The power of creative destruction
On 10 March 2022, the Rafael del Pino Foundation organised the conference live on the Internet via www.frdelpino.es entitled "What drives economic growth?" which will be given by Philippe Aghion, on the occasion of the publication of his latest work entitled "The Power of Creative Destruction", published by Deusto.
Philippe Aghion is Professor of Economics at the Collège de France, at INSEAD and visiting professor at the London School of Economics, and a member of the Econometric Society and the American Academy of Arts and Sciences. His research focuses on the economics of growth. Together with Peter Howitt, he pioneered the so-called Schumpeterian growth paradigm, later used to analyse the design of growth policies and the role of the state in the growth process. Much of this work is summarised in his books Endogenous Growth Theory (MIT Press, 1998) and The Economics of Growth (MIT Press, 2009), in his book with Rachel Griffith on Competition and Growth (MIT Press, 2006), and in his study "What Do We Learn from Schumpeterian Growth Theory" (together with U. Akcigit and P. Howitt).In 2001, Philippe Aghion received the Yrjo Jahnsson Prize for the best European economist under 45, in 2009 he received the John Von Neumann Prize, and in March 2020 he shared the BBVA "Frontier of Knowledge Award" with Peter Howitt for "developing a theory of economic growth based on innovation arising from the process of creative destruction".
On 10 March 2022, the Rafael del Pino Foundation organised the online conference "What drives economic growth?", given by Philippe Aghion, professor of economics at the Collège de France and INSEAD, on the occasion of the presentation of his book "The Power of Creative Destruction".
Aghion recalled that Schumpeter is the person who introduced the concept of creative destruction, i.e. new innovations displacing old technologies. Schumpeter talks about it in "Capitalism, Socialism and Democracy". When he started studying economics, the concept of creative destruction did not exist, the theory was not structured. What he and Peter Howitt did in 1987, when they were both teaching at MIT, was to develop the model that included the concept of creative destruction.
There are three fundamental ideas. The first is that long-term growth is driven by innovation. The second idea is that innovation is incentivised by the revenue prospects derived from the results of innovation. The third is that new innovation will displace old technologies. A contradiction arises here. On the one hand, revenue from innovation is needed to incentivise innovation, but on the other hand, innovators want to use this revenue to block the entry of other innovators. In industrialisation, in the middle-income trap, in the environment, we will always face this contradiction.
Schumpeter thought that the early innovators would become incumbents who would prevent the emergence of new innovators, but we think that there are other doors that will prevent this prophecy from being activated. We are optimistic because we know that we can mobilise to avoid this pessimistic future. To do this, we use the lens of creative destruction to challenge some of history's conundrums.
In the industrial revolution the enigma is why industrialisation takes off in 1820 and why this happens in Europe and not in China, which had invented many important things. What we see is that the elements refer to this paradigm. First of all, accumulated innovation is essential, with institutions like the encyclopaedia, European universities. So there are institutions in Europe that favour this cumulative process. The problem is that if you used to make money, an aristocrat would expropriate you, but that changed and the rights of those who had innovated were protected. The problem is not only the incumbent companies but also the political powers, which may feel threatened by innovations. This is what happened in China, where the emperor was threatened by innovators and banned them. In Europe, on the other hand, there was competition between countries, so that if a scientist was persecuted in one country, he could leave another. For all these reasons, the industrial revolution arose in Europe, not in China.
Another puzzle is the stagnation of productivity. We know that factor productivity grew and then declined. The most convincing explanation has to do with the IT revolution. Think of superstar companies like Amazon or Facebook. When they grow, it is thanks to IT, but they invade the other sectors thanks to mergers and acquisitions. This becomes a deterrent to innovation in other small companies. Competition policy in the US does not accommodate these superstars. There is a perception that if you reform policy in the US, you are going to weaken the structures. If you adapt it to the digital age and when you allow a merger you make sure that there is going to be more innovation, you can turn the innovation curve around, which is going downwards.
Then there is the middle-income trap. This refers to countries that start to grow a lot but then stop growing, such as Argentina, South Korea or Japan. There are two ways to grow, one is to imitate advanced technology, and the other is to innovate at the frontier. Competition is essential to encourage innovation at the frontier, to avoid competition with rivals. The more the economy develops, the more it will have to rely on innovation at the frontier. In Korea there were the chaebols, business conglomerates that prevented competition and pressured the government not to transition to good institutions. The same is true in Japan with the keiretsus, which prevent other firms from operating and put pressure on existing firms not to move forward. The financial crisis of the 1990s reduced the power of the chaebols in Korea, forcing the government to open up competition. As a result, the power of the conglomerates weakened and more firms emerged.
Then there are the dynamic sources of inequality. Piketty, Atkinson and others have studied top income inequality, which has skyrocketed since 1980. There are different ways to get rich, one is by innovating, which allows you to get very rich. But there are other ways, like lobbying, lobbyists. Slim is rich because he is at the head of a monopoly thanks to moving well behind the scenes of power. Innovation generates growth, but lobbying does not generate growth. There is another difference, the effect of innovation on the intensity of inequality. In global terms the Gini coefficient does not show the effect of innovation because innovation also affects social mobility. Children's incomes are not correlated with parents' incomes, which means that there is new wealth replacing old wealth, i.e. there is social mobility. Innovation drives inequality, but it also drives social mobility, so it does not have as much effect on overall inequality. You see it in the evolution of wages in innovative companies, which tend to pay more to unskilled workers because these companies create jobs even for them, they learn, they are trustworthy, and this is very important. Innovation has these effects. The lobbyist, on the other hand, reduces this innovation because he tries to prevent access to new innovators, does not promote growth, prevents innovation and will have a negative effect on social mobility. In other words, it affects the Gini coefficient. In Piketty's world there are only lobbyists, there are no innovators. It is essential to have a policy to ensure competition. You cannot use wealth to prevent innovation.
There are also several general beliefs that turn out to be false. The first is that if we tax robots we will create jobs. But companies that automate create jobs, because they are more competitive, they lower their prices, they can sell more, and globally there is going to be more demand and they are going to have to hire more workers. So if we consider replacing humans with robots and the effect on productivity is good, we will have to hire more people, so taxing robots is a bad idea.
The second belief is protectionism. The problem with protectionism is that there will be retaliation, trade wars with other countries. If you lose export markets, you reduce the possibilities for innovation. So protectionism does not encourage competition and innovation. Germany has achieved a trade surplus because it has innovated, unlike France, which has distanced itself from Germany because it innovates less than it did before. France has lost market share because it has lost the ability to innovate.
Another general belief is that negative growth is the way to interrupt climate change. Global temperatures start to rise when the industrial revolution takes off. To a certain extent, we can say that those who advocate negative growth are right, but we cannot consider it because China and India start emitting CO2 and the curves start to rise when these countries start emitting. We cannot go back to 1920 because we live much better now - life expectancy is higher, poverty is lower - than we could have dreamed of before 1920. There was a natural experiment of negative growth, the first lock-in, where everything stopped between March and May 2020 and CO2 emissions were reduced by 8%. If we want to solve the climate issue in this way, we are going to have to change lives, with very bad effects on people, for example young people. The other alternative is to innovate in an ecologically friendly way. The problem is to find a cleaner source of energy, clean technologies. That is achieved by innovation. Creative destruction would be good because new companies don't have this legacy of old polluting technologies.
The state has a role to play in promoting greener innovation, for example through the green tax, but beware of protests, such as those of the yellow waistcoats in France. There are also subsidies for organic production. Civil society also has a role to play. Consumers have to be informed, and they will focus on those companies that are perceived as virtuous. In those countries where awareness has been raised, competition for innovation has increased, because customers prefer to consume environmentally friendly products. This is a very powerful instrument to promote innovation. This triangle of business, state and consumers is very powerful.
COVID has taken the blindfold off and we are rethinking capitalism. In the United States, the social model has been broken. In Europe we do not encourage innovation. Unemployment soars during COVID. The problem in the US is that when you lose your job, you also lose your health insurance. In Germany everybody has health coverage, so the US does not protect the most vulnerable parts of the population well. Also, in the US, when you lose your job, the risk of poverty increases; in Germany it does not. Another reality is the increase in mortality due to despair, due to the stress of losing your job, insurance, falling into poverty, depression. In Europe we don't have these problems.
But there is a very positive side to the US model, which is innovation. The US far outstrips Europe in biotech patents. They are much, much better and they have a fantastic ecosystem. Innovation is a process that goes from basic to applied research to commercialisation. The basic research is done in universities, which are very well funded in the US. There are also excellent agencies that fund research. There are also private donors. What these foundations do is identify the brightest, fund for the long term and encourage researchers to take risks, which generates excellent results. We don't have this in Europe.
In addition to the private sector, there are other realities, such as the possibility of creating start-ups, private investors in venture capital, which is much more developed. Then there are other institutions, such as DARPA, in defence, which promote this research. To win the space race against the Russians, you had to have a goal and coordinate resources very quickly, so the US created DARPA. Funding comes from the Ministry, a team leader launches projects and encourages their achievement. The results of DARPA are the internet, GPS. Then they created DARPA Energy and BARDA in biomedicine. BARDA was the agency that funded the research for the COVID vaccine.
The good side of the American model should be combined with the European model. Some say they are incompatible, but there are policies that allow innovation and protection to be combined. The first is flexicurity. In Denmark, even if you become unemployed, you will not consume more antidepressants and so on because they have flexicurity, which is that you receive 90% of your salary for three years, the state trains you and offers you jobs. If you turn down two jobs, you lose it. In Denmark it's easier because this support allows you to be more innovative and to protect workers.
Then there is education. With little income, there is little chance for someone to be innovative. In Finland, parental income matters because families with higher incomes are more educated, pass on knowledge and make their children aspire to more. So there is a growing relationship between income level and innovation. Why does it matter that schools are good, as in Finland? The explanation is that they reformed the system there in 1970. If we limit the investigation to those who entered the education system from 1970 onwards, the curve flattens because most Finns will have gone through a system of excellent quality established in the 1970s and there will be more potential innovators. Innovation leads to more inclusion and more innovation.
Growth and decline is associated with superstar companies. If we adapt competition policy to the digital age and break up the big conglomerates, or force them to share data, or reform mergers and acquisitions law, we will encourage innovation and the economy will be more innovative and inclusive.
Schumpeter was a pessimist because he thought that the first innovator would block the access of other innovators to the market. The state can react because it can enforce competition policy. The problem is that conglomerates try to prevent the state from applying this kind of legislation. Maybe we can say Montesquieu comes along and we can talk about the separation of powers. What happens is that, then, the constitutions of the countries contrast with real life. Colombia's is a copy of the French one, but in Colombia you can be killed if you are a trade union leader, but not in France. We need a state that is not captured by the market, and we need civil society. If we want to avoid being pessimistic, let us always remember this triangle of state, market, civil society. It is also important when we consider green.
The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.
The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.