Special Report

Creative Destruction, Properly Understood

A primer on this primary's hottest issue.

By 1.13.12

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Late Tuesday night, after finishing fourth in the New Hampshire primary, former Speaker of the House and current Republican presidential hopeful Newt Gingrich offered some remarks in which he tried, subtly, to say that he supports entrepreneurship and capitalism -- even while he and his supporters assail fellow GOP candidate and former venture capitalist Mitt Romney for the necessary "creative destruction" (not a term used by Gingrich) that accompanies capitalistic entrepreneurship.

There is no doubt that "creative destruction" is a pleasant sounding term -- made famous by Austrian economist Joseph Schumpeter -- describing the unpleasant fact that when businesses find ways to do something better or cheaper, they end up putting others out of business.

This means that the path toward long-term improvement of not just Americans', but humans', standards of living is crowded with losers along with the winners. As Michael Cox and Richard Alm of the Federal Reserve Bank of Dallas put it:

Herein lies the paradox of progress. A society cannot reap the rewards of creative destruction without accepting that some individuals might be worse off, not just in the short term, but perhaps forever. At the same time, attempts to soften the harsher aspects of creative destruction by trying to preserve jobs or protect industries will lead to stagnation and decline, short-circuiting the march of progress. Schumpeter's enduring term reminds us that capitalism's pain and gain are inextricably linked. The process of creating new industries does not go forward without sweeping away the preexisting order.

Newt put it this way: "The fact is the entrepreneurial free enterprise system, which attracted people from Benjamin Franklin to the Wright brothers to Henry Ford, to Thomas Edison, to Bill Gates, to Steve Jobs. That model of maximizing the development of new approaches, new energy, new opportunities, new technology has raised the standard of living of people across this planet more than any other system in the history of the world."

Meanwhile, Gingrich along with Texas Governor Rick "why am I still here?" Perry continues to assail Romney with terms like "Vulture Capitalist" seemingly oblivious of their hypocrisy.

The men Newt Gingrich lionizes were inventors who created identifiable products that have improved people's lives, with Henry Ford being responsible for the "assembly line" process which made automobiles affordable rather than for inventing cars.

Nobody is going to put Mitt Romney in a category with any of the great inventors of American history. Nevertheless, Romney's function in terms of "creative destruction" is not fundamentally different from that of any other participant in the capitalist system. Businesses aim to profit by doing or making something with better quality and/or lower price (as consumers frequently value a low price over high quality) than others are providing that same good or service. Some companies purchased by Bain Capital met these goals; some didn't. Some profited; some didn't. Some hired; some fired.

As Bastiat would point out, those who are only counting jobs are focusing on that which is seen while missing (in this case intentionally) that which is not seen.

Rick Perry is trumpeting the fact that some South Carolina workers lost their jobs in companies that were bought and sold by Romney's Bain Capital. A Gingrich-supporting Super-PAC is making a similar case in a 28-minute movie. Few other than Romney's supporters are talking about Romney's successes and how many jobs those created.

The problem with the entire discussion is that jobs are being used as the only measure of the "good" done by Romney. Profits are also good as they allow companies to grow and as they return capital to investors who can then fund the creation or growth of other companies. Indeed, despite our being surrounded by Keynesian-thinking politicians who believe that nothing is as important as consumers having spending money, the indirect benefits to society of profits to investors are arguably at least as large as the indirect benefits of employment.

But let's go back to Newt's list for a minute, as long as we're going to talk about jobs, and as long as we're going to use that as the only yardstick:

The Wright brothers' invention is responsible for the employment of hundreds of thousands, but also for the unemployment of many in competing industries such as railroad (almost 2 million jobs lost since 1920). Henry Ford's creativity would have ended the careers of even the best carriage and buggy-whip makers, some horse breeders, and hundreds of street cleaners. (Essentially all of the more than 100,000 carriage and harness making jobs which existed in 1900 have long since disappeared.)

Thomas Edison no doubt bankrupted dozens or hundreds of candle and oil lamp makers, not to mention the double-edged impact on the whaling industry.

Bill Gates, with Microsoft Office, ended the need for thousands of accounting firm employees and typing pools (there are more than 1/3 fewer secretaries today than in 1980, totaling roughly 1.5 million jobs). Apple's Steve Jobs, well he probably ended the jobs of quite a few of Bill Gates' former employees by out-teching the master of tech.

And were there YouTube a century ago, one can imagine a bitter movie being made about any of these great men by the few, or even not so few, whose lives were disrupted by the inevitable creative destruction of capitalism:

Narrator: So, Ethel, I know this is difficult for you, but what happened after Thomas Edison came to town?

Ethel: Our lives were never the same. I worked the afternoon shift at the Amalgamated Wick Company, supplying wicks to Acme Candle and Sealing Wax Inc. But once those electric lights came along, people only needed candles for séances and church services. I lost my job and have never been able to look at a light bulb again with having a panic attack.

Narrator: And Obediah, how did Henry Ford impact your life?

Obediah: I used to be the chief street sweeper in Rockport, Illinois. Our residents had the finest horses and buggies in the state. What's more, we had the finest Illinois grain to feed the horses, and so sweeping the streets was such a pleasure, with large piles of the best horse manure a person could ever hope to shovel. It was never too runny, never too smelly -- unlike the stuff I had to clean up as a boy growing up in Arkansas. Once the Tin Lizzie came along, though, people stopped appreciating the fine aroma of our well-fed horses, the fine consistency of their excrement, and instead rode around in those furless masses of steel and rubber, leaving the streets horribly clean, with an unnaturally s**t-free smell in the air. Can I say "s**t" on the wireless?

Yes, Ethel and Obediah were hurt, at least for a time, by the inventions of others which improved the lives of millions. And while nobody is claiming that Mitt Romney belongs in a pantheon with greatness like Ford, Edison, and Gates, the arguments against him could almost as easily have been made against them or against any other businessman competing in the marketplace.

The argument is easy to make because someone who lost his job is a sympathetic face to pose as a victim of a heartless capitalist. But it's the wrong argument, the wrong yardstick, especially for a presidential race where the issue is the long-term benefit of the entire nation. Would it have been better had Ethel and Obediah's jobs never gone away?

As Cox and Alm put it, "The disruption of lost jobs and shuttered businesses is immediate, while the payoff from creative destruction comes mainly in the long term. As a result, societies will always be tempted to block the process of creative destruction, implementing policies to resist economic change.

"Attempts to save jobs almost always backfire. Instead of going out of business, inefficient producers hang on, at a high cost to consumers or taxpayers. The tinkering shortcircuits market signals that shift resources to emerging industries. It saps the incentives to introduce new products and production methods, leading to stagnation, layoffs, and bankruptcies. The ironic point of Schumpeter's iconic phrase is this: societies that try to reap the gain of creative destruction without the pain find themselves enduring the pain but not the gain."

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About the Author
Ross Kaminsky is a self-employed trader and investor and is a senior fellow of the Heartland Institute. He is the host of The Ross Kaminsky Show on Denver's NewsRadio 850 KOA on Saturday mornings from 6 AM to 9 AM. You can reach Ross by e-mail at rossputin(at)rossputin(dot)com.