1-Page Summary

A technological revolution is a cluster of new technologies, products, and industries causing an upheaval in the economy and propelling a long-term surge in development.

The five technological revolutions of the past 2 centuries, with their approximate start date:

Progress does not happen linearly and constantly. Instead, technological revolutions happen in predictable cycles, spanning ~50 years:

technological-revolutions-phase.png

Much is said about the evils of finance in propping up bubbles and profiting from technology. Instead, financial capital is crucial in the installation and deployment of new technology.

Society shapes the development of the revolution, through initial inertia from the previous revolution, then mass acceptance and diffusion of the new revolution.

Understanding this framework can help you counter erroneous common wisdom at different phases.

Technological Revolutions

A technological revolution is a cluster of new technologies, products, and industries that causes an upheaval in the economy and propels a long-term surge in development.

These technological breakthroughs spread far beyond the industries and sectors from which they originated - they cause broad jumps in productivity for a broad span of economic activities. Economically, the technology brings a shift in price structure (often by making things significantly cheaper) that guides economic agents toward use of the new technologies. Hence Carlota Perez calls these “techno-economic paradigms.”

Even further, the technological revolution penetrates social practice, legislation, governance, and ideology. It becomes the general and shared “common sense” of the period, a new way of doing things that approaches something like the ‘ideals’ of the period. It creates new mental maps of all social actors and institutions.

There have been 5 technological revolutions in the past 2 centuries. We’ll give an overview, then dive further into how each one fits the above model:

Revolution Core country Big-bang event Year
Industrial Revolution Britain Arkwright’s mill in Cromford 1771
Steam and Railways Britain ‘Rocket’ steam engine for Liverpool-Manchester railway 1829
Steel, Electricity, and Heavy Engineering USA and Germany Carnegie Bessemer steel plant in Pittsburgh 1875
Oil, Automobile, and Mass Production USA (and Germany) First Model-T out of Ford plant in Detroit 1908
Information and Telecommunications USA Intel microprocessor announced in Santa Clara, CA 1971

Properties of Technological Revolutions

The innovations that create the technological revolution gestate for some time before they make their huge impact. But a revolution needs a highly visible attractor to appear, symbolizing the new potential and sparking the imagination of pioneers. Often the attractor is not only a technological breakthrough, it is also cheap or opens new cost-competitive possibilities for industry. Perez calls this a big-bang. Often, these events can only be identified in hindsight, since at the time they’re obvious only to a narrow community.

Geographically, the revolution often gestates in a particular region, and propagates from core to periphery. This means the time that the new technology is deployed is not the same for all countries and can be delayed by decades. Globally, the full revolution may take a full century.

The new technologies prompting revolutions are not isolated; often many products had existed for some time playing minor roles, until the new technology offers it unprecedented value and scale. Oil and automobiles had both been developed since the 1880s, but the combination of them with mass production in the 1900s led to a revolution in affordable automobiles for the general public. Likewise, transistors and semiconductors were available in the 1950s, but the microprocessor made visible the potential of cheap microelectronics, the “computer on a chip.”

Each revolution consists of several technology systems that develop at different rhythms and in a sequence depending on feedback loops. The information revolution began with chips and hardware, leading to software and telecom, leading to the Internet, leading to mobile. Each of these can appear as separate revolutions rather than interdependent systems under a wider umbrella - each smaller system benefits from the previous mini-revolution, while also reinforcing the overall paradigm to which it belongs.

Revolutions often involve significant changes in direction, uninstalling what was previously installed, unlearning much of the old to learn the new, closing dead end paths as others are jumping onto new bandwagons. Thus, often the radical innovations come from outsiders who have not been imbued with the previous paradigm.

The nature of the paradigm can favor certain comparative advantages unique to a society or nation. The fourth revolution of mass production favored large homogeneous populations, thus favoring the USA and the Soviet Union over more heterogeneous populations like Europe.

The Role of Society in Technological Revolutions

Society shapes technological revolutions by cycling between inertia and desire for growth.

At first, society feels inertia. Each revolution is initially received as a threat to the established way of doing things in firms, institutions, and society - which have all optimized for the previous revolution. The new economy implies job losses, geographic displacement, and unaddressed regulatory challenges. The unfolding of the new revolution’s potential thus begins chaotically, causing a mismatch between the economy and socio-institutional systems.

As the technological revolution spreads through society, frictions mount. Political pressure begins calling for action to propel the required institutional changes to accommodate the new revolution. Often the most persuasive event to induce changes in regulation is the financial collapse of the bubble of “irrational exuberance.” This spurs adaptations in government, education, and social behaviors, until the revolution becomes the “new common sense.” Only when the revolution has this proper context in society can the “golden age” of growth proceed.

As the revolution becomes the new prevailing paradigm, it favors compatible innovations and it excludes incompatible innovations. An innovation that fits in the natural trajectory of the prevailing paradigm is readily accepted by society, allowing progress. In contrast, incompatible innovations may be rejected by investors or consumers, and are instead adapted in a minor way to the current paradigm, even though they may very well be the focal point of the next technological revolution.

As the revolution matures, technological innovation shows decreasing returns and markets become saturated. Growth and profits are threatened. Social unrest reoccurs when the growth that was promised earlier in the revolution does not materialize. This is the point of greatest reception to radical innovations, and firms experiment with new technologies to revitalize themselves. Promising innovations attract idle capital, and the big-bang event kicks off a flywheel effect of capital and labor that leads to the next revolution cycle.

Thus, Carlota Perez maintains that society shapes innovation to occur in these predictable revolutionary cycles, providing both a propelling and dampening force at different phases.

When there is inertia in one sphere of change, unrest in another exercises enough pressure to induce changes. When there is inertia in technology, unrest in the financial sphere (from declining profits) and social sphere (from wealth inequality) prompts looking for radical technology innovations. Likewise, unrest in technology forces past the inertia in the social sphere.

The Five Revolutions of the Past 250 Years

In Technological Revolutions, Carlota Perez outlines five revolutions that each upended the economy. We’ll summarize the new technologies that appeared, the infrastructures enabling the revolution, and new principles that became common wisdom.

Industrial Revolution - 1771

New technologies and industries

New or redefined infrastructures

“Common-sense” innovation principles

Steam and Railways - 1829

New technologies and industries

New or redefined infrastructures

“Common-sense” innovation principles

Steel, Electricity, and Heavy Engineering - 1875

New technologies and industries

New or redefined infrastructures

“Common-sense” innovation principles

Oil, Automobile, and Mass Production - 1908

New technologies and industries

New or redefined infrastructures

“Common-sense” innovation principles

Age of Information and Telecommunications - 1971

New technologies and industries

New or redefined infrastructures

“Common-sense” innovation principles

(Shortform note: the transition between the previous technological revolution of mass production and the current one of information technology may be the most familiar to readers, so it’s worth elaborating on this.

A key point of the book is that the technological revolution not only shapes the economy but also social mindsets. In this case, information technology allowed distribution at zero marginal cost, which allowed for the proliferation of niches and emphasis on diversity.

In the past, distribution used to cost a lot of money - newspapers had to be printed, retail stores needed rent. Thus producers benefited from large economies of scale, encouraging homogenization of consumption.

The internet made distribution nearly free, reduced startup costs, and enabled discoverability. Thus niches could thrive without needing mass economies of scale. In turn, this developed into a general social acceptance of diversity and individuality. And thus technology shapes society.)

The Four Phases of Each Technological Revolution

At a high level, the four phases of each revolution look as follows:

technological-revolutions-phase.png

In the next chapters, we’ll dig further into each phase, covering the technological, social, and financial aspects.

Financial Capital vs Production Capital

In Technological Revolutions, when Carlota Perez uses the term “capital,” she refers not to the actual capital (money), but rather to the agents and their motives in wealth creation.

Financial capital represents the agents who possess wealth in the form of money or relatively liquid assets. Their objective is to make money from money, and they perform actions that are most likely to increase their wealth. Financial capital reallocates and redistributes wealth.

Production capital represents the agents who generate new wealth by producing goods or services. These agents do this with borrowed money from financial capital and share the generated wealth. Their desire is to accumulate greater profit-making capacity by innovating, growing, and expanding.

As we’ll see, both financial capital and production capital have critical roles to play in the arc of each revolution.

Financial capital and production capital are different by nature:

Phase 0: Maturity of the Last Revolution

It helps to start from the end of the previous revolution, which offers the gestational environment for new innovation.

At the dawn of the new revolution, the previous revolution has played out.

However, the previous revolution approaches the exhaustion of profitable opportunities.

Phase 1: Irruption

(Shortform note: irruption is defined as “a forcible and violent rushing in,” as opposed to eruption, which a rushing outward. This reflects Schumpeter’s notion of creative destruction, where the economic structure is revolutionized from within, destroying the old while creating the new.)

The big-bang event offers a visible attractor for investment, sparking the imagination of engineers and entrepreneurs. This technological breakthrough offers new cost-competitive possibilities in a sluggish landscape. This is a 0 → 1 event.

New products and technologies arise that show future potential.

The powerful firms from the previous revolution will use the innovation as a new lease on life and become testbeds for the new technology.

But many innovators are likely to come from outside the prevailing paradigm. They do not hold onto the past and so can explore unfettered.

The new revolution looks to have far higher profit-making potential than the prevailing paradigm. And so financial capital develops a heated love affair with the emerging production capital.

Financial capital thus enables and spreads the revolution.

Social Tensions in Irruption

The prevailing paradigm is still wedded to the previous revolution. Thus, tensions arise between:

Unemployment is high, from sources like stagnation and technological replacement.

Perverse price behavior is seen, leading to both deflation in the 1870-80s and inflation in the 1970-80s, depending on the institutional framework.

Phase 2: Frenzy

The new paradigm becomes a significant force, overcoming resistance of the old paradigm.

Intense technological exploration occurs. New markets are created and old industries are rejuvenated.

The infrastructure begins to be laid out: suppliers, distribution channels, skilled labor, cultural adaptation. (This infrastructure is critical for the later Deployment phase.)

Financial Capital Becomes Exuberant

Financial capital takes over. Convinced it can thrive on its own, enthralled by its new magic rules for inventing a new sort of economy, it separates from production capital.

Financial capital becomes inebriated with the high levels of profit in the new industries and expects the same from all investments.

Financial capital is convinced it’s discovered a recipe for generating profits, which is then repeated over and over, without concern for fundamentals.

Investment firms take center stage, even outperforming the production capital stars of the boom.

Finance diverts from wealth creation to finding whatever objects of speculation are at hand. This includes real estate, gold, art, etc.

Production capital has no choice but to adapt to the new rules. New and old producing firms must bend their decisions to provide the high short-term gains demanded by investors.

Because of limited diffusion to the broader market, the real opportunities are relatively few, so financial capital develops sophisticated, speculative instruments to make money out of money. Derivatives, junk bonds, and other instruments bring in capital from wider sources, making “everyone an investor.”

A phase of frantic investment occurs, usually typified by a stock market boom. This is a period of speculation and unashamed love of wealth. Individualism reigns.

Financial capital thus generates a magnet to attract investment into the new revolution.

A Growing Gap Between Paper Value and Real Value

The gap between paper values and real values widen. This is a structurally unstable acceleration of diffusion of the paradigm. Notions of the real value of anything are lost.

As assets increase in price, confidence grows that they will continue to do so. Excitement and feeling of prosperity are the overriding emotions. This is the new world, promising unending bliss. (Shortform note: the disappointment of the previous revolution’s Maturity phase probably stokes this further. “This is my chance to reverse the last many years of stagnation.”)

New and old firms come to the gambling house to play the capital gains game, without fulfilling strict profitability criteria.

New millionaires appear. They want to multiply their wealth at the same rate as which they made it, and so they redeploy idle capital with high pressure to generate profits.

Since profits are amazing (at least on paper), everybody - “including widows and orphans” - becomes aware of incredible possibilities. They enter the financial markets, a foreign territory to them, to get a piece of action.

Fundamentals are irrelevant in this new technological age, when the future is unknown and possibilities endless. So strange business plans are readily accepted. “Who really knows what’s possible? It’s a time to place bets.”

The newly rich have the hubris to believe it’s their own superior insight and intuition that led to growth, not the circumstances of the period.

Participants refuse to recognize the delusion that the bubble might be inflated. (Shortform note: a few psychological effects could be at play here:

The old economy still exists and is relatively stable, while the new technology is becoming rapidly cheaper. Therefore, there are really “two moneys” at work here with rapidly changing relative values, making proper valuation of companies difficult.

The increase in the volume of transactions and number of actors involved attracts even more money and more actors into the game. These are self-reinforcing virtuous cycle effects.

Possible indicators of irrational exuberance:

Social Tensions in Frency

Ethics soften. The regulatory framework is impotent to govern the new technology (for which there is little legal precedent), and is even seen as hindering the way to a successful society.

To avoid harmful price competition, the new firms move toward oligopoly/cartel-type agreements.

Income distribution becomes polarized, as modern firms and regions accelerate past the sluggish incumbents.

Supply of the new technology outstrips demand. Income concentration at the upper end becomes an obstacle for mass adoption and full economies of scale. Excess money is poured into furthering the technological revolution, including its infrastructure.

The leading countries that feel threatened by free competition often take protectionist measures.

Through all this, financial capital is unwittingly attracting the funds necessary to install basic infrastructure and facilitating social learning, paving the way for the full unfolding of the revolution during Deployment.

Break: Turning Point

The irrationally exuberant bubble bursts, causing a recession and social unrest. This is the trigger for regulatory and institutional change to adapt to the new revolution.

Three tensions make the Frenzy impossible to sustain indefinitely, bringing on the recession:

Financial Capital is Humbled

Paper values are brought back in line with real values.

Humbled by the evaporation of paper gains and pressured by the victims of semi-fraudulent practices, financial capital is more willing to accept regulatory safeguards.

The significant failure of the bubble bursting is necessary for a regulatory change. Without these seismic shifts, financial capital would never abide by regulation.

The power shifts from financial capital to production capital.

In Frenzy, financial capital separated from production capital and took on a life of its own. In the Turning Point, financial capital and production capital recouple. This recoupling is necessary for deployment and ushering in a golden age of more harmonious growth. Prior to this, too much tension exists to fully reap the fruits of the new growth potential.

The Tone Shifts to Long-Term Growth and Diffusion

Institutions are set up to encourage diffusion of the new paradigm.

The social values pendulum swings from individualism in Frenzy to collective well-being in Deployment.

Institutional choices will shape the next two phases. With one set of choices, social cohesiveness, social safety nets, and income redistribution can happen - with another set of choices, selfish prosperity will continue.

Phase 3: Synergy

Using the infrastructure developed in Frenzy and the regulatory safeguards in Turning Point, the technological revolution diffuses across the whole economy. A “good feeling” sets in with increasing coherence. Business is satisfied about its positive social role. Technology, and even finance, is seen as a positive force.

Financial Capital and Production Capital Recouple

Production capital is now recognized as the wealth-creating agent, with financial capital as the facilitator.

Production Capital

For entrepreneurs and people working in the new revolution, the path to success has been successfully signaled. People can join the bandwagon with lower risk. 1 → n growth occurs.

The new firms from the installation period are now giants.

Financial Capital

Financial capital serves to facilitate production capital, less exuberant than in Frenzy but more stable and still profitable.

Financial capital creates instruments of credit that facilitate the new paradigm.

Paper values and real values are more closely aligned, so growth and dividends are more real than in Frenzy.

Perez argues this may be the only period when aggregate statistics are reliable, since the economy is in relative harmony (and not with stark differentiation between old and new sectors, as in Irruption).

The Paradigm Diffuses throughout Society

Feedback effects reinforce growth. The raw labor and supplies are readily available, distribution networks are in place, new products are intercompatible, social acceptance increases, cost of inputs and infrastructure is reduced - all driving a flywheel effect for diffusion.

Institutional enablers like regulation, specialized education, and financial innovations continue diffusion of the paradigm.

New means of expanding demand to successive layers of the population arise, involving the middle and working classes and enabling economies of scale.

Social Adaptation in Synergy

Culture adapts to the logic of the technologies. Consumers accept the progression of innovation as normal.

Accessory branches that help diffuse the paradigm also experience growth.

Employment rises steadily and (depending on the institutional framework) there can be a shared feeling of improving quality of life.

Phase 4: Maturity

Finally, the technological revolution begins to deplete its possibilities. Refer to Phase 0 above. This is the twilight of the golden age, “though it shines with false splendor.”

Core industries experience market saturation and decreasing returns.

Widespread market and production experience shorten the life cycles of later products because of very rapid learning and saturation curves.

Those who reaped the benefits of the golden age continue to believe in the virtues of the system. They insist on continuous progress of the current paradigm, in a complacent blindness.

But promises of constant progress and social progress are not met, leading to labor and political unrest. The young and nonconformists stage rebellions and romantic protests.

Firms amass money without profitable investment outlets, creating idle capital.

Financial capital begins separating from production capital again, seeking more profitable or exciting things.

Radical innovations are demanded to propel further growth. During the Synergy phase, innovations that disrupted the diffusing paradigm were rejected. Now, they are sought after by firms desperate for growth.

Phases of Financial Innovation

Throughout the revolution, innovations in financial capital enable the diffusion of technology.

Carlota Perez classifies financial innovations along six types, then illustrates when innovations in each type occur.

Type Purpose Examples
A Invest in new products or services Venture capital for radical innovations

Joint stocks for large investments

B Help growth or expansion Production expansion domestically and abroad (bonds)

Government funding (eg war, infrastructure investment)

C Modernize financial services themselves New service to clients (telegraph transfers, personal checking accounts, e-banking)

Incorporation of new technologies (communications, transport)

D Profit-taking and spreading risk Attract small investors (mutual funds, bonds, IPOs)

Facilitate risk taking (derivatives, hedge funds)

E Refinance obligations or mobilize assets Reschedule debts (Brady Bonds, swaps)

Buy active production assets (mergers, takeovers)

Acquire and mobilize rent-type assets (real estate, futures)

F Questionable innovations Legal loopholes (fiscal havens)

Making money from money, taking advantage of incomplete information (FX arbitrage, leads and lags)

Making money without money (pyramid schemes, insider trading)

Phase Prevalent innovation Characteristics of finance
A B C D E F
Irruption X X X X X X Highest intensity of financial innovation
Frenzy X X X Attract funds, speculate, inflate assets
Synergy X X X Supportive innovations to accompany growth
Maturity X X X Accompany diffusion of paradigm, escape regulatory control

This table refers to when innovation and invention happens - the application of the practices can last a long time afterward.

Addressing Criticisms

Carlota Perez addresses a few arguments against her model of technological revolutions.

This model doesn’t perfectly apply to this and that situation.

The four phases model is deliberately meant to be impressionistic. Each revolution has unique ideological, institutional, political factors that lead to particularities, but the general shape holds true.

For instance, in the third revolution, madness in the US stock market occurred more during 1903 and 1907 during a “frenzied Synergy” in a strong drive to forge ahead.

Further, the Great Depression in the USA after 1929 lasted especially long. Perez suggests that Roosevelt’s New Deal would have erected the structure for successful synergy, but these were opposed for fear of socialism and inordinate state intervention in the economy. It took the military-industrial complex in World War II to teach how state and capitalism could coexist. (Shortform note: others argue that artificial wage floors suppressed employment and output, or that insufficient fiscal stimulus was applied.)

This model should show up in economic analysis and in aggregate variables like GDP.

There is no expectation of neat upswings and downswings in aggregate metrics like GDP. Aggregate figures have a tendency to conceal what is really going on.

The book’s model argues for increasing differentiation within the economy. Some branches grow at very high rates while others are stagnating. Maturity of the previous revolution is occurring in the background of Irruption of the new one. Whether the sum of these trends shows up in aggregate metrics depends on the relative weights and relative growth rates.

Furthermore, many measuring attempts use money values, but there are really “two moneys” operating under one. Given the rapid improvement in technology, it is hard to control the value of money across two periods. Money buying telecom today is not the same value as money buying furniture in the 1970s. Even for the same good, the decreasing prices and increasing volume make measurement difficult - how do you compare one computer in 1960 vs one computer in 2010?

Finally, given the time lag of diffusion of the technology, the core countries in the revolution may be experiencing trouble at the same time that catching-up countries are reaching their maximum height.

However, in the synergy phase, there should be stability of relative productivities in certain branches. This does not last long, as in maturity there is heterogeneity in dynamic growth of latecomer branches and sluggish growth in the now traditional core industries.

Cycles must be simultaneous worldwide phenomena.

Proponents of long-wave Kondratiev cycles expect worldwide progress coinciding in all sectors and geographies at once.

In reality, diffusion tends to propagate in ripples, both across sectors and across geographies.

Between sectors, the most closely connected industries form very high synergy and intensive feedback effects. This establishes the paradigm and lowers cost of adoption for an ever-wider circle, until it penetrates the whole economy.

(Shortform example: in the information age: commerce and media were synergistic and developed quickly (selling people things enabled advertising which enabled media). Later, wide diffusion of the paradigm allowed for adoption of digital tools in farther-out industries like healthcare and government.)

Geographically, the process is similar. The paradigm spreads in the core country and then, as Maturity arrives and markets stagnate, propagates to the periphery. Through the life cycle of the revolution, the core country begins as a net exporter of the technology, then becomes a net importer as the paradigm reaches the periphery. Whether any particular country in the periphery adopts the new paradigm depends on its ability to take advantage of the opportunity.

This model doesn’t predict all bubbles.

While all technological revolutions have a bubble and a crash, not all bubbles are strictly connected with technological revolutions. Other collapses may have other causal chains.

Shortform Exclusive: Questions to Ponder

Knowing the concepts, consider where we are now.

The Current Information Age

Which of the four phases are we in now?

If we are in deployment, what industries are the best candidates for deployment?

When will we transition into Maturity?

Predicting the Next Revolution

What are possible candidates for the next technological revolutions? Remember that they tend to start with cheap disruption (like microprocessors) and allow cost-competitive innovations

What technologies were hyped as the new wave that then faltered? In other words, what seeming “revolutions” were false positives? How do you tell these are false positives as they’re happening?

The location of the revolution can change. Britain was the center of the industrial revolution, but the US became the center of future revolutions. Where might the next technological revolution arise?

The next technological revolution is incompatible with the current paradigm. What are disruptive technologies that would threaten today’s paradigm, and are thus resisted today?

What technologies would make existing titan companies obsolete?

Finance tends to adopt new technology early. Can you use financial innovation and new organizational models as harbingers for the larger technological revolution to come?