Creative Destruction Means You are Unafraid of Failure

I find much of the criticism of the US economic model far overdone during this current economic crisis. Many have passed judgment on the entire US economic model as a failure based on just the most recent events. What's most surprising is how some can gasp as to how this is the worst crisis since the Great Depression yet in the same thought fail to realize that the US survived the great depression and then leapt forward at an amazing pace afterwards developing world-changing innovation such as semiconductors, software, the internet, etc. Meanwhile a lot of more "stable" countries just kept plodding along with "follow-on" growth, growing mostly via tech transfer of innovations invented outside their borders and/or the simple application of increased labor. I hate to say it, but most countries worldwide add very little in the way of innovation. Anyhow, below is a long excerpt from Der Spiegel which made me write this post. The simple thing Der Spiegel forgets is that one major ideal of the US economic system is that failure is allowed and not frowned upon. Thus a massive failure doesn't show that that the overall system is structurally broken in any way.

The banking crisis in the United States has shaken many things in recent days, not just the chancellor's affection for America and the respect the rest of the world once had for the US as an economic and political superpower. Since the US investment bank Lehman Brothers plummeted into bankruptcy two weeks ago, the financial crisis has developed a destructive force of almost unimaginable strength. The proud US investment banks with globally recognized names like Merrill Lynch and Goldman Sachs have all gone bankrupt, been bought up or restructured. The American real estate market has essentially been nationalized. And the country's biggest savings and loan, Washington Mutual, has failed and been sold at a loss.

With its rule of three of cheap money, free markets and double-digit profit margins, American turbo-capitalism has set economic standards worldwide for the past quarter century. Now it is proving to be nothing but a giant snowball system, upsetting the US's global political status as it comes crashing down. Every bank that US Treasury Secretary Henry Paulson is currently forced to bail out with American government funds damages America's reputation around the world...

Of course, it is not solely the result of undesirable economic developments that the United States is in the process of forfeiting its unique position in the world and that the world is moving toward what Fareed Zakaria, editor of Newsweek International, calls a "post-American age."...

Ironically, it is in the country of unfettered capitalism that the government now plans to intervene in the economy on a scale not seen since the Great Depression, and, with hundreds of billions of dollars, attempt to save the financial sector from failure -- out of fear of something even worse: an economic collapse with declining prices and widespread unemployment.

This is no longer the muscular and arrogant United States the world knows, the superpower that sets the rules for everyone else and that considers its way of thinking and doing business to be the only road to success.

A new America is on display, a country that no longer trusts its old values and its elites even less: the politicians, who failed to see the problems on the horizon, and the economic leaders, who tried to sell a fictitious world of prosperity to Americans.

Also on display is the end of arrogance. The Americans are now paying the price for their pride.

The effects of the financial crisis are already serious, both for the American taxpayer, who will end up footing the bill no matter what, and for the relationship between the government and the economy. An era of American economic policy is coming to a close. Ironically, and surprisingly to many, the last few months of the Bush administration will mark the end of the so-called "Reagan revolution."

First thing is that its really not a big deal to lose some pride. You can get it back. Losing some arrogance isn't a bad thing either. In the end I'll take an innovative and creative system over a stagnant yet proud one. Its also not a big deal to lose big companies. Many more will be created and a brief check of US business history has seen a lot of big names come and go. The people, skills, systems, and knowledge are never lost, merely incorporated into a new venture, somewhere. And that's where the value creation is, the people, skills, systems, and knowledge. Not just in the Lehman corporate entity for example. Lehman's skilled former employees are still around. Their ability to create value is still part of the US, and perhaps enhanced given what they have seen. Respect may be lost near term due to a failure, but when in a few years people around the world are adopting your latest innovation respect can be rebuilt.

Also, for those who see the crisis as a judgment of failure for past 20 or so years of policy, the US GDP is nearly 11.7 trillion dollars (Real GDP, using 2000 dollars) per year. This is an improvement from only 6 trillion dollars in 1985. I would say that innovation has even accelerated over that period. If we add up all the has produced in the last 22 years, then even the worst case losses due to the current crisis are small in comparison. Cumulative GDP from 1985 to 2007 created was 197 trillion dollars. If the US just grows at 2.5% per year, then from 2008 to 2030 we can expect another 360 trillion dollars of cumulative GDP. This crisis is a big hit all at once, but in the greater scheme of things its not the end of the US system and likely to be an OK trade-off for an economic system of experimentation.

What is currently the problem is that the US simply built too many houses and then banks gave out too many bad loans. So a lot of efforts were badly allocated in the economy. Now we are in the readjustment process where efforts will be redirected to more productive and less destructive pursuits. Sure many companies will go bust and some hard times are ahead. But all the people and their skills and knowledge aren't lost. The US has and will continue to be a vibrant culture for experimentation, though perhaps a bit shell-shocked in the near-term. New companies will be created and new types of business experiments will commence. And if this volatile American economic system can just crank out another Google every few years, creating massive value within a short period of time out of simply two smart brains at a college, then I feel its very likely that we end up looking back on this crisis as just another explosion in the universe of American creative destruction. Most Americans don't lose too much sleep over their "reputation" for the Great Depression these days. And I think in the future they won't lose much sleep over this latest crisis either, once they get through the hard parts.

My key point is that in the (relatively) open US economic system, failure is not to be feared, and it might actually be a sign that problems are being corrected and learned from. This isn't the end of US economic power or system, but rather a reallocation of productive efforts and a process of correction and improvement. Also, I think many misunderstand where economic value comes from. Its not a fixed quantity like gold in the ground. Value in the US comes from the value-generation potential of its system. Thus money and value is currently being lost but more will be created out of sharp minds as long as they have an open playground with which to do so. To think that this current crisis erases all the value generation of the last 20 years is to vastly under appreciate what the world currently has in 2008. You have to be quite ignorant of things in order to criticize the innovative American system as a failure while using your computer over the internet and perhaps listening on your iPod to musicians who blatantly copy the ideas of hip hop music...

Thus hopefully the US remembers to let itself fail in the near term in order to continue succeeding for the long term with the key near term goal being to help those who are most impacted readjust and redeploy to new productive efforts. And hopefully innovative efforts in other countries aren't cowed as well. Long-term, does the US have any less innovative potential than it had before this crisis? No. The system isn't broken... as long as the economy isn't locked down due to near-term fear under the dangerous banner of economic stability.

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