Creative destruction
The Austrian economist Joseph Schumpeter (1883 – 1950) popularized the term “creative destruction”, and showed that a process of transformation such as a financial crisis can enable new entrepreneurship and radical innovation. Schumpeter’s theory was based on the assumption of ordinary macroeconomic equilibrium. This equilibrium, claimed Schumpeter, is perpetually being destroyed by entrepreneurs who will try to introduce innovation. A successful innovation disturbs the normal flow of economic life, because it forces some of the already existing technologies and means of production to lose their position within the economy. Placed in today’s setting, the theory of creative destruction actually entails that a financial crisis is a natural process.
In a Schumpeter view of evolutionary economics, a crisis is in fact a necessary cleaning process, particularly after a long period of excessive growth. It is necessary for modernization of the economy and to open up for new entrants.
Due to lack of empirical evidence it is difficult to prove Schumpeter right. But several events in the past economic depressions underpin Schumpeter’s ideas. As argued by Kåre Valebrokk at Eksportfinans’ Open House in April, the global depression of the 1930s was in fact not a depression in Norway. Despite the bad reputation of the 1930s, the decade proved to be positive to Norway’s economy. According to Valebrokk, Norway experienced a period of negative growth in 1931 and 1932 followed by eight years of economic growth until World War II. As Valebrokk argues, the 1930s was the prime time for the entrepreneurs. Thousands of new companies were created. It was the break-trough of the car industry, while electricity and telephones became common components in Norwegian households. Indeed, the years of negative growth had set the stage for years of new opportunities.
Four outcomes of the crisis
The global economy that will evolve after the current financial crisis is difficult to envision. Most economists, policy makers and politicians are not overly optimistic at the time being. Nevertheless, it is certain that the crisis will subside at some point, and leave time and space for new creativity.
The Copenhagen Institute for Future Studies recently released a study on the possible outcomes of the current crisis. Four different scenarios are predicted.
The first depicts a future of rapid adaptation and renewed growth. Confidence will be restored and people will eventually view the opportunities rather than the problems. The financial crisis will be used as a reason for necessary cut-backs and the balance between private and public expenditure will be in favor of the public sector. In addition we will see stronger market regulations.
The second scenario is a new world order with slow adaptation and stagnation in the Western countries. The crisis packages will end the financial crisis, but will not create new growth. The BRIC- countries (Brazil, Russia, India and China) will manage well without growth in Europe, and their role will change dramatically with strengthened economic and political power.
The third scenario, “global capitalism checkmate”, also entails a view of slow adaptation and stagnation. In this pessimistic foresight, the crisis will deepen long into 2010 and become the worst crisis since the Great Depression. Increasing protectionism worsens the crisis and increases the already high unemployment rates. The confidence for the future is weak.
The final scenario is more optimistic and prophets sustainable new growth. The world will be working on high speed to find new solutions to climate change and energy. The war against terror will be replaced by a “war against fossil fuel” in 2010, and creates a wave of new investments for solar and wind energy. Corporate Social Responsibility is no longer just decorative words, but a part of the social contract.
Bubble Theory
At Eksportfinans’ Open House, Professor Victor Norman shared his thoughts on “bubble economies”. According to Victor Norman, every economic crisis has occurred when an economic bubble has grown so big that it is about to burst. The Great Depression in the 1930s was followed by a long period of economic growth in the aftermath of World War I. The Nordic bank crisis around 1990 followed an incredible period of growth in international trade, property development and share prices all through the 1980s.
The fear now, according to Victor Norman, is that a government supported bubble will bring us out of the current financial crisis, but only temporarily. He mentions an environmental bubble as one possibility – where government supported investments in more or less viable environmentally friendly projects will blossom. Another scenario is that the low interest rates will create another housing bubble – that may collapse if the economic situation continues to be difficult for a longer period of time.
Professor Norman is clear: What we need is healthy, sustainable economic growth built on sound enterprises and a well-functioning financial system. We need more highly educated people in the industry sector, and less focus on public sector growth. We need investments in education and development of human resources. Only then can we build a sound foundation for continued prosperity in the world.