MainStreet Macro: Creative Destruction

Today I’d like to introduce a new economic concept into our discussion of the jobs recovery.  It’s called creative destruction. Although it sounds mysterious, maybe even a bit ominous, it has deep roots in economic research on the labor market, new business formation, and economic growth.

Creative destruction describes the process by which old companies with outdated technologies and ways of doing business fade away as new entrants with modern systems take their place.

Creative destruction tends to track the economy and the ebb and flow of the business cycle. However, the unprecedented global pandemic has both shifted and accelerated the process of creative destruction in three unique ways.

Destruction first, creativity second

Creative destruction works well when innovative companies capture new business opportunities and replace competitors that fail to keep up.

At its best, the process boosts economic growth. But it also picks economic winners and losers.

That’s fine in normal times — it’s called capitalism, folks — but during the pandemic, the uneven effects of creative destruction proved devastating to some Main Street businesses. That contributed to deep downturns in the labor market and economic growth.

When destruction has roots in a health crisis, there’s nothing creative about it.

Despite these challenges, many employers were able to adapt to the shifting economic landscape and some even thrived, reaching record levels of revenue and profitability. They managed to think creatively, break the mold, overhaul old ways of doing things, and innovate amid the pandemic calamity.

Small, but resilient 

Small businesses were the first to reduce headcount when the pandemic began. But during most of this year, ADP payroll data shows that small firm hiring has kept pace with that of much larger employers.

Small employers lost 7.7 million jobs in March and April of 2020, according to ADPRI analysis. Despite enormous challenges, they’ve recovered nearly 86% of those jobs.

The new risk is that economic activity slows in the second half of the year because of the Delta variant’s impact. If that happens, small firms might again be hit hardest.

This time around they won’t have the cushion of low-cost borrowing and loan forgiveness afforded by the Paycheck Protection Program that Congress passed in March 2020. These programs are no longer the  lynchpin of financial support for small firms that they were last summer.

Opportunity, seized

The third way creative destruction has manifested during the pandemic is in a huge pickup in new companies. Successful startups are characterized by rapid growth and above-average productivity. 

In a time of tremendous economic turmoil, the rapid pace of new business formation has been extraordinary. In the 10 years leading up to the pandemic there were, on average, 240,000 new business applications submitted each month. 

From 2020 to today, that average has skyrocketed to 400,000 a month. While the pace of growth slowed in July and is down from last year, the fact that more Main Streeters are hatching new money-making ideas, even in the depths of unprecedented economic upheaval, is a sign of a structural shift in business activity and hiring trends.

My Take

Creative destruction is foundational to the idea that capitalism, in its purest sense, is based not on static equilibrium but on economic dynamism — constant change and evolution.

Yes, many small businesses were destroyed prematurely due to the ravages of the pandemic. As rotten as those losses are, the fact that new businesses are launching at a rapid rate is a sign that economic dynamism is alive and well.