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Investor's Business Daily


A Growing Economy Necessarily Has To Have A Destructive Side

April 30, 2012

By Guy Sorman

The 2012 presidential race will be, in part, a showdown between two different models of economic growth.

President Barack Obama and his Democratic administration will defend the once-discredited and now-resurgent theory that government must act as the economy’s "tutor" and use public funds to stimulate it.

The Republican nominee, almost certainly Mitt Romney, will advance the free-market argument that the main source of new growth is the innovative energy of American entrepreneurs and that government needs to get out of the way.

An essential part of the free-market argument is "creative destruction," a theory proposed by the great Austrian economist and Harvard University professor Joseph Schumpeter. If you don’t understand Schumpeter’s insight — expressed most powerfully in his classic 1942 book "Capitalism, Socialism and Democracy" — you’ll have a hard time understanding why free markets work so well to generate prosperity.

Yet creative destruction is a complicated concept, poorly understood by the general public and not always easy to defend. As November nears, the Republican nominee may have to figure out a way to show voters how essential it is to American prosperity.

Schumpeter believed that progress in a capitalist economy requires that the old give way constantly to the new: production technologies in a free economy improve constantly, and new products and services are always on offer.

But this creative transformation also has a destructive side, since it makes earlier products and services — and the workers who provided them — obsolete. Today’s consumers have little reason to buy an oil lamp instead of a light bulb, or a Sony Walkman instead of an iPod — which can be bad news for the people who manufacture the oil lamp and the Walkman.

Looking back at the history of Western capitalism, we can see how the discovery of new energy sources, new communications systems and new financial instruments regularly demolished old ways of doing things.

When this happened, the result was typically short-term pain, as certain workers found themselves displaced, and sometimes even what appeared to be economic crises — but also substantial long-term gain, as the economy became more efficient and productive.

Economists W. Michael Cox and Richard Alm point to transportation as a striking example of the process. "With the arrival of steam power in the 19th century, railroads swept across the United States, enlarging markets, reducing shipping costs, building new industries and providing millions of new productive jobs," they write. Automobiles and airplanes had similar effects.

Yet "each new mode of transportation took a toll on existing jobs and industries. In 1900, the peak year for the occupation, the country employed 109,000 carriage and harness makers. In 1910, 238,000 Americans worked as blacksmiths. Today, those jobs are largely obsolete."

Creative destruction can take place not just across sectors of the economy but within particular firms, too. Since the invention of the automobile, many automakers have disappeared, unable to improve their products; those that survived have had to transform themselves radically to stay competitive.

Sometimes firms even change their business to stay alive. Think of IBM, which started in 1930 by building calculating machines, shifted to computers in the 1950s and today is a service company.

Trying to prevent creative destruction brings economic torpor or worse. At the extreme were the 20th century’s totalitarian Communist regimes.

I vividly recall the Soviet economy under Brezhnev and the Chinese economy under Mao Zedong. In these state-controlled societies, competition was illegal and existing factories were never shuttered; every industrial complex contained layers of antiquated technologies to which more recent ones had been added.

Innovation is very rare under such state-stifled conditions. The same weakness affects, though less dramatically, the watered-down form of state economic planning often practiced in European democracies and renascent in America under the Obama administration, with its Keynesian stimulus spending, massive bailouts of the auto industry, partial takeover of General Motors, and subsidies of alternative energy.

Economies open to creative destruction have innovated more, created more employment and enjoyed higher growth rates than their statist rivals. No place has been more open to creative destruction than the United States, where whole cities, left behind by technological advance, have crumbled into ruin, with abandoned factories standing forlornly alongside rusted railroad tracks and many workers long since departed to clear new lands, like the pioneers of yesteryear.

The willingness of Americans to endure creative destruction has allowed their economy to outperform European economies for decades. But creative destruction always runs the risk of ruining the lives of individuals along the way, which poses a significant political problem for defenders of free markets.

Yes, free-market advocates can point out that a job "saved" in an obsolete economic sector is a job — often many jobs — forgone elsewhere in the economy. But that’s a very hard argument for a politician to make.

As Milton Friedman frequently observed, a business closing gets on the television news, while the new businesses that get created from the reallocated capital go unnoticed because they are so widely dispersed.

Mitt Romney has run smack into this problem during his campaign for the Republican nomination. Bain Capital, the firm he led, was a pure engine of creative destruction: a private investment fund that bought troubled businesses, restructured them (often by firing people), and sold them for a profit.

Even some of Romney’s Republican opponents, who know better, couldn’t resist attacking him for his entrepreneurial work. Romney contended that Bain had helped create 100,000 new jobs, which may be true, but — underscoring Friedman’s point — no one knows exactly where they are.

It may therefore be necessary for defenders of creative destruction to balance Schumpeter with some form of social support. It is misguided to protect superseded firms and industries, they would maintain, but helping people displaced by economic progress is a moral imperative.

They would argue for the implementation of a "compassionate capitalism," perhaps including unemployment benefits, retraining and various welfare services. (These should be designed not to become disincentives to work, as they frequently have been in the past.)

A compassionate capitalism wouldn’t merely be humane; it would also help preserve capitalism, because in a democracy, creative destruction cannot occur without some type of safety net. Workers who risk losing their jobs and lack any social support will soon vote an end to free markets.

Can a Schumpeterian candidate make it to the White House in 2012? Yes, but in the current climate of economic uncertainty, he will need to be a talented rhetorician.

Otherwise, the American economy in a second Obama term will probably continue to move in a European direction — and without the liberating fire of creative destruction, the United States will follow Europe down the path of slow growth, high unemployment and decline.

Original Source:



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