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Tuesday, May 3, 2011

When Destruction Can Be Creative

Uheaval and entrenched interests.

Those of us who write for TheFreemanOnline never tire of pointing out instances in the news of the “broken-window fallacy” (BWF), which is good because people never seem to tire of committing it.  In recent times, for example, following natural disasters in Haiti, Japan, and now Alabama, you can always depend on some pundit trying to argue that all the spending on repair and replacement will have the net effect of stimulating the local economy.

My first Wabi-sabi column in fact dealt with this fallacy in the case of the terrible earthquake in Haiti.  To quote from something I wrote in the comments section of that piece:

It is the belief that if Paul breaks Peter’s window, the community will become richer when Peter has to shell out $100 to replace it because “now” the glazier will have $100 more to spend, and so on. The fallacy is that a similar spending cycle can occur (e.g., before his window got broken Peter was going to pay Mary $100 for her painting) without Peter’s window needing to be broken at all — and Peter will not have lost the value of his original window.

But why does this fallacy persist?  Can destruction ever promote economic development in a way that would be better than if the situation had remained status quo ante?  Let me try to explain how in a certain sense it might, but in a way completely different from the BWF.

Joseph Schumpeter and Mancur Olson

Joseph Schumpeter was a great Viennese economist (part neoclassical economist, part Austrian economist, although in my opinion more the former than the latter) who famously described the forces of capitalism, the entrepreneurial dynamics of change, as “gales of creative destruction.” In his view entrepreneurial innovations unleash powerful waves of change throughout the economy that overturn established markets and ways of doing things.

However, the social-choice theorist Mancur Olson has argued that over time in stable societies where organizations and understandings have long formed and operated, coalitions of businesses and other political interests are able to gain privileges that protect their members from precisely the kinds of entrepreneurial change that Schumpeter placed at the heart of capitalism.  With the help of political power, various forms of collusion emerge throughout society, presumably on both the demand side and supply side of markets, with the effect that “on balance special-interest organizations and collusions reduce efficiency and aggregate income in the societies in which they operate and make political life more divisive.”  Moreover they “slow down a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions, and thereby reduce the rate of economic growth.”

In the language of social networks that I often invoke in this column, the ties that connect a given individual to a host of networks become thicker and thicker while at the same time the rate at which she can move out of one network and into another becomes slower and slower.  These might take the form of guilds, unions, and cartels on the supply side, and renters’ rights and consumer-protection groups (and the accompanying regulations) on the demand side.  All of these have the object of insulating special interests from dynamic competitive forces.

Under these circumstances it’s hard to expect ordinary economic processes to dislodge strongly tied special-interest groups from their privileged positions — not impossible but very hard.

The Role of Upheaval

Olson argues that disrupting these cozy connections can open space for the kinds of creative innovation Schumpeter described.  While Olson says war and revolution may sometimes serve as such initiating forces, he adds that no one in her right mind would recommend those as an economic policy.  (Would that that were true!)  Instead he makes the more sensible case that free trade is disruptive enough to do the trick:  “[T]here should be freer trade and fewer impediments to the free movement of factors of production and of firms.”  I can hardly disagree with this recommendation.

But his analysis of the conditions for radical change would seem to apply not only to wars, invasions, and free trade, but perhaps also to violent natural events. They could possibly serve a similar function, at least at the local level.

An earthquake, hurricane, or tornado not only damages and destroys the physical infrastructure of a community, it can also damage and destroy its social infrastructure.  In a relatively free society like ours, the harm done to social networks is overwhelmingly bad.  Obviously the lives lost and families, businesses, and communities torn asunder are an unmitigated tragedy.

In less-free societies the human tragedy is just as great of course, but where social networks serve more insidious purposes, such as to monitor and control the private lives of individuals, a natural disaster could undermine old politically connected networks and cronyism. What dynamic free markets require, in addition to economic liberty, are dense, weakly tied social networks that can serve as both sources of information about entrepreneurial opportunities and the means of diffusing discoveries throughout the community.  At least for a time, then, a natural disaster could open a space for new, informal relationships to arise – relationships with people outside one’s immediate circle of family, work, and closed community which can serve as bridges that may be useful when normal times return.

Policy Implications?

Does this always happen?  I think it does sometimes.  In the case of wars, one of the examples Olson gives is how World War II broke up the old Zaibatsu cartels in Japan, which may have contributed to that country’s postwar resurgence.  This is not the broken-window fallacy – Japan certainly would have been better off without the war – but rather a possible explanation for its explosive growth.

The historian Peter Hall posits that cities achieve their “golden ages” often as a result of great upheaval.  The Athens of Socrates, Plato, and Aristotle emerged from plague and wars that decimated the majority of its population.

I had hoped something like this would happen in Haiti after the earthquake.  The government disappeared, and new communities, in the form of tent cities, sometimes operated with an efficiency and order superior to the pre-earthquake neighborhoods.  Unfortunately, it appears that the status quo ante is reemerging there. Perhaps it’s too soon to tell.

Uncertainty over whether destruction will actually release creative energies, as well as abhorrence of destructive aggression per se, would, I hope, keep sane people from advocating a policy of destruction.  Unfortunately, we are not all sane.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.