The Power of Creative Destruction

In Capitalism, Socialism, and Democracy (1942), Joseph Schumpeter argued that economies grow through a process of creative destruction; that is, new ideas, products, and services drive out old versions since they offer better value. Schumpeter characterized capitalism as founded on such a process, but he concluded this book with the argument that eventually the process would run out of energy (ideas, capital, labor, and raw materials), realize diminishing economic returns and, thus, lose popular support. At that point, he argued, capitalism would cease to be the dominate way to organize an economy and be replaced by some form of socialism.

Philippe Aghion, Celine Antonin and Simon Bunel take issue with Schumpeter’s conclusion and argue in The Power of Creative Destruction (2021) that capitalism remains vibrant because of the power of creative destruction and the persistence of innovation. Of course, such persistence should not be taken for granted as those who developed products and services in the past will seek to sustain their economic rents (above normal profits) by devoting resources to influencing political and regulatory authorities to construct barriers to entry for new firms rather than devote them to innovation. (This exchange is emphasized in Clayton Christensen’s seminal work The Innovator’s Dilemma.)

To sustain innovation, the authors cite economic historian Joel Mokyr’s three keys (A Culture of Growth: The Origins of the Modern Economy (2016)): the diffusion of knowledge across industries and borders, competition among organizations and countries for innovative people, and supportive public institutions including well defined property rights and consistent implementation of the rule of law.

To sustain innovation as a driver of economic growth, barriers to entry must be low and the potential for the interruption of economic rents must be high. Stated differently, past innovators should not be able to inhibit present innovators from disrupting their generation of abnormal profits. That leaves at least two explicit roles for governments: to restrict the concentration of economic power (through policies such as anti-trust and taxation) and to ensure that workers harmed by the resulting economic turbulence have sufficient economic security during the transition from old to new innovators. As an example of the latter policy, Aghion et al. cite Denmark’s flexicurity policy, which both encourages labor turnover and provides economic security for workers. I intend to write more about this Danish policy in the future.

The authors conclude that there exist many weaknesses to uninhibited capitalism but that, within a given country, market augmenting government (a term coined by Mancur Olson -see the Preface to Power and Prosperity (2000)) could both capture the benefits of capitalism’s creative destruction process and ensure economic security for a country’s population. Of course, as is often said, “the devil is in the details.”

I intend to return to such details in future postings; however, to encourage everyone to read this book, here is one of many insightful reviews.

“Accelerating technological change, global warming, pandemics, individual and national stagnation, over-indebtedness: this century decidedly provokes anxiety. Armed with legitimate concerns, anti-globalization protestors and neo-Luddites look inwards and denigrate innovation. The Power of Creative Destruction offers another vision, more persuasive and based on the innovation that creates wealth and jobs. Philippe Aghion, Céline Antonin, and Simon Bunel dismantle contemporary myths about such economic phenomena as secular stagnation and the impact of automation on employment. They show the need for competition and the fight against rents. They advocate a regulated capitalism that will allow us to keep society prosperous and the planet green. They explain, in short, how to manage the creative destruction that over the past two centuries has brought to our society a previously unimaginable prosperity. Provocative and rigorous, this book is an important milestone in our reflections on the future of our societies. A must-read.”Jean Tirole, Nobel Laureate, Toulouse School of Economics

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