Plate iv in print

The Churn

Aghion; creative destruction — growth as the churning replacement of the old by the better, and the power that would block it.

Each new method prospers by ruining the old; the better machine bankrupts the maker of the worse, and the progress of the whole is paid for by the destruction of the part — so that growth and disruption are not opposites but the same thing, seen from two sides.

— the argument of this plate, after Philippe Aghion, 1992

If the engine of growth is the residual — technological progress, the improvement of methods — then the question is how methods improve. The Solow model, having identified the residual, left it as a black box, a rate of progress arriving from nowhere. The first step in opening the box is to see that technological progress is not a smooth, painless accumulation of better knowledge, like water rising quietly in a tank. It is a violent, disruptive process in which each new method prospers by destroying the old — the better machine bankrupting the maker of the worse, the new firm displacing the incumbent, the rising industry hollowing out the falling one. Joseph Schumpeter gave this process its name, creative destruction; and a later generation of growth theorists, chief among them Philippe Aghion and Peter Howitt, built it into a formal engine of growth, showing how the churning replacement of the old by the new is not a byproduct of growth but its very mechanism.

In the Schumpeterian model of growth, the source of progress is innovation driven by the pursuit of profit. A firm that invents a better product or a cheaper method gains, for a time, a monopoly — it can sell what others cannot, and earn the profits of its advantage. These profits are the prize that motivates the costly, risky work of innovation; the hope of the temporary monopoly is what calls forth the research and the gamble. But the monopoly is temporary precisely because the same prize motivates the next innovator, who labors to invent something better still, and who, succeeding, destroys the first innovator's monopoly as surely as the first destroyed his predecessor's. Growth, in this model, is the unending sequence of such displacements: each innovator climbs to the top by toppling the one before, enjoys the profits of the summit briefly, and is toppled in turn. The rate of growth depends on how fast this sequence runs — on how strong the incentive to innovate is, which depends in turn on the size and the duration of the monopoly profits the winner can expect. Growth is powered by the race to render one's predecessor obsolete.1

1. The Schumpeterian engine: progress is innovation driven by profit. A firm inventing a better product or method gains a temporary monopoly and its profits — the prize that motivates costly, risky innovation. But the monopoly is temporary, because the same prize motivates the next innovator, who invents something better and destroys the first's monopoly. Growth is the unending sequence of displacements: each innovator topples the one before, profits briefly, and is toppled in turn. The growth rate depends on the strength of the incentive to innovate — the monopoly profits the winner expects.

This engine, abstract in the model, is vividly real in the economy. It appears as the constant churning of firms, products, and jobs that marks a growing economy: old companies dying as new ones rise, whole industries shrinking as others boom, jobs destroyed in the declining sectors as they are created in the ascending ones. The great firms of one generation — the makers of carriages, of typewriters, of film cameras — are bankrupted by the innovations of the next; the dominant companies of today were, many of them, unknown a generation ago, and will be eclipsed by firms not yet founded. This churn is not a sign of a sick economy but of a healthy, growing one; the economies that grow fastest are those in which the turnover is greatest, the old most readily displaced by the new. And the churn falls on people, not only firms: the worker whose skill or whose industry is rendered obsolete by the new method bears a real cost, even as the society as a whole grows richer. Creative destruction is creative and destructive at once, and the destruction is borne by particular people and firms while the creation is spread across the whole.2

2. The churn made visible: the constant turnover of firms, products, and jobs in a growing economy — old companies dying as new rise, industries shrinking as others boom, jobs destroyed in declining sectors and created in ascending ones. The great firms of one generation (carriages, typewriters, film cameras) are bankrupted by the next's innovations. This churn marks a healthy, growing economy, not a sick one. But it falls on people: the worker whose skill is rendered obsolete bears a real cost even as society grows richer. Creative destruction is creative and destructive at once.
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Here the churn reveals its political edge, and its connection to the rule the previous family established. Creative destruction creates winners and losers: the new innovator wins, but the incumbent he displaces loses — and the incumbent, being established, often has the power and the motive to resist. The maker of the old machine, threatened by the new, will lobby to ban it, tax it, or regulate it out of existence; the dominant firm will use its influence to raise barriers against the upstart; the guild will forbid the labor-saving device that would idle its members. The history of growth is littered with such resistance — with technologies suppressed, inventions blocked, innovators thwarted by those whose livelihoods they threatened. And the resistance is not irrational; it is the rational defense of those who stand to lose from the destruction. The deep point, which the architect's account of institutions sharpens, is that whether creative destruction is allowed to proceed depends on the distribution of power: where the incumbents who would be destroyed hold the power to block the new, growth is strangled in its cradle; where they do not — where the rules permit the upstart to displace the established — the churn runs free and the economy grows. The enemy of growth is not scarcity but the power of those whom the new would ruin.3

3. The churn's political edge (connecting to The Rule): creative destruction creates losers — the displaced incumbent — who often has the power and motive to resist, lobbying to ban, tax, or regulate the new out of existence. History is littered with suppressed technologies and blocked inventions. The resistance is rational (the defense of those who lose). Whether creative destruction proceeds depends on the distribution of power: where incumbents can block the new, growth is strangled; where they cannot, the churn runs free. The enemy of growth is not scarcity but the power of those the new would ruin.

The Schumpeterian engine also reframes a tension the failures family studied: the relation between monopoly and growth. The power volume treated monopoly as an unambiguous harm — the monopolist restricts output and raises price, destroying surplus. But in the Schumpeterian model, the prospect of monopoly is the very thing that motivates innovation: the innovator works for the temporary monopoly his invention will bring, and without that prospect of monopoly profit, the costly gamble of innovation would not be worth making. So a measure of monopoly power is not simply a harm but a necessary incentive for growth — which is why societies grant patents, deliberately creating temporary monopolies over new ideas to reward and encourage their creation. The art of policy is to balance the static harm of monopoly, higher prices now, against its dynamic benefit, more innovation and so faster growth later — to allow enough monopoly to spur the innovation, but not so much that the monopolist, once established, can block the next innovator and freeze the churn. This balance, between the monopoly that rewards innovation and the competition that compels it, is among the central and unsettled questions of growth policy.4

4. The engine reframes monopoly (cf. The Power): the power volume treated monopoly as pure harm (restricted output, higher price). But here the prospect of temporary monopoly motivates innovation — the prize that justifies the costly gamble; hence patents, which deliberately create temporary monopolies over ideas to reward their creation. Policy must balance monopoly's static harm (higher prices now) against its dynamic benefit (more innovation, faster growth later) — enough monopoly to spur innovation, not so much that the incumbent blocks the next innovator.

The churn opens the black box of the residual one turn further: technological progress is the relentless replacement of old methods by better ones, driven by the pursuit of the profits that innovation brings, and proceeding only where the power of the displaced does not block it. But the churn describes how methods improve at the frontier — how the leading economies push the boundary of what is known outward, one displacement at a time. It does not yet explain the deeper puzzle of the question this volume was built around: why some nations grow rich while others, no less able, do not. For most countries, growth is not a matter of pushing the frontier but of catching up to it — of acquiring methods already invented elsewhere. Why is this catch-up so easy in theory, since the methods already exist and need only be copied, and yet so hard in practice, since so many nations have failed at it for so long? The next plate turns from the frontier to the followers, from invention to adoption. The next plate is the catch-up.5

5. The churn opens the residual one turn further: progress is the replacement of old methods by better ones, driven by innovation's profits, proceeding only where the displaced cannot block it. But this describes frontier growth — how the leaders push the boundary outward. It does not yet explain the openq: why some nations grow rich and others, no less able, do not. For most countries growth means catching up — acquiring methods invented elsewhere. Why is catch-up easy in theory (copy what exists) yet so hard in practice? The next plate turns from frontier to followers, invention to adoption: The Catch-Up.

Creative destruction is the mechanism of progress at the frontier. Technological advance is not a smooth accumulation of better knowledge but a violent sequence of displacements, in which each innovator wins the temporary monopoly his invention brings by destroying the monopoly of the innovator before him, and is destroyed in turn by the one after. This churn — of firms, of products, of jobs — is the visible face of growth, and the fastest-growing economies are those where it runs most freely. But the churn makes losers as well as winners, and the losers, being established, often have the power to resist; whether growth proceeds depends on whether the rules let the new displace the old, or let the old strangle the new. The engine of frontier growth is the race to obsolete one's predecessor, run on a track that the powerful can block. Yet most nations do not grow by pushing the frontier; they grow, or fail to grow, by catching up to it. The next plate is the catch-up.