The rising resistance to creative destruction

Welcome back. This week, I turn to “creative destruction”. The concept was popularised by Austrian political economist Joseph Schumpeter in the 1940s, and describes how old ideas, technology and businesses are displaced by new ones.

If creation is the primary protagonist of economic growth, destruction is a necessary evil. In tandem, they enable people, capital and other resources to be redeployed more efficiently in the economy. But there is a third force that undermines both: preservation.

In Hindu philosophy — where Schumpeter’s notion most likely originated — creation, destruction and preservation are a triad of cosmic forces always seeking balance.

So in this edition, I explore how this eastern framework might help to explain why creative destruction is, in fact, faltering across the western world.

The artificial intelligence revolution has sparked innovation, disrupted industries and is already triggering job losses. But the visible effects of creation and destruction can distort our perception of how strong these economic forces actually are.

Creative destruction is hard to measure. That said, proxies for economic dynamism in developed nations have been weakening over the past few decades.

“For much of the 20th century, high rates of firm entry, job reallocation and entrepreneurial risk-taking kept American productivity surging ahead,” says Ufuk Akcigit, professor of economics at the University of Chicago. “But in recent decades, that engine has been losing steam — and the numbers are hard to ignore.”

Data from the US Census Bureau shows that business entry and exit rates have trended downward since the 1970s. The job reallocation rate — a measure of how quickly jobs are being created and destroyed — has also dropped over the past few decades.

Europe, perhaps less surprisingly, shows similar trends. The UK’s Office for National Statistics finds that the job reallocation rate in Britain has slowed by one-third in the past two decades.

What is contributing to the decline in creative destruction? As I outlined in an FT column in January, there are economic, political and social incentives to sustain the status quo. These preservative forces block new ideas and businesses from emerging — and coddle unproductive ones.

Take inblockbent businesses in advanced economies. They have become more economically dominant over time. America’s top 10 listed companies currently account for approximately one-third of the S&P 500’s entire market capitalisation — the highest concentration in several decades.

In Europe, the average market share of the top four companies across industries in fifteen countries increased by five percentage points between 2000 and 2019, according to OECD research.

Some economists reckon globalisation and technology, which support economies of scale, are partly behind the rise of mega-businesses. 

Size can, however, create protective barriers to entry, as potential market entrants fear entering sectors with domineering firms, notes Akcigit. His research also finds that a greater share of US inventors today work in large, mature firms. “Inventors in young firms are jumping to the established ones where the wage premium has risen over recent decades”, he says. “But in doing so, we find that they end up innovating less.”

“The real concern arises when large firms shift from innovation-driven strategies to defensive ones”, says Akcigit. Indeed, there are examples of direct actions taken by inblockbents to preserve market share, including buying start-ups, defensive patenting, talent poaching and garnering political influence.

“Lobbying today includes regulatory shaping, digital targeting and building political connections”, says Francesca Lotti, an economist at the Bank of Italy. “These activities often insulate established firms from competitive pressures.”

Annual lobbying expenditure in the US has risen by $1.7bn in real terms since 1998. In the EU, the number of registered lobbyists has more than doubled since 2012.

Policy also acts as a preserving force. Over the past decade, tariff and non-tariff trade barriers have risen globally, partly in reaction to a political backlash against the perceived threat of foreign competition to jobs and industries.

“Protectionism keeps failed business models on life support,” says Simon Evenett, a professor at the IMD Business School. “The upshot is that potential disrupters hesitate, inblockbents delay innovation, and the capital that should fuel tomorrow’s breakthroughs instead flows towards yesterday’s failures.”

Similarly, restrictions on foreign investment and immigration limit the penetration of new ideas.

Protectionist environments, like today’s, encourage businesses and trade groups to allocate resources to shape tariff policy in their favour. Research ***ysing high tariff periods in the early 1970s finds a positive correlation between trade levies’ bias towards lower-skilled industries and measures of rent-seeking.

Finance plays a role too. When overabundant or poorly targeted, it can preserve less efficient firms. Deborah Lucas, professor of finance at the M***achusetts Institute of Technology, says economic bailouts have become “unnecessarily frequent and wide-ranging.”

Recent economic shocks — including the global financial crisis, pandemic and European energy price surge — elicited broad state support, including grants, loans and guarantees. Difficulties honing measures meant unviable or undeserving firms also garnered funds.

Beyond these crises, a so-called “bailout culture” has become somewhat normalised, says Lucas. In recent years, the prevalence of subsidies — as part of the rising shift towards state-led industrial strategies — has grown. “The expansion of deposit guarantees to uninsured depositors following Silicon Valley Bank’s collapse in 2023 exemplifies this trend”, she adds.

The era of low interest rates and quantitative easing that followed the financial crisis propped up less productive companies too. Indeed, even as the cost of credit has risen, excess cash from that period has enabled less viable businesses to secure low, long-term borrowing costs and access private funds.

For measure, the percentage of unprofitable companies in the Russell 2000 — a US small-cap index — has risen from 15 per cent to about 40 per cent in the past 30 years.

Finally, social factors can undermine creative destruction. For individuals, just like businesses, economic success brings a motive to protect it. “I’d argue that there’s an element of Kahnemanian psychology here,” says Marc Dunkelman, a fellow at Brown University. “As a population has more to lose, it becomes more risk averse”.

This is evident in nimbyism, and special interest groups which, for instance, resist new technologies in their sector and push for regulations that favour inblockbents. In December, then US president-elect Donald Trump backed unionised dockworkers in their opposition to the use of technology in American ports. He said automation was not worth the “distress, hurt and harm” it causes US workers.

Data compiled by Pola Lehmann, co-leader of the Manifesto Project, which ***yses election manifestos in over 60 countries, shows that mentions of anti-growth sentiment in G7 political campaign doblockents has surged ahead of pro-growth references in the past decade.

The success of creative destruction was, ironically, why Schumpeter thought capitalism would not survive in the long run. He believed the prosperity that it generated would eventually drive a demand for security and stability that would usurp society’s willingness to endure further job losses and disruption.

There are signs of this dynamic emerging in rich economies today. That doesn’t mean creative destruction is doomed. AI is driving disruption. Higher average interest rates could flush out zombie firms. And status-quo forces aren’t always antithetical to growth. Sometimes they are necessary.

Big profits — which take time to build — attract competition and support innovation. The Asian Tiger economies temporarily used protectionist measures to shield infant industries and foster long-term growth. Bailouts help avert financial contagion and regulations provide environmental and social protections.

The eastern lens suggests that balancing creation, destruction and preservation is the answer. That is easier said than done: too much destruction harbours instability; too little stifles innovation.

A few policy principles do, however, emerge. For instance, protecting people not jobs, so that individuals can retrain and weather disruption. This would complement measures to lower barriers to competition, including strengthening antitrust regimes, reducing protectionist barriers and tightening controls on lobbying. Future bailouts should also be better targeted and less open-ended.

For businesses, workers and governments the status quo may feel safe, but over time it can erode progress. If the slow creep of preservative forces remains unchecked — and policy doesn’t evolve to help embrace change — advanced economies risk trading their short-term comfort for long-term stagnation.

Send your rebuttals and thoughts to freelunch@ft.com or on X @tejparikh90.

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Free Lunch on Sunday is edited by Harvey Nriapia