Thursday, October 2, 2008

Whatever happened to 'creative destruction'? The key difference between Mr. Bernanke and his predecessor, Mr. Greenspan

America is in the middle of a fierce debate over a complex matter -- whether or not to use the federal government to save investment bank organizations whose creditworthiness is under intense pressure and who are in need of massive re-capitalization. Three banks have already gone by the wayside. The only organization that can save the remaining two is the American government, financed by the American public.

So what are the arguments? On one side are the banks. Represented by the Treasury Secretary and seconded by the Fed Chairman, they argue that they are indispensible contributors to the economic growth and wealth that the public has enjoyed over the recent years and decades. Save us or forget about that standard of living, the banks are saying: We are too important to you to fail. $700 billion too important.

On the other side, the critics of the plan argue it is dubious that the public should finance companies that made the bad loans in the first place. They ask: Why should we buy the bad assets at higher than market prices?

The banks' answer is, because market prices won't save us.

So, the debate comes down to, save the banks or let the banks be destroyed. Which is in the country's best interest?

If this is indeed a prime question, it strikes me that the troubled banks should feel fortunate. This is because Ben Bernanke, rather than Alan Greenspan, is the current Fed Chairman. Why do I say that? Isn't Mr. Greenspan the best friend the banks have had? The one who allowed all this easy money into the system to begin with? The ultimate de-regulator? Well, yeah.

But what's interesting is Mr. Greenspan's theoretical devotion to the late economist Joseph Schumpeter's notion of 'creative destruction.' Here is Greenspan in his recent book:

Working with heavy industry gave me a profound appreciation of the central dynamic of capitalism. "Creative destruction" is an idea that was articulated by the Harvard economist Joseph Schumpeter in 1942. Like many powerful ideas, his is simple: A market economy will incessantly revitalize itself from within by scrapping old and failing businesses and then reallocating respurces to newer, more productive ones. I read Scumpeter in my twenties and always thought he was right, and I've watched the process at work through my entire career.

(The Age of Turbulence, 2007, Penguin Press, p48)

Instead of Greenspan and his inclination to let "old and failing businesses" fail, Chairman Bernanke is in charge of the Fed. And we know Mr. Bernanke's motivatations are less about maintaining any central dynamics of capitalism and more about preventing a historic downturn in the macroeconomy. As an academic economist, his research was on the causes of the Great Depression. He seems ready -- too ready? -- to put that research to work.

The point is this: In getting behind the Paulson Plan, Chairman Bernanke is willing to go to extraordinary lengths to prevent the very kind of destruction that Prof. Schumpeter and former Chairman Greenspan consider important to a well-functioning capitalist economy. For this reason, the banks are lucky to have Mr. Bernanke, rather than Mr. Greenspan, in charge.

For those interested, the following is Prof. Schumpeter's classic statement on creative destruction.

Capitalism, then, is by nature a form of method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action; this fact is important and these changes (wars, revolutions and so on) often condition industrial change, but they are not its prime movers. Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries of a monetary systems of which exactly the same thing holds true. The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial production that capitalist enterprise creates.

Schumpeter, Joseph. Capitalism, Socialism, and Democracy. Harper. 1942. p82-83.

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