Schumpeter’s ‘creative destruction’ could be key to recovery from Covid
In economic jargon, the term “creative destruction” is best known for highlighting capitalism as a system of winners and losers. It was invented by Joseph Schumpeter, a member of the Austrian School of Economics which dominated free market thought in the 20th century.
Schumpeter, like many other prominent Central European intellectuals, moved to the United States in 1932; he died in 1950. His background was no different from that of FA (Friedrich) Hayek, who fled to the United Kingdom in the 1930s, arrived in the United States in 1962 and died in 1992.
At the Auckland Writers Festival last weekend, Wellington writer Danyl McLauchlan posted a photo of Hayek in a presentation on the most influential moral thinkers. Most thought it was JM Keynes, the most famous economist of the last century. No one in the general public recognized Hayek, one of the main defenders of capitalism.
Hayek and Schumpeter were both on the defensive against capitalism, which among intellectuals was much less attractive than socialism and seen as closer to fascism. Schumpeter first wrote about creative destruction in Capitalism, socialism and democracy (1942) when most of the world was at war. It was recently reissued as Can capitalism survive? (2009).
In the prologue, he recognizes the “atmosphere of hostility” towards capitalism and that condemning it was “almost a requirement of the etiquette of the discussion”.
In other words, it wasn’t something you could discuss in a polite conversation.
“Anything else is voted not only stupid but anti-social and is seen as an indication of immoral bondage,” Schumpeter added.
“On the one hand, the most obvious truths are simply dismissed from the court a limine [at the outset]; on the other, the most obvious inaccuracies are supported or applauded.
In a footnote on his use of the legal term, Schumpeter observes another way of dealing with an obvious but uncomfortable truth is to poke fun at its triviality.
Not the type to miss an opportunity for sarcasm, he also noted that a weakness of capitalism was that it produced a class of traitorous intellectuals who undermined the system from within, presumably in the hope that socialism could smooth over business cycles, eliminate competitive uncertainties and reduce competitive uncertainties. friction between state and economy.
Schumpeter’s fears about the future of capitalism turned out to be exaggerated, as the neoliberalism of Hayek and his cronies such as Milton Friedman finally triumphed over Keynes in the second half of the 20th century.
But, in Schumpeterian fashion, neoliberalism has stumbled into the global financial crisis and takes a back seat as the Covid-19 pandemic ignites the “free money” supporters of the new monetary theory.
Surely this will not last, and following Thomas Piketty’s update on the shortcomings of capitalism, other French economists have reignited creative destruction as an engine of growth in the post-pandemic economy.
The power of creative destruction is written by Philippe Aghion, professor at the Collège de France, and was first published in French last year, at a time when the pandemic was doing its best for economies around the world.
Governments shut down industries overnight, throwing millions of people out of work, and in examples like New Zealand, they have chosen not to revive them in the near future. Instead, workers were subjected to vacation pay or wage subsidies, forced to work from home, and faced with the prospect of retraining in new roles.
Reversal of the disturbance
Aghion and his colleagues recognize the benefits of this disruption, just as global capitalism has lifted billions of people out of poverty in just two centuries.
The starting point is 1820, when the Industrial Revolution in Britain shattered several millennia of weak economic growth. The most reliable historical measure of comparative economic performance – GDP per capita – is based on the work of Angus Maddison in The world economy (2004) and other studies. GDP per capita was close to the subsistence level, estimated at US $ 400, in Europe from year zero to US $ 1,000. In China, which is slightly more urbanized, it was US $ 450.
From 1000 to 1820, long and sustained periods of growth took place in two countries, Italy (1350-1420) and England in the 17th century. There were also slumps, but Aghion focuses on the “takeoff” of 1820 when economic growth finally sounded the death knell for subsistence.
The failure to reach this goal sooner has been largely attributed to demographics and agriculture. The land could only produce so much, and more people to share meant no growth in GDP per capita. Improved technology fueled population growth and therefore reduced per capita income – a phenomenon known as the Malthusian trap.
Aghion argues that this trap was avoided through education. Parents began to downsize their families as each child needed more resources to learn new skills. Fewer but more educated people have led to rapid growth in GDP per capita.
This historical evidence provides pointers to the critical components of creative destruction highlighted by Schumpeter: cumulative innovation as an engine of growth; institutions that protect property rights, allowing profits (capital) to be invested in new innovations; and competition that breaks down barriers to entry and prevents governments from protecting incumbent operators.
These building blocks of innovation require more than the simple ability to adapt to changing circumstances, as all societies have done to varying degrees. This meant a distinction between theoretical and practical knowledge. Innovation comes from knowing how to do something better.
But theoretical knowledge comes from knowing why – the scientific method, which did not exist in pre-industrial societies.
For example, in chemistry, the formulas of compounds had been known for centuries, but new compounds were not possible until they had been conceptualized. Mathematics and other scientific advancements were possible when this knowledge could be disseminated through the postal services and the printing press.
As this revolution spread across Europe, the cradle of many innovations, China banned shipping and resisted changes that could disrupt social stability. It took China two more centuries before it could catch up with the West.
The lesson for modern politicians and policymakers is to encourage change that generates growth. It is not necessarily instinctive. Monopolies owned by the state or other entities can call on their reliable rents, but they are the least likely to announce a change.
Aghion cites examples of technological innovations like the steam engine, light bulb, and microprocessors that have taken years to contribute to productivity growth.
This is in part due to the slow pick-up in secondary innovation that creates real value from technological breakthroughs. This delayed the introduction of electricity and computers, largely due to a reluctance to replace existing methods.
One measure of creative destruction is the formation and extinction of businesses. Countries with a high rate of both, including New Zealand, are positive. Countries dominated by a few large, long-standing companies are less likely to experience strong growth. One of the reasons is that these companies can afford lobbyists to ensure that their interests are protected by governments against new entrants.
Although not much of the research cited by Aghion and his colleagues comes from New Zealand, readers will be comforted by the obvious parallels. New Zealand’s first place in the World Bank’s Doing Business project is due to the relatively low costs of an open market.
However, this can be limited by the lack of market size, the degree of concentration and the lack of flexibility in the ability of companies to change.
Recent government decisions are both positive and negative in this regard. Investigations into competition concerns in building materials and food retailing could be useful if they produce real improvements rather than populist rhetoric.
But the re-regulation of the labor market and the co-governance arrangements envisaged in water and land management with organizations engaged in long-term rent-based ownership will likely result in less productive labor practices, stagnant investments and resistance to change.
Aghion’s research, based on 20 years of work at universities in the UK, US and Europe, covers many more questions than those outlined above. These include inequality, the role of governments in promoting green technologies, the impact of creative destruction on health and happiness, the benefits of immigration on growth, and how capitalism can continue. to achieve the goal of sustainable and equitable prosperity.
The power of creative destruction: economic upheaval and the wealth of nations, by Philippe Aghion, Céline Antonin and Simon Bunel. Translated by Jodie Cohen-Tanugi. (The Belknap Press of Harvard University Press). Available on Amazon Kindle.
Nevil Gibson is a former editor for NBR. He has contributed to film and book reviews in various publications.
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