One of the key questions facing many economists is how economies can continue to grow and innovate in ways that are sustainable over the long term.
For Philip of Agios, a professor at the College de France and INSEAD, helps think of the problem in terms of “creative destruction”—the process by which new products and ideas replace old ones. Aghion was recently at Kellogg to deliver it Nancy M. Schwartz Memorial Lecture. During his visit he spoke with Kellogg’s Ben Jonesstrategy professor, to discuss innovation, competition and designing a fairer 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?
Philip AGION: The term refers to three things: First, innovation is an additive process — you stand on the shoulders of predecessors. Second, you innovate because you are motivated to innovate. And third, new innovations tend to displace old technologies.
Part of the interest in this is that you have a contradiction at the heart of the development process. On the one hand, you need innovation to drive innovation. But on the other hand, there is this temptation for yesterday’s innovators to prevent future innovators because they don’t want to suffer creative destruction themselves.
JONES: Correctly. Many existing players do not want to be displaced, and when they are powerful, they will use their political and regulatory influence to prevent their own destruction.
When you think about innovation through this lens, you realize that innovation isn’t just about being creative. You have to think about the market and the political institutions that enable this fluid destruction and redistribution. It is easy to see why countries prevent this from happening.
A market that works well without interference can allow people to start something new. When Amazon or Walmart come along, they destroy many smaller mom and pop retailers. These are very painful experiences, but you hope that in a well-functioning, liquid market, those owners and workers can be reallocated to more productive businesses and the market will push consumers toward those businesses. But in a system where that doesn’t happen, that’s where you can get into that middle-income trap.
AION: Exactly. While the US and the UK have systems in place to manage creative destruction, other countries such as China and Korea are pioneering innovations. They developed because they imitated technology, so competition was not as critical. During the catch-up phase, the large firms that developed not only blocked entry and innovation from smaller firms, but also used the government to prevent the transition to institutions that favored the cutting edge of innovation. Large conglomerates become an obstacle to competition.
When it comes to regulating capitalism, governments must choose their tools. For example, if they overtax business capital income, they will discourage innovators. Innovation allows people to reach the top income brackets. But because of creative destruction, it is 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 resource because it reduces entry, social mobility and growth while increasing global inequality.
JONES: A different way of thinking 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: First, the market does too many things, like we probably produce too much carbon because no private sector actor has to be held accountable for pollution. So the cost of pollution is wrong. But the market can also fail by doing too little. And innovation and science are areas where markets do very little.
You can often motivate tax policy by saying, “We want to ideally tax the things 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 US, but we have an important infrastructure in place, from the research and development tax credit, basic science funding, government grants, and federal research agencies.
Based on this idea, how would you bring companies and governments and civil society organizations into the climate change debate?
AION: It is true that growth is the source of rising temperatures. If you look at China and India, the takeoff in growth coincides with the takeoff in CO2 emissions. But would you go back to the 1820s? No.
The state has ways to redirect the shift to 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 businesses to innovate greener, particularly in more competitive environments. Because even if my company is not virtuous, I may lose my clients to you if you are virtuous.
JONES: I think innovation and R&D is the solution to climate change. It is a tale of two global public goods. On the downside, it doesn’t matter where the greenhouse gas emissions come from. they cause heating everywhere.
On the bright side, new ideas can help worldwide. The way we will solve climate change is when everyone adopts better technologies. This will only happen when they are cheaper. And no matter what country you are in, you benefit.
AION: Speaking of market failures, COVID has exposed some of the weaknesses of capitalism, which are different from one country to another. While the US is the best innovation model—with its core research funding, venture capital, and institutional investors—it may not be the best social model. During COVID in the US, many people lost their jobs and health insurance and fell into poverty when they needed support. We didn’t see anything like this in Scandinavia or Germany. This raises a big question for discussion: Can you be innovative like the US 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 that there are many “lost Einsteins”, or highly intelligent children born into poor families who cannot give them the proper education and aspirations to become inventors. Now, what is very interesting is that Finland did 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 end up with a more innovative economy because more people can become inventors and it’s more inclusive.
JONES: There are characteristics of markets that are ideal for innovation, but the idea that the market left alone will get it right is far-fetched. If we eliminate the pipeline of future innovators by not offering high-quality access to K-12 education in the United States, these lost Einsteins are truly lost. And that’s in public policy to get that right.
AION: Education and competition policy are as effective in making growth more inclusive as taxation.
Here’s another example: competition. We know that competition policy in the US has not adapted to the digital age. We obsess over market share and market definition and don’t consider whether mergers and acquisitions are preventing future entry and innovation. During the IT revolution, superstar companies emerged: Google, Amazon, Walmart. At first, they were growth enhancers, 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 I hope you could reverse this trend.
And remember, creative destruction causes social mobility. So if you succeed in renewing competition policy, you will make the economy more innovative and more inclusive. And that makes me optimistic that we can improve capitalism.