The success of the U.S. at creation destruction

The U.S. has evolved into an efficient, sometimes callous, economic machine. The ease at which companies can discard workers has helped underpin productivity and corporate profit levels in spite of a recession and has traditionally helped the economic behemoth in recovery.

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But as the government steps in to bail out automakers and financial institutions, is the world’s largest economy undermining the very process of creative destruction that has propelled it thus far?

Steven Davis, a professor of international business and economics at the University of Chicago Booth School of Business, said the solid employment and productivity performance of the U.S. of the past 25 years has been driven to a considerable extent by the country’s success at “creative destruction.”

The term creative destruction was popularized by Austrian economist Joseph Schumpeter in 1942. It describes the process whereby constant innovation sustains long-term economic growth through improved productivity. This process of creation effectively destroys old products, companies and industries that are unable to compete with the new.

Creative destruction is not unique to recessions; it is a constant driver of capitalism. However, the destruction side of the theory becomes magnified in recession as low demand squeezes out companies which, in theory, are less competitive. Davis said the U.S. was particularly successful at evolving in the face of an economic shock because it had flexible labor market policies and low regulation in some markets, such as retail.

“This is why, after the major oil price shocks of the 1970s and the global downturn of the early 1980s, the U.S. recovered in terms of unemployment and economic growth much more rapidly than, say, continental European countries did,” he said.

Since the recession began in December, 2007, 5.7 million jobs have been lost in the U.S. Bill Cheney, chief economist at MFC Global Investment Management in Boston said the ability of the U.S. to maintain productivity by slashing its workforce would help the country be the first to recover.

“The easier it is to fire people, the more willing and the less stressful it is for employers to decide to hire people,” he said. “In the U.S., if you get a couple big orders, you start hiring people because you know that when you don’t need them you can lay them off again. It all sounds rather callous. But an efficient economy is one where the devil sort of does take the hindmost.”

Nevertheless, U.S. productivity and corporate profits have naturally been scorched by the recession. However, a large number of corporations including McDonald’s Corporation, Target Corp., and Foot Locker Inc., have posted better than expected profit results.

Productivity growth, while down from the lofty 2.5 percent levels experienced over the past decade, also remains relatively firm. The preliminary seasonally-adjusted annualized rate for Q1 of 2009 rose 0.8 percent, up 1.8 percent from a year earlier.

Canada has historically under performed the U.S. in productivity. In 2008, Canadian productivity fell 1.3 percent compared with growth of 2.9 percent south of the border. From 1996 to 2000, U.S. productivity grew an average 2.5 percent a year compared with 1.6 percent in Canada.

Pedro Antunes, director of national and provincial forecast at the Conference Board of Canada, said solid productivity growth is crucial to maintaining a strong economy.

“The reason it’s crucial is we are competing with the rest of the world and if we want to pay our salaries and have a real increase in wages, we need to ensure that productivity growth is over and above that. Otherwise, we are eroding our competitiveness.”

Antunes expects Canada to churn out higher productivity this year and next as investment in the resource sector begins to pay off amid recovering commodity prices. The U.S., meanwhile, may be more hampered than boosted by government stimulus plans.

“I am concerned that some of the steps that have been taken at the end of the Bush Administration and at the start of the Obama Administration are really a move away from what has traditionally been U.S. strength, which is going back to this creative destruction process, which means allowing for the destruction side as well as facilitating the creative side,” Davis said.

Author: Alia McMullen writes for the Financial Post in Vancouver