Originally published on KelloggInsight. Based on the insights of Benjamin F. Jones, Philippe Aghion.
What will the future of capitalism look like?
One of the central questions facing many economists is how economies can continue to grow and innovate in ways that are sustainable over the long term.
For Philippe Aghion, a professor at the College de France and at INSEAD, it helps to think about the problem in terms of “creative destruction”—the process by which new products and ideas replace older ones. Aghion was recently at Kellogg to deliver the Nancy M. Schwartz Memorial Lecture. During his visit, he spoke with Kellogg’s Ben Jones, a professor of strategy, to discuss innovation, competition, and designing a more equitable capitalist future.
This conversation has been edited for length and clarity.
Ben JONES: What do you mean when you use the term “creative destruction” in relation to innovation?
Philippe AGHION: The term refers to three things: First, innovation is a cumulative process—you stand on the shoulders of predecessors. Second, you innovate because you have incentives to innovate. And third, new innovations tend to displace old technologies.
Part of what’s interesting about this is that you have a contradiction at the heart of the growth process. On the one hand, you need innovation to motivate innovation. But on the other hand, there is this temptation by yesterday’s innovators to prevent subsequent innovators because they don’t want themselves to be subject to creative destruction.
JONES: Right. A lot of existing players don’t want to be displaced, and when they’re powerful, they are going to use their political and regulatory influence to prevent their own destruction.
When you think of innovation through this lens, you realize that innovation isn’t simply about being creative. You have to think about the market and the political institutions that allow this fluid destruction and reallocation. It’s easy to see why countries prevent this from happening.
A well-functioning market without interference can allow for people to start something new. When Amazon or Walmart comes in, they’re knocking out a lot of smaller mom-and-pop retail. These are powerfully painful experiences, but you hope that in a well-functioning, fluid market, those owners and workers can reallocate to more productive firms and the market will push consumers toward those firms. But in a system where that doesn’t happen, that’s where you can get into this middle-income trap.
AGHION: Exactly. While the U.S. and the UK have systems to manage creative destruction, other countries like China and Korea are catch-up innovators. They developed because they imitated technology, so competition has not been so crucial. During their catching-up phase, the large firms that developed not only inhibited entry and innovation by smaller firms, but also used the government to prevent the transition towards institutions that favored frontier innovation. The big conglomerates become a barrier to competition.
In terms of regulating capitalism, governments have to choose their tools. For example, if they overtax the capital income of firms, they will discourage innovators. Innovation allows people to get to the top income brackets. But because of creative destruction, it’s also a force of social mobility. You could argue that this is a “good” source of income inequality. Whereas an entry barrier like lobbying is a bad source, because it reduces entry, social mobility, and growth while it increases global inequality.
**JONES: **A different way to think about the problem of regulation is through the lens of market failures—or where the market gets things right or wrong. Market failures come in two forms: One, the market is doing too much of something, like we probably produce too much carbon because no private sector player has to account for pollution. So the costs for polluting are wrong. But the market can also fail by doing too little. And innovation and science are areas where markets do too little.
You can often motivate tax policy by saying, “we want to ideally tax the things that the market does too much of and then subsidize the things where the market does too little.” Of course, we don’t necessarily get it right in the U.S., but we do have considerable infrastructure in place, from the research and development tax credit, to funding basic science, to government grants and federal research agencies.
Building on that idea, how would you bring companies and governments and civil-society organizations into the climate-change conversation?
AGHION: It’s true that growth is the source of the increasing temperature. If you look at China and India, the takeoff of growth coincides with the takeoff in CO2 emissions. But would you go back to the pre-1820s? No.
The state has ways to redirect change towards greener technologies with carbon offsets, but also subsidies for clean innovation and smart industrial policy.
But civil society also has a role to play. Consumers can force firms to innovate greener, particularly in more competitive environments. Because even if my company is not virtuous, I may lose my customers to you if you are virtuous.
**JONES: **I think innovation and R&D is the solution to climate change. It’s a tale of two global public goods. On the negative side, it doesn’t matter where greenhouse gas emissions come from; they cause warming everywhere.
On the positive side, new ideas can help globally. The way we’re going to solve climate change is when everyone adopts better technologies. That’s only going to happen when they’re cheaper. And whatever country you’re in, you benefit.
**AGHION: **Speaking of market failures, COVID revealed some of the weaknesses of capitalism, which are different from one country to another. While the U.S. is the best model of innovation—with its basic research funding, venture capital, and institutional investors—it might not be the best social model. During COVID in the U.S., a lot of people lost their jobs and their health insurance and fell into poverty when they needed support. We didn’t see anything like this in Scandinavia or Germany. Which raises a big question for debate: Can you be innovative like the U.S. and protective and inclusive like Denmark?
I think there are policies that can make you both more innovative and more inclusive. For example, when you lose your job in Denmark, for three years, you get 90 percent of your salary. The state helps you find a new job and they retrain you.
Another example is education. We know there are many “lost Einsteins,” or very smart children born to poor families that cannot give them a proper education and aspirations to become inventors. Now, what’s very interesting is that Finland had a reform in 1970 to make education high quality and very inclusive. With this inclusive education system, they overcame the “lost Einsteins” phenomenon. When you do that, you manage to have a more innovative economy because more people can become inventors and it’s more inclusive.
JONES: There are features of markets that are great for innovation, but the idea that the market left to itself is going to get it right is far off. If we starve the pipeline of future innovators by not offering high-quality access to K-12 education in the United States, these lost Einsteins are really lost. And that’s on public policy to get that right.
AGHION: Education and competition policy are as effective at making growth more inclusive as taxation.
Here’s another example: competition. We know that competition policy in the U.S. has not adapted to the digital era. We are obsessed with market share and market definition, and not looking at whether mergers and acquisitions prevent future entry and innovation. During the IT revolution, you had the emergence of superstar firms: Google, Amazon, Walmart. At first, they were a booster of growth, but then, through mergers and acquisitions, they became hegemonic and discouraged entry and innovation.
Now, suppose you reform competition policy, like what the Biden administration tried to do last year. Then you will make the economy more innovative. I don’t know if it will be effective, but hopefully, you could reverse that trend.
And remember, creative destruction induces social mobility. So if you manage to revamp competition policy, you will make the economy more innovative and more inclusive. And that makes me optimistic that we can improve capitalism.