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Explaining the Long Wave Business Cycle

written by: N Nayab•edited by: Jean Scheid•updated: 2/22/2011

The Long Wave Business Cycle, known as Kondratiev waves or K-waves is a theory of the modern capitalist economy undergoing phases of boom and bust lasting about forty to sixty years. Read on for an explanation of this concept, and what this means to an entrepreneur.

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    Origins

    Long Wave Business Cycle The Russian economist Nikolai Kondratiev first propounded the long wave business cycle theory in his 1925 book The Major Economic Cycles. Joseph Schumpeter, an Austrian economist soon took up this theory and hypothesized the existence of very long-run macroeconomic and price cycles lasting for about 50 to 54 years. In the 1950s, the French economist François Simiand undertook further studies on long waves and proposed naming the ascendant period of the cycle as "Phase A" and the downward period of the cycle as "Phase B".

    Most academic economists, however, do not accept the long wave business cycle, and even those who do accept the long wave theory, differ on the start and the end years of particular waves.

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    The Concept

    Kondratiev’s long wave had three phases of expansion, stagnation, recession. Later economists have modified the phases to four: spring, summer, fall, and winter. Regardless of the division, each phase strongly links to social shifts and changes in public sentiments.

    • The Kondratiev “Spring” phase denotes improvement or plateaus in the business environment, and usually results in higher prices. The resultant capital accumulation and innovation creates upheaval and displacements in the society, with economic changes redefining work and the role of individuals in society. On a macro scale, scholars such as Immanuel Wallerstein links the long wave business cycle to warfare, and postulates that highly destructive wars tend to begin just before an output upswing.
    • The “Summer” is the phase of acceleration or prosperity, resulting in high growth of the “spring” phase. The price rise stop, but high prices remain. The prosperity and the resultant affluence, however, create inefficiencies and stagflation.
    • The “Fall” phase denotes the period when growth plateaus and recession sets in. Prices drop and interest rates rise. The social mood of affluence shifts to stability, normalcy, and isolationism.
    • “Winter” is the final phase of the wave, denoting total economic depression. This phase marks the completion and integration of the social changes that started in the “spring” phase.
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    Cause

    Of the many theories regarding the origin and progress of the long waves, the innovation theory and credit cycle theories stand out.

    The innovation theory holds that the bunching of many basic innovations launch technological revolutions that in turn, create leading industrial or commercial sectors, triggering off a long wave. This theory holds major technological landmarks in history, the start of the Industrial Revolution in 1771, the invention of steam locomotive in 1829, the invention of electricity in 1875, the invention of the automobile in 1908, and the spread of information and telecommunication in 1971 as landmark events that started a long wave.

    The credit cycle theory holds that excessive debt, be it public or private, internal or external, while creating exceptional periods of high productivity growth has always led to financial crises that culminates in default of the loan, and restructuring based on currency devaluation. This causes an extended slump as businesses and consumers take years to rebuild their balance sheets. The periods of growth and slump constitute a wave. This theory holds that the economic cycle that began in 1939 is now ending, and the economic crisis of 2008 is a manifestation of the end of the wave.

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    Uses

    Businesses would do well to use the long wave business cycle theory to forecast the next boom or bust, and predict the social characteristics associated with such a wave to restructure their business accordingly, and prepare to seize opportunities as they come.

    A business, for instance can look to expand in the anticipation of an upcoming boom, make plans of liquidation anticipating a long wave, or prepare a business plan based on the technological innovation that may herald a new wave. Businesses can also identify warning signs of the economy crashing by monitoring debt levels, and take adequate precaution to protect assets.

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    Reference

    Sterman, J. (1993). "Business Cycles and Long Waves. A Behavioral Disequilibrium." Retrieved from http://dspace.mit.edu/bitstream/handle/1721.1/46906/businesscycleslo00ster.pdf?sequence=1 on 12 February 2011.

    Image Credit: geograph.org.uk/Bob Jones