The Upside of Economic Carnage

You may have heard the phrase "creative destruction." Well, now you're living in it.

Economist Joseph Schumpeter coined the concept in the aftermath of the Great Depression to explain how, in a free market economy, the death of obsolete companies and industries makes way for newer and better ones. We seem to be in the early phase of that now, as banks, auto companies, retailers, and other longstanding firms falter. To gain a better understanding of what's going on, and how the past might predict what happens next, I interviewed economic historian Tom Nicholas of Harvard Business School. Some of his thoughts:

We're seeing the destructive part of creative destruction. Where's the creation? People tend to hold their plans in abeyance, which is why you don't see many of the positives right now. But there is a flip side to recession. For certain companies with assets at their disposal, this is a good time to increase market share and increase R&D. Companies do this.

[See how bailouts can butcher capitalism.]

We've been hearing so much about the Great Depression for last six months. What are some examples from that time? DuPont is a good one. During the Great Depression, when most companies were holding back, DuPont invested in neoprene and nylon. The breakthrough leading to commercialization came in 1930. So at that point, DuPont had to make a decision: invest more or cut back? In 1931, it announced neoprene, and introduced it in 1937. When the uptick came, they were ready to take advantage of it. By 1938, 40 percent of the DuPont's revenues were coming from products that didn't exist in 1929. By 1939, virtually every car and aircraft had neoprene components.

What are some other examples? IBM invested a lot in R&D, under Tom Watson Sr., during the depression. They were kind of lucky, that was the beginning of the Social Security Administration, and the government needed punch cards to help. Then IBM got into electric typewriters. But again, they were ready.

[See 5 signs the bailouts are getting better.]

We often think of entrepreneurship as something that hits a standstill during tough times. But during the Great Depression, companies like Hewlett Packard, Polaroid, and Revlon all got started.

Do you think that will happen in this downturn? In some sense, what you see is a readjustment. Unemployment is another way to think of it. Sometimes unemployment is the reallocation of workers from where they're not needed to where they are needed. The thing is, it takes awhile.

We also need to think about the difference between recessions and depressions. Recessions are almost okay. Underperforming companies get wiped out, dying industries die. This can actually be quite good.

[See who will lose the most from a GM bankruptcy.]

But there's something different about this recession. The financial sector no longer exists in the form that it did. It's structural, not cyclical.

So is creative destruction on hiatus? Is it just destructive destruction? It's difficult to see the upside right now because the uncertainty hasn't resolved itself yet. But there are companies out there being founded that will be important firms. We just don't see them yet.

Should we expect downsides? Maybe. The consolidation of market power is not always a good thing for consumers. Among other things, it can lead to regulation, which can stifle innovation.

[See the best and worst bailed-out banks.]

A lot of these comparisons to the Great Depression have been overblown. Do you think anything happening now is likely to resemble what happened then? Yeah. Some. We're probably no longer going to see massive levels of wealth accumulation like we've seen in the last decade or two. Many hallmarks of the Great Depression are relevant now: What's happening in the financial sector, the massive government response, a focus on the longer run. History reveals these things, but while it's still going on, we don't know. The only thing we can do is rely on the past.