Creation And Destruction Of Creative Destruction

By Philip Marey, Senior US strategist at Rabobank

The S&P500 rebounded yesterday as the US and China are trying to de-escalate the trade tensions that flared up recently. The Chinese want to save the summit between Xi and Trump and the Americans want to save their stock market. However, the Trump administration is considering various options to strike back at the China, if necessary. While most countries have surrendered on trade to the US, this conflict is giving Trump’s team a bigger headache.

To be continued.

Let’s turn to rate cuts. In a speech at the NABE conference in Philadelphia yesterday, her first on the economy since becoming president of the Philly Fed in July, Anna Paulson indicated she favored two more rate cuts this year, as monetary policy should look through the impact of tariffs in consumer price increases.

“For me, the bottom line is that I simply don’t see the type of conditions, especially in the labor market, which seem likely to turn tariff-induced price increases into sustained inflation.” Paulson said some increase in goods prices is to be expected “over the next few quarters,” though she pointed to the stability of longer-term inflation expectations and the lack of signs of “problematic spillovers.”

Meanwhile, a recent increase in unemployment “suggests that momentum in the labor market is to the downside.” So she is clearly in the camp of the doves. However, Paulson does not get to vote this year.

Today, Fed Chair Powell is talking at the same conference, likely providing us with the consensus view in the FOMC.

Time for some more fundamental stuff. Yesterday, the Nobel prize in economics was awarded to Joel Mokyr, Philippe Aghion and Peter Howitt for their work on innovation-driven economic growth. Earlier Nobel laureates already showed that innovation and technological change are the key drivers of sustained economic growth (Robert Solow, 1986 laureate) and developed endogenous growth theories with technological change driven by knowledge accumulation (Paul Romer, 2017 laureate).

However, according to the Royal Swedish Academy of Sciences this year’s laureates have taught us that sustained growth cannot be taken for granted.

“Economic stagnation, not growth, has been the norm for most of human history. Their work shows that we must be aware of, and counteract, threats to continued growth.”

The scientific background note explains that the three researchers have contributed to the understanding of the relatively recent phenomenon of sustained economic growth driven by innovation. Of course, innovations have taken place throughout human history, but they occurred as sudden outbursts of short-lived economic dynamism that interrupted long periods of stagnation or very slow growth.

All of this changed with the Industrial Revolution. Joel Mokyr’s work focuses on this era and he showed that the interplay between science and applied technology played a central role. Practitioners, ready to engage with science, along with a societal climate embracing change, were key reasons why the Industrial Revolution started in Britain.

In contrast, but complementary to Mokyr’s work, Aghion and Howitt focus on modern-day sustained, innovation-led growth in advanced economies. They analyzed the process of creative destruction at the micro level with conflicting interests of different agents.

The idea is that an innovation leads to business stealing: the innovation is carried out in one firm, or by one individual, but partially destroys the rents of others. In their basic model, new goods are perfect substitutes with old ones, but simply better.

This contrasts with the work of 2017 laureate Paul Romer, where innovations were still modelled as complementary to pre-existing activities. The framework developed by Aghion and Howitt – which links aggregate growth to microeconomic firm-level data – allows us to evaluate counter-factual policy experiments explicitly, such as changes in patent protection, competition policies and R&D subsidies.

The Royal Swedish Academy of Sciences warns that two centuries of sustained growth is just a small fraction of human history and the continuation of this trend is not be taken for granted. Impediments to the open exchange of ideas and fading support for science could pose future threats to economic growth. The academy highlights the trade-off between regulating tech and pharma without harming the technological progress they create. The committee also speculates about the possibility of artificial intelligence greasing a positive feedback loop between science and applied technology in the right regulatory and societal environment, leading to faster progress.

To summarize, a Nobel prize in economics with a lot of practical relevance: are we able to sustain sustained growth or are we going to destruct creative destruction?