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Technology and Theories of Economic Development

(Neo-Schumpeterian Approach: Techno-economic Paradigms)

Structural Crises of Adjustment, Business Cycles and Investment

Behaviorby C. Freeman and C. Perez, 1988

in G. Dosi et al. (eds.), Technical Change and Economic Theory, London: Pinter, p. 38-66.

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Introduction

Schumpeterian theory of business cycles Failure of Keynesian economics with the

influence of technical change Techno-economic paradigm → accompanied

by structural crisis of adjustment Why Schumpeter’s ideas?

Slow down in the growth of the world economy Application of Keynessian policies to prevent

reoccurence of depression comparable to 1930s, but deeper reccessions of 1970s and 1980s

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Business Cycle Theory

The 1930s depression and recessions of the 1970s and 1980s Sources of cyclical fluctuations (Samuelson, 1980)

The instability of investment Characteristics of investment making fluctuations inevitable:

postponability, competitive pressures to expand capacity, uneven development in relative growth rate and capital intensity, accelerator principle (endogenous)

External factors like technological innovation, dynamic growth of population and fluctuations in business confidence

Over restrictive monetary policy, instabilities in the international economy, lack of sufficient new markets, saturation of some existing markets, uncertainties about technology, protectionism Self-regulating private market mechanism

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Keynes

Neo-classical tradition: limitations of self-regulating market mechanism

Public responsibility for the overall level of investment and employment

Impossibility of rational calculations about the future rate of return from new investment

Importance of climate of confidence and the role of animal spirit in the level of investment

Importance of technical change for investment behavior

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Keynes

Technical change and investment: uncertainty Favorable conditions like complementarities between

innovations and appropriate infrastructure favoring diffusion of new technologies and leading to further investment

Opposite effect due to diminishing returns and declining profitability may lead to sluggish investment

In early stages of radical technical innovation uncertainty prevails so that Schumpeterian entrepreneurship and Keynesian animal spirit needed

Diffusion of new technologies and resulting exceptional profits may generate rising confidence given the social and institutional framework and infrastructure favoring these developments

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Keynes

Influence of technical change on investment behavior Keynes accepts Schumpeter’s explanation of investment but also

emphasizes role of monetary policy and does not recognize the crucial role of technical innovation

Keynesian analysis lack long-term changes in technology: purely quantitative aspects of investment and employment, whereas Schumpeter stated the importance of qualitative aspects

Criticism of Keynesian theory: the relationship between technical change and business cycles Schumpeter’s long-wave theory:

Booms (as 1950s and 1960s based on the diffusion of major new techno-economic paradigms)

Depressions (periods of structural adjustment when social and institutional framework adapting to the rise of new technologies)

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Complexity of Technical Change: Generalization

Incremental innovations: Continuous Due to combination of demand pressure, socio-cultural factors,

technological opportunities No R&D activity Outcome of inventions and improvement suggested by

engineers, others engaged in production process or by users Improve efficiency in use of all factors of production Associated with the scaling-up of plant and equipment and

quality improvements to products and services Apparent in the steady growth of productivity

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Complexity of Technical Change: Generalization

Radical innovations: Discontinuous Result of delibarete R&D activity Unevenly distributed over sectors and time Important for the growth of new markets and new

investments Product, process and organizational innovation Structural change but in terms of aggregate impact

they are relatively small and localized Example: nylon, nuclear power

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Complexity of Technical Change: Generalization

Changes of “technology system”: Far-reaching changes in technology Combination of radical and incremental innovations together with

organizational and managerial innovations Example: petro-chemical innovations

Changes in “techno-economic paradigm” (technological revolutions): Influence on the entire economy Clusters of radical and incremental innovations and new

technology systems Pervasive effects both directly and indirectly Schumpeter’s long cycles as a succession of “techno-economic

paradigm”

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Characteristics of Techno-economic Paradigm

“Techno-economic paradigm develops initially within the old, showing its decisive advantages during the downswing phase of the previous cycle and becomes established as a dominant technological regime only after a crisis of structural adjustment, involving deep social and

institutional changes” A combination of interrelated product, process and organizational

innovations, embodying increase in productivity and new investment and profit opportunities

Diffusion pattern is spread from the initial industries to a much wider range of industries

A radical transformation of the prevailing engineering and managerial common sense for best productivity and most profitable practice

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Characteristics of Techno-economic Paradigm Conditions for key factors of the paradigm:

Low and rapidly falling relative cost Unlimited availability of supply over long periods (important condition of

confidence for the investment) Potential for the use or incorporation of the new key factors in many

products and processes throughout the economic system These key factors existed long before the new paradigm but

become possible if the previous key factors and technologies give strong signals of diminishing returns and limits to potential for further increases in productivity and profitable investment

Innovations as means for overcoming the specific bottlenecks of the old technologies

Differs from conceptualization of changing factor costs in neo-classical theory but similar in persistent search for least-cost combinations of factor inputs to sustain and increase profitability

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The Waves of Technological Change

Long waves or cycles Key features of dominant infrastructure Approx. timing

Kondratieff waves Science technology education and training

Transport communication

Energy systems

Universal and cheap key factors

1780s-1840s Industrial revolution: factory production for textiles

Apprenticeship, learning by doing, scientific societies

Canals, carriage roads

Water power Cotton

1840s-1890s Age of steam power and railways Professional mechanical and civil engineers, institutes of technology, mass primary education

Railways (iron), telegraph

Steam power Coal, iron

1890s-1940s Age of electricity and steel Industrial R&D labs, chemicals and electrical, national laboratories

Railways (steel), telephone

Electricity Steel

1940s-1990s Age of mass production (Fordism) of automobiles and synthetic materials

Large-scale industrial and government R&D, mass higher education

Motor highways, radio and TV, airlines

Oil Oil, plastics

1990s- Age of microelectronics and computer networks

Data networks, R&D global networks, lifetime education and training

Information highways, digital networks

Gas/oil Microelectronics

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Characteristics of Successive Long-waves Early mechanization Kondratieff

1770s &1780s to 1830s &1840s Upswing: Industrial revolution Downswing: Hard times Main carrier branches and sectors: textiles Key factor industries offering abundant supply at

descending price: cotton Other sectors growing from small base: steam engines,

machinery Organization of firms: individual entrepreneurs and small firms,

local capital and individual wealth, partnerships between financial managers and technical innovators

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Early Mechanization Kondratieff Limitations of previous paradigm: scale and process control in

domestic system, hand-operated tools and processes Solutions which new paradigm offers: mechanization and factory

organization Technological leaders: Britain, France, Belgium Newly industrializing countries: German states National regime of regulation: breakdown of privileges on trade

and competition, laissez-faire International regime of regulation: emergence of British

supremacy in trade and international finance Features of national systems of innovation: learning by doing,

local scientific and engineering societies Other sector developments: rapid expansion of trade, merchants

as source of finance

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Industrial Revolution

Adam Smith: Wealth of Nations Why British standard of living was higher than in other

European countries? The growth of national income due to agricultural productivity Manufacturing industry and trade

The division of labor in manufacturing facilitated the use of new machines and the accumulation of specialized skills

The opening of markets enabled these manufacturers to compete, to enlarge their market

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Industrial Revolution

Technical change, capital accumulation and specialized skills The embodiment of inventions in new machines through

capital investment A fundamental organizational change from a system of

cottage production of textiles to a system of factory production with political change and cultural changes

Acceleration of British industrial output, investment and trade in the last two decades of 18th century

The manufacturing industry and the transport infrastructure as well as agriculture

Social and economic changes in agriculture was one of the main factors facilitating mobility of labor and capital

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Industrial Revolution

Not balanced growth of all industries but rapid growth of a few leading sectors, the cotton industry and iron

Big increases in productivity based on system of factory (mill) production

The improvements in process technology made possible the rapidly falling prices which in turn provided competitive strength for British exports to undercut Indian and other Asian textiles

Exports of cotton textile increased The speed with which inventions became innovations The inventions were incremental improvements to existing

processes and products that were often made by workers

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Industrial Revolution

Innovations in the cotton industry was time-saving that also resulted indirectly to savings in capital, labor and land

The capital accumulation through a developed capital market, the wealthy class of landlords and family

The coal-mining regions, the new industrial textile regions, the ‘village industries’

The manufacturing interests also determined government policy, merchant and landed interests, “bourgeois”

Inventor-entrepreneurs

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Characteristics of Successive Long-waves Steam power and railway Kondratieff

1830s &1840s to 1880s & 1890s Upswing: Victorian prosperity Downswing: Great depression Main carrier branches and sectors: steam engines, railway Key factor industries offering abundant supply at

descending price: coal, transport Other sectors growing from small base: steel, electricity, gas,

heavy engineering Organization of firms: larger firms employing hundreds, limited

liability and joint stock company, small-firm competition Political economist: Ricardo, Marx

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Steam Power and Railway Kondratieff Limitations of previous paradigm: water power in terms of

inflexibility of location, scale production Solutions which new paradigm offers: steam engine and new

transport system Technological leaders: Britain, France, Belgium, Germany, USA Newly industrializing countries: Italy, Netherlands National regime of regulation: Laissez faire International regime of regulation: ‘Pax Britannica’, international

free trade, gold standard Features of national systems of innovation: growing

specialization, development of professional education Other sector developments: growth of domestic service, transport,

distribution, financial services, universal communication services

Steam Power and Railway Kondratieff The second wave of major innovations related to

revolutionary developments in transportation and the powering of the factories

The major innovation: steam power The application of steam power in factories

(flexibility in terms of choosing location) and in transportation

The new applications of steam saw the spread of industrialization to the European continent (Belgium, Germany) and the US

These countries took over part of British technologies and in many cases improved on it (steam engines in the US)

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Steam Power and Railway Kondratieff The steam power actually an innovation that

emerged during the previous long wave As steam power taking control of the economy, the

technological paradigm that was going to replace steam power, electricity was slowly being invented

The main application of electricity during the age of steam and railways was the telegraph

Together with the railways, the telegraph increased communication between different parts of the country

At the same time there were innovations laying the foundation for the chemical industry that was going to rise during the next waves

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Steam Power and Railway Kondratieff The institutional changes: the joint-stock

company and stock market Facilitated the raising of capital for the

establishment of new firms and decreased the dependence on personal capital

The type of speculative behavior by investors having high expectations of firms applying new technologies: that is the main driving force of the Schumpeter’s secondary wave

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Characteristics of Successive Long-waves Electrical and heavy engineering Kondratieff

1880s & 1890s to 1930s & 1940s Upswing: Belle époque Downswing: Great depression Main carrier branches and sectors: electrical engineering Key factor industries offering abundant supply at

descending price: steel Other sectors growing from small base: automobiles,

aluminum Organization of firms: emergence of giant firms, monopoly and

oligopoly, concentration of banking and finance capital Political economist: Marshall, Pareto

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Electrical and Heavy Engineering Kondratieff Limitations of previous paradigm: iron in terms of strength and

durability, inflexible belts Solutions which new paradigm offers: group drive for electrical

machinery, power tools, standardization in worldwide operations Technological leaders: Germany, USA, Britain, France Newly industrializing countries: Italy, Canada, Japan National regime of regulation: nationalist state, social legislation,

growth of state bureaucracy International regime of regulation: imperialism and colonization,

destabilization of international financial and trade system Features of national systems of innovation: ‘in-house’ R&D,

university scientists Other sector developments: domestic service industry,

department and chain stores, education, tourism and entertainment

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The Age of Electricity and Steel So far → Inventor- entrepreneur, invention coupling with a potential

market defined as innovation, specific innovations Leading sectors, steel and electricity, had linkages with almost all

other industries US imported much of its technology from Europe but modified and

reshaped to national circumstances British colony: transfer of innovative thinking and institutions Higher relative price of labor interacted with the resource

abundance advantage to induce substitution of capital and natural resource inputs for skilled labor

Labor-saving, capital-intensive technological trajectory of mechanization and standardized production

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The Age of Electricity and Steel Development of new production techniques in steel led to

large-scale production and usage, reduction in the costs and application in many new products

The interdependence of developments in steel and electrification

A wide range of new applications: machinery, electric furnaces, electrical transformers, generators, stainless steel, consumer goods like cans, bicycle, construction

The complementarities between innovations affecting every branch of industry and services

The applications of electrification started in 1860s but diffusion with further series of inventions in steel

The role of laboratory science in the development of electricity was important

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The Age of Electricity and Steel The electric power generation for tramways and electric railways,

communication, lightning, industrial applications in electrochemistry, wire and copper, aluminium industry, electric engines, electric phones

The new investment opportunities based on cheap steel and electric power, new infrastructure, new regulatory framework

The new flexible source of energy overcome the inflexibility of the old system (steam engine) saving energy and factory floor space

Giant firms (Germany: Siemens and AEG, US: General Electric and Westinghouse) (capitalist enterprise) and management innovation (office organization, professional manager)

The emergence of specialized R&D department in electrical and chemical firms

The Age of Electricity and Steel Why US leadership? US possessed a large and homogenous market

As the new technologies were capital intensive and displayed important scale effects, this led to production costs falling when served to a larger market

US were abundant in natural resources, including land and minerals This gave American firms an important cost advantage and

helped them to keep the prices low and hence serve a large market and reap the scale economies of the new paradigm

The liberal “American spirit” was aimed at entrepreneurship and capitalist investment and was also very much open to change and the introduction of new technologies

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The Age of Electricity and Steel Changes in the type of firms due to scale economies: the giant

management-led firm (DuPont) The rise of professional manager himself The growth by means or mergers and take-overs Taylorism: the principle of division of labor, breaking down the

production process into simple tasks, each of which could be standardized and timed (the amount of work to be optimized)

Large managerial companies were well suited to take the advantage of economies of scale (decreasing unit costs resulting from an increase in the scale of production) and scope (knowledge may be used for several product families)

The giant-management led firm causing to a shift away from the individual inventor in the technological process: introduction of R&D departments

The first R&D laboratories emerged in Germany in the chemical industry from 1870

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Characteristics of Successive Long-waves Fordist mass production Kondratieff

1930s & 1940s to 1980s & 1990s Upswing: Golden age of growth and Keynesian full employment Downswing: Crisis of structural adjustment Main carrier branches and sectors: automobiles Key factor industries offering abundant supply at

descending price: energy (oil) Other sectors growing from small base: computers, software Organization of firms: oligopolistic competition, multinational

corporations based on FDI, increasing concentration, ‘techno-structure’ in large corporations

Political economist: Keynes, Schumpeter

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Fordist Mass Production Kondratieff Limitations of previous paradigm: batch production Solutions which new paradigm offers: assembly line production

techniques, new patterns of industrial location, cheapening of mass consumption products

Technological leaders: USA, Germany, Japan Newly industrializing countries: Korea, Brazil, Mexico National regime of regulation: welfare state, high levels of state

expenditure and investment, Keynesian techniques International regime of regulation: ‘Pax Americana’, US military and

economic dominance, decolonization, Cold War, US dominating international trade and financial regime

Features of national systems of innovation: specialized R&D departments, military R&D, technology transfer through licensing

Other sector developments: decline of domestic service, self-service, researchers and financial services

Fordist Mass Production Kondratieff Reliance on scale economies and mass-

production in the US spread to Western European countries and NICs

The adoption of mass-production methods led to significant rise of labor productivity levels relative to the US: Abramovitz “catch-up boom”

The expansion of mass-production depended on application and spread of automobile (internal combustion engine) and (petro) chemical technology, again had been around for some time

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Fordist Mass Production Kondratieff Henry Ford’s Model T in 1908 Managerial capitalism Introduction of the assembly line in the production process:

a process innovation that was characteristic of the Taylorist way of producing

Breaking down the task of assembling an automobile into small parts and giving workers a standard (and small) amount of time to carry out this task

High productivity, relatively low prices of the final product led to rapid growth of the sales of the Model-T Ford

Applied in factories producing in mass volumes Disadvantage: decreased the quality of work, repetition of

tasks and mental stress resulting from the steadily moving belt

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Fordist Mass Production Kondratieff The unionization: a special mode of regulation of

labor relations based on negotiations between employers and unions

This led to increase in wage levels in the industrialized world, in turn led to increased demand for consumption goods and increased the circle of scale economies and mass-production

Fordism: the above mode of regulation in the labor relations and the general socio-economic changes associated with it

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Fordist Mass Production Kondratieff The mineral oil: automobile depended on gasoline derived from

mineral oil, ways of cracking, cracking process providing as a stimulus for the development of the synthetic materials: plastic materials

Thus oil became a main source for both energy and material input in the age of mass production

The widespread diffusion of the technological paradigm based on oil took place in the period after 2nd WW and the same holds for the process innovation, assembly line

The organizational changes: large conglomerate firms extended their activities beyond with the help of developments in air travel and telecommunications, multinational firms

New concepts: International trade and foreign direct investment (FDI)

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Characteristics of Successive Long-waves Information and communication Kondratieff

1980s & 1990s ? Upswing: Downswing: Main carrier branches and sectors: computers, software

network Key factor industries offering abundant supply at

descending price: chips (microelectronics) Other sectors growing from small base: third generation

biotechnology products, space activities Organization of firms: networks of large firms based on

computer, just-in-time production

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Information and Communication Kondratieff Limitations of previous paradigm: inflexibility of assembly line,

energy and material intensity Solutions which new paradigm offers: electronic control systems,

networking and integration of design, production and marketing Technological leaders: USA, Japan, Germany Newly industrializing countries: Brazil, Mexico, China National regime of regulation: regulation of ICT, regulation of

financial institutions and capital markets International regime of regulation: “multi-polarity”, institutions Features of national systems of innovation: computer networking

and collaborative research, factory as laboratory Other sector developments: ICT, integration of services and

manufacturing in publishing, growth of information services

Information and Communication Kondratieff

The success of the mass production paradigm broke down in the 1970s when growth rates slowed down significantly

Two oil crises The first oil shock (1973-79) The second oil shock (1979-83)

The technological opportunities for further increase in the efficiency of mass production systems were coming to an end

“productivity slowdown”

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Information and Communication Kondratieff

In the late 1980s, the productivity slowdown turned into a “productivity paradox”

A potential new technological revolution associated to computers and electronics was not yielding to an upswing: technological paradigms taking a long period to reach their full potential

The need to connect computers to each other forcing advances in the telecommunications sector

The convergence between the computer industry and the telecommunications industry led to ICTs

The ICTs reached a level of diffusion and application that gives reason to speak of a new technological revolution beginning to shape up

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Information and Communication Kondratieff The organizational changes: growing importance of

networks The early form of networking applied in Japanese firm

Toyota, “lean production” from the late 1940s The system was aimed at reducing inefficiencies in the

assembly line process Ohno’s system consisted of adding flexibility to the process

(also called flexible production) by Relying on the skills of the workers who were trained to perform a

large variety of tasks rather than a single task A large number of suppliers for specialized parts that is a model

of networking firm (consisted of long-term ties between the buying firm and its subcontractors)

The possibilities of networking between firms have been facilitated with ICTs

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Diffusion of New Techno-economic Paradigm A new paradigm emerges in a world still dominated by

an old paradigm and begins to demonstrate its comparative advantages at first only in few sectors

New paradigm not displace the old until the supply of the new key factors satisfies three conditions: falling costs, rapidly increasing supply and pervasive applications

Emerges gradually as a new type of productive organization, brings a radical shift in engineering and managerial common sense

Diffuses as rapidly as conditions allow and replaces the investment pattern of the old paradigm

Also restructuring of the whole productive system

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Diffusion of New Techno-economic Paradigm The new techno-economic paradigm involves

A new best-practice form of organization A new skill profile in the labor force A new product mix using low-cost key factor intensively New trends in radical and incremental innovation A new pattern in the location of investment A tendency for new innovator-entrepreneur-type small firms A tendency for large firms to concentrate A new pattern of consumption goods and services

The period of transition is characterized by deep structural change in the economy requiring a transformation of the institutional and social framework

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The Information Technology Paradigm Post-war boom technological regime

Low cost oil and energy intensive materials Giant oil, chemical, automobile and mass durable good

producers Continuous-flow assembly-line turning out massive quantities of

identical units Corporations In house R&D Middle range skills for labor Expansion of the marker for consumer durables Adaptation of the financial system Infrastructural network of motorways, airports Expenditure of government stimulating aggregate demand

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The Information Technology Paradigm Today:

Cheap microelectronics Developments in computers and telecommunications Energy and material intensive inflexible mass production not valid

no longer Information intensive productive organization with integrated

system Electronics and information sectors Price of getting information lower Skill profile change from the concentration on middle-range craft

and supervisory skills to increasingly high- and low range qualifications and from narrow specialization to broader multi-purpose basic skills for information handling

Diversity and flexibility Computer-based capital equipment

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Structural Crisis of the 1980s

A major upheaval in all sectors of the economy and changes in skill profile and capital stock throughout the system

Increase in instability of investment behavior Leading-edge industries: over capacity, technology changing so out

of date capital equipment Manufacturing and service sectors which still have growth potential

but need a change in their production processes, product mix, management systems and skill profiles Possibility for the world economy to experience a depression

Sources of instability that also prevailed in 1930s: the international debt situation, imbalances in international payments, weakness in agricultural prices, instability in exchange rates, absence of an adequate system of regulating international economy and lack of long-term vision in policy-making

Development of new national and international “regimes of regulation”