“Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary…The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.
[T]he history of the productive apparatus of a typical farm, from the beginnings of the rationalization of crop rotation, plowing and fattening to the mechanized thing of today — linking up with elevators and railroads — is a history of revolutions. So is the history of the productive apparatus of the iron and steel industry from the charcoal furnace to our own type of furnace, or the history of the apparatus of power production from the overshot water wheel to the modern power plant, or the history of transportation from the mail-coach to the airplane. The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. 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 [my emphasis].”
-Joseph Schumpeter, Capitalism, Socialism and Democracy, 1942
With this being an election year, the usual economic topics are foremost in the nation’s mind: job growth, wage growth, education and healthcare affordability, etc. This year, however, the disappointing recovery seems to have created, – or to have awoken, – a strident populism both on the left and on the right, led by candidates who seek to disrupt the status quo by imposing trade barriers, making immigration more difficult, and other anti-free market policies. The idea seems to be that the economic pie can’t grow, so how it is apportioned should take precedent. In simpler terms, If our economy won’t grow, we should refuse to share it with more people.
The economic paranoia that many Americans are feeling is understandable. As Doug Short noted, real median household income has only recently surpassed the pre-recession levels of 2007, yet current levels are still below (albeit fractionally) the peak of 2000 (chart from Doug Short):
The pain of a slow recovery hasn’t been felt only at home; as Ritholtz Wealth’s Michael Batnick wrote in February, stock returns so far this century have been very anemic:
Despite the weak recovery and disappointing equity returns, it would be foolish to embrace either a wholesale change in economic policy, or for investor to abandon hope for future equity returns.
The reality is that these prolonged periods of economic malaise and weak equity returns are normal, and, as you can see from both the chart above and the GDP chart below, there is a certain cyclicality to both the economy and the markets.
The periods of rapid economic growth (and usually high stock returns) usually coincided with major technological shifts that freed up labor for more productive purposes and gave birth to new industries that promised better jobs and lifestyles than those they displaced. In 1989, only 15% of households had a personal computer, but now there are many high-paying jobs that revolve around the computer‘s (more accurately, the internet’s) dominance of our daily lives. The flip side of that coin is that jobs in the manufacturing sector have declined, leading to real pain for workers displaced by things such as automation and outsourcing (even though manufacturing output has soared):
It may not surprise readers to learn that every quarter, more than 7 millions jobs are created, but I am sure it would surprise many that an almost equal number of jobs are destroyed. It might also surprise people that even though this has been one of the longest, albeit weak, expansions on record, there have been almost 7,400 Chapter 11 bankruptcies a year since the recovery took hold in 2010. Other examples of creative destruction are these:
-Compared to 2004, more than a fourth of the companies then in the S&P 500 have “been acquired, taken private, or gone bankrupt,” though there have been hundreds of IPOs since.
The bottom line is, just as Schumpeter said in the above passage, that you can’t have creation without the destruction. Just look at how many companies in the US have been founded during recessions. One need look only at Japan to see why the destruction part of the equation is necessary. Japan has had a stagnant economy for decades, even though its unemployment rate has stayed well below levels in the US. Part of this is due to the culture of “lifetime” employment that hamstrings Japanese companies during downturns. Perhaps as an unintended consequence of guaranteed employment, – and no doubt also due to the stagnation in the economy, -Japanese have largely abandoned risk-taking. Finances for the elderly are in such dire straits that many have resorted to crime just to get the guaranteed amenities of prison. Because of government protectionism, among other things, Japanese equities have dramatically underperformed relative to the US and the globe. The tide is turning, however; the Wall Street Journal noted that the recent sale of Sharp to Foxconn is the first time foreigners have been allowed to buy a Japanese technology firm. Opening up Japan, Inc. to such animal spirits will help to reinvigorate the Japanese economy and natural industriousness.
I’m not going to be overly simplistic and suggest that the world is binary, and that we have a choice only between continual disruption and Japanese-style sclerosis. The takeaway is that there will always be periods of rapid, dynamic economic growth and high equity returns, and there will always be the intervening periods, – perhaps as we all digest the innovation and the wounds from dramatic disruption heal, – when growth and returns disappoint. That’s no reason, however, to assume the future will be awful.