Creative Destruction

A version of this is in the current edition of Perspective Magazine.

According to a quip once made by Peter Ustinov, “Just before the world blows itself to bits, the last audible voice will be that of an expert saying it can't be done.”

Yes, it’s pretty standard for experts to fail to see the end coming.

Of course, you won’t find many experts who express doubts that the physical world will eventually end, but I have something else in mind. You see, there are always worlds entering death spirals, pushed into non-existence as new worlds emerge to take their place.?If we could predict this process?– what the great Joe Schumpeter called “creative destruction” – we’d have the key to economic forecasting,?effective economic policy making, and wildly successful stock market investment.?

?Pretty good eh? Unfortunately, any systematic prediction of creative destruction is beyond us. Allow me to illustrate...

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In the summer of 1886, every village in England had at least one smithy. Indeed, according to the census, there were more than 200,000 blacksmiths working in the country back then. It was an ancient industry stretching back into prehistory. And although the Industrial Revolution brought significant changes for the blacksmith, as the end of the nineteenth century approached the industry remained strong with farriery, the manufacture of horseshoes, providing a strong and stable core business. However, within ten years the number of blacksmiths had more than halved.

It isn’t difficult to work out what happened. In 1886, Carl Benz patented his Benz Patent-Motorwagen: the modern car had been born. And by 1908 the Ford Model T brought automotive transport to the masses and death to the village smithy.

I’ve searched in vain for any analysis of this in the works of late nineteenth-century economists. If anyone knows of one, please let me know, it would be very interesting to know if any of them saw it coming.

Watch out for hindsight bias. From our early 21st-century perspective, the advent of the motor car was obviously going to lead to the downgrading of the blacksmith. However, at the time, making that connection would have been a very major (in fact, an almost impossible) intellectual feat. As for predicting the growth of ancillary industries, forget it. More on that in a moment.

As the motor car’s popularity grew, village smithies were converted into petrol stations, and former blacksmiths became car mechanics. A vast economic ecosystem had been obliterated; an ancient and venerable world had ended, but a new one had been born.

The motor car brought economic growth and, as the new ancillary industries proliferated, many more jobs were created than had been destroyed, but a long-established, traditional way of life had gone forever. Over the next few decades, coaching inns would close as motorway service stations opened, and saddlers would attempt to pivot into car seat manufacture. In towns and cities, the ubiquitous stables would be converted into homes; and the heirs to John Loudon McAdam’s road-building innovations were about to become very rich.

Could you, on hearing of Benz’s invention, have predicted any of this? If so, you could have made an absolute killing. Here comes the important technical bit. One of the most important distinctions in economic theory is also one of the most elusive. It is the distinction between “risk” and “uncertainty”.? We face risk only when there is a defined range of possible outcomes, think of roulette for example.

However, when the range of possible outcomes is intrinsically undefined...such as when there’s a new invention... we don’t face risk, we face uncertainty. What impact will a new invention have? If you conducted an analysis based on the impact of previous inventions you would, at best, be wasting your time.

More strongly, if you apply the tools of risk to a situation of uncertainty, you’re going to lose. Given Benz’s invention, what was the probability of the death of the smithy or the emergence of the motor vehicle industry or any of the ancillary industries? Forget it. Probability doesn’t apply here. Can you imagine yourself in 1886, having heard about Benz’s invention, getting a message to your broker with the instruction to short farriers, saddlers, and country inns, and to go long on Tarmac??Or, in even more stark terms, can you imagine taking a position on ESG investments back then? The very idea is ludicrous of course. But why is it ludicrous? The answer to that gives a clear insight into the difference between risk and uncertainty.

You might be tempted to think the invention of the motor car was an event of unique importance. Not at all, as the constant revolutions in the music business illustrate very clearly. Back in 2005, I was doing something with EMI. EMI was still an industry giant; home of the Beatles no less. However, as negotiations continued, it became clear that the company had completely failed to see the significance of downloads. I thought, bloody hell, they’ve had it. And so they had. The old world, the world of records and CDs was dying, to be replaced by iTunes.

But it goes on: the traditional record industry was blown to bits by downloads but, amazingly, Apple didn’t see the significance of streaming until it was too late and iTunes was, in turn, decimated by Spotify.

Here’s another: those arch baddies, The Post Office, should have been at the forefront of the proliferation in delivery drivers that came with the growing dominance of online shopping, but they completely missed it.

In every established industry, considerations of uncertainty, if they exist at all, are completely dominated by considerations of risk. This is one of the principal reasons why so many experts fail to see the end of their world coming.?

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