Carl Menger, the founder of the Austrian School of Economics, had the ambition that economics should be a ‘map of the forces at work’. Standard textbook economics (‘neo-classical economics’) takes as its starting point a metaphor of ‘equilibrium’ based on the state of the physics profession in the 1880s. This force towards equilibrium is, however, only one of many forces at work. The most fundamental feature of capitalism is change, and this change is only poorly reflected in standard economics. Financial crises are just one of the many things that happen in real life, but cannot happen in standard textbook economics. From the standpoint of Joseph Alois Schumpeter (1883–1950), an Austrian economist and Harvard economics professor who spent much time at Harvard Business School, ‘equilibrium’ is the opposite of economic development. Equilibrium theory therefore fails to reflect many of the mechanisms of industrial and economic dynamics that create economic welfare. This chapter attempts to outline some of these forces.

Productivity explosions

What from a long-term perspective may look as relatively smooth curves of economic development are in reality the result of explosive productivity changes in a small number of industries. Figure 24.1 shows an early such ‘productivity explosion’ from a breakthrough innovation: that of cotton spinning in the late 1700s, when annual labour productivity rose by more than 25 per cent annually for a brief period.

At the time the common sense of economics was for nations to attempt to get industries behaving like this inside their borders. Productivity explosions create a system of triple rents: profits are high, wages rise and the government tax-base grows. In its essence colonialism was a system that prohibited such production activities – industry in general – from being carried out in the colonies. At the time of this early productivity explosion, this prohibition of manufacturing was a main motive for the United States’ independence in 1776.

Recently we have experienced a similar productivity explosion in the computer industry. Moore’s Law tells us that, since the late 1970s, the capacity of the computer chips doubles roughly every 18 months, creating an upward curve like the one of the cotton industry in the 1700s.

Also the activities, even technologically pedestrian ones, that are near the productivity explosion may achieve triple rents. The task of cutting and preparing cables for the computer industry grew up geographically close to the computer industry itself when