Tag Archives: creative destruction

Creative Destruction

The Nobel Prize for economics this year went to three economists who together developed an economic concept known as creative destruction. Creative destruction describes the economic impact that occurs when new technologies displace old ones.

Joel Mokyr is an economic historian. He identified the prerequisites for sustained growth through technological progress. His work pointed out that economic growth requires that a society must value the accumulation of useful knowledge, have the capability to transform ideas into tangible production, and have the cultural willingness to embrace change. He highlighted periods in history that were full of innovations, like ancient China, the Islamic world, and ancient Greece and Rome. But these societies never saw sustained economic growth. He contrasted this with the Enlightenment era, starting in 1750, when Western Europe began to institutionalize curiosity and reward experimentation. As an example, Britain’s Industrial Revolution celebrated innovation as a virtue rather than a threat.

Philippe Aghion and Peter Howitt shared the prize for developing a dynamic mathematical economic model that can quantify the impact of new technologies, products, and business models emerging to replace old ones. In the Aghion-Howitt model, firms invest in research and development in the hope of discovering better technologies. Innovators hope to be rewarded for breakthroughs with a temporary monopoly as their breakthrough renders existing technologies obsolete.

The dynamic economy created by creative destruction forces companies to constantly reinvent themselves or exit the market if they can’t keep up. The team argues that this is not a flaw and that continual renewal is the engine of economic progress. Creative destruction is not destruction for its own sake but is a way to constantly replace inferior technologies with better ones. Their theory explains why individual industries can be experiencing high turbulence while the overall sector continues to grow steadily.

Their models also warn against policies that shield incumbents from competition or attempt to “pick winners.” Governments that try to protect existing firms misunderstand the nature of growth. The process of creative destruction requires openness and freedom for new market entrants to challenge incumbents. Government policy must embrace entrepreneurship and allow for failure.

It’s interesting to look at the telecom industry from the perspective of creative destruction. From a pure technology standpoint, we’ve constantly embraced new technologies. Since 2000, when broadband emerged as in industry there has been a non-stop stream of new and faster broadband technologies that have displaced slower ones. It’s hard to think of a broadband technology that wasn’t given a chance to sink or swim on its merits in the market.

We’ve also seen a lot of companies reinvent themselves. AT&T went from a traditional telco to become a dominant cellular carrier, and is back investing again in wired fiber networks. The last twenty years have seen dozens of vendors thrive and then disappear as others made a better product.

However, at the same time, we’ve had a regulatory and legislative environment that has favored incumbents over new firms. Much of the regulation in our industry for the last thirty years has been intended to shield the giant telcos and cable companies from competition. For example, the large ISPs have been successful for years in demonizing municipal broadband as a way to preempt new competition. The big cell companies gobbled up all available spectrum to keep competitors out of the market.

But competition still finds a way to win against incumbents. Witness the recent success of FWA wireless and satellite technology. We’re starting to see historic incumbents that are stumbling and even failing, like the steady downhill trajectory of CenturyLink.

Are We at the End of Creative Destruction?

closed-factory-Flickr-sludgegulperCapitalism has thrived over the past few centuries due in large part to a phenomenon called creative destruction. This phrase was coined by economist Joseph Schumpeter and refers to the process where new technologies and new industries replace old ones, with a net gain for society.

There are thousands of examples of this through time. In the transportation area alone we’ve moved from horse & buggies and canals to cars, subways, interstate highways, and airplanes. We’ve moved from hand looms to cloth factories to synthetic fabrics (and were able also to replace the ironing board). There is almost nothing from a hundred or more years ago that is still made in the same way.

Creative destruction has always resulted in a net good for the economy and has thus been good for mankind. For every technology that has been displaced something better took its place. Overall there were more jobs created by new technologies than displaced by old ones. Look at the automotive industry as a great example and consider how many jobs there are in car and parts factories, gas stations, repair shops, etc. — far more than were employed taking care of horses and trolleys.

I read an article that said that per capita incomes in the US were 28 times higher in 2000 than they were in 1790. This is largely due to creative destruction, which is why it’s the bedrock of capitalism. Each new technology that has come along has been more efficient than the last, and the growth in wealth has largely been due to this increase in efficiency.

This is not to say that creative destruction is not disruptive. People who worked for industries being displaced have always lost their jobs. This is never smooth on a local level and there are thousands of communities along the way that suffered when their local factory or businesses were supplanted by something new. To a large degree, over the last century the new businesses tend to be in urban areas, which is one of the contributors to the long-term trend of rural populations migrating to cities around the world.

But there are now a number of economists who think that we might have reached the end of creative destruction and that the old paradigm is no longer functional. Economists measure overall efficiency of an economy using labor productivity – the output per hour of the average worker. For example, since World War II productivity grew at an annual rate of about 3%. But starting in 2004 that rate has slowed to 1% per year, and most recently is under 0.5%. This is one of several factors that have led to wage stagnation.

There is still a lot of wealth being created in the country, but a lot of it now comes from information technologies and not from the historic phenomenon of replacing industries with something better. A great example is Facebook and all other social media. They have created tremendous wealth for their creators, but they are replacing and/or monetizing older ways of socializing. Granted they are new industries, but they bring very few jobs. It’s amazing how many of the largest web companies have created billions in wealth with less than a few hundred workers.

Lately, we are also seeing whole industries dying without being replaced by new jobs. The typical example given is photography. There was a huge photography industry that was replaced by digital cameras. Gone are most of the companies that made cameras and film and who processed pictures for people, replaced by one minor component of smartphones. But this has happened to other industries like the music business and the news business. Blogs are interesting, but they really don’t take the place of having live news coverage of worldwide events.

Worse, we are standing at the edge of a time when large numbers of jobs might be permanently replaced. For example, companies like Amazon created a large numbers of jobs in their warehouses, but they are working to automate the whole warehouse process. We see robots starting to take on roles like hospital orderlies, hotel concierge, baristas, and a number of other jobs. The combination of robots and AI is also likely to start replacing scores of traditional white-collar jobs like accountants, paralegals and other information workers.

The big changes we are now seeing are due largely to both the application of Moore’s law and the fact that computers are getting strong enough to be able to mimic human behavior well enough to take over functions that only humans could do.

I always read that there is still going to be room in the world for human creativity. The problem with that is that society probably won’t value a lot more creative jobs than there has been. We’ve always had our inventors and scientists and writers and artists and most people are not able to do this kind of creative work, nor is there going to be a huge uptick in demand for these kinds of skills (meaning somebody willing, or able, to pay for it). It could be that creative destruction is now going to be replaced by plain destruction and that technology is going to replace a lot of jobs that cannot be replaced. If so, the world better get ready to find ways to deal with a lot of people who can’t find paying work. It’s a scary thought.