Posts Tagged ‘Schumpeter’

The Fear of Creative Destruction

As an undergraduate student of economics in Delhi University some four decades ago, I was immensely flattered when my classmate and dear friend Ramachandra Guha conferred on me the name “Schumpeter”; he was in the habit of naming after famous economists those of his classmates whom he considered scholastically minded. Many years later, Schumpeter came to my notice again when his famous concept “creative destruction” was referred to in that brilliant book by Daren Acemoglu and James Robinson “Why Nations Fail: The Origins of Power, Prosperity and Poverty (2012)”. The central thesis of their book is that countries with extractive political and economic institutions falter on the growth path because their elites are preoccupied with their ability to extract rent from economic activities through the exercise of unfettered political authority coupled with keeping out groups that constitute a threat to their economic oligarchy. These countries are, therefore, in a situation where innovations leading to high economic growth are not possible, because of the opposition to change from vested interest groups benefiting from the current system. When Schumpeter referred to the “process of creative destruction” in his 1942 book “Capitalism, Socialism and Democracy”, he was emphasising the fact that capitalism involved the destruction of existing economic structures and their replacement by new structures. This was not price competition between existing producers but a discontinuity following the introduction of new technology, new products and new forms of industrial organisation, many of which could not even have been envisaged prior to their development.
W. Michael Cox and Richard Alm, co-authors of “Myths of Rich and Poor (1999)” have given a graphic example of creative destruction in the transportation sector. Water transport was increasingly replaced by railroads, which in turn (along with animal transport), was supplanted by road and air transport. In our own lifetime, we have seen typewriters and fax machines vanish with the advent of personal computers. The impact of these revolutionary changes was felt not just in the eclipse of once powerful industries but also in dramatic changes in the job market and a churning in industrial enterprises, with new companies elbowing their way to the top. Of the top hundred companies in the USA in 1917, only five retain their position in the top hundred. Half of the top hundred companies in the USA in 1970 have been replaced by newer companies today. We don’t need to go as far as the USA; India itself is abundant proof of this phenomenon. Who had heard of Reliance Industries or Sun Pharma in 1970? Infosys and Tata Consultancy Services were nowhere on the horizon till the 1991 reforms and the development of the information technology industry. The nature of jobs also registers dramatic changes over time. Occupations like those of drivers of motorised vehicles were almost non-existent at the start of the twentieth century, while computer programmers and scientists were nowhere in evidence at the end of the Second World War.
I give these instances to buttress my theory that the failure of the Indian economy to grow rapidly (in the sense of benefiting large sections of its population) can be linked to an almost mortal dread of “creative destruction”, at considerable cost to the people of India. The landed aristocracy and the agricultural elite, in the decades after independence, kept land redistribution efforts at bay and successfully resisted the imposition of an agricultural income tax. Coupled with high support prices for agricultural produce grown by the rich farmer and extensive subsidisation of the profligate use of fertiliser, power and water (largely by the rich farmer rather than his humble subsistence farmer cousin), this has implied a reversal of the traditional pattern where a booming agriculture sector finances the growth of a robust industrial sector. By stifling the growth of the industrial sector, which would enable off-farm employment to reduce the growing pressure on agricultural land, it has been ensured that agricultural productivity remains low and farming has become (or remains) a non-viable occupation.
Other policies of the state continue to impede rapid industrialisation. The 2013 Land Acquisition Act is a case in point. In a classic case of the remedy being worse than the disease, the requirements (in case of acquisition for public private partnerships and for private companies for a public purpose) of consent of at least 70 to 80 percent respectively of affected families, the high rates of compensation and the provision of a social impact assessment, as well as the passing of a resettlement and rehabilitation package by the district authority (even for negotiated sales by a private company) taken together will ensure that no project or industry can get off the ground in a reasonable period. The fear of creative destruction operates here too: rural poverty is sought to be addressed through complicated (and infeasible) compensation and resettlement packages rather than giving the rural community a chance to be a partner in rapid industrialisation and to move to more remunerative work in the industrial sector. The same holds true for official urban policy (or what passes for it) — there has always been a bias against promoting opportunities in urban areas, given the misguided view that Gandhi’s “gram swaraj” must be kept intact at all costs, never mind the wretched and inequitable condition of India’s villages and the reality of massive rural migration to urban areas.
Nor do the political class and bureaucracy want their monopoly over patronage to be disturbed. Independent India has seen the politician use the public sector to disburse jobs to his constituents apart from skimming off economic rent through manipulating award of contracts. Controlling licenses also enabled the politician/bureaucrat to extract rent from the private sector. Only the form and manner of rent extraction changed in the post-1991 liberalisation era. With growing urbanisation, land use permissions in urban and semi-urban areas became a major area for abuse of discretionary powers. The lack of clear norms for allocation of natural resources and for infrastructure development project contracts contributed to the suspicion (often genuine) of manipulation of selection processes to favour cronies, the fallout of which is being experienced to this day. Failure to reduce government control over public enterprises and improve their public accountability meant that this cash cow (where it did not fall sick) was available for patronage distribution. Wilful major defaulters of bank loans are able to use their political connections to delay takeover/liquidation of defaulting concerns.
In preventing or delaying the “gale of creative destruction”, the political class at least has the alibi that it is looking after its narrow economic interests. The same defence is not available to India’s “thinking” classes, its intellectuals, media and bureaucracy, who have consistently opposed thoroughgoing reforms in different sectors. Efficient exploitation of natural resources through impartial bidding processes is slowly becoming a reality more than two decades after the start of the liberalisation process. But even now, vociferous sections in India’s middle class oppose moves to open natural resource sectors to private investment to add economic value. Trade unions in the coal and mining industries will, of course, oppose all such steps since it will diminish their powers. But the opposition of the bureaucracy, sections of the media and academia to these measures defies understanding. The same logic holds where freeing public sector enterprises from the stranglehold of government by reducing government holdings in these enterprises is contemplated. There still seems to be a touching faith in the ability of government to micromanage these enterprises. Foreign direct investment in retail would give better profit margins to the farmers by eliminating middlemen in mandis (market places) and agricultural produce marketing committees. It would also provide the badly needed investment in reducing wastage by streamlining the supply chain system from the farmer to the consumer. No such luck — by allying itself with vested interests protecting their traditional fiefdoms, the intelligentsia betrays the interests of the large body of farmers.
Ultimately, India’s middle classes have to decide whether they want to be in the vanguard of rapid economic change or are content to wallow in mindless, outmoded socialist rhetoric with a credulous belief in the capabilities of the state. The next two decades are crucial to India moving on to a path of sustained development. “Creative destruction” is no respecter of size or reputation. Consider the example from India’s favourite sport, cricket. India took over fifty years from its entry into international cricket to win a World Cup. Sri Lanka took about two decades to reach the pinnacle of world cricket by winning the World Cup in 1996. By defeating Pakistan and India in quick succession earlier this year, the Bangladesh team has shown its resolve to shorten the time span it needs to reach the top. Countries like Vietnam, South Africa and Bangladesh can well pose major challenges to India’s markets (both local and global) in the years to come and at a much faster pace than is anticipated. “The gale of creative destruction” can blow in both directions: move it outwards and you control your destiny; if it turns against you, you may well get blown away.