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The displacement of the old with the new, a capitalist ideal popularised as “creative destruction” by Austrian economist Joseph Schumpeter in the 1940s, actually has eastern roots. In Hinduism, creation and destruction are considered two parts of a trifecta of equilibrating cosmic forces. The etymology is informative because an imbalance in the third force — preservation — may be why creative destruction is in fact slowing across the advanced world.
According to Schumpeter, creative destruction is central to long-term economic growth, as it enables people, capital and other resources to be continuously better deployed. A glance at the US — the archetypal free market economy — would suggest the dynamic is alive and well. California’s Silicon Valley is the cradle of global innovation, and America’s Magnificent Seven tech stocks are leading the AI revolution.
But pan out, and it is not so obvious. “It is 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 proxies for business dynamism — they have been falling in the last decade.”
Beyond America, flagging business dynamism is less inconspicuous. Former Italian prime minister Mario Draghi’s recent report on Europe’s competitiveness lays bare its struggles with innovation. German industry is becoming a byword for inertia. And in Britain, the rate at which jobs are created and destroyed has slowed by one-third in the past two decades.
Philippe Aghion, a professor at College de France, INSEAD and the LSE, reckons a decline in creative destruction could explain some of the recent slowdown in productivity growth across the advanced world. If so, what explains it?
That is where preservation comes in. These are forces that seek to sustain the status quo. Sometimes they are necessary: big profits — which take time to amass — attract competition, bailouts help avert financial contagion in a crisis and regulations provide environmental and social protections. But they can also undermine disruption.
Take rising corporate concentration. The share of the US economy dominated by the top 1 per cent of companies by assets has risen above 90 per cent, compared with 70 per cent in the 1930s. Scale enables innovation, but incumbents can also leverage it to raise barriers to entry. For instance the network effects of data are already helping firms to build competitive moats in the AI sector.
Protectionism is another growing preservative force. Tariffs and non-tariff barriers prop-up domestic producers, stymying the innovative pressure of competitive forces. Restrictions on foreign investment and talent can also limit the penetration of new ideas.
Finance has a role too. The era of low interest rates and quantitative easing that followed the financial crisis kept weak firms afloat. Less efficient companies have also been able to ride-out the recent rise in rates by accessing government pandemic support, locking into longer-term fixes, or through private credit. The percentage of unprofitable companies in the Russell 2000 — a US small-cap index — has risen from 15 per cent to around 40 per cent in the past 30 years.
Then there are societal factors. Generational crises — including the credit crunch, pandemic, and energy price shock — may have raised expectations on the state to act as a backstop. Economic success also brings a motive to protect it. The economist Mancur Olson said lobby groups “slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions”. Nimbyism, industrial lobbies and rising regulatory burdens are all examples. (Red tape is a reason why California has the highest outflow of companies of any US state.)
A greater policy focus on economic agility would help. Trade and competition regimes should lower barriers to market entry. National retraining schemes need to support industrial transformation, bankruptcy regimes should ensure businesses fail well, fast, and lobby powers need to be checked. Any future bailouts and stimulus packages also need to be better targeted.
The AI boom may yet unleash a wave of innovation. Trade wars could separate the wheat from the corporate chaff. Higher average interest rates could flush out zombie firms. The effects of creation and destruction are easy to see, but that should not lull us into a false sense of security about just how dynamic our economies really are.
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