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Why the economy needs "creative destruction"

Analysis

Creating new businesses is crucial for the South Australian economy but this means that we have to move beyond protecting established interests, writes Richard Blandy.

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Economics 1 largely uses a framework for analysing the economy that does not take account of technological change. As a result, while it is very helpful for understanding and dealing with many problems, Economics 1 is not 100% helpful in understanding South Australia’s present economic plight.

To understand why South Australia is struggling economically, one has to look at how economies – and the companies largely comprising them – evolve over time.

This evolutionary process is widely known as one of “creative destruction”, derived by the famous Austrian-American economist, Joseph Schumpeter, in his book, Capitalism, Socialism and Democracy, from the work of Karl Marx and from the “long-wave cycle” theory of Russian economist, Nikolai Kondratief.

Schumpeter believed long business cycles were driven by technological innovation. He argued that capitalism can never be stationary, that the fundamental impulse that keeps the capitalist engine in motion comes from the incessant creation by businesses of new consumer goods, new methods of production or transportation, new markets, and new forms of industrial organisation.

This process incessantly destroys the old as it creates the new. In Schumpeter’s view, this process of “creative destruction” is what competitive market economies consist of and what every free enterprise business has to survive in.

In Schumpeter’s vision, innovative entry by entrepreneurs is the disruptive force that sustains economic growth, even as it destroys the value of established companies (and the job security of their employees) that had formerly enjoyed some degree of monopoly power deriving from previous technological, organisational, regulatory, and economic circumstances.

An essential fact about competitive market economies like Australia’s, therefore, is that new innovations undermine old ones in a continuous evolutionary process. Hence, the birth rate of firms in our economy is a key indicator of how vibrant and successful our economy is likely to be: the higher the birth rate, the more dynamic, innovative and continuously successful our economy is likely to be.

The dynamic, faster-growing, state economies have higher business birth and death rates than South Australia does. Their average productivity, Gross State Product and employment all advance faster than in South Australia as their businesses relentlessly modernise and improve their competitiveness faster than here.

South Australia shares with Tasmania (the two economically-slowest-growing Australian states) the lowest birth rate of firms in Australia. In 2014-15, 11.0% of firms were newly-born in South Australia, compared with 13.4% for Australia as a whole (and 14.4% in the ACT!). By the same token, 11% of firms in South Australia died in 2014-15, for no net gain in the number of firms, whereas 12.4% of firms died in Australia as a whole for a 1% net gain in the number of firms.

In fact, the lack of competitive pressure on South Australian firms is shown in their persistently low death rate by comparison with Australia as a whole. The dynamic, faster-growing, state economies have higher business birth and death rates than South Australia does. Their average productivity, Gross State Product and employment all advance faster than in South Australia as their businesses relentlessly modernise and improve their competitiveness faster than here.

Corporatist political mindsets, like those that have been dominant in South Australian politics for a long time, always favour protecting existing firms against competition. These firms employ voters and have money. Start-ups that compete with and undermine existing firms are seen as a menace to the established economic (and political) order. Too bad that employment and living standards will grow more slowly if the existing firms are protected. Who would know? Better to look after the established interests and their attached voters.

InDaily is a classic example of an innovative enterprise that is disrupting the established print newspapers in South Australia. It is free. It provides many in-depth articles about South Australia written exclusively for its readership. It has a substantial readership of people occupying high level positions in business, the public service and politics. It survives on sponsorship and advertising. It is read by people outside South Australia, because it is timely and easily accessible online. Its readership is growing fast. And it has accelerated a movement by the established print media into online delivery and subscription.

The Adelaide City Council has also showed the way with its sanctioning of “pop-up” eateries around the city. Of course, established cafes and restaurants have objected to this increase in competition, and cited regulations that they have to meet that the “pop-ups” do not, showing, as well, the influence of regulations in stifling competition. Often, regulations are supported by established businesses as a means of restricting competition.

A regulation that has the effect of restricting competition is the regulation that all commercial buildings must meet standards laid down for newly-constructed buildings. Many old buildings in the city stand empty because it is not worthwhile to bring them up to these standards. By the same token, many (particularly start-up) businesses could not afford the rent if these buildings were upgraded. This situation does not seem to serves any good purpose.

Kate Gray, Colliers International Associate Director of Research, says that the Adelaide CBD office market consistently has a higher level of secondary grade stock when compared to other capital cities, which also contributes to its higher vacancy rate.

“In Adelaide, the combination of C and D grade stock (secondary stock) accounts for 31.9% of total stock,” she says. “Compare this to Sydney (15.1%), Melbourne (15.2%), Brisbane (13%) and Perth (2.7%). This is important to note as in most CBD office markets secondary grade stock has a much higher vacancy rate.”

Over the last five years, just under 149,000sqm of space was withdrawn from the Adelaide market, with just over 100,000sqm of this space being secondary grade.

On 17 March, responding to this situation, State Opposition Leader, Steven Marshall announced that the Liberal Party would legislate to allow easier adaptive reuse of buildings constructed before 1980 (covering C and D grade building stock).

“Rather than just sitting empty, dilapidated and underutilised, we want to see these buildings come alive again – whether that be for hospitality, residential or office purposes,” he said.

“The State Liberals will draft legislation which will give the Minister for Planning the ability to override the Building Code of Australia’s restrictions on the adaptive reuse of buildings built before 1980 through a ministerial specification.

“This would greatly reduce the red-tape burden associated with repurposing an existing office building…

“… By making these changes now, we can speed up the process and reduce the regulatory burden on those who are wanting to upgrade their buildings.”

Adelaide’s brilliant, empty space revitalisation scheme, Renew Adelaide, which started in 2010, has been circumventing these regulations by offering start-ups 30-day “rolling” tenancies with building owners, putting non-rent-paying tenants into their buildings, generating street activity and vibrancy of value to neighbouring businesses.

Renew Adelaide manages the tenants under a licence agreement with the property owner. If a paying tenant is found, Renew Adelaide makes good the property and moves out within 30 days.

It has assisted a large number of fledgling creative businesses and artists to find affordable accommodation in this way.

Richard Blandy is an Adjunct Professor of Economics in the Business School at the University of South Australia and is a weekly contributor to InDaily.

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