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Replacing the old with the new, a capitalist ideal popularized as “creative destruction” by Austrian economist Joseph Schumpeter in the 1940s, is actually Eastern roots. In Hinduism, creation and destruction are considered two parts of the trifecta of balanced cosmic forces. The etymology is informative because an imbalance in the third force—conservation—may be why creative destruction actually slows across the developed world.
According to Schumpeter, creative destruction is essential for long-term economic growth, as it enables the ever better use of people, capital and other resources. A look at the US — the archetypal free market economy — would suggest that dynamic is alive and well. California’s Silicon Valley is the cradle of global innovation, and America’s seven great tech stocks are leading the AI revolution.
But pan out, and it is not so obvious. “It’s hard to measure directly,” says Michael Peters, an associate professor of economics at Yale University. “But, in America, if you look at entry rates, exit rates, or the frequency of job-to-job transitions — which are indicators of business dynamism — they’ve been falling for the last decade.”
Outside of America, the emphasized business dynamics are less noticeable. Former Italian Prime Minister Mario Draghi’s recent report on Europe’s competitiveness exposes its problems with innovation. German industry is becoming synonymous with inertia. AND in Britainthe rate of job openings and closings has slowed by one-third over the past two decades.
Philippe Aghion, a professor at the College de France, INSEAD and LSE, believes that a reduction in creative destruction could explain the somewhat recent slowdown in productivity growth in the advanced world. If so, what explains it?
This is where conservation comes into play. These are forces that want to maintain the status quo. Sometimes they are necessary: large profits — which take time to accrue — attract competition, bailouts help prevent financial contagion in a crisis, and regulations ensure environmental and social protection. But they can also undermine interference.
Take the growing concentration of companies. The share of the US economy dominated by the top 1 percent of companies by assets has grown to over 90 percent, compared to 70 percent in the 1930s. Scale enables innovation, but leading manufacturers can also use it to raise barriers to entry. For example, the network effects of data are already helping companies build competitive channels in the AI sector.
Protectionism is another growing conservation force. Tariff and non-tariff barriers support domestic producers, preventing innovative pressure from competitive forces. Restrictions on foreign investment and talent can also limit the penetration of new ideas.
Finances also play a role. The period of low interest rates and quantitative easing that followed the financial crisis kept weak companies alive. Less efficient companies have also been able to weather the recent rise in rates by accessing government pandemic support, accepting long-term solutions or through private credit. The percentage of unprofitable companies in the Russell 2000 — the US small-cap index — has risen from 15 percent to about 40 percent over the past 30 years.
Then there are social factors. Generational crises—including the credit crunch, the pandemic, and the energy price shock—may have increased expectations for the state to act as a buffer. Eeconomic success it also brings the motive to protect it. Economist Mancur Olson said lobbying groups “slow down society’s ability to adopt new technologies and reallocate resources in response to changing conditions.” Nimbyism, industry lobbies and increasing regulatory burdens are all examples. (Bureaucracy is the reason why California has the largest corporate outflow of any US state.)
Greater policy focus on economic agility would help. Trade and competition regimes should reduce barriers to market entry. National retraining programs should support industrial transformation, bankruptcy regimes should ensure that companies fail well and quickly, and lobbying powers must be checked. Any future bailouts and stimulus packages must also be better targeted.
The boom in artificial intelligence may yet trigger a wave of innovation. Trade wars could separate the wheat from the corporate chaff. Higher average interest rates could drive out zombie companies. The effects of creation and destruction are readily apparent, but this should not lull us into a false sense of security about how dynamic our economies really are.
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