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The U.S. and the Brave New World

How can the United States harness the increasingly competitive global economy to its benefit?

August 2, 2007

How can the United States harness the increasingly competitive global economy to its benefit?

It would be unfortunate if the fear of stiffer competition induces U.S. policymakers to adopt a more defensive form of capitalism that, over time, retards the remarkable growth in innovation that has so far characterized the U.S. economy.

The fear we speak of grows out of necessary and inevitable consequence for any entrepreneurial economy, what Schumpeter called "creative destruction."

The creativity and the destruction are often brought about by the entrepreneur and successor firms, who commercialize the new technology that replaced the old. The list of examples includes the car instead of the horse, electricity instead of the steam engine, the semiconductor instead of the cathode ray tube — and computer hardware and software that have eliminated (and continue to eliminate) many tasks once formerly carried out by human beings.

Successful entrepreneurial economies embrace — and generally encourage — change. They do not erect barriers that prevent money and people from shifting from slow-moving or dying sectors to dynamic industries.

They do not wall off their existing producers from more efficient ones in foreign countries. And they seek out better ideas wherever they can find them, even abroad.

Radical innovations and the changes they spawn have a tendency to come in waves. They are accompanied by much disruption over an extended period of time, with many losers and just a few winners.

At one time, for example, several thousand firms or individuals were making and trying to sell automobiles in the late 19th and early 20th centuries. Only a handful survived. A similar story can be told about the telephone industry and — more recently, the numerous dot-com companies that quickly came and went in the 1990s.

Financial bubbles attend these technological revolutions, with investors placing bets on numerous competitors, pushing up their share prices only to see most prices fall to earth when most of the companies fail. This boom-and-bust nature of financial markets is inherent in any economy that spawns radical or paradigm-shifting innovation.

Economies characterized by entrepreneurial capitalism are also dynamic in another sense. There is a constant churning of firms in the pecking order among all firms, in contrast with greater stability in firm rankings in economies characterized by big-firm capitalism.

Consider, for example, the contrasting experiences in the United States and Europe. Of the 25 largest firms in the United States in 1998, eight did not exist — or were very small — in 1960. In Europe, all 25 of the companies that were the largest in 1998 were already large in 1960.

Moreover, the pace of the change in the United States seems to have accelerated. Whereas it took 20 years to replace one-third of the Fortune 500 companies in 1960, it took just four years to accomplish this task in 1998.

Because radical change is so disruptive, entrepreneurial economies can benefit from properly constructed safety nets that shield some of the victims of change from its harsh impacts — without at the same time destroying their initiative to get back on their feet.

This may seem paradoxical or counterintuitive. The former chief scientist of Israel once said that she believed one reason Israel was so entrepreneurial was that its people had a high level of discomfort, brought about largely by external threats to their physical security.

In societies where individuals may be too comfortable — much of Western Europe, for example — people may be reluctant to take the risks inherent in any entrepreneurial endeavor.

Indeed in 2004, a French government employee wrote a best-selling book called "Bonjour Paresse" (Hello Laziness), which extolled the virtues of not working hard.

This "avoidance of work" ethic is now a serious cultural issue across Western Europe. It manifests itself in a noticeable drop in average hours worked per year by employed individuals in major European countries. However, given the pressures of global economic integration, this trend is reversing itself in many European countries.

Either way, context makes a big difference. In Europe, where there is job security for those who have a job, it is not surprising to find authors hailing laziness.

In societies where this is not so and where people have much to lose if they lose a job, as is true in the United States, change from any source can be highly threatening. And when change hits home, it is easier to put a foreign face on it — blaming trade, outsourcing or direct investment by U.S. companies abroad.

What is much harder is to recognize that most change is domestically driven — by continuing improvements in productivity that allow firms to make do with fewer workers — with or without foreign competition or outsourcing.

In such an environment, then, actual and potential losers from change have a strong incentive to try to dispute very visible sources of change, such as trade, outsourcing and the like.

Thus, although it may seem counterintuitive, constructive safety nets that catch the fallen without destroying their incentive to get back up can be more important in high-income, entrepreneurial economies than in economies with lower average standards of living.

This is because the potential losers from change in high-income countries have more to lose — and thus greater incentive to try to stop it or slow it down.

Given all that, entrepreneurial capitalism is the system we believe is most conducive to radical innovation. But no advanced economy can survive only with entrepreneurs — just as individuals cannot survive by eating just one type of food.

Big firms remain essential to refine and mass-produce the radical innovations that entrepreneurs have a greater propensity to develop or introduce. Given all that, one area for future research is the optimal mix of entrepreneurial and large firms.

Editor’s Note: Copyright 2007 Yale University Press. Used with the permission of the authors.