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Lockdown 2.0: A creative destruction revolution, or the death knell of innovation?

Lockdown 2.0: A creative destruction revolution, or the death knell of innovation?

So Boris Johnson has failed to follow his own government’s guidelines on cost-benefit appraisal.

Study after study by economists show that the costs of lockdown far exceed the benefits.

The NHS — the “envy of the world” — has conspicuously failed to develop sufficient capacity to deal with a second wave, despite having had months in which to prepare.

The Prime Minister’s cronies have failed to deliver on his claims of various “world-beating” devices. We are reminded of Glendower’s boast in Henry IV Part 1: “I can call the spirits from the vasty deep”, and Hotspur’s withering reply: “Why, so can I, or so can any man. But will they come, when you do?”

From this litany of failure, one certainty emerges. The economic recession will now be even longer and deeper than it need otherwise have been.

Perhaps there is a silver lining. In the 1930s, the Harvard economist Joseph Schumpeter coined the memorable phrase “gales of creative destruction”.

He developed an original insight of Karl Marx, who argued that under capitalism firms are under constant pressure to innovate. Failure to innovate increases the chances of going under.

Schumpeter emphasised the “cleansing effect” of recessions. In an economic downturn, trading conditions are hard. The less efficient companies are at greater risk of closing down. This creates an opportunity for new, more dynamic firms to enter the market.

The very deep recession generated by the policy response to Covid-19 might therefore simply sweep out the dead wood. The performance of the economy will be even stronger when the upturn comes.

There is, however, an alternative view to this positive outlook, also developed by a major American economist in the 1930s, which is far less well known outside of economics.

Irving Fisher of Yale set out his theory of debt-deflation while the Great Depression was raging in the west and unemployment rates rose above 20 per cent in many countries.

In the light of the financial crisis of the late 2000s, his perspective is strikingly modern. Fisher regarded major recessions as being created by the balance sheets of companies, and in particular by debt.

In his view, innovation was not stimulated by economic downturns, as Schumpeter thought. On the contrary, it was when the economy was growing rapidly that balance sheets were strong enough to finance innovation, especially of the trail-blazing kind whose outcome is of necessity very uncertain.

In the current circumstances, a lot depends upon who was correct, Schumpeter or Fisher. Is the Covid recession stimulating or reducing innovation?

A timely paper on this has been published in the latest issue of the American Economic Association’s economic policy journal.

Jorge Guzman and Scott Stern, of Columbia and MIT respectively, make excellent use of big data to estimate the quality and the quantity of entrepreneurship and innovation over a 25-year period in the US.

The analysis is complex, and the authors make very proper qualifications to their results. But on balance, their results support Fisher’s view.

Innovation flourishes when the economy is doing well. Yet another reason to exit from lockdown as quickly as possible.

As published in City AM Wednesday 4th November 2020
Image: Pxhere
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Innovation is the only way to recover from the Covid crisis

Innovation is the only way to recover from the Covid crisis

One silver lining of the Covid-19 crisis has been a surge in innovation.

Enterprising firms have invented both new products and different ways of delivering existing ones.

Innovation is the life blood of any prosperous economy. Innovation is much more than a scientific invention. It turns inventions into things of practical and affordable use to people.

The ability to deliver innovation in a sustained way is the one single quality which distinguishes capitalism from all other forms of social and economic organisation.

Yet our understanding of it remains imperfect.

MIT Nobel laureate Robert Solow laid the foundations for the modern theory of economic growth over 60 years ago. His neat mathematical model postulated that growth was caused by increases in the amount and quality of both capital and labour used in the productive process, and by innovation.

But when the theoretical model was applied to real world data, it created a problem for economics. The increases in the inputs which could be readily measured — capital and labour — could only explain a small fraction of the growth which had taken place.

By implication, most of the huge growth experienced in the west was due to innovation. But innovation itself was not explained in the Solow model.

Despite various attempts to do better, including an ingenious one which won the Nobel Prize for another MIT economist Paul Romer, economists are still far short of a convincing explanation of innovation.

Matt Ridley, the author and scientific polymath, has made a valuable contribution in his recently published book How Innovation Works.

Ridley describes how major innovations arose in a wide range of sectors, such as energy, public health, food, transport and computing.

From this mass of detailed, empirical description, he synthesises some general principles, the vital ingredients for success.

A classic image of innovation is Archimedes jumping out of his bath shouting “Eureka!” But Ridley makes clear that such moments are exceptionally rare, even if the story is true.  This is for two reasons.

First, innovation is almost always a gradual process. It involves re-combinations of existing ideas and methods of production rather than single revolutionary events.

Second, innovation is, as Ridley puts it, a team sport. The myth of the isolated genius is deeply ingrained, but it is a myth. Innovation requires collaborations and building on what went before. Even Isaac Newton, one of the greatest minds in world history, acknowledged that he “stood on the shoulders of giants”.

Innovation also requires an acceptance of failure.  When Edison perfected the electric light bulb, he had tried 6,000 different materials for the filament before discovering what really worked.

The book ranges far wider than just the science. For example, Ridley argues that the EU has evolved into a system in which innovation simply cannot flourish. Of Europe’s 100 most valuable companies, not a single one was formed in the past 40 years. What a massive contrast with America.

Innovation is key to a successful recovery from the Covid crisis — and Ridley’s book offers excellent insights on how to make it happen.

As published in City AM Wednesday 1st July 2020
Image: Silver Cloud by lfranks via Pixabay
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