Has “Creative Destruction” Reached Silicon Valley?

We begin today with a quote from the great economist Joseph Schumpeter, who is credited with coining the term “Creative Destruction,” to describe the effect of innovation on legacy industries and technology.

“The possibility that the economic wants of humanity might someday be so completely satisfied that little motive would be left to push productive effort still further ahead…A more or less stationary state would ensue. Capitalism, being essentially an evolutionary process, would become atrophic. There would be nothing left for entrepreneurs to do. They would find themselves in much the same situation as generals would in a society perfectly sure of permanent peace…the management of industry and trade would become a matter of current administration, and the personnel would unavoidably acquire the characteristics of a bureaucracy. Socialism of a very sober type would almost automatically come into being.” -Joseph Schumpeter

There’s a lot baked into this excerpt from Schumpeter’s seminal work Capitalism, Socialism and Democracy. First, he muses on the possibility that innovation might have a ceiling because humans no longer desire the next new thing. Hard to imagine, given our rabidly consumptive behavior, but as my friend from Brooklyn says, “there’s too much good weed and free porn in the world today.” A debauched sentiment, but real. But Schumpeter is also analyzing a system of innovation based upon needs, not wants. Necessity as the mother of invention, and all of that.

If not for an appetite to live longer, freer, easier, then what would compel organizations and people within an economic system to drive to innovate? Are we to become mere managers of a system? Social and economic bureaucrats? Is that why billionaires are looking to space as an escape from the destruction that unfettered innovation and capitalism has wrought on earth?

The inevitability of a sober socialism is just one of countless musings that Schumpeter offers in his writings. Schumpeter is one of the crucial heirs of the Marxian tradition, though he breaks with Marx in key areas. Whereas Marx believed that capitalism would ultimately exploit the working class to the point of revolution, Schumpeter saw capitalism as inherently iterative and malleable due to the concept of creative destruction. And that the working class would not be entirely exploited; they would shift over time along a spectrum of activities within new markets generated by the creative destruction of old ones. But while the pair disagree on the journey, they arrive at much the same conclusion. As The Guardian’s Adrian Daub writes:

“While creative destruction is viable economically, its experience is too disorienting politically to allow capitalism to survive long-term. In the end, Schumpeter believed, creative destruction makes capitalism unsustainable: gradually and peacefully (through elections and legislative action), capitalism will yield to some form of socialism.”

Chapter One: What is Creative Destruction?

This essay asks the question whether Silicon Valley, or the tech sector as a whole, has reached peak innovation, and whether or not we are approaching Schumpeter’s vision of a peaceful and bureaucratic socialism. It’s an interesting thought experiment, but one that cannot exist outside of the harsh reality that the capitalist system has brought challenges to the world more destructive than even Marx might have imagined. Modern theorists are left to grapple with the effects of climate change on the natural world, the cultures it supports and the economies we function within.

One of the primary resources for this essay is a book titled The Power of Creative Destruction: Economic Upheaval and the Wealth of Nations. The book is a collection of essays and lectures curated by Philippe Aghion and other authors who seek to contextualize the role innovation plays in building capitalist economies. Importantly, the book takes a subdued but optimistic view of capitalism generally, so this is less about attacking the structure of it and more about analyzing the circumstances that allow capitalism to thrive and ways that it can theoretically be improved to benefit society.

Aghion and team, much like Schumpeter, are more clinical in their views of capitalism. That’s not to say they don’t have their own critiques. But the purpose of bringing their ideas forward today is to illustrate how capitalism functions within different social, cultural and legal structures.

As for the concept itself, creative destruction isn’t all that complicated. What’s far more interesting is trying to understand the circumstances that allow for it to occur. To wrap our minds around it, here’s Aghion’s definition in plain terms:

“Creative destruction is the process by which new innovations continually emerge and render existing technologies obsolete, new firms continually arrive to compete with existing firms, and new jobs and activities arise and replace existing jobs and activities. Creative destruction is the driving force of capitalism, ensuring its perpetual renewal and reproduction, but at the same time generating risks and upheaval that must be managed and regulated.”

Like the horse and buggy being replaced by the automobile, or Netflix replacing Blockbuster Video. In each of these, and the countless historical examples of creative destruction, more than the founding technology, there is always a supporting constellation of goods, services and labor surrounding it. Aghion refers to these as rents and renters; the saddle and horseshoe makers or VHS machines and the dude who had to put all the tapes on that rewind thing ’cause you were too lazy to “be kind and rewind” at home.

Right. So pretty basic. The question at hand is whether or not the tech sector, with Silicon Valley as its figurehead proxy in the United States, has reached the end of creative destruction. Are we really innovating any longer? It’s a question pondered by asshats like Peter Thiel, whom you know I dislike. But here he is pondering this very notion"

“There is a question how much innovation is actually happening. And that’s, that's what I always come back to where I’m somewhat on the sort of side that we’ve had, you know, generally sort of limited progress in technology and science. The last 50 years there was, uh, very big exceptions, and computers, software, internet, mobile internet the last quarter century; this was sort of this narrow cone of progress in the world that really drove things. And I sort of wonder if there’s actually less innovation possible even in those areas at this point.”

What’s interesting about Thiel is that his prescriptions for curing what ails Silicon Valley and society in general are the exact opposite of what Aghion and company determine from tomes of research. On Thiel’s planet, people would drop out of college, the government would tax no one and nation states would give way to corporate oligarchy. He’s a classic libertarian in every sense. It’s part of what drives me nuts about people like him.

He’s decrying the lack of innovation in the tech sector and claiming that real innovation hasn’t taken place in 50 years. I’ll grant him that, and you’ve heard me make this argument before. Iteration and improvements are distinct from true innovation. But if we look back to the period when people like Thiel believed innovation thrived in the United States and the European economies, they were characterized by three pillars: investments into public education, public sector investment into private industry, and public welfare and social reforms. Obviously, the key word here is public. Not private, public.

Where we’re aligned is in defining innovation. For better or worse, many of the technologies we rely upon today came out of the defense department and the investments they made during World War Two. On the positive side, or maybe not, we have the internet. Spawned from a research project within the Defense Advanced Research Projects Agency (DARPA), the internet was originally known as ARPAnet, borrowing from the agency name. This led to innovations such as GPS, which is definitely a positive thing for me, considering I have the worst sense of direction in human history. Or electronic medical records, a concept that started among doctors in the VA looking for a better way to track the troubled and transient population of veterans returning from foreign wars.

On the flip side, of course, we have weapons of mass destruction and chemical agents used for biological and agricultural purposes, many of which have done more harm than good. Public sector investments into renewable energy, subsidizing companies like Tesla, for example, helped create an entire industry. Favorable trade agreements have allowed U.S. companies to plunder natural resources the world over used to manufacture everything from clothing to the lithium battery in your phone. Microprocessing capabilities developed by the government, in collaboration with universities subsidized by government research grants. The list goes on. True innovation in the United States can be traced back in a straight line to government funded or supported trials.

Chapter Two: Innovation or Iteration?

A distinction must be made between innovation and entrepreneurship. The capitalist system allows for entrepreneurs of a certain background to thrive through access to capital, protections of physical and intellectual property and a workforce that is available through exploitation, or otherwise to perform critical functions that contribute to surplus wealth for the entrepreneur. The physical infrastructure, designed and maintained by several layers of government funding and agencies, allows for unfettered transport of goods and services.

Financial systems matured over the past two hundred years to help foster entrepreneurship through investment and low cost capital as well. As Aghion notes:

“Financial development played a central role in stimulating innovation and enabling industrial takeoff in Europe in the nineteenth century: the creation of commercial banks and development banks, the emergence of equity financing and stock exchanges, the appearance of limited liability companies—these financial innovations dynamized real innovation and risk-taking, thereby enabling sustained and robust growth such as the world had never seen before 1820.”

Modern entrepreneurs like to pat themselves on the back and spin tales of their bootstrapping exploits. Self made men are everywhere in places like Silicon Valley. Men who “came from nothing,” only to wind up at the top of the mountain. A mountain that rises above the roads, bridges and tunnels built by the government that transport their goods without fear of being stolen. A mountain that rises high above the legal system that was designed to protect their interests and ideas from being stolen. Ideas that originated in a lab somewhere in a government program or university setting, only to be set free for the entrepreneur to build upon and take credit for. All while doing everything in his power to avoid paying taxes to the very same government responsible for his position in life.

Once again, I’m deliberately using the male pronoun to describe this particular brand of asshat. Peter Thiel is right that true innovation has been scarce in the past 50 years. Iteration? Improvements? Yes. Innovation, no. But he must have missed the chapter that explains where this true innovation started.

The idea of creative destruction isn’t necessarily unique. What made Schumpeter’s view of it unique was his contention that it was necessary and positive up to a point. Giants in the field of economics and the social sciences had been predicting the decline of capitalism at the hand of innovation for years.

Keynes believed in the concept of what he called “technological unemployment,” whereby traditional laborers would be phased out of a capitalist system. Alvin Hansen called it secular stagnation. Thomas Malthus extrapolated his theory that the fixed production of agriculture would limit population growth to all sectors of the economy. But one of the great benefits of capitalism that challenged Malthusian theory, therefore, was technological advances in agriculture production. Similarly, as we’ve spoken about before, M. King Hubbert predicted the end of fossil fuel production given the lifespan of proven oil reserves in the mid-20th Century. New reserves, offshore drilling, hydraulic fracturing and other advances staved off Hubbert’s claim and allowed capitalist economies to continue drilling in the far reaches of the ocean and deep in the earth.

From the Industrial Revolution forward, capitalism proved to be far more resilient than any of these great theorists imagined, which is why you find so many today who defend the system. That’s not to say that an institutional rot can’t set in. That’s at the heart of the question today. Again, Aghion:

“The Industrial Revolution serves as an illustration of three fundamental principles of the paradigm of creative destruction; namely: cumulative innovation is a driving force of growth; institutions are critical, starting with property rights to protect innovation rents and more generally to foster innovation; and competition is necessary to combat the barriers to entry that existing firms and governments create to thwart the process of creation destruction in order to prevent new entrants from challenging their rents or their power.”

So, let’s build out on this last point. The necessity of competition, because in many ways Silicon Valley and our entire economic system today might be stretching boundaries not seen since the major combinations at the turn of the 20th Century.

There are contributing factors to healthy competition. Tax policy, regulations, lobbying activity, capitalization. These are all contributing factors to a competitive landscape. Where Aghion and team offer caution is in the credit markets, which might help explain the Silicon Valley quandary.

“Relaxing credit constraints on incumbent firms allowed even the least productive incumbent firms to remain in the market, which in turn discourages new, potentially more productive firms from entering the market.”

What we can take from this is that one reason tech firms throughout the country have been able to thrive despite a lack of true technical innovations is due to an extended period of cheap money. Capital was simply so cheap and abundant that even the most mediocre firms appeared viable and less susceptible to external competitive threats. And many of the tech giants were able to snuff out competition by buying them outright with that same cheap money. The United States has been far more lenient in allowing firms to monopolize entire sectors than European counterparts.

Chapter Three: The so-called disruptors.

In terms of sector dominance, as the authors point out, innovation is linked closely to manufacturing and tech because other sectors like service, real estate or education aren’t ameliorated by economies of scale. But tech has crafted an especially boastful narrative. Tech nerd titans have been all the rage since Bill Gates became a billionaire and Mark Zuckerberg dropped out of Harvard. They fancy themselves disruptors. There’s a theme in the movie Glass Onion where Ed Norton’s character, loosely styled on the head fraudster himself, Elon Musk, delivers a speech on the nature of disruption.

The joke of it is that he’s full of shit. In fact, that’s the entire conceit of the plot. Also, it’s not a very good movie. The first Knives Out, way more entertaining. Anyhoo, these so-called disruptors seem to be scrambling of late now that the Fed has turned off the spigot and investors are seeking actual returns in traditional sectors. When we covered the tech layoffs, a lot of it had to do with the post-COVID cooling off period of companies that thrived from being locked down. More time on social media. More time watching Netflix. More packages being delivered. More bandwidth required. More Zoom meetings and FaceTime. For a brief period of time, it looked like nothing would ever be the same. Until things went back to kind of being the same.

And now they’re coming into territory they haven’t been in for 16 years, the last time the federal funds rate was this high. Right before the financial crisis. And the last time it was previously that high was in 1999, right before the dot-com crash. So the investors know what’s up. Wall Street knows what’s up. The legacy tech giant leaders also know what’s up, which is why you see them cutting payroll so aggressively.

The Guardian article also takes kind of a sour view on the tech bro culture of disruption by really questioning how much they’re disrupting. It’s a great take:

“Disruption depends on regarding people as participating in the business cycle who insist that they’re doing no such thing. And it depends on extending the sense in which the terms “monopoly” or “oligopoly” can be applied. Did big taxi companies once dominate personal transportation, or did thousands of individual cabbies who were barely making ends meet? The term “disruption” makes a monolith of structures and organisations that are old, have grown up organically and are therefore pretty scattered and decentralised. Think about the peculiar alchemy involved in talking about how Google disrupted the media landscape: suddenly the hundred-billion-dollar company is a scrappy underdog and a magazine with 40 employees is a Big Bad Monopolist.”

These so-called disruptors positioning themselves as the great capitalist liberators setting the working class free from the shackles of oligarchy suddenly don’t sound as magnanimous when put this way. But this is all part of creative destruction, just without the bullshit hero’s journey construct.

Today’s shiny new toy is ChatGPT. Together, with Google’s new competitor and several others that have already been in existence for years, these are impressive entrants into a space that has been in development for decades and is only now ripening on the vine. And AI will have a tremendous impact on myriad industries. But, as sure as creative destruction is once again in the air, so too is the steady replacement of old renters for new renters.

There’s also competition on the horizon from other parts of the world. The tech sector in Israel is booming. South Korea and China have formidable sectors growing at exponential rates, in some cases entirely due to government subsidies. AI threatens to further decentralize the tech landscape, offering opportunities to new renters of all shapes, sizes and geographic locations to bolt onto existing technologies and take them to new heights. Iterations and improvements. But hardly innovations.

So, as the Fed continues to push rates and tech gurus spend more time navel gazing than fundraising, the question remains as to whether the United States has the right formula to prevent this latest round of creative destruction from being the final chapter in a remarkable saga; the moment we finally pivot toward Schumpeter’s sober socialism.

If we’re to ingest the research of Aghion’s team and apply that to a wholesale strategy for the future, we have to return to the basic formulations of success. “The protection of property rights. Massive investment in education. Proactive policy to support the development of large national leaders by means of subsidized credit, state procurement contracts, and export subsidies.”

It’s possible that salvation comes through the unlikely source of the Biden federal government, which has committed to the largest investment into infrastructure and technology since the Second World War. The one pillar that is missing and stands out like a sore thumb, however, is the investment into education. We’ve got education policy backwards in this country, and the right-wing House and Supreme Court are determined to move even further away from what’s needed. And all of this ignores the biggest elephant in the room. Again, Aghion:

“Exploding inequality, growth stalled for the past decade and a half, unrelenting climate disturbance, and now the COVID-19 pandemic that has laid bare the deficiencies of our economic and social systems: these very real phenomena are the bread and butter of proponent of isolationism and the end of globalization, of antigrowth partisans, and of those advocate for abandoning capitalism altogether. Capitalism is thus confronting an unprecedented identity crisis. No one can deny that capitalism, particularly when it is unregulated, has a number of adverse consequences: it exacerbates inequality and enables the strong to fetter the weak; it can fragment society and destroy the sense of community; it makes employment precarious, causing deterioration of individuals’ health and increasing their stress; it enables incumbent firms to use lobbying to block the entry of new innovation firms; it aggravates global warming and climate change; it induces financial crises that generate severe recessions such as those of 1929 and 2008.”

Bring it home, Max

As much as Aghion’s collection of data and essays provides a glimpse into the inner workings of capitalism and the support structures that must be in place to allow it to thrive, he concludes the team’s findings with these sober sentiments by posing the ultimate quandary:

“A market economy, because it induces creative destruction, is inherently disruptive. But historically it has proved to be a formidable engine of prosperity, hoisting our societies to levels of development unimaginable two centuries ago. Must we therefore resign ourselves to the serious pitfalls and defects of capitalism as the necessary price to pay to generate prosperity and overcome poverty?”

The more I contemplate these words. The more I dig into the voices of the past that both guided us and warned us. The more convinced I am that Schumpeter may be proven right in the long run. Perhaps creative destruction is the engine of entrepreneurship and innovation, but it has a natural lifecycle. Perhaps we’ve reached the end of useful technology. Sure, we will continue to improve upon it, making things faster, more efficient and more powerful. But to what end?

We already have the capacity to feed the poor, house the homeless, provide more leisure and security, ensure dignified retirements and provide healthcare to all. We simply choose not to. There are other countries that choose to provide these things, and their citizens have just as much wearable technology as we do. They can access ChatGPT. Search the internet. Smoke good weed and watch free porn.

The proletariat probably isn’t going to rise up for one simple reason. There isn’t a proletariat.

We’re laborers, service workers, bureaucrats and renters of technology that has developed through creative destruction of legacy systems and thinking. And the mediocre firms who muddled their way through the past two generations of technological advancements did so due to the largesse of the cheap money Fed and government contracts. With the Fed chickens coming home to roost and conservatives fighting tooth and nail against investments into the pillars of the very capitalist structures they hold so dear, we find ourselves in a strange predicament; designing a future where everyone has a smartphone on a dead planet. The ultimate example of creative destruction at the hands of mercenary capitalists.

Here endeth the lesson.