Capitalism rethink: innovation needn't come at the expense of worker protection

rethink capitalism., superstar firms, reforming competition policy, deaths of despair

The Covid-19 pandemic has highlighted major weaknesses in both the US and European capitalism models. In the United States, the crisis has shown the limits of an economic system that fails to protect individuals from the effects of creative destruction and the social consequences of macroeconomic shock.

In Europe, it has revealed the insufficient dynamism of its innovation ecosystem – particularly in biotech. For all the harm caused, the pandemic is also a call to rethink capitalism.

We do not regard the US model’s lack of protection and inclusiveness as the price of greater innovation. Nor do we think Europe’s lack of innovation a natural consequence of greater inclusion and social protection.

So, besides calling for greater education, we advocate two policies that should stimulate innovation-based growth and make it more inclusive and/or protective: beefed-up competition policy, and a Danish-style “flexicurity” system.

So why has the innovative US economy, which spearheaded the information technology revolution, seen declining productivity growth over the past two decades? Two possible explanations emphasise a competition problem.

Thomas Philippon argued in The Great Reversal that the main reason was the weakening of antitrust policies, which led to greater concentration in many sectors and eroded dynamism, especially company creation.

An alternative explanation, which one of us (Aghion) helped to develop, also features inadequate competition, but centres on the IT revolution.

In a nutshell, rapid technological advances have enabled superstar firms – those with social capital and know-how that is difficult to imitate, and/or have developed strong networks – to control a larger share of economic sectors. Hence the acceleration of US productivity growth from 1995-2005, especially in IT-related sectors.

But, in the longer term, superstar firms discourage innovation as their challengers must drastically reduce their prices and thus their innovation rents. So the IT revolution, by enabling superstar firms to grow rapidly and control ever more sectors, ends up reducing market entry, innovation and economic growth.

This implies that maximising the IT revolution’s growth potential requires reforming competition policy to better account for the effect of mergers and acquisitions on innovation and market entry. This would foster innovation-led growth, make it more inclusive and encourage greater social mobility.

Flexicurity schemes, meanwhile, can help to address deep-seated labour-market problems, including in the US. A 2017 study showed that, following a long period of decline, mortality within the middle-aged (45-54 years) non-Hispanic white population in the US began to rise in the early 2000s, accelerating sharply after 2011-12.

In particular, the rapid increase in “deaths of despair,” resulting from suicide or substance abuse, primarily among low-skilled workers, has no contemporary equivalent in other developed countries.

This trend reversal was attributed to mounting job insecurity associated with creative destruction, which often results in increased household instability.

We have moved from a world where many could expect to spend their entire career in the same company, probably moving upwards, to one where frequent disruption is the norm.

Is it possible to design a system to make creative destruction more palatable by allowing individuals to navigate periods of unemployment with greater serenity and in a way that benefits the economy?

Another important 2017 study suggests that Denmark, which introduced a flexicurity system in 1993, may have found the right formula.

The Danish system has two pillars. It makes the labour market more flexible by simplifying employee-dismissal procedures. But the government also provides generous unemployment benefits and investment in training for people to return to work.

The study compared the health of Danish workers whose workplaces closed between 2001 and 2006 with those whose companies did not. Strikingly, it found that company closures did not affect some important individual health indicators, particularly the consumption of antidepressants or probability of consulting a general practitioner. Nor did a company’s closure affect its worker mortality rate.

Denmark’s flexicurity system achieved two goals simultaneously. First, it fostered innovation-led growth by making creative destruction easier to implement and more efficient. Second, it made innovation-driven growth more protective and inclusive by providing income support for those laid off.

One of the Covid-19 pandemic’s many economic lessons is that innovation and inclusion need not be mutually exclusive. With the right policies, Western governments can promote both and help bring about a dynamic and equitable recovery.

Philippe Aghion, a professor at the Collège de France and the London School of Economics and Political Science, is a fellow at the Econometric Society and the American Academy of Arts and Sciences. Aymann Mhammedi is a research assistant at the Collège de France. Copyright: Project Syndicate

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