Creative destruction, why the buggy whip makers lost and America won

Here is a paradox that every economy on earth lives inside. The thing that makes us richer is the same thing that makes us anxious. A country cannot have new industries without losing old ones, cannot have better products without worse ones going dark, cannot raise its standard of living without somebody, somewhere, losing a job they were good at. If you want a prosperous society, you must accept the churn. If you want to abolish the churn, you must accept the poverty. There is no third option, though politicians have been promising one for as long as there have been politicians.

The economist who gave this paradox its name was Joseph Schumpeter, and the name is a classic: creative destruction. I want to explain what it means, why it is true, what it has done for American workers, and why the standard answer to it, which is to protect the dying, is a mistake that looks like kindness.

Terms and claim

Creative destruction is the process by which new products, methods and firms continually replace older ones, so that the economy is revolutionized from within. The "creative" part is the new way of doing things. The "destruction" part is what happens to the old way and to those who earn a living from it. Schumpeter published the idea in 1942, in Capitalism, Socialism and Democracy, and he treated it as the essential fact about capitalism, not a side effect.

My thesis is that creative destruction is the source of rising living standards, that the pain it causes is real and deserves a decent response, and that propping up declining firms and industries is the one response guaranteed to make things worse. I will put it in four numbered premises.

1. Rising incomes come from producing more value with the same labour, which requires replacing old methods with new ones.
2. Replacement destroys particular jobs and firms even as it creates others and expands the total.
3. The history of the American workforce is a story of this process, and every generation has been told that it would be the one to end in mass unemployment.
4. Protecting incumbents transfers wealth from consumers and from tomorrow's workers to a small group of today's owners and employees.

From the farm to the office

Consider the largest creative destruction in American history, which took place so slowly that most people did not notice it as a story. At the start of the twentieth century, roughly four in ten American workers worked on farms. Today it is under two in a hundred. A farm worker of 1900 could not have imagined that his grandchildren would grow far more food with a tiny fraction of the labour, and that the rest of the workforce would be free to do something else.

Where did the farmers go? They went into factories, then into offices, hospitals, schools, trucking, software and a thousand occupations that did not exist when their ancestors were ploughing. If a clever government in 1900 had decided to protect farm jobs, by taxing tractors or limiting the harvest, it would have preserved millions of jobs that did not need to exist, and it would have kept food expensive and kept the country poor. The great mass of American prosperity is the free gift of having fewer people needed to do the old work.

The same pattern ran through the middle of the century, when factory employment grew and then began to fall as manufacturing output kept rising, and then through the late century, as clerical and retail work changed. Telephone switchboard operators gave way to automatic switching. Elevator operators gave way to buttons. Typing pools gave way to the personal computer. In each case, some people lost something. In each case, the country was better off.

The cars that ate the horse trade

The textbook example is the buggy whip. By the usual telling, there was once an industry that made whips for the drivers of horse-drawn carriages, and when the automobile arrived the whip makers were wiped out. As a historical matter the story is partly legend. The small Massachusetts town of Westfield was the centre of the American whip business, and the trade did shrink dramatically as horses left the roads, though some firms found other work. But as a parable, it captures something true.

When the automobile replaced the horse, a whole ecosystem of work went with it: the stables, the farriers, the carriage builders, the harness makers, the feed dealers, the people who cleaned up after the animals, the veterinarians who served the working horse. Let us be honest, that was a great many people with a great deal of skill. And the automobile created a larger ecosystem in their place: assembly lines, steel, rubber, glass, oil, roads, filling stations, motels, repair shops, car dealers, trucking, and the suburbs that made the lives of ordinary families bigger than the distance a horse could walk in a day. Henry Ford's moving assembly line, introduced at his Highland Park plant in 1913, lowered the price of the car until workers could buy what they built. The destruction of the old was the price of the creation of the new, and the creation was larger.

Film and the digital camera

A more recent parable is photography. For most of the twentieth century, Kodak dominated the business of taking pictures, because taking pictures meant buying film. An engineer at Kodak, Steven Sasson, built an early digital camera in 1975. The company had the invention in its own laboratory, and it still could not turn its business around, because digital photography threatened the film sales that paid its bills. Kodak filed for bankruptcy in 2012.

What happened to photography itself? It exploded. More pictures are taken now than in any earlier time, by more people, at almost no cost per shot. The destruction of the film business was the creation of a medium that a child can use. The jobs in film processing, the labs and the chemical plants, disappeared. The jobs in image software, camera design, phone manufacturing and online media appeared. That is creative destruction in one sentence.

The data on churn

The best evidence for the claim that churn is normal comes from the Bureau of Labor Statistics, which tracks how many jobs are created and destroyed in the economy. Its Business Employment Dynamics series counts the jobs added by opening and expanding establishments and the jobs lost by closing and contracting ones. What the series shows, in any normal quarter, is that gross job gains and gross job losses each run into the millions. The net change we hear about in the monthly headline is the small difference between two very large numbers.

Think about what that means for the person who says that a particular firm's closing is a catastrophe for jobs. It may be, for those workers. But the economy is constantly closing some establishments while opening others, and a healthy labour market is one in which millions of jobs end and millions of others begin every quarter. A country that did not have that churn would not be stable. It would be stagnant. You can look up the current series on the BLS website and see the scale for yourself; I would rather send you to the source than quote a number that will be stale.

The job market's turnover is also the reason that The EITC began as a conservative idea and now pays out billions in error and similar supports are better designed to help people move than to pin them in place.

The steelman

The best argument for protecting dying industries goes like this. Workers are not abstractions. A man of fifty-five who has spent thirty years in a mill or a mine is not going to become a software engineer. His town depends on the mill. When the plant closes, the tax base collapses, the shops shut, the young leave, and the community never recovers. The gains from creative destruction go to the economy as a whole, spread thin across millions of consumers, while the losses fall concentrated on specific people and places. It is therefore unfair, and perhaps politically unsustainable, to tell those people that the system is working. A decent society would slow the change, with tariffs, subsidies or bans on closure, to give them time.

I take that seriously. The human cost is real, and conservatives who dismiss it deserve the contempt they sometimes receive. The question is not whether the pain exists. It is what to do about it. And here is my answer in numbered points.

1. Protection does not stop the change, it delays it and raises its cost. An industry that cannot compete is propped up by someone, and that someone is the consumer and the taxpayer. The jobs saved are visible and the jobs lost elsewhere because of higher prices are invisible. When a country protects an industry, its customers pay more, and the industries that use the protected product as an input become less competitive.
2. The cost per protected job is often larger than the job's wages. This has been shown repeatedly in studies of tariffs and quotas, and the best-known cases are in steel and in textiles. I would invite the reader to examine them, and I will not give a specific figure here because they vary by case.
3. Protection rewards the firms that are least adaptive. A subsidy to the failing firm is a penalty to the one that is succeeding, because both compete for the same workers, customers and capital.
4. The better response is to help people, not positions. Help workers move, retrain and relocate, keep the tax and licensing rules that block entry out of the way, and make sure that starting a new business is easy. Those policies leave the economy free to adjust while giving the displaced a real way forward.

Let me add a point where I stay honest about what the evidence does not show. The "China shock" literature has argued that some communities hit by import competition in the early 2000s adjusted far more slowly than the textbook predicts, and the fair-minded reader should read both sides. That debate is covered in The China shock was real, and what free traders and tariff hawks each get right. My claim is not that adjustment is painless. It is that the cure for slow adjustment is faster adjustment, not none.

The Founders and the freedom to start something

This is not only an economic argument. It is a constitutional and moral one. The Founders understood that the free country was one in which a man could try a new trade, build a new thing, and offer it to his neighbors without asking the incumbent for permission. A guild that can block you from competing is a privilege that the Declaration's language of equal rights does not recognize. The first Article of the Constitution gives Congress power "To promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries." It grants a limited monopoly, for a limited time, as a reward for novelty. That is the opposite of a permanent shield for the old.

The modern equivalents of the guild are the licensing board, the incumbent-friendly regulation and the barrier that looks like consumer protection. The case of a state dental board and teeth whitening, which went to the Supreme Court, shows how it works, and it is told in North Carolina's dental board, teeth whitening and the Supreme Court. The Jones Act is another instance, described in The Jones Act, a 1920 shipping law that costs Puerto Rico and Hawaii.

A word about fear

Every wave of change comes with a prediction that this time the machines will take all the jobs. The Luddites, who smashed textile machinery in England in the years around 1811 to 1816, were sure of it. So were many commentators who feared automation in the twentieth century. They were not stupid. They were right that particular jobs would go. What they missed was that human wants are not fixed. When a thing becomes cheaper, people do not stop wanting things; they want other things, and someone must make them. The economy has not yet run out of wants.

That is the optimistic conclusion, and I mean it. We should be neither Pollyannas nor doomsayers. The right attitude to change is the one a good coach has toward a team that has lost its best player: he does not pretend the loss did not happen, and he does not cancel the season. He trains the people he has for the game that is coming.

The case in brief

1. Rising living standards come from replacing old methods with better ones, a process Schumpeter named creative destruction in his 1942 book.
2. The American workforce moved from farms to factories to offices as that process ran, and every step destroyed particular jobs while expanding the total.
3. The BLS's job-flow data show gross job gains and losses in the millions each quarter, which means churn is the normal state of a healthy economy.
4. Shielding dying industries raises prices, penalizes adaptable firms and delays the change at a high cost, and it benefits the few who are protected at the expense of consumers and of future workers.
5. The humane response is to help people move, retrain and start new things, and to remove the licensing and regulatory barriers that keep newcomers out.

What you can do: look up your state's occupational licensing requirements for one trade you know, and ask your state legislator whether each requirement protects customers or protects the people already licensed.