statistics, claim that in the long-term the share of energy costs over total production costs is constant. Thus, factor substitution tends to reduce unit costs of production, but not the proportion between the cost of energy and the cost of the other factors, once their energy content has been accounted for. Figure 2. Energy Intensity 1850-2005 These constant proportions suggest that the underlying functions are homogenous, as in a Cobb Douglas production function, with energy claiming a constant share of total output. But this would imply no energy saving (or energy augmenting) technological progress over a very long time. Alternatively, we could conjecture that the physical proportion between output and input remained the same, but, unlike the famous case of Baumol’s disease, energy productivity increases are totally reflected into price increases. More specifically, denoting with Q and E , respectively the quantity of output and of energy and with P and p the corresponding prices, we can write: (1) ( P + Q dP dQ dp )p E −(p + E )( PQ) → α (1 + ε ) − (1 + µ ) = 0 dQ dE dE where α is output elasticity with respect to energy, ε output price flexibility (the inverse of elasticity), and µ the energy price flexibility. In this relationship, the only technical supply parameter is the output elasticity, while the price flexibilities depend on the market for the output and for energy. Thus, if there is an increase in productivity ( a shock in output elasticity), the price elasticity of demand for energy will have to go down, or the price elasticity of demand for output will have to increase to re-establish the equilibrium. On the other hand, if the willingness to pay for energy increases (i.e. energy price flexibility increases), an increase in productivity, or an increase in output price flexibility will be needed, if a constant value share of energy is to be maintained. We can also argue within the scheme of Baumol’s disease, since energy production is certainly a sector where productivity has increased throughout the centuries, with corresponding price declines. But energy services, including the provision of energy to industry and consumers, and transportation services have seen their prices increase more than proportionally, with corresponding increases in employment and decreases in productivity. Does this mean that supply factors are more important than demand factors, since the economy always tries to keep the value share of energy constant? We may recall that Ricardo believed that supply factors were the ultimate fundamentals of the natural price of commodities and that demand shocks or adjustments were only a source of market exchange fluctuations. According to an orthodox Ricardian interpretation, in fact, for energy, increases in production costs will determine price adjustments - ultimately high enough to bring other sources of energy into production, until exchange values and profit rates will be ultimately reduced to their natural level, even if demand doubles or trebles. Thus, impacts of demand expansion are limited to the period required for the supply to adjust. In this context, the large perspective rise in demand of energy that is going to occur in China and in India can be interpreted as a temporary phenomenon, whose function is to push up prices, bringing less productive wells back into production as well as bringing alternative energy sources wind, liquid natural gas, and coal - increasingly on line. The nature of the process of producing energy is thus changing , with a redistribution of comparative advantage in favor of countries, with large potential energy resource base. Because the main resources that can be envisaged in this respect are coal, the sun and the biomasses, countries such as China, the countries with solar power potential (Egypt, Morocco, the Emirates ecc.) and countries with large agricultural areas (Brazil, Argentina) are going to capture large benefits from trade if and when the future energy revolution materializes. But, as exporters of energy and energy services, they will also be vulnerable to price declines in the production sectors and productivity declines in the service ones. Table 1: Characteristics of renewable energy sources Viability Wind Wind energy is a proven technology. High altitude wind power has not been demonstrated yet at scale. Economics Varies by location. Depends also on transmission costs, storage opportunities, and cos of alternatives Risks/co-benefits No carbon emissions, but high oppositions from environmentalists on esthetic and cultural grounds because of impact on landscape Improvements in complementary technology like transmission and energy storage will facilitate spreading Wind energy would potentially meet all the world’s power needs. Diffusion Scale Comparative advantage Mostly countries in the continental and temperate zones Paradigm shift Locality, selfsufficiency, small scale flexibility Source: Our elaborations on Barret(2009) Solar Photovoltaic are proven. Large solar concentrated power projects are being planned. Space solar power has not yet been demonstrated. Varies by location. Concentrated solar can compete with fossil fuels in some sun rich locations at $35/tCO2 Biomasses Proven technology. Land based biomasses with storagesequestration yet undemonstrated Varies by crop and by location. At this time biomasses are economically inefficient and have higher emissions. Hope is with biotechnology and CO2 sequestration/storage. Risks associated with Negative effects on food beaming power by prices and availability. lasers or microwaves. Risks of solar or satellites being attacked Depends complementary technologies. on Depends on new biotech products Available solar energy Energy from biomasses exceeds the world’s would potentially meet total power needs more than 50% of world’s power needs Mostly countries in Mostly countries with the tropical areas large land base for field crops and fast track deciduous trees Locality and Extracting primary modularity energy through cultivation and plant selection As Table 1 shows, renewable energy sources appear to hold the promise of the most momentous changes in triggering a new technology revolution. This would happen both because the development of these sources has a potential for rapid diffusion that goes beyond any other available technology and can be triggered at prices very close to the ones prevailing at this time. Their diffusion, furthermore, has all the numbers to cause the famous “paradigm shift” identified by Kuhn (1961 ). As the last row of Table 1 demonstrates, the paradigm shift mostly consists in a major change of scale and scope of energy production. In the case of wind and solar technology, this change has mainly to do with exploiting geographical diversification, modularity and networking. In the case of biomass, a basic re-orientation of agriculture and forestry would ensue, re-directing a significant part of these sectors activities to extract energy that can be directly used by mechanical and chemical systems, rather than by biological ones. 3. The Challenge and the Options of Climate Change Climate change dramatizes the energy issue. In fact, as explained by a recent literature (see, for example, the Spring 2009 issue of Economic Perspectives), for many aspects the two issues have become identical. Stabilizing climate change at 2°c implies stabilizing carbon emissions and both objectives depend critically on energy technology and the mix of energy sources along the technological path. Because global warming may induce irreversible changes in the environment, but also mitigating policies may be entail technological trajectories that cannot be easily reversed, modeling of irreversibilities and the associated option values and action/inaction thresholds have dominated one part of the literature on climate change. Papers of this sort include Fisher and Narain (2002), Gollier et al. (2000), Kolstad (1996a, b), Pindyck (2000), Ulph and Ulph (1997), and several others. The main notions in these models concerns the so called irreversible abatement capital (IAC), which embodies the idea of costly irrecoverable investment in both equipment and new technology as opposed to irreversible damage that inaction may cause because of climate change and the associated environmental degradation. In Kolstad’s model, these countervailing factors are embodied in two option values that act in opposition: the option to wait and learn before costs are sunk into IAC and the option to act to avoid that GHG accumulation may result into irreversible changes in climate and the environment. Both options suggest the need to commit resources to new technologies for mitigation and adaptation purposes beyond a point of no return. On one hand, in fact, while mitigation may be more firmly related to new technologies, to the extent that adaptation requires costly and irreversible investment (e.g. migration, relocation of economic activities, commitment to research to adapt rather than to innovate), an option to wait and learn arises. On the other hand, delaying adaptation may result in irreversible damages or may cause a loss of the option to effectively adapt. Ulph and Ulph and Kolstad give sufficient conditions under which the preservation of the existing climate regime offers alternative options to wait or to act. In the result obtained by Epstein and others, an inequality involving the third derivative of the utility function determines whether climate change may be associated with a threshold of action that cannot be ignored . The intuition is that the third derivative is associated with a propensity to increase savings as uncertainty increases, an attitude that receives the name of “prudence” in the literature. Thus, a sufficiently high degree of prudence implies that decision makers associate a positive value to commit resources in order to preserve the possibility of future action. This might be irreversibly lost otherwise. In the case of adaptation, a similar argument can be made, since prudence implies that investment may be made to preserve the option to adapt, which may be irreversibly lost if timely steps are not taken to adjust to climate changes. Fisher and Narain note that the consequences of irreversibility of abatement investment depend on whether one defines irreversibility as the durability of capital, or its “non shiftability” to other uses, in the sense of earlier growth theory ( Arrow and Kurz, 1970). The latter case seems to be particularly important for adaptation, in the sense that countervailing real options to “wait and learn” or “to act and learn” would emerge more strongly where projects would commit resources to adapt to climate change, through new technologies, relocation, reuse or other forms of specialized adaptations. In these cases, committing substantial “non shiftable” resources would be determinant in the direction and the momentum of the technological path eventually chosen. Pindyck elaborates on the same theme by using a multi-period stochastic optimal growth model. While he can only provide numerical solutions, his comments are clear: “I have focused largely on a one-time policy adoption to reduce emissions of a pollutant. If the policy imposes sunk costs on society, and if it can be delayed, there is an opportunity cost of adopting the policy now rather than waiting for more information. This is analogous to the incentive to wait that arises with irreversible investment decisions. In the case of environmental policy, however, this opportunity cost must be balanced against the opportunity “benefit” of early action – a reduced stock of pollutant that might decay only slowly, imposing irreversible costs on society. In the simple models presented in this paper, an increase in uncertainty, whether over future costs and benefits of reduced emissions, or over the evolution of the stock of pollutant, leads to a higher threshold for policy adoption. This is because policy adoption involves a sunk cost associated with a discrete reduction in the entire trajectory of future emissions, whereas inaction over any small time interval only involves continued emissions over that interval. The validity of this result depends on the extent to which environmental policy is indeed irreversible, in the sense of involving commitments to future flows of sunk costs”. An implication of this result is that it holds also for adaptation policies that require a longer term, irreversible commitment to a certain course of action, since the payoff for waiting before engaging in such a binding commitment would tend to be greater than the payoff from immediate action. Flexible adaptation policies, on the other hand, would not suffer from a similar handicap, as compared to small postponements and would tend to be acceptable on the basis of a simple trade off with the wait and learn alternative. Project design thus again becomes crucial, in that adequate flexibility options are required to overcome the weight of the deferment option, when there is uncertainty and new information unfolding over time. Gollier et al. (2000) use the idea of the “precautionary principle” to sketch out a general approach to a strategy of action toward climate change. They quote the 1992 Rio Declaration (Article 15) as a statement of this: “where there are threats of serious and irreversible damage, lack of full scientific certainty shall not be used as a reason for postponing cost-effective measures to prevent environmental degradation”. Their interpretation of this principle is that it arises from the two contrasting effects of a “wait-learn-and-act prevention policy as opposed to an act-learn-and –act one in presence of information that becomes available over time. Applying the first policy reduces the risk of engaging in more costly investment than it would be necessary, but increases the risk of doing insufficient prevention and suffer more in the future. Engaging in the second policy, on the other hand, reduces future risks but may generate higher costs in the short run. The balancing of these two policies, according to the authors, depend on the shape of the utility function and, in particular, on its third derivative. On the pure adaptation front, Smith and Lenhart (1996) and Smith(1997) confront the problem of evaluating anticipatory adaptation policies using implementability and net benefits as basis for evaluation. Tol et al(1999), on the other hand, take a disaster management point of view and suggest economic viability, public acceptance, environmental sustainability and behavioral flexibility as evaluative criteria. These approaches (see also Klein and Tol (1997), UNEP, 1998) appear to advocate the use of multicriteria methods, as in the analysis of environmental impacts, even though they describe several evaluation methods . 4 Conclusions: Is a new technological revolution in the making? Two unexpected characteristics of technology revolutions appear to be, according to several influential authors ( North, Kuhn and Foucault are three outstanding examples) that (i) they do not depend on technological discoveries, however important and, (ii) that they require momentous changes in beliefs, social behavior and models of thinking. North (1984), for example, claims that most of the technology of the industrial revolution in the 1800’s had been available since the previous century, but the revolution came about only when the stock of knowledge and the organization of society together were ready to utilize the innovations to foster institutional change. Kuhn’s (1962) paradigm shifts determine a scientific revolution by changing the entire model of interpretation of the world, thereby making the single advancements in science a byproduct of more momentous changes in the relationship between knowledge and the social setting (the wissensociologie) and in the vision of reality (the weltanschauung). According to Foucault, on the other hand, as Andrew Feenberg (1991) suggests, power/knowledge is a web of social forces and tensions in which everyone is caught as both subject and object. This web is constructed around techniques, some of them materialized in machines, architecture, or other devices, others embodied in standardized forms of behavior that do not so much coerce and suppress the individuals as guide them toward more productive use of their bodies. Thus, technological innovations do not determine social changes, but a pool of new technologies is always available when society is mature for it. More generally, Schumpeter suggested that innovations tend to occur in clusters, as a consequence of positive externalities, the spill over of knowledge, the rise of general purpose technologies and the growth of information and communication networks. Paradigm changes can thus be expected and are as much the effect of the clusters of innovations as the causes of it. In what has been called “the Schumpeterian renaissance”, a critical mass of innovations and the ensuing momentous changes in the economic, cultural and scientific environment can be seen as the engine of endogenous growth. Are we near an energy technological revolution? Two elements that seem to point in this direction are the rising scarcity of fossil fuels and the increasing damage that their use is making to the planet. Climate change has made the small miracle of concentrating the attention of scientists and politicians on a single parameter: the price of carbon, whose opportunity cost is roughly $200 per ton in terms of abatement and only about $43 in terms of carbon market trading. Given that we need an energy revolution both to foster economic growth and save the planet, it seems reasonable to argue that rising the carbon price to its full opportunity cost would be a powerful instrument to move in the right direction. A sufficiently high increase in carbon prices would thus push the world economy to the range of adoption of a cluster of technologies that are already available and could, by their critical mass, determine a paradigm shift. Yet, there are several elements of ambiguity that render problematic both the prediction of an energy led technology revolution and the prescription of a higher carbon price. First, is society really ready to accept much higher energy prices in order to save the environment? Valuation studies seem to suggest otherwise, as people consistently show willingness to pay for the environment at less than 1% of their income (Pearce and Moran, 1994). Second, the social cost of climate change is highly uncertain. A meta-analysis of 232 published estimates (Tol, 2009) shows a marginal cost of carbon of $105 per ton of carbon, but a model estimate of only $13/tC, with an estimate at the 99th percentile of $1500/tC. These large differences in part depend on the different social rates of return used in these studies, but is also a reflection of a basic disagreement on how to account for the fact that future generations are being affected by decisions taken today. Also, black swan meteorological events, even though becoming more likely with climate change, remain elusive in that their probability remains low beyond the threshold of appreciation. Table 2: Impact of a carbon price increase on renewable energy sources Wind Minor increase Wind energy would become more attractive and would (from $40 to $80 ) spread further in many locations. Investment in energy storage and high altitude wind power would increase Moderate Network and storage projects. Selected high Increase (from $80 to altitude wind power projects would go over $100) threshold of economic convenience. High Increase (from Network and storage $100 to $200) financing would become acceptable. High altitude projects enhanced. Solar Photovoltaic projects and large solar concentrated power projects would be boosted. Space solar power projects would enter active experimentation. Biomasses No major effect on current biomass programs. R&D in Storage- sequestration projects. Varies by location. Threshold of economic convenience with respect to fossil fuels alternatives would be crossed. Fully economically convenient without subsidies. Satellite systems and space projects adopted. No major effect unless C=2 emission solved through storage – sequestration projects Major investment in biotech, and storage and sequestration projects. Major effects on transport. Source: Our elaborations Second, it is not clear how to “lock in” any series of policy changes into an irreversible collective choice that would give the private agents the incentives needed to commit long term resources to low carbon research and technology. Before entering the “virtuous circle” of an energy revolution, it thus seems that we have to solve the problem of breaking the “vicious circle” of time inconsistency of public policies and its associated lack of credibility. In this regard, the situation is made more difficult by the fact that there is an open question on the decline in the growth rate fostered by climate change. Would it be just a temporary inflection in the growth curve of the world economy or should we just accept it as a permanent fall in our standards of living and try to adapt downward? Also, would it mainly weigh on the low income countries, posing additional problems of distribution and unfair burden on the poor? Third, long term effects (beyond 2100) have not been estimated or even considered and they would depend, more than short term effects, on the policies implemented, their size, their timeliness and their appropriateness. But the amount of research brought to bear on these issues is minimal, and, as a consequence, the degree of uncertainty on how to proceed is huge. The energy revolution is being advocated on the basis of irreversible impending damage to the environment, rather than, as before, because of depletion of fossil fuel deposits. While this may make the argument more dignified, it does not necessarily make it more convincing. Beyond these doubts there is the reality of many technologies that appear ready to be used, offer high potential for growth and are already being implemented on a relatively large scale. These technologies are themselves rapidly changing and offer high hopes for second or third generation products that could be truly revolutionary. The dynamics of demand and the structure of comparative advantage also appear to be affected in a potentially dramatic way, but only time will tell whether the revolution is already among us or is yet to come. References Bashmakov I. 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