Wednesday, November 30, 2005

Creative Destruction and Sustained Growth

Established blue-chip companies are posting major losses - $1.3 billion for a quarter for both GM and Ford and $1 billion for Kodak. Airlines are going bankrupt. There are losses a plenty. But there are gains too. Irwin Seltzer reports in the Weekly Standard
That destruction of the value of existing assets and businesses is, fortunately, only half the story. The other half was long ago pointed out by Joseph Schumpeter. Schumpeter is said to have remarked, "Early in life I had three ambitions. I wanted to be the greatest economist in the world, the greatest horseman in Austria, and the best lover in Vienna. Well, I never became the greatest horseman in Austria." Not having access to the historical records in Vienna, I have no way of knowing whether Schumpeter achieved the final of his three goals. But he has a valid claim to having achieved the first, or at least to ranking right behind Adam Smith. Over 60 years ago, when the American economy was still in the early phase of a war-induced recovery from a decade of stagnation and depression, and the future of capitalism was in doubt, Schumpeter wrote, "Capitalism . . . is by nature a form or method of economic change and not only never is but never can be stationary. . . . . The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumer goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates." This process "incessantly" destroys the old economic structure, and creates a new one. Schumpeter concluded : "This process of Creative Destruction is the essential fact about capitalism. . . . Every piece of business strategy acquires its true significance only against the background of that . . . perennial gale of creative destruction . . . " That is the process that is now accelerating in the U.S. economy. The future of newspapers is threatened by new technologies that multiply the methods of delivering news and advertising to consumers. Hardest hit are those, like Knight Ridder, that relied for their profits on monopolies of local advertising. If Google, its share price soaring as media companies' shares languish, succeeds in creating a jobs market that replaces classified advertising, which accounts for over half of the revenue of local newspapers, the old method of spreading ink on dead trees will face an even greater threat.
Today's giants are trying to adapt. But the changes required are fundamental.... Telecoms... Blockbuster....
As for airlines, deregulation freed innovators to negotiate more reasonable contracts with employees, develop point-to-point service as an alternative to the hub-and-spoke business model of the traditional, legacy carriers, and offer low, load-increasing fares. Whether the old-line carriers, several in or emerging from bankruptcy, can adapt is uncertain (although United says there is black ink in its future). What is certain is that creative and profitable newcomers Southwest and Ryanair know something that busted Delta, US Air, and others have to learn if they are not to join Pan Am, Eastern, and other once-mighty carriers in the dustbin of history.... Which brings us to General Motors, which is in the process of being destroyed by a combination of what Schumpeter called "new consumer goods" (higher-quality and more attractive imports), "new methods of production" (the lower-cost plants of Toyota and others), and "new type[s] of organization" (shorter drawing-board-to-production-line times)--not to mention inept management and the cost of benefits lavished on workers when those costs could be passed on to consumers. Investors responded to the company's survival plan by selling off its shares, already down 42 percent in the past year. Fortunately, it is not the case that what is bad for General Motors is bad for the country. Competition of this sort, wrote the man who never succeeded in becoming Austria's greatest horseman, "strikes not at the margins of the profits . . . of the existing firms but at their foundations and very lives." Good news for creative destroyers and consumers, bad news for hidebound managers and their shareholders.

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