What Schumpeter Would Say about Techlash

A bipartisan anti-tech fever has taken hold in Washington with Left and Right alike calling for greater regulation of America’s digital giants such as Google, Facebook, Amazon, Twitter, and others. This so-called “techlash” threatens to undermine the massive benefits associated with the rise of the Internet and the Digital Revolution by putting antitrust lawyers and regulatory bureaucrats in control of fast-moving tech companies, whose apparent crime is giving the world affordable, high-quality services.

Worse yet, some tech companies appear ready to cut deals and cozy up to regulators here and abroad. For example, Facebook’s Mark Zuckerberg recently penned an essay inviting increased oversight of his sector, which is easy to say once you’ve made your billions and want to close the door on new competition with the help of expensive new mandates.

Joseph Schumpeter must be rolling in his grave at the sound of all of this. Writing over 75 years ago, the Austrian-born economist laid out a vision for how dynamic competition and innovative  economies develop. In doing so he gave us a model for how to think about public policy in fast-moving tech markets—and how to get all new markets and technologies.

Two Lessons

If Schumpeter were alive today, he’d have two important lessons to teach us about the techlash and why we should be wary of misguided interventions into the Digital Economy.

First, Schumpeter would remind us that textbook theories of static “equilibrium” and “perfect competition” do not represent reality. Economic change is instead “an organic process” that “never can be stationary.” What really matters, he argued in his 1942 book, Capitalism, Socialism and Democracy, is “competition from the new commodity, the new technology, the new source of supply, the new type of organization,” because it is that sort of innovation, “which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”

This was Schumpeter’s now-famous model of “creative destruction,” and it perfectly explains much of the intense competition we see at work in the modern Digital Economy. “This kind of competition is much more effective than the other,” he argued, because the “ever-present threat” of dynamic, disruptive change, “disciplines before it attacks.”

We can summarize Schumpeter’s first lesson in two words: Change happens. But disruptive change only happens in the right policy environment. Which gets to the second great lesson that Schumpeter can still teach us today, and which can also be summarized in two words: Incentives matter. Entrepreneurs will continuously drive dynamic, disruptive change, but only if public policy allows it.

Schumpeter explained how entrepreneurs are in a sort of quest for a prize. The primary prize he identified was profits, of course.  Entrepreneurial gains—even supranormal short-term profits—need to be tolerated if innovation is to occur. Innovators will only take risks if they can expect the potential for gains from it. But there are other “prizes” entrepreneurs are in the game to “win”—novelty and notoriety are two other big drivers. Other times entrepreneurs dream of changing the world to advance an important cause or personal desire.

Regardless of the prize, public policy must not discourage these races or else fewer innovators will be willing to risk everything in an attempt to unseat dominant market players. Instead, regulatory attempts to micromanage markets and limit entrepreneurial rewards will give us stasis and retard market change by undermining what Schumpeter referred to as “the most powerful engine of that progress,” i.e., profits. Denying those in the race for the potential for profits or other rewards means that society will be stuck with yesterday’s technologies and industries when what we really need is all new players and innovations.

Constant, Unexpected Change

This is the formula that helped power the Digital Revolution and topple Analog Era giants in the process. Think back just 15 years ago and consider the markets for video rentals and cell phones. In 2005, the Federal Trade Commission pressured video rental firms Blockbuster and Hollywood Video to call off a proposed merger. Antitrust officials were defining markets so narrowly that they didn’t even see the coming online video tsunami, which would wipe local video stores off the map thanks to Netflix and other innovators.

Around the same time, regulatory pundits were worried about the growing power of firms like Motorola, Nokia, Palm, and Blackberry in the mobile phone market. The idea that computer or Internet companies like Apple and Google could displace those giants was unthinkable at the time.  Today we laugh about ever being concerned about those old players.

Similarly, starting around 2010, upstarts Uber and Airbnb rolled the dice on risky gambits to enter local transportation and hotel markets respectively to square off against dominant incumbents who benefited from decades of special rules. Few people gave these Sharing Economy innovators much of a chance, but they are now firmly in the race and offering consumers new choices we previously never enjoyed and will never relinquish.  

These case studies represent Schumpeter’s “creative destruction” in action. Moreover, those disruptors inspired countless other innovators who used these new digital platforms and capabilities to give us a growing constellation of “apps” and other corresponding services. Again, this all happened over the course of just 10-15 years.

Change is Still Possible

Critics always have the same response: But this time it’s different! They again take their static snapshots of current market conditions and tell us we have settled into an unassailable monopoly situation. Oh sure we foolishly thought AOL-Time Warner and MySpace were social networking monopolies a short time ago, but this time Facebook really has conquered the world! At least that’s what the pessimists want us to believe.

Again, Schumpeter had an answer for the skeptics: there is no discernable end point to the process of entrepreneur-driven change—so long as creative destruction is not replaced with cronyist public utility-style regulation. If Washington really wants to see challenges to today’s tech giants, then policymakers should not be cutting deals with them or crafting policies in a backward-looking fashion to preserve the old markets those firms dominate.

Instead, policymakers should be clearing away regulatory barriers and tax obstacles so that entrepreneurs can usher in the next wave of innovation, competition, and job opportunities. For example, every convoluted federal, state, and local licensing regime represents a potential barrier to competition and innovation.

Meanwhile, new data collection regulations will limit the ability of new digital ventures to take on tech incumbents. Big incumbents can bear the cost of complying with all that red tape; upstarts cannot.

America’s seemingly inexhaustible supply of entrepreneurial spirit will surprise us with better alternatives than any regulatory wrecking ball Washington devises to demolish existing players or markets. Heed Schumpeter’s lessons and let change happen by getting incentives right such that another wave of creative destruction can work its magic.

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