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Can Government Harness Creative Destruction? April 2012

Can Government Harness Creative Destruction?

By James W. Fossett

James W. Fossett

Perhaps the most influential six pages in modern economics can be found in Joseph Schumpeter’s Capitalism, Socialism, and Democracy, first published in 1942. In a short chapter entitled “The Process of Creative Destruction,” Schumpeter lays out an authoritative view of how capitalist economies change and evolve. What determines economic growth, Schumpeter argues, is not competition between established firms, but rather continual innovations in commodities, technologies and organizational structures that create new industries and wealth, while making old industries obsolete:



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James W. Fossett is a senior fellow at the Rockefeller Institute and associate professor of public administration and public health at the Rockefeller College of Public Affairs and Policy, University at Albany.

“(The question is not) how capitalism administers existing structures ... (but) how it creates and destroys them … The opening up of new markets, foreign and domestic, and the organizational development from the craft shop to such concerns as US Steel illustrate the same process of industrial mutation ... that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” [1]

Countless examples of this process can be found throughout American history. The advent of digital photography, for example, led to the demise of Kodak, and the Internet has transformed media industries. Creative destruction has also contributed to a large-scale movement of manufacturing jobs out of this country, in many cases to cheaper and more efficient plants in Asia. Nationally, manufacturing employment declined by almost 6 million jobs, or almost one-third, between 1999 and 2009.

Many state and local agencies, as well as the federal government, are trying to compensate for this loss of jobs by investing in the collaborative commercialization of research based in university labs centered around nanotechnology, “clean energy” and other advanced technologies. Many are attempting to enhance the flow of scientific discoveries into the marketplace via long-term collaborations between university researchers, private companies and government agencies. Federal, state and local governments are supporting these initiatives in a variety of ways. Historically, government support has centered around support for basic research, but recent state and local government initiatives are focused explicitly on economic development. New York City, for example, has awarded Cornell University and an Israeli engineering school city-owned land and major infrastructure improvements to establish an engineering campus that is expected to generate spinoff companies, economic activity and employment.[2]

These new collaborative organizational structures created to invest in cutting-edge technology can be understood, at least in part, as an attempt to capture the next generation of “creative destruction” and provide a regular flow of innovative products and processes that will enable American companies to maintain their competitive advantage. Schumpeter also noted that potential competition also poses an “ever present threat … that disciplines before it attacks” by encouraging established companies to maintain a high rate of innovation. By maintaining closer ties to university researchers and developing the means of incorporating research results into their products and manufacturing processes, larger companies may hope to maintain a competitive advantage and avoid being rendered obsolete by the next wave of innovation.

While these new organizational structures and the technologies they are developing are works in progress, it may be possible to attempt some informed guesses about their likely impact in capturing the next generation of innovation for American companies.

First, it seems clear from past experience that creating and sustaining these new organizational structures is harder than it looks. There are strong political norms, for example, that state economic development funding should be spread around to many communities rather than concentrated on more promising projects. University scientists may not be interested in the applied research that companies want to have done, and companies may be unwilling to enter into agreements on such matters as intellectual property and royalties on terms that universities find acceptable. At least some universities have proven unwilling or unable to support the commercialization of faculty research through “spin-off” companies. Private investors also appear to be more conservative in investing in smaller companies without limited track records.[3] Expectations on the part of many economic development officials that “if we build it, they will come” have proven unfounded.[4]

Second, these strategies are unlikely to make a dent in replacing lost manufacturing jobs. Employment in many emerging technologies, while growing more rapidly than other sectors of the economy, remains modest. Data compiled by the Pew Center for the States, for example, indicates that total national employment in 2007 in biotechnology and so-called “clean” energy amounted to less than 1 million jobs, or only a fraction of the manufacturing jobs lost over the past decade.[5] Earlier predictions that employment in nanotechnology would amount to as many as 800,000 jobs in 2015 from a base of 160,000 in 2008 appear to have been overly optimistic.[6] While the longer term employment impact may well be larger, it will fall far short of replacing lost manufacturing jobs even if employment in these sectors doubles or triples in the immediate future.

Third, it seems likely that this model of creative destruction will be more successful in some industries than in others. Industries whose business models require heavy investment in expensive research and development (R&D) may be well suited to this form of collaboration because of its potential for sharing the expense of product development. The semiconductor industry, for example, has a long history of outsourcing and collaboration between companies in the R&D process.[7] Pharmaceutical and biotech companies, by contrast, have been fiercely protective of patents and other intellectual property, making the sort of integrative collaboration practiced in the semiconductor industry uncommon and unlikely.[8]

Fourth, it is to be expected that many government investments will fail. Emerging technologies are by their nature emerging, and it may require considerable experimentation with alternative business models before companies are able to become profitable. A high failure rate early in an industry’s life cycle is thus to be expected, regardless of the source of financing. Venture capital firms that invest in these technologies expect a high failure rate in their investments — the oft-quoted rule of thumb is one-third. Gary Pisano of the Harvard Business School has written of the privately financed biotech industry, “in aggregate, the vast majority of resources spent in pharmaceutical R&D goes toward projects that end up being ‘losers.’”[9] Government investments may have a higher failure rate than one would like, but investing in emerging technologies is a risky investment for public and private investors alike.

One should not conclude from a high failure rate, as some have, that government is congenitally incapable of picking winners. Certainly, it would be difficult to find investments that made greater contributions to economic growth or been the cause of more “creative destruction” than government investments in canals, railroads, interstate highways, air traffic control and the Internet. In similar fashion, one would have to credit investments by the military and NASA for innovations across a wide range of technologies that have proven to have civilian applications. One recent analysis of award-winning innovations indicates that fewer are funded solely by individual private companies and more are the results of collaborative efforts financed by various federal funds.[10] History suggests that success in these enterprises requires the right combination of industry needs, university expertise and organizational flexibility, and political conditions to come together. Individual projects may well be successful in stimulating local employment if these conditions are satisfied, but success or failure will be determined by project-specific factors. Creative destruction doesn’t happen overnight.

[1] Joseph Schumpeter, Capitalism, Socialism, and Democracy (1942), p.82,83.

[2] Oliver Staley and Henry Goldman, “Cornell, Technion Are Chosen by New York City to Create Engineering Campus,” Bloomberg News (December 19, 2011) online at http://www.bloomberg.com/news/2011-12-19/cornell-university-said-to-be-chosen-by-new-york-for-engineering-campus.html

[3] Ernst and Young, Beyond Borders:Global Biotechnology Report 2011.

[4] Thanks to my colleague David Shaffer for suggesting this phrase.

[5] Pew Center for the States, The Clean Energy Economy: Repowering Jobs, Businesses and Investments Across America (June 2009)

[6] Ann Thayer, “Filling Nanotech Jobs,” Chemical and Engineering News (July 19, 2010): 10-16.

[7] Clair Brown and Greg Linden, Chips and Change: How Crisis Reshapes the Semiconductor Industry (MIT, 2011)

[8] Gary Pisano, Science Business (Harvard School of Business, 2006), p. 149-153.

[9] Gary Pisano, Science Business (Harvard Business School Press, Boston, 2006); p.57.

[10] Fred Block and Matthew Keller, “Where Do Innovations Come From? Transformations in the US National Innovation System, 1971-2006,” Information Technology and Innovation Foundation, 2008.


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The Nelson A. Rockefeller Institute of Government, the public policy research arm of the State University of New York, conducts fiscal and programmatic research on American state and local governments. It works closely with federal, state, and local government agencies nationally and in New York, and draws on the State University’s rich intellectual resources and on networks of public policy academic experts throughout the country.