Joseph Schumpeter is famous for coining the phrase “creative destruction”. He described it as a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” This is a necessary component of capitalism. The strong survive and the weak die.
A new paper out of the University of Alberta by Claire Y. C. Liang, David McLean, and Mengxin Zhao finds that creative destruction has been on the rise in the USA over the last 50 years. Despite increasing concern over the size of our government and what many refer to as “central planning” the facts actually show that US companies are becoming more dynamic. They conclude:
“The rate of creative destruction among public firms increases in the U.S. during the period 1960-2009. We document statistically significant increases in big business turnover, changes in market share, the difference in growth rates between firms that gain and lose market share, and other measures that show an increasingly dynamic economy. The increase in economic dynamism is driven by increasingly fast-growing firms that exhibit increasingly high growths in total factor productivity, value-added, and profit margins, and have increasingly high R&D spending and patent grants. The type of firm that generates this creative destruction changes during the sample period. Creators are increasingly smaller and younger, and increasingly issue shares and debt; the average creator would have run out of cash by year-end had it not raised capital, and this financial dependence increases throughout the sample period.”
Perhaps most interesting in this discussion is the lack of creative destruction in the world of banking. I am generally in favor of deregulation, however, with regards to the financial industry I think a different approach is required due to the importance of this industry to overall US economic stability. As we now know, this industry has the ability to cause massive instability. And in one of the great ironies of economic history, deregulation led to what should have been massive creative destruction of our banking system in 2008.
Despite evidence showing that the US economy is becoming increasingly dynamic due to creative destruction, we have recently avoided this natural market process by saving the banks. And while Wall Street thrives, Main Street continues to struggle. Perhaps a bit more creative destruction in 2008 wouldn’t have been such a bad thing after all? Unfortunately, as a nation, we’ve decided that creative destruction is not allowed to occur for the Too Big to Fail banks. And that alone is the primary reason why they need to be strictly regulation.
You can’t have it both ways. If you’re not going to regulate them then you must allow the market to work and the process of creative destruction to play out. That’s clearly not an option and so regulation is the preemptive common sense approach. Unfortunately, the time for that appears to have passed. And so the boom/bust cycle continues. Since we have not regulated the banks properly it’s only logical that creative destruction will again impose its will on this sector at some point in the future. Next time, I hope we will be wise to utilize that event to fix this serious flaw in our economy.
The paper is attached in its entirety here.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.