Falsity of Creative Destruction
By Staff News & Analysis - August 24, 2010

From the Ashes … The most dynamic economies rely on creative destruction to grow. As the world continues to recover from the Great Recession, governments and businesses are focused on how to spur economic growth. But if they really want to create jobs, raise incomes, and lift living standards, they should devote more energy to figuring out how to generate economic dynamism over the long term. At times like this, governments tend to champion particular sectors like manufacturing, or industries like green technology. But true dynamism flows from continuous innovation, experimentation, adaptation, and change, all of which raise productivity over time. Those productivity gains, in turn, lift incomes and drive consumption. This fuels more innovation—and a dynamic economy thus expands in a healthy, sustainable way. Unfortunately, economic dynamism can also cause dislocation and turmoil as workers lose jobs in failing companies or in fading industries. Change in the ranking of companies has accelerated in many countries, including the United States, over the last century. The 90 names listed on Standard & Poor's index of major U.S. companies in the 1920s remained there for an average of 65 years. By 1998 a company listed on the S&P 500 could expect to stay there for an average of only 10 years. – McKinsey Institute, Newsweek

Dominant Social Theme: Capitalism constantly reinvents itself.

Free-Market Analysis: This is a very interesting article that appears in Newsweek by James Manyika, Susan Lund and Byron Auguste. Manyika is a director of the global management and consulting firm McKinsey & Co, (Newsweek tells us), and of the McKinsey Global Institute, where Lund is the director of research; while Auguste is the director of McKinsey & Co.'s social-sector office. From our point of view, the article espouses a kind of dominant social theme – that the Great Recession and the pain it is causing is part and parcel of the natural evolution of capitalism.

While an Austrian analysis would arrive at much different conclusions in our view, The McKinsey article does make use of a quasi-free-market oriented perspective which is obviously Schumpeterian. While Joseph Schumpeter can certainly be seen as something of a free-market economist, his theory of capitalism departed considerably from the monetary emphasis of more mainstream free-market analysis offered by the Austrians of his day. (His lifespan spanned the first part of the 20th century and he taught at Harvard.)

The von Mises Institute tells us this about Schumpeter: "He … aspired to be the greatest economist, lover, and horseman in the world — but then would add that he was having trouble with the horses. Although he was of Austrian descent and was a student of Eugen von Böhm-Bawerk, Schumpeter cannot be considered part of the Austrian School. He never opposed government intervention like his classmate Ludwig von Mises."

Schumpeter, apparently, is continuously cited by current economic heavyweights in the West, especially in Washington DC. Here is an excerpt from a bio in Wired magazine (2002) giving us some insight into his continued popularity. "In a paper presented at a recent Fed retreat, former treasury secretary Lawrence Summers and his ex-deputy Bradford DeLong observed that 'the economy of the future is likely to be "Schumpeterian,"' with creative destruction the norm and innovation the main driver of wealth. Products based on ideas – music, software, pharmaceuticals – require an enormous investment to develop but very little to keep making. And they're often subject to network effects, which reward those that achieve critical mass. Together, these factors – high cost to create, minimal cost to produce, and a winner-take-all environment – tend to generate natural monopolies, at least until the next innovation comes along."

The article itself may be seen as partaking of the above point of view. It postulates that the current pain that Western citizens are feeling as a result of the Great Recession and government "austerity measures" are part and parcel of dynamic capitalism. The trio also have a well-defined idea of what makes a successful Western nation-state, one that it presented toward the end of the article:

How exactly do we foster economic dynamism? Twenty years of McKinsey Global Institute research shows that the mix of sectors within an economy explains very little of the difference in a country's GDP growth rate. In other words, dynamism doesn't turn on whether an economy has a large financial sector, or big manufacturers, or a semiconductor industry, but instead on whether the sectors are competitive or not. Instead of picking winners and funneling subsidies to them, countries must get the basics right. These include a solid rule of law, with patents and protections for intellectual property, enforceable contracts, and courts to resolve disputes; access to finance, particularly for startups; and an efficient physical and communications infrastructure.

From our point of view, the argument being espoused here is convenient for those who want to explain the current economic disaster in terms of creative destruction rather than monetary failure. Schumpeter, of course, was knowledgeable about Austrian monetary theory and business cycles. But somehow he didn't see the need to apply business cycle theory to his perspective on how economies work, preferring to focus on the entrepreneur as his agent of creative destruction. He also believed that ultimately capitalism was doomed to turn into socialism as a result of governmental interferences, but that part of his vision is not convenient to the argument being postulated by McKinsey and Co. writers.

This article takes an economic theory and applies certain parts of it to modern circumstances to come up with a justification for the current economic disaster. By focusing on creative destruction, the article does not have to deal with the overwhelming monetary failure of central banking that brought the West to this place. That is also, probably, why Schumpeter is popular with the bankers at the Federal Reserve. He provides them with a template (if they massage his perspectives) that allows them to avoid talking about the monetary disasters that they tend to inflict upon the world.

Not only does the article use Schumpeter's theories to disguise the failures of central banking, it then proposes the predictable statist nostrums when suggesting what is necessary for success in the modern era. Patents, of course, are a government-created entrepreneurial status; meanwhile, the "solid rule of law" would tend to revolve around Western monopolistic legal practices in which the laws, judges, prosecutors and prisons are all run by the same authorities, leading to conflicts of interest and abuses.

Finally, the article suggests that "access to finance" is important. The reference here is to Wall Street and other financial centers. As we have pointed out in past articles, such financing mechanisms are essentially statist in the modern era, with winners and losers being sorted out not by the government but by power elite elements that have inserted themselves into an increasingly mercantilist marketplace.

What we have then in Newsweek is an article that misrepresents a man and his economic theory in order to try to divert attention away from the monetary failures of the central banking business cycle. Further, the solutions offered by the article are predictably statist and partake of the same failed authoritarian model that has brought us the current misery.

After Thoughts

It is perhaps fitting that such an article should appear in Newsweek magazine which was just sold, perhaps for as little as a single dollar. While we have admiration on a purely intellectual level for the way the authors have constructed this article, it devalues truth and has found a fitting home.

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