Without knowledge of the past there is no future

Humanity is being confronted with the same problems as those experienced at the end of the second Industrial Revolution, such as decreasing stock exchange rates, rapidly increasing unemployment, towering company and government debt, and bad financial positions of banks. Every production phase or civilization or other human invention must go through a so-called transformation process, a transition. In this article I will use one such transition to demonstrate the position of our present civilization.

The third Industrial Revolution

When we consider the characteristics of the phases of a social transformation we may find ourselves at the end of what might be called the Third Industrial Revolution. Transitions are social transformation processes that cover at least one generation (25 years). A transition (according to Professor Jan Rotmans) has the following characteristics: 1) it involves a structural change of civilization or a complex subsystem of civilization, 2) it shows technological, economical, ecological, sociocultural and institutional changes at different levels that influence and enhance each other, and 3) it is the result of slow changes (changes in supplies) and fast dynamics (flows).

Examples of historical transitions are the demographical transition and the transition from coal to natural gas that caused transition in the use of energy. A transition process is not fixed from the start because during the transition processes will adapt to the new situation. A transition is not dogmatic.

Four transition phases

In general, transitions can be seen to go through an ‘S curve’ and we can distinguish four phases: 1) a pre-development phase of dynamic balance in which the present situation does not visibly change, 2) a takeoff phase in which the process of change starts because of deviations in the system, 3) an acceleration phase in which visible structural changes take place through an accumulation of sociocultural, economical, ecological and institutional changes influencing each other; in this phase we see collective learning processes, diffusion and processes of embedding, and 4) a stabilization phase in which the speed of sociological change slows down and a new dynamic balance is achieved through learning.

Three drastic transitions

When we look back over the past two centuries, we see taking place three transitions with far-reaching effects.

1. The first Industrial Revolution

The first Industrial Revolution lasted from around 1780 to 1850. It was characterised by a transition from small-scale handwork to mechanised production in factories. The great catalyst in the process was the steam engine, which also caused a revolution in transport as it was used in railways and shipping. The first Industrial Revolution was also centered on the coal industry. Because steam engines were made of iron and ran on coal, both coal mining and the iron industry also flourished. The beginning of the end of this revolution was in 1845 when Friedrich Engels, son of a German textile baron, described the living conditions of the English working class in The Condition of the Working Class in England.

2. The second Industrial Revolution

The second Industrial Revolution started around 1870 and ended around 1930. It was characterised by ongoing mechanisation because of the introduction of the assembly line, the replacement of iron by steel, and the development of the chemical industry. Furthermore, coal and water were replaced by oil and electricity and the internal combustion engine was developed. Whereas the first Industrial Revolution begun through (chance) inventions by amateurs, companies invested a lot of money in professional research during the second revolution, looking for new products and production methods. In search of finances, small companies merged into large-scale enterprises that were headed by professional managers and offered shares on the market. These developments caused the transition from the traditional family business to limited liability companies and multinationals. After the roaring twenties this revolution ended with the stock exchange crash of 1929.

3. The third Industrial Revolution

The third Industrial Revolution started around 1940 and is nearing its end. The United States and Japan played a leading role in the development of computers. During the Second World War great efforts were made to apply computer technology to military purposes. After the war the American space program increased the number of applications. Japan specialised in the use of computers for industrial purposes such as robotics. The acceleration phase of the third Industrial Revolution started around 1980 with the advent of the microprocessor. Now computer and communication technology have an irreplaceable role in all parts of the world.

Effects of the three industrial revolutions

The first (and second) revolution transformed an agricultural society into an industrial society where mechanisation (finally) relieved humankind of physical labour. The craft industry could not compete with the factories that put products of the same or even better quality on the market at a lower price. The result was that many small businesses went bankrupt and their workers went to work in the factories. The effects of industrialisation were seen in the process of the rapid urbanisation of formerly small villages and towns where the new plants materialised. These turned into dirty and unhealthy industrial cities. Still people from the country were forced to go and work there.

Because of this a new social class emerged: the workers, or the industrial proletariat. They lived in overcrowded slums in poor housing with little sanitation. The average life expectancy was low, and infant mortality high. The elite accepted the filth of the factories as the inevitable price for their success. The chimneys were symbols of economic power, but also of social inequality. You see this social inequality appear after each revolution. The gap between the bottom and the top of society becomes very large. Eventually there are inevitable responses that decrease this gap. It could be argued that the industrial revolutions have created the conditions for a society with little or no poverty.

The third revolution transformed an industrial society into a service society. Where mechanisation relieved humankind of physical labor, the computer relieved him of mental labor. This revolution made lower positions in industry more and more obsolete and caused the emergence of entirely new roles in the service sector.

Industrial revolutions and stock market indices

The Dow Jones Industrial Average (DJIA) was first published in 1896, halfway through the second Industrial Revolution. The DJIA is the oldest stock index in the United States. This was a straight average of the prices of twelve shares. A select group of journalists from The Wall Street Journal decided which companies were part of the most influential index in the world market. Unlike most other indices the Dow is a price-weighted index. This means that stocks with high absolute share price have a significant impact on the movement of the index.

The S&P Index is a market capitalisation weighted index. The 500 largest US companies as measured by market capitalisation are included in this index, which is compiled by the credit rating agency Standard & Poor’s.

What does a stock exchange index really mean?

In many graphs the y-axis is a fixed unit, such as kilograms, metres, litres or dollars. In graphs showing stock exchange values, this also seems to be the case because the unit shows a number of points. However, this is far from the truth! An index point is not a fixed unit in time and does not have any historical significance.

An index is calculated on the basis of a set of shares. Every index has its own formula and the formula gives the number of points of the index. Unfortunately many people attach a lot of value to these graphs, which are actually very deceptive.

Set of shares

An index is calculated on the basis of a set of share prices. Every index has its own formula and the formula results in the number of points of the index. However, this set of shares changes regularly. For a new period, the value is based on a different set of shares. It seems very strange that these different sets of shares are represented as the same unit. After a period of 25 years, the value of the original set of apples is compared to the value of a set of pears. At the moment only six of the original 30 companies that made up the DJIA at the start of the acceleration of the last revolution (1979) are still present.

Formula

Even more disturbing is the fact that with every change in the set of shares used to calculate the number of points, the formula also changes. This is done because the index, which is the result of two different sets of shares at the moment the set is changed, must be the same for both sets at that point in time. The index graphs must be continuous lines. For example, the DJIA is calculated by adding the share prices and dividing this result by some number. Because of changes in the set of shares and the splitting of shares the denominator changes continuously. At the moment the divider is 0.132319125, but in 1985 this number was higher than 1. An index point in the two different periods of time is therefore calculated in different ways:

Dow 1985 = (x1 + x2 + ........+x30) / 1

Dow 2013 = (x1 + x2 + ........ + x30) / 0.130216081

In the 1990s many shares were split. To make sure the result of the calculation remained the same, both the number of shares and the divider changed. An increase in share value of $1 of the set of shares in 2013 results is 7.7 times more points than in 1985. The fact that in the 1990s many shares were split is probably the cause of the exponential growth of the DJIA. At the moment the Dow is at 14659 points. If we used the 1985 formula it would be at 1908 points.

Constantly changing set

The most remarkable characteristic is of course the constantly changing set of shares. Generally speaking, the companies that are removed from the set are in a stabilisation or degeneration phase. Companies in a takeoff phase or acceleration phase are added to the set. This greatly increases the chance that the index will increase rather than decrease. This is obvious, especially when this is done during the acceleration phase of a transition. From 1980 onward, seven ICT companies (3M, AT&T, Cisco, HP, IBM, Intel, Microsoft), the engines of the latest revolution, were added to the DJIA as were five financial institutions, which always play an important role in every transition.

Pyramid scheme

This is actually a kind of pyramid scheme. All goes well as long as companies are added that are in their takeoff or acceleration phase. At the end of a transition, however, there will be fewer companies in those phases.

Will the share indexes go down any further?

Calculating share indices as described above and showing indexes in historical graphs is a useful way to show which stage of the cycle is currently being experienced.

The third Industrial Revolution is clearly in the saturation and degeneration phase. This phase can be recognised by the saturation of the market and increasing competition. Only the strongest companies can withstand the competition or takeover their competitors (for example, takeovers executed by Oracle and Microsoft over the past few years). The information technology world has not seen any significant technical changes recently, despite what the American marketing machine wants us to believe.

During the pre-development phase and the takeoff phase of a transition, many new companies spring into existence. This is a diverging process. Financial institutions especially play an important role here, as these phases require large quantities of money. Graphs showing the wages paid in the financial sector therefore show the same ‘S curve’ as both previous revolutions.

Investors get euphoric when hearing about mergers and acquisitions. Actually, these are indications of the converging processes towards the end of a transition. When looked at objectively, each merger or takeover is a loss of economic activity. This becomes painfully clear when we have a look at the unemployment rates of some countries.

New industrial revolutions come about because of new ideas, inventions and discoveries, so through new knowledge and insight. Here too we have reached a point of saturation. There will be fewer companies in the takeoff or acceleration phase to replace the companies in the index shares sets that have reached the stabilisation or degeneration phase.

Will history repeat itself?

Humanity is being confronted with the same problems as those at the end of the second Industrial Revolution, such as falling stock exchanges, high and increasing unemployment, towering debts of companies and governments, and the weak financial position of banks.

History has shown that there are five pillars to a stable society:food, security, health, prosperity, and knowledge.Transitions are initiated by inventions and discoveries, new knowledge of humankind. New knowledge influences the other four components of society. At the moment, there are few new inventions or discoveries. So the chance of a new Industrial Revolution is not very high. At the end of every transition the pillar of prosperity is threatened. We have seen this effect after every Industrial Revolution.

The pillar of prosperity in society is about to fall again. History has shown that the fall of the prosperity pillar always results in a revolution. Because of the high level of unemployment after the second Industrial Revolution, some societies initiated a new transition, the creation of a war economy. This type of economy flourished especially in the period 1940 to 1945.

Now societies will have to make a choice for a new transition to be started. Without knowledge of the past there is no future.