A Change Maker’s Guide to Economic Paradigms

We are in the midst of a collapsing economic paradigm. This is evident in the widespread wealth inequality, absence of strong civic institutions, corrosive infusion of money into our broken democracy, and a deteriorated environment ravaged by a profound blindness to our impacts on the larger world.

As Change Makers, it is our job to understand the patterns of economic systems so we can participate in the creation of the next economy — one that must embody ecological principles if we are to survive on the Earth.

I want to help you understand:

• How economic paradigms come into being;

• The role of financial capital in driving boom-bust cycles; and

• The ascension of a new paradigm that pulls society out of collapse.

We Change Makers need to understand this entire process if we want to transition to a sustainable form of civilization in the coming decades.

The Governing Dynamics of Capitalism

Every complex system has a governing dynamic – the signature pattern that gives it a unique character. For capitalism, the defining pattern is Boom-Bust Cycles set on top of a growth curve. These cycles of growth and collapse that recur in market economies are what economist Joseph Schumpeter described as the tendency for “creative destruction” to cascade through economic systems. This pattern builds on an exponential growth curve… which I’ll come back to below.

This schematic view (overly simplified), depicts the basic structure of a Boom-Bust Cycle:

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There are periods when the economy hits a plateau and becomes stable. Sometimes called “Golden Ages” these periods are defined by widespread prosperity, a growing middle class, and general peace and stability. Golden Ages are preceded (and typically followed) by “Recessions” created by destabilizing economic conditions — indicators include dramatic wealth inequality, lost confidence in societal institutions, and speculative bubbles where large sums of money vanish in a short period of time.

What this graphic conceals is the fundamental shift that happens with each new pulse. The continuous line suggests that the same economy can be found on either side of a recession. Yet, each pulse entails deep structural changes to the economy. Every cycle is the destruction of the old economy followed by the birth of a new one.

In other words, it is a normal part of capitalist systems to go through paradigm shifts. This is very good news for all of us Change Makers working to build a sustainable global economy. We can leverage the natural evolution of market economies to disrupt and create anew.

Digging Deeper

To really understand Boom-Bust Cycles, we’ll need to take the work of Carlota Perez (especially, her book Technological Revolutions and Financial Capital) and see how economic paradigms rise and fall.

Carlota Perez set out to explain an interesting phenomenon — that every 50 years or so there have been new economic structures that forced the collapse of what came before. She identified five economic paradigms (or “Great Surges”) throughout this period:

1. Industrial Revolution in Britain (~1770-1830)

2. Age of Steam and Railways (~1830-187o)

3. Age of Steel, Electricity, and Heavy Engineering (~1870-1920)

4. Age of Oil, Automobiles, and Mass Production (~1920-1975)

5. Age of Information and Telecommunications (~1975-20??)

Each of these periods represents a major technological breakthrough that resulted in a fundamental restructuring of the economy. Each period has its own paradigms for wealth-generation, institutional structures, regulatory environments, and desired trajectories for society. The technologies themselves are but one piece in an array of vital inputs that ultimately defined each era. It is the overarching perspective or worldview that captures the core of each paradigm.

Perez's major contribution to economics is the model for how paradigm shifts occur, as depicted in this graphic:

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There are four phases of each economic paradigm — Irruption, Frenzy, Synergy, and Maturity.

Each economic paradigm begins with a technological breakthrough capable of generating entirely new modes of production. In the Age of Steam and Railways, this was the dual invention of steam engines and a manufacturing process for producing cheap, high-quality steel. These breakthroughs made it possible to build vast transportation networks (railways) that were durable when exposed to the elements and could carry vehicles powered by steam engines (trains) over long distances.

During the Irruption Phase, breakthrough technologies became recognized as “game changers” for economic development. They may have been discovered earlier without their latent potential being recognized. Very little money was invested during this period, until a catalyzing event captured the imaginations of investors and entrepreneurs.

After such a catalyzing event, the Frenzy Phase unfolds. During this period, a large pool of investors jump on the bandwagon to support a wave of entrepreneurs in the creation of new business models that exploit the benefits of the new technologies. This leads to the emergence of entirely new economic sectors that build on legacy institutions from the previous paradigm.

The convergence of business applications into new sectors occurs during the Synergy Phase. Mainstream investors start to recognize the profitability of businesses that have proven themselves as “winners” in the highly competitive space of entrepreneurial activity during the Frenzy Phase. These business models are expanded and consolidated to create “economies of scale” that maximize profits in the emerging new economic sectors.

Through the rush of consolidations and mergers of the Synergy Phase, new markets become saturated and it becomes more difficult to keep profit returns high. This constitutes the Maturity Phase as a period when investments decouple from productive forces in the mature economy and financial tools arise to “make money from money.” This phase often leads to widespread income inequality, corrosion of regulatory environments by the corrupting influence of money, and a stagnation in profitability.

The stage is now set for the next economic paradigm to arise. The old economy becomes unstable and lurches into decline or collapse, depending on which environment it unfolds into.

Where “Speculative Bubbles” Come From

This unfolding process reveals why capitalist economies go through Boom-Bust Cycles. The role of money changes in each phase of the evolving market system, creating instabilities along the way.

This is how it works:

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Investment pools are scarce during the Irruption Phase. The new wave of business leaders is tinkering away in their garages without financial support (or in corporate research labs without obvious pathways to commercialization). The absence of finance defines this period. Revolutionary ideas are unable to scale upward because they don’t fit with the institutional or investment cycles that still dominate under the maturing economy of the previous era.

Then a shift happens allowing the new technologies to rise quickly. A central driver of the Frenzy Phase is the flood of money invested in the new that accompanies rapid growth of agile companies whose success could not be predicted by the common sense of established players (Facebook and Google are two recent examples of the new arising seemingly out of nowhere to define a new paradigm for business).

The massive profitability of these shining stars gets the attention of mainstream investors. And the new business practices require changes in the regulatory environment to pull investments away from the old way of doing business. Corrupting influences often arise as established power players resist such fundamental changes in their effort to maintain control over the economy. This is where anti-innovation tendencies creep into the system. All of these activities unfold in the Synergy Phase of the new paradigm, making it very difficult to predict how the economy will grow and change.

And finally, the investors who made a killing on the meteoric rise of the Frenzy wave become hungry for larger returns. This introduces corrupting influences into the mix, largely arising through the creation of financial tools for generating money from money itself — decoupling the wealth-creation process from activities that produce real value for society.

As money decouples from real value, a speculative bubble emerges. As financial capital feeds on itself the bubble grows, until it consumes the entire system and drives it into decline (or collapse, as we saw in 2008).

Putting All the Pieces Together

By now it should be clear that the fundamentals of capitalism can be studied and understood by Change Makers. I have sketched the core dynamic elements of a very complex web of processes to give you a sense that this can truly be learned and made use of as part of our tool set for creating change.

I want to tie together the loose end left hanging at the beginning — the Growth Curve that keeps the system going through each wave of creative destruction. Each Boom-Bust Cycle sits on top of a trend of economic expansion, as the total value of the market system increases with time.

Real data is more messy than the pure theory, but the patterns I’ve described are easy to see in the Dow Jones over the last 100 years:

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(This graph was found here.)

Notice how the size of the economy grows with 50 year pulses that match the paradigms discussed by Perez. This growth pattern reveals our salvation along with a profound threat. The good news is that civilization remains robust in the face of Boom-Bust Cycles. The achievements of the previous era are built upon to increase the general wealth of humanity (as measured in economic terms).

What's missing from this picture is the depletion of many different invisible forms of wealth that are destroyed as profits rise. Every economy is grounded in the physical reality of our biological existence as human beings. We require food, water, land, shelter, and other vital physical inputs for our survival. As market economies have grown in their ability to “produce” goods and services, they have simultaneously depleted the capacity of the world’s ecosystems to provide these fundamental needs.

And so the Growth Curve is untenable for the long haul. We cannot grow the size of our economy indefinitely because physical limits exist that are more fundamental than economic laws. This creates the context for the next wave of Change Makers. Not only must we cultivate a new economic paradigm, we must also replace the fundamentals of human economic systems to align them with our ecological nature as living beings.

This is why I've taken the time to share this knowledge with you, so we can work together to create a New Epoch of Ecological Economics for the survival of the human species. I encourage you to take the insights presented here and expand them to discover new modes of social organization that profoundly redefine what we mean by a healthy economy.

And, of course, feel free to ask me questions if you'd like more clarification on this very complex evolutionary process.