Conventional Economic Thinking, Getting It Wrong

Yesterday I mentioned Paul Krugman, a NYT opinion columnist, and the tantrum he was in the midst of throwing over the result of the election. Despite his regular columns on politics, his day job is as an economist, a Nobel-winning one at that. This fact doesn’t render his views any more right, given the fact that economics is essentially a branch of Philosophy rather than a branch of the Hard Sciences.

Krugman took time out of his of his anti-Trump meltdown to post this tweet, in which me mocked ‘creative desctruction.’

(Tweet: “So creative destruction is mostly BS. Kind of suspected that  “)

Krugman has long held an antipathy to the idea of creative destruction, in particular when applied generally to an economy in the mold of Joseph Schumpeter. Consider this post he wrote a couple years ago:

The same impulse, I think, is why Schumpeter gets cited so much. If you read his stuff directly, it’s interesting, I guess, although his attempts to explain the business cycle were a waste of good paper. But it’s that glamorizing phrase “creative destruction” that did it, because it’s so flattering to the big money (and excuses a lot of suffering, too).


So here’s a revolutionary thought: maybe we need to do less disruption and put more effort into doing whatever we do well.

The post in question, as well as the recent tweet was in reference to the idea of creative destruction on a micro level in the sense of business innovation. The abstract of the paper in the tweet reads as follows:

Entrants and incumbents can create new products and displace the products of competitors. Incumbents can also improve their existing products. How much of aggregate productivity growth occurs through each of these channels? Using data from the U.S. Longitudinal Business Database on all non-farm private businesses from 1976–1986 and 2003–2013, we arrive at three main conclusions: First, most growth appears to come from incumbents. We infer this from the modest employment share of entering firms (defined as those less than 5 years old). Second, most growth seems to occur through improvements of existing varieties rather than creation of brand new varieties. Third, own-product improvements by incumbents appear to be more important than creative destruction. We infer this because the distribution of job creation and destruction has thinner tails than implied by a model with a dominant role for creative destruction.

These conclusions are, in truth, straightforward. Following on Peter Thiel’s concept of ‘zero to one,’ it is much harder to create an entirely new product, concept or entire industry from scratch as opposed to improving an existing product, concept or industry. However, the true advances in humanity come from these ‘zero to one’ moments. Going from horse and carriage to automobile was a far more substantive and ‘ball advancing’ move than the improvement of the automobile which has taken place since.

Applied to the individual businesses, there is more ‘growth’ from the likes of Proctor and Gamble, Ford and GE than there are from the likes of Google simply because there are simply fewer Googles.

Krugman uses this to poo-pooh the idea of creative destruction generally. His fight is with the like of people such as myself, who argue that when economies as a whole enter into recession, the best thing for that economy would be for those stricken businesses to be allowed to fold, that bad debt to be liquidated, and prices find their appropriate level, in line with the incomes and economic reality.

This is where the disdain for the ‘glorification’ of creative destruction comes from, because when applied to an economy as a whole, the aforementioned recessionary symptoms lead to falling employment and lower prices in the short term. This is, of course a painful thing, and Krugman, with his pro-government  leanings, believes that the government can solve these problems by easing monetary conditions and spending money to prop up the failed businesses and restoring debt. When Krugman writes about sticking to doing ‘whatever we do well,’ he means ‘whatever economic paradigm was prevailing before the recession,’ when applied to economies as a whole.

The problem with his, and indeed the standard Keynesian approach to the world, is that existing paradigms may not be lasting. They may fail under changing conditions and thus must adapt to stay relevant to the new economic reality. As such printing trillions of dollars to revive a failing economic model founded on debt fueled spending collateralized by ever rising asset prices is a recipe for failure, in the long run. Creative destruction is thus far from being ‘BS’ but in fact the only way for economies as a whole to be structured appropriately, so as to be in line with the underlying economic realities of the time.


Elsewhere in Ivy League Economics PhD News, Alan Kreuger, also of Princeton, and Lawrence Katz of Harvard recently released a study which showed that 95% of the jobs created in the Obama ‘recovery’ were part time or contractor work. This is hardly surprising to most who understood the problem with the idea that reflating asset bubbles was not a strategy for success.

The prior bubble popped because prices were sent out of wack. Businesses could not recoup the ever higher costs of production with ever higher prices for the final goods. The lack of demand at higher prices meant that prices could only fall, and with them wages, the price of labor.

Keynesian economists such as Krugman, Krueger and Katz, have no tolerance for such vagaries of the market, and seek to prop prices. In doing so, they propped the higher costs of production which meant they were forced to cut costs elsewhere. This meant workers were either laid off, replaced with robots, or had their hours reduced, or some combination of the three.

This thrust the worker into an environment in which his or her hours were cut while the prices he or she had to pay for goods and services rose. This meant that the worker had to supplement the now part-time or no-time work he or she was doing with a second or third part-time job, or becoming a contractor.

Obamacare crystallized this phenomenon, with its mandates on employers, especially service sector employers, leading to many of them reducing the hours of their staff to avoid the mandatory health care expenditures, hiring more part time workers to fill in the gaps.

This was how Obama’s ‘stellar’ job creation statistics were constructed. The most telling part of the article is the following [emphasis mine]:

Krueger, a former chairman of the White House Council of Economic Advisers, was surprised by the finding.

The disappearance of conventional full-time work, 9 a.m. to 5 p.m. work, has hit every demographic. “Workers seeking full-time, steady work have lost,” said Krueger.

Under Obama, 1 million fewer workers, overall, are working than before the beginning of the Great Recession.

That the likes of Krueger, a Keynesian through and through, would be surprised is of no surprise to me. The Keynesian understanding of the economic world has shown to be bankrupt in the long run. That it is survives as a respected school of thought is down to its ‘success’ in the short run, on a superficial basis. The fact that the Obama administration created millions of jobs, tripled the stock market and has engineered housing prices back to near pre-crisis levels is seeming evidence of the fact that these Keynesian polices have succeeded.

But as this paper notes, this was a papering over the cracks. Despite the touts of the administration, the people know that the economic recovery hasn’t been as great as it seemed, as they see it every day. They are the ones who have to go out in search of multiple part time jobs to make up the hours that were lost elsewhere. They are the ones who are paying higher and higher costs for the same standard of living.

To do this and to be continually told that the economy is improving was a slap in the face which proved one too many for the average voter, which ultimately goes some distance to explain why Trump had such a stern base of support.

Furthermore, this explains why the old media outlets who crow endlessly about how unqualified Trump’s picks are for his cabinet. Krugman, Katz and Kreuger have a combined 100 plus years of economic experience, yet for all their ‘wisdom,’ their understanding of the economy is wholly inadequate.