Freeman

ARTICLE

Creative Destruction--Again

Innovation Necessitates Job Displacement

APRIL 01, 1996 by DAVID LABAND

Whose heart bleeds for the virtually nonexistent blacksmith? In 1900, there were 226,477 blacksmiths counted by the U.S. Census. Today the number is negligible. Who laments the slide into occupational oblivion by tallow-renderers? The invention of electricity and electric lights killed off the candle-making industry. Henry Ford almost singlehandedly wiped out buggy manufacturers (as well as cartwrights and wheelwrights). Have the violins stopped playing yet?

The recent announcement by AT&T that company management intends to eliminate 40,000 jobs over three years sent shock waves through New Jersey, in which a large number of the job losses are anticipated, while precipitating a 5 percent jump in the price of AT&T stock over a two-day period. Media reaction to the announcement was predictable: interviews of wary workers likely to lose their jobs filled newspapers 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 America’s market economy: job destruction for a relative few is a by-product of a vibrant economy that enhances the welfare of many millions of individuals.

Typically, in a growing economy, job losses result from two sources: competitive pressures that force firms to economize on production costs, and technological developments 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 unemployment 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, Socialism 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 industrial 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 Destruction is the essential fact about capitalism.”

The value of the aggregate economic enhancement to millions of lives utterly swamps the aggregate economic suffering of displaced workers. An example is illustrative. Suppose that, in the aggregate, each individual in America will gain the equivalent of $10 worth of added value to his/her 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 100,000 existing jobs. With 260 million (or so) consumers, the aggregate well-being of Americans increases by some $2.6 billion.

In truth, the typical consumer probably gains far more than $10 worth of added value to his life (especially in a present-value sense) from the introduction of new products and services, as well as 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, microwave 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 displaced workers are typically temporary. These individuals (or others who might have followed them into their old employment) 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 agriculture, occupational flight from farming reflected simply stunning gains in farm productivity during the first half of the twentieth century. The fact that it took only three Americans per 100 workers to feed America in 1995 rather than the 40 in 1900 reveals prosperity that freed up 37 percent of our workforce to pursue other types of productivity: designing and building automobiles and aircraft, communications systems, electric power systems, developing new medical procedures and drug therapies, and inventing 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 business failure over time reveals the essential relationship between creation of new products 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) business failures. Over the first half of this period (roughly 1965-77), the intensity of innovative activity falls, as does the incidence 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. Nonetheless, the two graphs suggest, at a minimum, that the innovative activity that is so vital to enhanced economic well-being over time is associated positively with the obsolescence of products and industries that, in turn, leads to displaced workers.

Government Regulation

Government regulation tends to exacerbate the job destruction associated with innovative activity. This is because the effect, if not the intent, of many government regulations is to insulate the affected industries from competition. This creates conditions under which domestic firms not only charge higher prices to consumers than would exist in a more competitive environment, they lack incentive to produce efficiently. 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 continuous labor force adjustment that firms would undertake in a more competitive environment.

The fact that we are now experiencing declining unemployment with little evidence of any upward pressure on inflation is puzzling to many economists, as well as non-economists. We believe that this is not surprising at all, given the constant economic metamorphosis that characterizes the modern American economy. The dual processes of innovation and re-engineering production 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.

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April 1996

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