On Schumpeter

In the last issue of The Economist, a new column was created in the Business section and the editors named it Schumpeter. After months of exhorting on Keynes and the fiscal pump-priming that would be necessary to put the World economy back on path of recovery, it is past overdue that Schumpeter, a compatriot and no-less great economist to Keynes, and his ideas be explored and talked about in main-stream media.

As summarized by The Economist, the central themes behind Schumpeter's theories are Innovation, Entrepreneurship and the process of Creative Destruction. The weekly journal is drawing parallels between these motifs and the business enterprises that it find it apt to name the business column after the Austrian Economist.

In my opinion, Schumpeter's theses are even more relevant to the macro-economic environment than Keyne's.

In the just-ended G20 Summit in Pittsburg, world leaders were congratulating themselves and putting out a message that because of collective actions of governments in the major economies in undertaking unprecedented monetary expansions and massive Keynesian-prescribed fiscal spendings, the world economy has regained stability and is poised to grow again. Although the official statement acknowledges much are to be done in reforming and restructuring, suspicion that the proclamation is nothing more than lip-service runs high. This is especially so when one reviews some of the actions promised subsequent to the collapse of Lehman Brothers a your earlier vis-a-vis the progress status in the past 12 months:

1. To reform too-back-to-fail financial institutions; All major Western banks that required massive governments' aids (and most of their CEOs) remain intact. In fact, in some cases, they are even bigger because of mergers and acquisitions.

2. To ensure banks unload toxic assets from their balance sheet; The U.S. Treasury-sponsored plan never took off.

3. To regulate bank executives' compensations; Executives continue to take home fat pay-cheques.

4. To address unregulated financial derivative markets; To begin with, lawmakers are divided as to which government body or bodies should be tasked with the mandate. Amidst the confusion, of course, the markets remain unregulated.

Indeed, it can be argued that the 'stabilised' world economy resulted from government interventions such as bailouts, easy and cheap credits and fiscal stimulus, belies the imbalances in the system: Fiscal deficits in U.S. and U.K. at unprecedented post-war high; housing bubbles are forming in Asian countries; Dollar value continues to fall while commodity prices remain stubbornly high; inflation is raring to go.

In short, the Keynesian-inspired dosages of novocaine is effective in alleviating the economic pains but the roots to the problem remain unresolved. The numbing effect gives us the false impression that the crisis is over and the good-old days have returned. Yet, the decaying tooth is just one gulp of cold water away from unleashing a new wave of pain.

Indeed the U.S. economy has undergone the Keynesian-induced expansion almost 40 years ago when President Nixon declared: "I am now a Keynesian in economics" as he swiftly unpegged U.S. Dollar from the restrictive Gold Standard and continued with his wildly popular deficit-spending. While the economy received an immediate boost in which conveniently afforded Nixon a landslide victory in the 1972 re-election, it did not take long for unemployment to begin climbing while inflation remain stubbornly high and rose through the roof aided by the two oil shocks. The term "stagflation" was later coined to described the Keynesian conundrum of rising unemployment AND inflation.

That is not to entirely discredit Keynesian initiatives in buffering the economies from hard-landing. In my opinion, fiscal stimulus is justified provided that it is, as described by Lawrence Summers, "targeted, timely and temporary". By administering adequate amount fiscal expenditure and interest rate easing, the economies are provided with cushion to ease the pain brought about by necessary adjustments, as prescribed by Schumpeter's creative destruction.

In the analogy of decaying tooth, by applying the anesthetic, it lessen the pain of extracting the decayed tooth. But extracted, it must be.

In the process of creative destruction, old business models that are no longer efficient and relevant should be allowed to fail. Entrepreneurs will then step in and innovate in providing goods and services that meet the market demands with the free-up resources. At the same time, entrepreneurs should be made aware that any potential returns are coupled with market risks. Should their venture fail, the entities should be dismantled and economic resources should again be channelled by market forces into other economic activities.

In order for the Invisible Hands to work best in a capitalistic system, adequate returns should be appropriately accorded to successful innovations and risk-taking entrepreneurs. Yet at the same time, should any business venture fail, the process of creative destruction, as dictated by market forces, should be allowed to run its course. Any efforts in propping up inefficient markets (such as the housing markets) and ineffective institution (such as the car industries), such as those we are witnessing in the Western countries, will merely delay the clearing of market and prolong the beginning of sustainable recovery.