Economic Growth Trade-Off: Creative Destruction V Stability

Why Economic Growth Rates Are Important

Our earliest estimates of the U.S. economy begin in 1790. From then to 1850, gross domestic product per capita grew at an average rate of 1.2% annually, adjusted for inflation. Then through 2000 our growth averaged 2.0% per year. Is that a big difference? Actually, it’s huge because it compounds annually, like interest in an investment account.

Generations are about 30 years apart. (That’s the average age of the mother when a child is born.) So a grandchild is 60 years away from the grandparents, on average. Over a 60 year period, economic growth of 1.2% means that the grandchild is about twice as prosperous as the grandparents. But with 2.0% growth, the grandchild is more than three times as prosperous.

Putting these percentages into numbers, suppose the grandparents live on annual income of $40,000. At the 1.2% growth rate, the average grandchild would live on income of $82,000 a year. At the 2.0% growth rate, though, the average grandchild lives on $131,000 a year. That’s a whole lot more.

GDP is not a perfect measure of well-being, but it correlates very highly with other important measures, such as health, education, life expectancy and overall life satisfaction. Thus, long-term growth rates should be considered in debates about public policy.

Business Effects Of Long-Term Growth Rates

Businesses making long-term decisions about capital spending and product development must think about demand for products 20 years from now. California’s largest electric plant, for example, took over 20 years for planning and construction, and it has lasted over 40 years so far. That requires business leaders to take a very long-term perspective. Other industries have shorter time lines, but compound growth can make a noticeable difference over just ten years, much shorter than the average lives of buildings and much machinery.

Companies developing new products should wonder if future consumers will be relatively rich or poor. A sense of long-term growth rates helps this. If growth continues at a faster pace, people will look to upgrade many of the goods and services they buy. They’ll be more willing to purchase nicer cars and to take vacations in more luxurious locations, to cite just two examples.

Forecasting Long-term Growth Rates

Predicting long-term growth rates seems difficult, with plenty of controversies among the economists studying the matter. Though the pessimists should be considered carefully, the latest Nobel laureates—awarded their prizes for their on work long-term growth—are optimistic.

A simple version of some pessimism is that the low-hanging fruit has already been harvested. More formally, economists have long believed that many processes face diminishing returns. For instance, if you have some workers and give them a little equipment, that helps a lot. Give them more equipment and that will help them, but not by as large an increment as the first addition. Eventually, further equipment will have a negligible impact on total production. The example also works with a fixed amount of equipment but additions of more workers. The first additional worker may be able to run a second shift; the next will work a third shift. A fourth might cover lunch and coffee breaks for other workers. But at some point, adding more workers does very little for overall production.

Healthcare provides a good example. The germ theory of disease was a huge step forward, helping doctors understand that polluted water sources spread disease, and then helping to develop antibiotics. It’s hard for us to imagine another scientific breakthrough as big as the germ theory.

Commenting on the low-hanging fruit analogy, though, economist Joel Mokyr said that we can build higher ladders. In a sparkling Nobel Prize lecture (understandable by non-economists), he pointed out some of our innovations spawned many offspring, magnifying their importance. Crispr technology in biology has enabled many further innovations. Artificial intelligence is enabling a tremendous number of new discoveries. There is a strong argument for exponential growth rather than diminishing growth.

Another Nobel laureate studied companies and found some tried to maintain the status of their past innovations without much further development, but there were young, “hungry” firms that wanted to displace the established ones. Philippe Aghion argues that we can have faster growth than we’ve achieved, but that we have to ensure that the dominant firms don’t block further innovation by others. And that leads us to consider the choice between growth and stability.

Economic Growth Versus Stability

Although economic growth seems like an obvious goal for an economy, it contrasts with another possible goal: stability. Mokyr describes in Conversations With Tyler the Chinese goal in Medieval years: “What they wanted, above all, was stability and internal peace, rather than what the Europeans wanted, which was progress and growth.”

Joseph Schumpeter described a process “… that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” The destruction aspect entails employees losing the jobs to which they have become accustomed, old companies closing down, and old institutions shrinking. It is the very opposite of stability.

Examples of stability-driven policy abound. In Japan’s “lost decade” of the 1990s, the government pressured banks to continue lending to failing companies. The banks had limited resources and thus could not lend much to small, innovative companies. Trying to avoid the destruction prevented creative growth.

Many European countries have strong employee protection laws, so laying off employees is expensive. In that environment, companies are very hesitant to take risks that involve hiring new employees. And start-up companies have trouble finding experienced workers to hire, because layoffs are so rare.

In the United States, environmental protections have stopped or slowed many projects that would fuel economic growth, leading to the complaint that we cannot build anything. For example, just as artificial intelligence ramps up as another example of creative destruction, a movement has arisen to oppose creation of new data centers needed for AI.

All of the stability policies will help some people in some way. Being laid off of a job is tough, even if the old must end to make room for the new. It’s a legitimate public policy debate. From a business perspective, two issues are crucial. First, will the overall economy grow as it has in the past, or will stability concerns win out? Second, will a particular business’s innovations be stymied by pro-stability policies?

Although I am not certain how the future will play out, I lean toward predicting more growth. Part of the innovation we will likely see is clever ways to avoid the limits caused by stability policies. If banks won’t fund start-ups with cool ideas, venture capitalists will provide capital outside of the traditional financial system. If employees are hard to hire because of labor protections, we use more automation and outsource work to other countries. And if we cannot build fiber optic transmission lines, we’ll set up a satellite internet system.

The range of potential products and services that could possibly be created is huge, perhaps infinite. The range of potential production methods is similarly huge. And the range of human creativity is also pretty large.

Joel Mokyr said in his Nobel lecture: “So what is my bottom line on the future of technological progress and innovation? It’s very simple and it’s a very American kind of expression. You ain’t seen nothing yet and the best is yet to come.”