The economics of "creative disruption", a place for everybody on the chair?


The economics of "creative disruption", a place for everybody on the chair?

08 Sep, 2017

Imagine a ballroom with 10 tables and 10 people at each table. There is a podium with a band and a master of ceremony. He invites the participants of one table to exchange seats with the participants of another table. Everything goes fluidly. Transition is harmonious. Then he asks everybody to stand up go to another table but warning them that in the meantime one table and its chairs will be removed. People without a chair will have to leave the party. The result is chaos, not to say panic or should we simply say 'disruption'.

Checking an on-line bookstore for titles referring to 'disruption' yields an impressive list. Disruption is hot because by its very nature it causes fascination and fear and also because it comes in different guises. The sources of disruption are multiple: geopolitical events, political or social developments in a single country, the environment, regulation, financial and monetary factors, change on the demand or supply side of the economy.

The factors from this non-exhaustive list have in common a big impact on society, business, the economy; a long adjustment process; a prolonged period of uncertainty. Uncertainty is a key attribute of any type of disruption and helps to explain why the economic costs can be considerable. Uncertainty implies reduced confidence in forecasts which are relevant for business decisions. This will weigh on the willingness to invest, cause slower growth or make the recession last longer and this may in turn make the economy structurally weaker because potential growth slows and productivity growth declines. However, it will also trigger a quest for efficiency enhancement by means of innovation.

The Austrian economist Joseph Schumpeter called this 'creative destruction': challenging economic times create an urge to innovate but in doing so it causes profound change because it gives innovative companies at least temporarily a competitive edge pushing competitors out of business or forcing them to imitate the innovator. Creative disruption may sound less frightening than creative destruction but the change it imposes on the economy is nevertheless huge not to say colossal.  In analysing this change, a demand side and a supply side perspective can be adopted. The former emphasizes the offering of new products (e g driverless cars), more sophisticated yet cheaper products, new types of services (Airbnb, Uber).

Generally speaking one can argue that the consumer experience will be enhanced (economists would say that consumer utility increases) and/or that spending power will increase because of downward pressure on prices: consumers who were willing to pay a high price and previously were doing so, now get the same goods or services at a lower price (in economics speak: the consumer surplus has increased).

On the supply side it's another story: the aggregate producer surplus declines as companies make less from the same quantity they sell (of course overall demand can increase though there are limits to this). Moreover, some companies or even sectors may thrive whereas others suffer. Financial market investors and bank credit departments face the challenge of identifying the future winners whilst avoiding the losers: company-specific risk increases. Then there is the issue of the labour market. It is here that the differentiated consequences of disruption are perhaps most visible.

Somebody working in a company or being self-employed is both a consumer who benefits from the consumer surplus (more products at a cheaper price) and a producer, a factor in the production chain, who can benefit from disruption when employed by a 'disruptor' but will suffer when working for an incumbent which is now under attack. In case of the latter, increased job uncertainty, if not job loss altogether, will weigh on his consumption and in the aggregate on economic growth. This is nothing new though and this process of technological change/innovation/destruction/ adjustment has repeated itself many times since the industrial revolution.

Is this time different? No, when looking at the basic characteristics of disruption which forces companies and societies to adapt and find a new edge. Yes, in the sense that today's disruption has many faces (demographic, environmental, monetary and financial, technological) and is impacting many sectors simultaneously (think of the metaphor of the tables in the ballroom at the start of this article). Technology in particular plays a key role in view of the labour savings which digitalization, robotisation and artificial intelligence will entail whereas the jury is out on the number and types of jobs which will be created in new areas. This creates huge challenges for governments: the quality of education, fostering research and development, facilitating access to risk capital, creating and maintaining a social safety net, etc. 

Success in this respect is all the more important because the ensuing economic growth will allow to reinvest tax money so as to be well prepared for future disruptive shocks.

Group Chief Economist, BNP Paribas Group
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