Creative Destruction - Again; D. Laband and J. Wells

Media reaction to the announcement was predictable: interviews of wary workers likely to lose their jobs fillednewspapers and the airwaves. The anticipated human misery makes for good copy and even better 60 second sound bites. Yet to focus attention on this aspect of the job losses and not on the underlying causes and consequences is to completely overlook one of the most fundamental and positive aspects of Amer ica's market economy: job destruction for a relative few is a byproduct of a vibrant economy that enhances the welfare of many millions of individuals. Dr. Laband is Professor ofEconomics at Auburn University in Auburn, Alabama. Dr. Wells is an assistant professor of economics at Auburn. Typically, in a growing economy, job losses result from two sources: competitive pressures that force firms to economize on production costs, and technological devel opments that either improve the production process of firms or lead to the marketing of new products that make other products "outmoded." Both lead to structural unem ployment and associated hardship for the adversely affected individuals.

When the media focus only on individual hardships, they fail to consider the long term economic consequences of the job losses. Lost is the fact that literally millions of Americans' lives are enhanced by virtue of the lower prices they pay for goods and services they consume and by virtue of the new, perhaps revolutionary, products that previously were unavailable. As Joseph Schumpeter pointed out in Capitalism, So cialism and Democracy, "[t]he opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.s. Steel illustrate the same process of indus trial mutation-if I may use that biological term-that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative De struction is the essential fact about capital ism."

The value of the aggregate economic en hancement to millions of lives utterly swamps the aggregate economic suffering of displaced workers. An example is illus trative. Suppose that, in the aggregate, each 210 211 individual in America will gain the equiva lent of $10 worth of added value to hislher life each year from price cuts and new products produced in 1996, and that, again in the aggregate, the developments that promoted these gains by consumers were achieved at a loss of 100,000existing jobs. With 260 million (or so) consumers, the aggregate wellbeing of Americans in creases by some $2.6 billion. In truth, the typical consumer probably gains far more than $10worth ofadded value to his life (especially in a present-value sense) from the introduction of new prod ucts and services, as wellas by development of new methods of production that lead to price cuts on existing merchandise. Think of the enrichment to human lives generated by computers and word processors, micro wave ovens, fax machines, automobiles, airplanes, radios and televisions, washing machines, disposable diapers, electricity, hearing aids, contact lenses, pharmaceutical drugs, and so on. The average American probably values these advances to the tune of thousands, if not tens of thousands or even hundreds of thousands of dollars, each year.

Moreover, the job losses suffered by dis placed workers are typically temporary. These individuals (or others who might have followed them into their old employ ment) develop new skills that contribute to the production of other, valuable goods and services. Who weeps for the nearly 37 percent of Americans who no longer are engaged in farming? In 1900 nearly 40 percent of all workers were engaged in farming; today that fraction is less than 3 percent. Did the lost jobs impoverish America? Were job losses in the agricultural sector "bad"? Of course not. Far from reflecting evil times in agri culture, occupational flight from farming reflected simply stunning gains in farm pro ductivity during the first half of the twentieth century. The fact that it took only three Americans per 100workers to feed America 5000~--------------~5.0 3.0 3.5 4.5 4.0 r __ ,, " , " II ' I : \j,, I I, I " ," ,I' I I ' I , ", 'o!

I, I I ,...... I , ..,,,, I I, I I I 1 I " ,... ..., , "I, ", I , I, I \ I , , , I , " J \ : , I \\ ,\: " \ I" '\ I, J \ \ / \~ \, \ J , \ I , " ,~ \,,,,, \ ---I I, \ 1\ I , \ , , \ 1 " \, , \ , I \ I , \ \, ,, , I , , 1 I I I I , I , I "II 2000 3000 4000 1000 o 2.5 66 68 70 72 74 76 78 80 82 84 86 88 90 92 1--FAILURES um_ PATENTS I 212 THE FREEMAN • APRIL 1996 in 1995 rather than the 40 in 1900 reveals prosperity that freed up 37 percent of our workforce to pursue other types of produc tivity: designing and building automobiles and aircraft, communications systems, elec tric power systems, developing new medical procedures and drug therapies, and invent ing new products and processes by the thousand that contribute to a standard of living in 1996 that could perhaps barely be imagined in 1900. A comparison of measures of innovative activity over time against measures of busi ness failure over time reveals the essential relationship between creation of new prod ucts and processes and the obsolescence and death of old products and processes.

The dotted line in the figure on page 211 depicts the number of per capita (times 1,000) new inventions patented over the 28-year period, 1965-92,inclusive; the solid line represents per capita (times 1,000)busi ness failures. Over the first half of this period (roughly 1965-77), the intensity of innovative activity falls, as does the inci dence of business failures. By contrast, during the more recent 15 years (1978-92), the incidence of innovative activity has generally been rising, accompanied by a general increase in the incidence of business failures. Obviously, there are many factors that influence both the pace of innovative activity and business failures, so an exact relationship between these two data series may ·be hard to define specifically. None theless, the two graphs suggest, at a mini mum, that the innovative activity that is so vital to enhanced economic well-beingover time is associated positively with the obso lescence of products and industries that, in tum, leads to displaced workers.

GovernmentRegulation Government regulation tends to exacer bate the job destruction associated with in novative activity. This is because the effect, if not the intent, of many government regulations is to insulate the affected indus tries from competition. This creates condi tions under which domestic firms not only charge higher prices to consumers than would exist in a more competitive environ ment, they lack incentive to produce effi ciently. Additional innovative activity by potential competitors eventually breaks down the barriers imposed by regulation. When this occurs, high-cost, regulation driven firms are forced suddenly to compete with low-cost, efficient, consumer-oriented firms. The result tends to be quite sudden, massive layoffs in the affected industries, as opposed to the more measured and con tinuous labor force· adjustment that firms would undertake in a more competitive environment.

The fact that we are now experiencing decliningunemployment with little evidence of any upward pressure on inflation is puz zling to many economists, as well as non economists. We believe that this is not surprising at all, given the constant eco nomic metamorphosis that characterizes the modem American economy. The dual pro cesses of innovation and re-engineeringpro duction imply continuous job creation as well as job displacement, and an expanding economy with little inflationary pressure. The announced job reductions at AT&T and other large (and small) firms may not make the displaced workers rejoice, but they should make everyone else feel pretty good. [] THEFREEMAN IDEASON LIBERTY Jack the Radical by Alastair Segerdal I n the late nineteenth century, despite fabulous wealth, gracious living, and an industrial revolution that had reached the far corners of her empire, Britain was also an island of social unrest. Working-class dis content with poverty and disease was fuel ing the rise of socialism, and new doctrines were calling for revolution and an end to the monarchy. Parliamentary controversy over the age-old "Irish Question" was bitter as rioting from the Emerald Isle spread to the not-so-United Kingdom. Its capital, Lon don, was a city of great commerce, high fashion, and sophisticated culture-a city of wealthy gentlemen and gentle ladies, their children attended by nannies as they played in Hyde Park.