The Power of Creative Destruction: Economic Upheaval and the Wealth of Nations

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Release Date: 
April 20, 2021
Belknap Press: An Imprint of Harvard University Press
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“To paraphrase a quote referring to Keynes, another famous economist, the book may convince readers that we should all be Schumpeterians now.”

The Power Of Creative Destruction is an important book for the times. For years now the focus has been on the alleged shortcomings of capitalism such as those related to increasing income inequality, the failure to address climate change, and the market dominance of Big Tech. In sharp contrast, in this book the authors “argue that the answer to our problems is not to abolish capitalism. It is to invent a better capitalism by harnessing the power of creative destruction—innovation that disrupts, but that over the past two hundred years has also lifted societies to previously unimagined prosperity.”

Creative destruction is the term coined by Joseph A. Schumpeter, a Harvard economist (by way of Austria and Germany) in his famous book Capitalism, Socialism and Democracy first printed in 1942. Schumpeter found that creative destruction is the essence of capitalism. It is the process of constant innovation in the way we produce goods and services, so that prices fall and quality rises.

It is hopeful and correct to show that capitalism can be the cure of what ails modern economies, not the cause of those ailments. The heated debate on income inequality, for example, has focused on the share of income going to the top one percent of income earners. The authors admit that innovation increases the income share going to the top one percent, but they add that there are three offsetting virtues. Specifically, the authors state that, “innovation does increase top income inequality, but it comes with a trio of virtues: it does not increase overall inequality, it fosters social mobility [people moving up from low to higher income], especially when it involves new innovators entering the market, and it stimulates productivity growth [which drives economic growth].”

Innovation can create prosperity even when an economy faces limitations such as the need to cut carbon dioxide emission that causes global climate change. The key is to properly diagnose the problem and then to define the policies needed to make for a better capitalism.

The authors state that the problem of climate change is about “two types of externalities” or two costs not reflected in market prices. They argue that “there is first an environmental externality associated with the production of polluting goods and the CO2 emissions this production entails. But there is another type of externality that has to do with the phenomenon of path dependence in innovation.” Path dependence reflects the tendency of a firm to stick with the technologies that it currently uses.

This book suggests a package of policies to address these two externalities. The authors opine that there is “the need for state intervention to redirect innovation toward green technologies. Yet the state should not try to take the place of the firms; it should act through incentives. We [the authors] have identified several levers to motivate firms toward green innovation: a carbon tax, subsidies for green innovation, technology transfer to developing countries, and carbon tariffs to discourage pollution havens.”

The authors also write of an “enigma” involving the relationship between competition and innovation. Those investing in innovation must earn rents (excess profits) as an incentive for that investment, and yet the purpose of creative destruction is to have new competitors, at some point, take those rents away. They write that “capitalism must reward innovation, but it must be regulated to prevent innovation rents from stifling competition and thus jeopardizing future innovation.” Regulations are needed to keep the path open for new entrants. This is a big issue today, for example, when discussing the market dominance of Big Tech. The fear is that Big Tech uses its rents to acquire emerging new entrants before they are large enough to compete on their own.

The authors turn to even broader issues that describe the political economy of innovation. They define “the critical triad of the market, the state, and civil society for the proper functioning of an economy of innovation and creative destruction.” The authors define the role for each of these three entities saying, “the market provides incentives to innovate and constitutes the framework in which innovative firms compete. The state is there to protect property rights on innovations, to enforce contracts, and to act as an investor and insurer. Finally, civil society—the media, labor unions, nonprofits—generate or call for the enforcement of constitutional provisions intended to check executive power and ensure greater efficiency, ethics, and justice in the operation of the market.”

The end goal for all three entities, according to the authors, is to promote innovation through new entry and to not allow incumbent firms to block that new entry. The authors succinctly connect politics to economics and argue that “Innovation Needs Democracy.”

The book is structured as a series of smart, analytic anecdotes. The narrative flow is disrupted at points by figures and tables (one or more every few pages). The reader has to take time to study those figures and tables to understand the metrics being used, the source of the data, and the time frame presented. The reader may also find points of contention: for example, the list above that defines civil society appears to be too narrow and the range of civil society’s responsibilities might be too broad.

These shortcomings are small in comparison to the value this book brings to the debate on the future of capitalism. Readers will want to have this book within easy reach if interested in economics, politics, or global development. To paraphrase a quote referring to Keynes, another famous economist, this book may convince readers that we should all be Schumpeterians now.