Kondratieff Waves & Schumpeter’s Creative Destruction

John Luther Adams: Dark Waves

Cyclical Economies

Most people are familiar with the term “history repeats itself” in the context of the rise and fall of empires and civilizations, but many economists apply the same philosophy to modern, capitalist economies: they argue that economies all go through boom and bust cycles that can be predicted if one is astute enough to see the signs. Throughout the past 100 years a number of economists have identified and published a plethora of studies about different business cycles of varying lengths, the standard one being the three to four year cycle but a number of others have been formulated including the following: the 40 month “Kitchen Cycle;” the 9 ¼ year “Juglar Cycle;” the 18 1/3 year “Kuznets Cycle”; and the longest and perhaps most interesting of all cycles, the 54-60 year “Kondratieff Long-Wave Cycle.”

The length of the Kondratieff Long-Wave theory has made it an especially captivating idea after it was first formulated in the 1920s and 30s because it appeared to be prescient as it seemingly explained the Depression that the Western-capitalist world found itself in at the time and where those countries’ economies could end up in the future. The Kondratieff Long-Wave theory gained popularity once more in the late 1970s and early 80s, especially in Europe, as the Western world found itself once more facing many of the same economic problems it went through during the 1930s; but as the West emerged from the recession and energy shortages of the 1970s, the application of the Kondratieff Long-Wave theory to predict future economic trends took a back seat. As the world faces economic uncertainty in 2016, a reexamination of the Kondratieff Long-Wave economic theory is pertinent and may help place many of the world’s current geo-political and macroeconomic developments into their proper context.

Nikolai D. Kondratieff (1892-1938) and His “Long-Wave” Economic Theory

The eponymously named “Kondratieff Long-Wave” economic theory was the brainchild of the bright yet humble Russian economist Nikolai D. Kondratieff, who began work on his theory while he was employed as a statistician by the Soviet Union during the 1920s. Eventually, Kondratieff’s work came to the attention of the Communist Party grandees who promoted him to the head of the Institute of Economic Research in Moscow. Kondratieff became a favorite of Soviet premier Josef Stalin who used Kondratieff and his theory for propaganda purposes since it could be construed as an indictment of the inherent weakness of capitalism. With that said, Kondrateiff, like many of his fellow Soviet citizens in the 1930s, eventually fell out of favor with Stalin and was sent to a gulag where he languished for several years before he was executed by firing squad. Despite the Russian economist’s premature and tragic death, his ideas were not forgotten and in fact found many acolytes throughout the West.

Several aspects of Kondratieff’s Long-Wave theory set it apart from other cyclical economic theories, which eventually helped it gain popularity among Western economists. Essentially, Kondratieff argued that Western-capitalist economies operate on 50-60 year cycles, which he called waves, that can be clearly predicted through statistical analysis. Besides the length of the cycles that Kondratieff forwarded, his work was also much more expansive than other theories of business cycles at the time. He examined the economies of the United Kingdom, France, the United States, and Germany from the early 1800s until the 1920s through data that he culled from price levels, rates of interest, wages, foreign trade, and consumption levels of coal and pig iron. Clearly, Kondratieff’s study was monumental and one could even say epic as it encompassed such a wide geographical area and period of time. Kondratieff identified three waves and subsequent economists who follow his theories have argued that world is currently at the end of the Fourth Wave.

 

Kondratieff argued that the First Wave began in the 1780s or ‘90s and then entered its decline sometime around 1810-1817, which lasted until 1844-1851. The Second Wave then took place and began its decline from about 1870-1875 until it hit its low point in 1890-1896. The Third Wave, which was the period when Kondratieff formulated his idea, then began with its decline beginning around the time of World War I and ending during World War II. Kondratieff died before the Fourth Wave began, but subsequent economists have identified its decline beginning with the recession of the 1970s. Current adherents of the Kondratieff Long-Wave theory place the world at the end of the Fourth Wave and/or the beginning of the Fifth Wave. According to Kondratieff’s theory, specific phases can be identified in each wave.

Within each wave there are three distinct phases that determine the direction of the economy. The first phase lasts about twenty to thirty years and is characterized as the upswing, where the economy is building inertia towards its peak. The second phase is where the economy reaches its peak, but is then hit with a recession that lasts about a decade followed by a recovery and a time of prosperity that also lasts about ten years. Finally, the third phase is the absolute crash when the economy enters into approximately twenty to thirty years of depression. Just as each wave is marked by specific phases, each phase of the waves is delineated by key details.

During the first phase of each wave, years of economic prosperity tend to dominate, while economic problems tend to dominate the final phase; but good years can happen during the third phase and bad years have happened in the first phase. The second phase is noted for important technological discoveries: advances in wireless technology and the automobile made before the 1920s; and the high-tech boom of the late 1970s and early ‘80s are two notable examples. Another hallmark of the first phase is the increased value of gold and silver, which increases proportionately with prices and wages. The end of the first phase is also marked by disastrous wars: The War of 1812, the Civil War, World War I, and the Vietnam War all took place towards the end of phase one in their respective waves. As Kondratieff’s theories became more popular in the West, economists began to modify and synthesize the Long-Wave theory to fit better with other theories of economic cycles.

Joseph Schumpeter (1883-1950) and “Creative Destruction”

Among the many early adherents of Kondratieff’s philosophy, perhaps the most influential was Joseph Schumpeter. Schumpeter was an Austrian born, American economist who had a long, successful career interpreting trends in Western economies. Kondratieff’s Long-Wave theory profoundly impacted Schumpeter to the point that he worked tirelessly to effectively synthesize the Russian economist’s ideas with those of the Kitchen and Juglar cyclical theories in his two volume book, Business Cycles.

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The key component in Schumpeter’s Business Cycles was the central role that new technologies play in creating long-waves. Kondratieff also believed that technology was an important aspect of the Long-Wave theory; but he asserted that the cyclical nature of capitalist economies shaped conditions favorable to technological innovation, while Schumpeter believed that innovation was the key agent in regards to both economic growth and instability. As proof of his theory, Schumpeter pointed out that Wave 1 was the result of new technologies in Britain that exploited coal and steam power, Wave 2 was pushed forward by new railway technology, and finally Wave 3 was the result of advances in electrical power. Schumpeter further argued that an unalterable characteristic of the third phase, or down phase, of every wave was the repetitive manufacturing and creation of technologies that are not fundamentally new. For instance, throughout the Great Depression radios became ubiquitous throughout the Western world, but each new one was just a minor improvement or variation of the original. The next onslaught of technological advances that brought forth the first computers and televisions helped spur the first phase of the Fourth Wave. Since Schumpeter was a Western born and educated economist, he was not restrained by the shackles of an autocratic government the way Kondratieff was, which meant that he was free to offer investing advice based on the Long-Wave theory. He advocated investing in the upswing and divesting in the downswing of a wave; but obviously the trick is determining where in the wave the economy is. Ultimately, Schumpeter took his ideas a step further and predicted an end to modern capitalism.

After Business Cycles was published it profoundly influenced the academic and business worlds as economists and political scientists alike held the tome up as a fresh and insightful look into Western capitalism. But Schumpeter did not rest on his laurels and instead developed a new idea known as Schöpferische Zerstörung, or “Creative Destruction” in his book Capitalism, Socialism, and Democracy. Although Schumpeter was an avowed capitalist and believer in the free market system, he approached the future of capitalism in Capitalism, Socialism, and Democracy from a Marxist perspective.

Schumpeter took Karl Marx’s historical model of thesis and antithesis and applied it to the global capitalist system, as he argued that the capitalist system is constantly evolving by enveloping older and weaker technologies and systems. In terms of the modern capitalist economy, there are two notable examples that seemingly validate Schumpeter’s theory: the Polaroid camera and print newspapers. The Polaroid camera enjoyed a unique niche in the photo industry until it was obliterated by the emergence of the digital camera on the market in the early 2000s, while print newspapers are gradually being eclipsed and replaced by online news sources. According to “Creative Destruction,” capitalism will eventually destroy itself in a long, drawn-out process that Schumpeter argued would be led by the intellectual class, who although have capitalism to thank for their livelihoods, are often inherently at odds with the system. Western parliaments and congresses will increasingly adopt leftist economic policies until those countries resemble the Soviet Union more than what they were in the middle of the twentieth century. Despite Schumpeter’s pessimistic view of the future, his and Kondratieff’s theories may be able to be used as tools in regards to long-term investment.

The Long-Wave Theory as a Prognostication Tool for the Future Economic Trends

In order to determine if the Kondratieff Long-Wave theory is actually valid and can therefore be used as tool for economic forecasting, one must first determine where the economy is currently situated. An examination of current events and the status of the economy reveals that many signs point to the world currently being in the first phase of the next, Fifth Wave. Most economists who adhere to the Long-Wave theory believe that the trough or low point of the Fourth Wave as around the year 2000, which would coincide with the bursting of the tech bubble. Sharply rising prices should be expected over the next several years and a costly war, or wars, should then take place in the next ten to fifteen years. The price of gold and silver will continue to rise over the next ten to fifteen years as well. Finally, an extreme cultural shift should also take place in the next few years that will reflect that of the early 1900s “flappers” and jazz culture and the counter-culture of the late 1960s. Although the above signs seem to indicate that the economy is currently in the first phase of the Fifth Wave, other economic and cultural factors seem to suggest otherwise.

If the economy is the first phase of the Fifth Wave then wages should increase rapidly along with prices, but currently they are increasing at a much slower pace. Along with wages, unemployment and partial employment remain a problem in most Western countries. Even in countries like the United States, where the unemployment numbers are currently relatively low, government reports are often skewed as they do not take into account part-time, temporary, and self-employed workers who do not qualify for unemployment benefits. Also, no one can deny that the world today is much different than the ones in which Kondratieff or even Schumpeter lived. Neither economist took into account such variables as mass immigration, nuclear proliferation, pandemics, environmental disasters, or terrorism. Recent history has shown that all of these have the ability to affect economies and there should be no doubt that repeated and simultaneous events could bring down whole systems. The Long-Wave theory remains a theory and is faced with the difficulty of predicting one of the most unpredictable aspects of nature – the human condition. Perhaps economist Henry Prudence best summarized the utility of the Long-Wave theory when he wrote:

The Kondratieff Wave thesis is an alternate filter through which you can view the world. Its use should come in providing a framework to which unfolding events can be matched, both as a means of interpreting the events and as a method of confirmation or disconfirmation of the Wave, resulting in appropriate adjustments in subjective probabilities about the course of future trends.

In the end, the Long-Wave theory holds some definite value for long-range economic prognostication, but it should not be applied rigidly and should never be viewed as the end all of economic theory.

Bibliography

Boehm, Stephan. “The Best Horse in the Viennese Stables: Gottfried Haberler and Joseph Schumpeter. Journal of Evolutionary Economics 25 (2015): 107-115.

Dickson, David. “Technology and Cycles of Boom and Bust.” Science 219 (1983): 9333-936.

Kondratieff, Nickolas D. “The Long Waves in Economic Life.” Review of Economic Statistics 25 (1943): 203-220.

Pruden, Henry O. “The Kondratieff Wave: Has the United States Economy Entered a Long-term Downtrend?” Journal of Economic Marketing 42 (1978): 63-70.

Rosenberg, Nathan and Claudio R. Frischtak. “Long Waves and Economic Growth: A Critical Appraisal.” American Economic Review 73 (1983): 146-151.

Schumpeter, Joseph. Business Cycles. 2 Vols. New York: McGraw-Hill, 1939.

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