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Posts Tagged ‘Creative Destruction’

I shared a video last year that pointed out that Americans live in a nation that became prosperous thanks to “creative destruction.”

That’s the term developed by Joseph Schumpeter to describe the economic churning caused by competition, innovation, and markets (international trade is just a minor part of this process, though it’s the part that generates the most controversy).

The bad news is that some people lose their jobs as the economy evolves and changes. And some companies go bankrupt. There are real victims and tragic stories.

But the good news is that other jobs are created. And entrepreneurs start new businesses.

And the better news is that our living standards increase. Especially over time. Even for many of those who lost jobs in the short run.

That’s why we’re much richer, on average, than our parents and grandparents.

Needless to say, a key measure of a healthy and dynamic economy is for the job gains to exceed the job losses.

So when I spoke to congressional staff earlier this week about trade and protectionism, I figured I should go beyond theory and include some numbers.

I went to the relevant website at the Bureau of Labor Statistics and found that more than 28 million jobs were lost in 2017 (final data for 2018 is still not available).

That sounds terrible. And for many workers, it was horrible news.

But the good news, as you can see in the screenshot below (click to expand), is that the U.S. economy created more than 30 million new jobs that year.

The obvious takeaway from this data is that the crowd in Washington should adopt policies that ensure we have strong growth so that people who lose jobs have lots of good options for new employment.

In other words, don’t impose the kind of policies that have created high unemployment and economic stagnation in many European welfare states.

For what it’s worth, that message seems to be lost on Bernie Sanders, who has a long list of policies that would turn America into a version of GreeceFrance, and Italy.

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I have a four-part video series on trade-related topics.

  • Part I focused on the irrelevance of trade balances.
  • Part II looked at specialization and comparative advantage.

Here’s Part III, which explains how trade (whether domestic or international) leads to creative destruction, which results in some painful short-run costs but also yields immense long-run benefits.

I recently argued that creative destruction is the best part and worst part of capitalism.

It’s bad if you’re a worker in a company that loses out (or if you’re an investor in that company). but it’s also what enables us to become more prosperous over time.

I’m not alone. Writing for CapX, Oliver Wiseman reviewed Capitalism in America, a new book by Alan Greenspan and Adrian Wooldridge. Here are some key observations.

…there was nothing predictable about America’s rise from colonial backwater to world-beating economy. …The fight for independence began a year before the publication of Adam Smith’s The Wealth of Nations; “the new country was conceived in a revolt against a mercantilist regime that believes a nation’s economic success was measured by the size of its stock of gold.” …The Constitution’s limits on the power of the majority set America apart from the rest of the world and “did far more than anything else to guarantee America’s future prosperity…” On top of this fortuitous start is the country’s “greatest comparative advantage”: its “talent for creative destruction”, the driving force of innovation, growth and prosperity that “disequilibriates every equilibrium and discombobulates every combobulation”. Americans realised that “destruction is more than an unfortunate side effect of creation. It is part and parcel of the same thing”. …The result is a system that has squeezed more productive energy out of its human capital than other countries, and generated unparalleled prosperity.

For those interested in economic history, Joseph Schumpeter gets most of the credit for developing the concept of creative destruction.

This Powerpoint slide is a nice summary of Schumpeter’s contribution (notwithstanding the fact that the person misspelled his name).

And here’s a Tweet showing that Schumpeter was under no illusions about the folly of socialism.

The bottom line is that creative destruction is what gives us churning, and churning is what dethrones rich and powerful incumbents. My friends on the left should be cheering for it.

Instead, they push for regulations and taxes that hinder creative destruction. And that means less long-run prosperity for all of us.

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I fully agree with my leftist friends who say that corporations want to extract every penny they can from consumers. I also (mostly) agree with them when they say corporations are soulless entities that don’t care about people.

But after they’re done venting, I then try to educate them by pointing out that the only way corporations can separate consumers their money is by vigorously competing to provide desirable goods and services at attractive prices.

Moreover, their “soulless” pursuit of those profits (as explained by Walter Williams) will lead them to be efficient and innovative, which boosts overall economic output.

Moreover, in a competitive market, it’s not consumers vs. corporations, it’s corporations vs. corporations with consumers automatically winning.

Mark Perry of the American Enterprise Institute makes a very valuable point about what happens in a free economy.

Comparing the 1955 Fortune 500 companies to the 2017 Fortune 500, there are only 59 companies that appear in both lists (see companies in the graphic above). In other words, fewer than 12% of the Fortune 500 companies included in 1955 were still on the list 62 years later in 2017, and more than 88% of the companies from 1955 have either gone bankrupt, merged with (or were acquired by) another firm, or they still exist but have fallen from the top Fortune 500 companies (ranked by total revenues).

It’s not just the Fortune 500.

…corporations in the S&P 500 Index in 1965 stayed in the index for an average of 33 years. By 1990, average tenure in the S&P 500 had narrowed to 20 years and is now forecast to shrink to 14 years by 2026. At the current churn rate, about half of today’s S&P 500 firms will be replaced over the next 10 years.

Here’s Mark’s list of companies that have stayed at the top of the Fortune 500 over the past 62 years.

Mark then offers an economic lesson from this data.

The fact that nearly 9 of every 10 Fortune 500 companies in 1955 are gone, merged, or contracted demonstrates that there’s been a lot of market disruption, churning, and Schumpeterian creative destruction over the last six decades. It’s reasonable to assume that when the Fortune 500 list is released 60 years from now in 2077, almost all of today’s Fortune 500 companies will no longer exist as currently configured, having been replaced by new companies in new, emerging industries, and for that we should be extremely thankful. The constant turnover in the Fortune 500 is a positive sign of the dynamism and innovation that characterizes a vibrant consumer-oriented market economy.

He also emphasizes that consumers are the real beneficiaries of this competitive process.

…the creative destruction that results in the constant churning of Fortune 500 (and S&P 500) companies over time is that the process of market disruption is being driven by the endless pursuit of sales and profits that can only come from serving customers with low prices, high-quality products and services, and great customer service. If we think of a company’s annual sales revenues as the number of “dollar votes” it gets every year from providing goods and services to consumers… As consumers, we should appreciate the fact that we are the ultimate beneficiaries of the Schumpeterian creative destruction that drives the dynamism of the market economy and results in a constant churning of the firms who are ultimately fighting to attract as many of our dollar votes as possible.

Incidentally, Mark did this same exercise in 2014 and 2015 and ascertained that there were 61 companies still remaining on the list.

So creative destruction apparently has claimed two more victims.

Or, to be more accurate, the needs and desires of consumers have produced more churning, leading to greater material abundance for America.

I’ll close with two points.

All of which explains why I want separation of business and state.

The bottom line is that an unfettered market produces the best results for the vast majority of people. Yes, people are greedy, but that leads to good outcomes in a capitalist environment.

But we get awful results if cronyism is the dominant system, and that seems to be the direction we’re heading in America.

P.S. Even when corporations try to exploit people in the third world, the pursuit of profits actually results in better lives for the less fortunate.

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There’s a meme on Facebook and Twitter that asks people to “confess your unpopular opinions.”

I suppose I could play that game by saying that I’d rather eat fast food than patronize most fancy restaurants (especially if I have to pay the bill!). And I’ve unintentionally played that game already by admitting that politicians aren’t always sinister and evil.

But I have something even more astounding to confess: My leftist friends are right when they assert that the free market destroys jobs.

Not only are they right, they probably underestimate the number of jobs that are destroyed by capitalism. Over time, millions of jobs vanish because of the greedy pursuit of profits.

Mark Perry of the American Enterprise Institute shares some very sobering data on how almost all of the big companies of the 1950s have faded over the past 60 years.

Comparing the Fortune 500 companies in 1955 to the Fortune 500 in 2014, there are only 61 companies that appear in both lists. In other words, only 12.2% of the Fortune 500 companies in 1955 were still on the list 59 years later in 2014, and almost 88% of the companies from 1955 have either gone bankrupt, merged, or still exist but have fallen from the top Fortune 500 companies (ranked by total revenues). Most of the companies on the list in 1955 are unrecognizable, forgotten companies today (e.g. Armstrong Rubber, Cone Mills, Hines Lumber, Pacific Vegetable Oil, and Riegel Textile). …That’s a lot of churning and creative destruction, and it’s probably safe to say that almost all of today’s Fortune 500 companies will be replaced by new companies in new industries over the next 59 years.

And why did these companies disappear or shrink in size, thus leading to major job losses?

Mostly because capitalists, seeking profits, invested money in ways that displaced old technologies, hurt old competitors, and made old products less attractive.

Sounds terrible, right? Jobs are lost because of greedy rich people trying to increase their wealth.

And if you’re one of the people in the unemployment line, it is terrible.

But keep in mind that this process of creative destruction led to new technologies, new competitors and new products. And the net effect of all these changes is that – on average – we are much richer.

Mark elaborates.

…for that we should be thankful. The constant turnover in the Fortune 500 is a positive sign of the dynamism and innovation that characterizes a vibrant consumer-oriented market economy… In the end, the creative destruction that results in a constantly changing group of Fortune 500 companies is driven by the endless pursuit of sales and profits that can only come from serving customers with low prices, high quality and great service.

Indeed, this system is what has given us the “hockey stick” of human progress.

All this disruption and change is what enables our society, over time, to grow faster and produce more goods and services and lower prices.

At least when the market is allowed to operate with the right set of policies – what I call the recipe for growth and prosperity.

In my speeches, I sometimes make similar points by using historical examples.

  • I ask audiences to think about how personal computers have made our lives more enjoyable and productive, but I then ask them to ponder what happened to the people who had jobs making, selling, and servicing typewriters.
  • I ask audiences to think about how the automobile boosted productivity and increased mobility, but I then ask them to consider the lost jobs of people in the horse and buggy industry.
  • I ask audiences to think about how electrification and the light bulb improved the economy in countless ways, but I then ask them to speculate on the number of jobs that were destroyed in the candle-making sector.

The sad reality is that progress has a price tag. Yes, we are far richer because of great inventions that boosted productivity and improved lives. But that doesn’t change the fact that real workers with real families often experienced genuine anguish when jobs in some sectors disappeared. And that’s still happening today.

And workers are largely blameless when job losses occur. All they did was exchange honest work for honest pay. It was the capitalists who made mistakes by not managing companies effectively and not allocating capital efficiently (or, to be more charitable, they simply failed to anticipate major changes that were about to occur).

By the way, this isn’t an argument for government intervention. We would be much poorer today if politicians tried to save jobs every time there was creative destruction in the economy. Perhaps most important, every job that they “saved” would be offset by the jobs (and prosperity) that weren’t created or didn’t materialize because the clumsy foot of government replaced the invisible hand of the market.

What Bastiat taught the world in the 1800s is still true today. We have to consider both the seen (the jobs that are saved) and the unseen (the greater number of jobs that don’t get created) when contemplating the impact of government.

This is why I want the economy to be as dynamic and innovative as possible so that displaced workers can find new positions as quickly as possible, hopefully earning even more money.

Here’s a short video from Learn Liberty that teaches about this process of creative destruction.

P.S. There’s also another Learn Liberty video that teaches about creative destruction. I’m a big fan of all their videos, including the ones on the Great Depression, central banking, government spending, and the Drug War. And the videos on myths of capitalism, the miracle of modern prosperity, and the legality of Obamacare also should be shared widely. You also should watch their videos on job creation, the price system, public choice, and the Food and Drug Administration.

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I sometimes wonder whether journalists have the slightest idea of how capitalism works.

In recent weeks, we’ve seen breathless reporting on the $2 billion loss at JP Morgan Chase, and now there’s a big kerfuffle about the falling value of Facebook stock.

In response to these supposed scandals, there are all sorts of articles being written (see here, here, here, and here, for just a few examples) about the need for more regulation to protect the economy.

Underlying these stories seems to be a Lake Wobegon view of financial markets. But instead of Garrison Keillor’s imaginary town where “all children are above average, we have a fantasy economy where “all investments make money.”

I don’t want to burst anyone’s bubble or shatter any childhood illusions, but losses are an inherent part of the free market movement. As the saying goes, “capitalism without bankruptcy is like religion without hell.”

Unlike today’s chattering class, King Canute understood limits to power

Moreover, losses (just like gains) play an important role in that they signal to investors and entrepreneurs that resources should be reallocated in ways that are more productive for the economy.

Legend tells us that King Canute commanded the tides not to advance and learned there are limits to the power of a king when his orders had no effect.

Sadly, modern journalists, regulators, and politicians lack the same wisdom and think that government somehow can prevent losses.

But perhaps that’s unfair. They probably understand that losses sometimes happen, but they want to provide bailouts so that nobody ever learns a lesson about what happens when you touch a hot stove.

Government-subsidized risk, though, is just as foolish as government-subsidized success.

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