Creative Destruction

Creative Destruction

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MEGAN DAVIS: Unless we get this structural reform, we're always going to have this torment of powerlessness. JULIA GILLARD: I do really think resilience is a muscle, and if you work it, it gets stronger. And I gave that muscle a fairly good workout. ROSEMARY KAYESS: The fundamental basis of this shift begins with people with disability being recognised as rights bearers, not passive recipients of care and protection. ANN MOSSOP: Hello and welcome. I'm Ann Mossop from the UNSW Centre for Ideas and I'm very happy to see you at this event in our International Conversation series where writers and thinkers from around the world join leading UNSW researchers to explore inspiration, new ideas and discoveries.

We're coming to you from our homes in Sydney and I'd like to acknowledge the Gadigal people of the Eora Nation, the traditional custodians of the land from which I'm speaking today, and pay my respects to their Elders past and present and to Aboriginal and Torres Strait Islander people who are with us today. Our conversation is titled Creative Destruction. It brings together two leading economists: globally renowned economist Philippe Aghion from the College de France, INSEAD, and the London School of Economics and Richard Holden from UNSW Sydney.

They're going to have a robust discussion about capitalism: is it dead or can we reimagine it in a way that will keep society prosperous, promote social justice and regreen our planet? Our host tonight is Richard Holden, Professor of Economics in the UNSW Business School, a prolific researcher and a frequent commentator and writer on all aspects of economics in the Australian media. RICHARD HOLDEN: Hello and welcome to tonight's event, Creative Destruction. My name is Richard Holden and I'm a Professor of Economics here at UNSW Sydney.

Tonight's event is presented by the UNSW Centre for Ideas and we are thrilled to be joined by esteemed economist Philippe Aghion. Firstly, I would like to begin by acknowledging the Bedegal people, who are the traditional custodians of the land on which I'm speaking tonight. I would also like to pay my respects to the Elders, both past and present, and extend that respect to any other Aboriginal and Torres Strait Islanders who are with us today.

To join the digital conversation during tonight's event, please comment on Facebook, use the live chat on YouTube or send us a Tweet and don't forget to use the hashtag #UNSWideas. I'd now like to welcome from France my friend and former PhD adviser Philippe Aghion, who's a Professor at the College de France at INSEAD, one of the world's leading and largest graduate business schools. He's also a Visiting Professor at the London School of Economics and, among numerous honours, he is a Fellow of the Econometric Society and of the American Academy of Arts and Sciences. His most recent book, 'The Power of Creative Destruction', with co authors Céline Antonin and Simon Bunel, is the one that we will be talking about tonight and I encourage you all to get a copy, digital or otherwise, or both, as I have, and we really look forward to this conversation this evening.

Philippe, welcome and thank you. PHILIPPE AGHION: Good morning or good afternoon. RICHARD: Philippe, you've made many contributions to economics in contract theory, financial economics and many areas, and obviously the topic of tonight's conversation will be with endogenous growth theory and growth theory in general. I'm sure it will be a wide ranging discussion because growth theory has so many implications for economic policy generally, for macroeconomic policy, tax, the environment, many things.

We'll talk about many things. But I'm interested to start with I'm always reminded of a quote that I think is due to the great economist and Nobel Laureate Bob Lucas, who said something along the lines of, "Once you start thinking about economic growth, it's hard to think about anything else." I wonder, what first got you thinking in economic growth? PHILIPPE: So I came to economics because I was a political militant in a left wing movement in France in the early '70s until the early '80s. It was all about changing the world and making the world prosperous and fair. So it was really about how to achieve shared prosperity and, you know, various people would say different things on how to do it and it was very hard to know who is right and who is wrong.

So I started questioning myself and that questioning has never ended to this day and that's what got me into economics and to economic research. But it was economic research to change the world, to make the world better, to make the world prosperous and in a way which is fair, to get people out of poverty, to you know, to allow anybody from any social origin to get somewhere and to realise his or her potential, and that's why I went into economics. So it was very natural that I would go into growth economics. RICHARD: Well, I think that's probably the best recruiting pitch I've heard for why young students should do economics, so we'll borrow that and we'll replay this clip to try and get more people to come and do economics, preferably at UNSW.

So I guess when you came to growth theory, there was a dominant theory of growth beginning in the 1950s, and before you developed so called endogenous growth theory, there was the neoclassical growth model. Can you tell us a little bit about that? PHILIPPE: Yes, absolutely. So the leading model was the neoclassical model of Robert Solow. The paper Solow's paper was published in 1956 in the Quarterly Journal of Economics and it was accepted as a benchmark model because it's a very elegant and parsimonious model. It has only two equations. The first equation tells you how you produce final good, consumption good, using a stock of capital and stock of labour.

And the second equation tells you how you accumulate capital. So the idea is that you accumulate capital because part of the production is being saved and the savings turn into investment and that's what generates capital. But what Solow showed is that on the reasonable assumptions on the aggregate production function, you cannot get sustained growth just with capital accumulation. That doesn't work.

Why? Because you have decreasing returns to capital accumulation. When you increase the number of machines you have from zero to one, you increase a lot production. But when you increase the number of machines from 9 to 10, you increase production by very little. You run into decreasing returns, and because of these decreasing returns, you see if you just, you know, count on capital accumulation to grow, you run out of steam at some moment.

You cannot grow forever just through capital accumulation. So Solow would say he realised that you need something called technical progress in order to have sustained growth, in order to have long run growth, but he would not tell you where technical progress would come from. And then to understand where it comes from, you have to go back to Schumpeter because Schumpeter had this view that, you know, it's innovation at the heart of the growth process.

So, in fact, technical progress comes from innovation. But Schumpeter did not have a model and did not have empirical analysis. So what we did with Peter Howitt was to develop a paradigm based on the notion of creative destruction. We operationalised the notion of creative destruction and we put it at the heart of a new growth paradigm where we developed a model and we confronted the model to Schumpeter and, in fact, now there's been a whole generation of economists who have further developed the paradigm and further confronted it with micro data.

RICHARD: Fantastic. So what are the key ingredients of your model, of the Schumpeterian model of creative destruction and growth? PHILIPPE: In fact, there are three main ingredients. The first ingredient is that long run growth comes from a cumulative process of innovation. Each innovator builds upon the giant shoulders of her or his predecessors. So that's the first ingredient.

You need a system of cumulative knowledge to avoid the Sisyphus issue. You see, you need to be able to build on the knowledge of preceding innovators. The second thing is that innovation does not come from heaven. It results from entrepreneurial activities motivated by innovation minds. I innovate because I know that if I innovate, I become a monopoly for a while, you see. I am able to produce something that nobody else produces or I am able to reduce the production costs of a good and, therefore, get to monopolise the market for a while, OK.

So I get an innovation rent from my knowledge. So that's very important. And the third idea is creative destruction.

New innovations make old technologies become obsolete. New innovations replace old technologies. But, you see, by the way, before I move on, that at the heart of the Schumpeterian growth, you have a contradiction.

On the one hand, you need innovation rents to motivate innovation but, on the other hand, there is the temptation for an innovator to use her or his innovation rights to prevent subsequent innovation because he wants to avoid creative destruction. "I don't want myself to be creatively destroyed by someone else so I'm very tempted to use my innovation rents to put entry barriers, to bribe the government, to do all kind of things to prevent entry and subsequent entry and subsequent innovation." And regulating capitalism is all about how to manage this contradiction and the whole book is about this contradiction. It has very for the debate on the inequality, for the debate on competition policy, for the debate on secular stagnation, for the debate on environment, everywhere you go for the middle income trap we talk about it's for all the the big dilemma, you know, the big enigmas of economic growth. At the heart of it, you are this contradiction that I just mentioned.

RICHARD: That's fantastic. And it does seem like a paradox or a contradiction, as you say, because, on the one hand, we need these powerful innovators and we need to give them some monopoly for a while to give them the right incentives to innovate. But if they can use that power and that could be political power through money and so on to corrupt the process and protect themselves, then we get the other end of the the other edge of that sword and it comes back to hurt us. So at the heart it seems to be kind of a political problem as well as an economic problem of incentives.

PHILIPPE: Absolutely. RICHARD: So I see why you're the perfect person, the left wing agitator and the formal economist. You have to put those two ingredients together to get to the heart of this problem. We're going to come to a lot of those things you just mentioned because there are so many implications of that. The first one I thought we might start with you already mentioned it because it's been very topical since maybe 2013 is this idea of secular stagnation and the way correct me if I'm wrong the way I think of it is this was your colleague former colleague Larry Summers sort of repopularising the term from Alvin Hansen from a while ago and sort of suggesting that the speed limit the way I think about it is the speed limit on economic growth is consistent with stable capital accumulation is lower than we thought it was in the past and we're going to have to learn to live with, you know, maybe 2% economic growth than the United States or Australia or France and not the kind of 3.5% or 4% that we've seen in the past.

What are the implications of your theory for secular stagnation and can we get out of this world where we've been for nearly a decade where even before COVID and even absent a big financial crisis, we kind of had pretty low growth in advanced economies compared to historically? PHILIPPE: Yeah, so, in fact, there are various views on that. There are some people who believe that the decline in growth is so first you have to understand first that developing countries, countries that are in catching up mode, they tend to grow faster. China grew at 10% per year, or 7%, but that's because China is catching up with more advanced technology. When you start from a very low level and you catch up with the most advanced with the technological frontier, you are bound to grow faster. So first you have to understand there is a normal reason why you should slow down as you catch up.

We cannot grow at the same rate as China because we are developed economies, Australia and France. We are already at the technological frontier, OK. So first you have to understand that. We cannot grow at the same rate as China but still we could grow more than we do. And the big enigma was how come in the US in particular, with the IT revolution and with the artificial intelligence revolution, the US have experienced a decline in productivity growth since the early 2000s? And in chapter 6 of the book, we explain that the main reason has to do very much with the Schumpeter contradiction. During the IT revolution, the IT revolution made it possible for some firms to become superstar firms, hegemonic firms.

Amazon, Google, Walmart, Facebook these firms grew very big and they invaded all sectors of the economy and at first it spurred productivity growth. If you look at productivity growth in the US between '95 and 2005, it was much higher than before. But then once they invaded the older sectors of the economy, they stifled innovation by other firms. They destroyed innovation by other firms, and that's why you have the decline.

So now the problem in the US is a problem of competition policy. You saw that Biden last week made a big move on competition policy. It was very much needed because you want somehow to limit the power of the superstar firms.

They could do merger and acquisitions without any limit. They could explore the advantage they have on data to put entry barriers to other firms. They could take advantage of tax advantages they get abroad to have a competitive edge on other firms. We know that big firms in the US have a huge power to finance political campaigns, to do lobbying, so you need in the US to really deal with competition, to regulate merger and acquisition to make sure that it's not preventing subsequent innovation and entry. You need to fight lobbying, which is too big there.

You need to regulate the financing of political campaigns. You may have to break up some of these firms. But you need big action to limit the power of incumbent firms, and that goes back to the contradiction I was mentioning before. In the US, the big problem is that income large income firms, and particularly the superstar firms, IT firms, they can do they can really stifle innovation by other firms and you have to really reform competition policy, to adapt competition policy, to the digital era in the US in order for growth to resume because it's really a competitive barrier, a competition barrier, to more sustained growth in the US.

RICHARD: That's so interesting because I think that lens of innovation gives one a different perspective in the new economy on competition policy than in the old economy. In the old economy, or the pre digital economy, we would think if there were four firms in the market that had 85% or some number we have these indices in economics; HHI and things like this we'd say that's a very concentrated market, but maybe that's not quite the right way to think about it in this new economy, which is if we have one firm that has 80% market share, well, that might have great network externalities; it might have great benefits to be on one platform. It probably depends more what are they doing for innovation, so maybe if they're buying up competitors, if they're killing innovation of small companies you know, some people have talked about this idea of killer acquisitions, that they'll buy a small firm to shut off the innovation and things like this, and so it seems that that innovation lens is very important for thinking about competition policy going forward as well. So that's interesting. And it brings in it seems to me it also brings in international tax policy as well, as we'll get back to later.

But with Janet Yellen, as Treasury Secretary, working on trying to dial down some of Europe's digital tax but also maybe cut off some of the Irish tax havens and things like that, it seems all connected, these things, to innovation ultimately. PHILIPPE: Yeah, absolutely. So, for example, it's very important on competition policy, very much the way to do anti trust up to now in the US but also in Europe is very much based on the notion of market definition and market share.

If you have a huge market share, I would go against you. You see what I mean? But you may have a very big market share and be a contestable market. What we call 'contestable' is you have high potential entry.

So I may have the whole market share of for example, high speed trains in Europe. You know there was Alstom and Siemens and they wanted to merge and the Competition Commission in Brussels told them, "No because the two of you, you have the full market share", but that was a very bad argument to prevent the merger because the market for high speed trains is highly contestable because the Chinese produce high speed trains, so anybody in Europe could go and buy trains from China. So, you see, it's a very limited notion, market share and market definition, and it's much better to say, "Before I forbid a merger and acquisition, I look at the effect it would have on subsequent entry and subsequent innovation." It's a much more, you know this dynamic way of doing anti trust is, I think, much more relevant particularly to the digital era and to deal with the problem I was mentioning before.

So that's one aspect. You have to change the way the practice of anti trust, putting much more innovation and entry at the heart and much less the static market share, market definition notion at the heart. The other thing, as you mentioned, is that, of course, the large GAFAM firms you know, the Facebook, et al they could take advantage of tax havens to get the competitive advantage of other firms in the US. I think whatever can be done to limit the tax havens worldwide will also, you know, increase competition because it will make the market a level playing field much more, and that I think is also the tax the tax level is as important as the direct redesigning of competition policy to make the environment more competitive. RICHARD: Yes, that's very that's clearly very important.

So one of the things that you touched on earlier on is obviously we need to provide incentives for people to innovate and you also talked about inequality. So how do we think about inequality in a world where we're trying to foster innovation? So you mentioned some superstar firms like Amazon and I don't know if they're superstar owners or people but they're certainly very wealthy but they've also created very big important things. So can it really matter if Steve Jobs makes tens of billions of dollars when he creates Apple? I mean, I don't know how rich Thomas Edison ever got but he created some pretty great things. Do we really care if Thomas Edison's worth $100 billion or $200 billion? What's the right way to think about the link between innovation and inequality? PHILIPPE: So my view my view, and there I depart from other people working on inequality, is that other people working on inequality, they would never distinguish where the rents come from.

It's not the same thing if the rent comes from successful innovation or if the rent comes from, you know, entry barriers, lobbying, et cetera. You see what I mean? So that's why I distinguish between Steve Jobs and Carlos Slim. Steve Jobs became rich because he created Apple.

Carlos Slim is a rich Mexican industry analyst. He became rich a lot because he's at the head of Telecom, the Mexico Telmex, which is a non regulated monopoly. And those are two very different things and you cannot ignore the distinction. It's very important when you look at the rents to know if the rents come from innovation or from pure entry barriers.

You should not treat them the same way. So now my problem with inequality is not that you have rich people. My problem is that you have poor people.

I am obsessed by poverty. I don't want people to be poor. I don't want people because they are born out of from poor families to not have the same possibilities as people born from other families. So I discuss that a lot in chapter 5 and chapter 10 of the book where we look at the Lost Einsteins. There are many people who could be innovators and they are not innovators because they come from poor families.

I would like everybody to get access to the same education but the same also aspirations so that they could all become innovators. You see what I mean? So my view is that the problem is not that you have rich people. The problem is that you have poor people, and because you have poor people, the poor people do not have the same access to the education, the possibility to become inventors and to realise life, and that's what I'm obsessed by. So my policy is really to deal with social mobility. It's very important, social mobility. You can reach with social mobility education.

Education is very important for social mobility, but innovation also because of creative destruction, innovation generates social mobility. So it's very interesting with innovation because innovation, it's true that it's a source of top income inequality. It's a source of inequality at the top because when you innovate, you get rents. But it's not the only source of top income inequality. Lobbying is also a source of top income inequality.

But the big difference between innovation and lobbying is that innovation is a source of top income inequality that raises social mobility because of creative destruction and, as a result, innovation does not increase lobbying equality. That's what we show in the book. So it's a very interesting source of top income inequality innovation. It raises top income inequality, inequality at the top, but it also increases social mobility. Therefore, overall it has not increased global inequality and it raises growth. So innovation is a good source of top income inequality, whereas lobbying is a bad source of top income inequality.

Lobbying raises top income inequality but because it reduces entry of new firms, it reduces creative destruction, it reduces social mobility, and, therefore, it increases global inequality. But also lobbying reduces growth because it reduces innovation by new entrants. So, you see, it's very different.

Lobbying and innovation are very different sources of top income inequality because innovation is a source of top income that doesn't increase global inequality and increases growth, whereas lobbying, it's a source of top income inequality, which reduces growth and increases global inequality, so you should not deal with them the same way. Now, having said that, should you worry about the rich? In Sweden, you have rich people. In Sweden, you know, Mr Skype Niklas Zennstrom is very rich because he invented Skype. You have the Wallmart family in Sweden. But the thing is that they cannot they have no problem because they don't prevent new firms from entering, and that's where it's Schumpeterian.

You want to make sure the rich do not use their wealth to bias competition, to prevent entry, to bribe governments, and in Sweden, you can't bribe government. A Minister had to resign in Sweden because she purchased a piece of chocolate with the credit card of the ministry. Just chocolate.

A piece of chocolate. So Sweden is very they are very monitoring very closely politicians. You cannot buy out a politician if you are wealthy in Sweden.

You cannot bias competition. So I don't mind having rich people but you need to put a no fly zone above that. That means you can be rich but don't use your wealth to prevent entry.

Don't use your wealth to do lobbying. Don't use your wealth to bribe governments. Don't use your wealth to finance political campaigns. As long as all this is warranted, no problem to have rich.

You see what I mean? But that's my view on this. You see what I mean? So my view is that you should not tax innovation the same way you tax other source of wealth and top income inequality, and the second thing is I don't mind having rich people but make sure they don't use their wealth to prevent creative destruction, to prevent entry of new innovators, to prevent social mobility and to prevent other people to have opportunities, and that's my way of looking at that. RICHARD: I think that's very compelling and it illustrates another good thing about thinking things through through an economic lens, which is some people say the fact that we have billionaires is bad. As Alexandria Ocasio Cortez famously said, "Every billionaire is a policy failure".

And one way to deal with that is to say: well, we'll have confiscatory tax rates so we don't have billionaires anymore and try to deal with it that way but, as you say, if you distinguish between what people are doing with the money rather than the fact that they might have a lot of money, you might not kill the innovation but you can sort of so maybe it's more a question, say, in the United States, of money in politics and Supreme Court decisions like Citizens United and the structure of government. So, yes, well, maybe your next book needs to be about how the US's political market could become a little more Swedish or something like that because that seems like something that's fairly far from the case. So that links up nicely with you've got views I think implications for innovation policy for tax policy and social mobility.

So there's been some real debate with actually quite a number of your compatriots, a very good French economist, with the view that we should be raising top marginal tax rates in countries like the United States and Australia and the UK a great deal. What's your take on social mobility and innovation and tax policy in general? PHILIPPE: So first I want to say that, you know, I am very much Scandinavian. I believe I think what the Danish or the Swedes are doing I think is very good. So you need taxation. That's why you need taxation because you want to have an education system, free access, and equality for everybody.

You need a good health system, free and accessible to everybody. You want to finance an active labour market policy the flexicurity system in Denmark. Maybe we will talk about it. You need to finance this.

And you may want to have also smart industrial policy, like the DARPA and the BARDA. That type of thing. So for that, you need tax. You need to raise tax. I mean, in Denmark if Denmark was not raising tax, they could not do what they do.

So I think you need taxation. So first I believe in taxation. I believe that taxation should be reasonably progressive. I believe that the tax rate should be higher for poor income earners and for rich the tax rate should be lower for poor income earners than for rich income earners. So that's what you have in Denmark. So you have reasonably progressive taxation on labour income and they raise tax because if they don't raise tax, no education, no health, no labour market policy, no industrial policy and all that.

So I think that's very important. So I believe in taxation. It's not that I'm not a Trumpist regarding taxation. Not at all. I'm believe I'm Scandinavian. So I believe very much in taxation.

This being said, Biden raised the tax. Biden was right because the taxes were way too low in the US. In the US they have a huge problem that the social model is broken in the US. They did not properly insure against COVID.

Many people lost their jobs because of COVID, and because they lost their jobs, they lost health coverage at the moment when they needed health coverage, you see. So they need to rehaul the social model, and clearly from where they were, there was a need to increase taxation in the US. So Biden was right. But, of course, the problem is that Piketty, since you named Thomas Piketty, my friend, and others, they want to raise tax in France, but in France we are already very high, and they want to raise the capital income tax, which is already very high in France. They want to raise inheritance tax, which is already very high in France. I am for inheritance tax.

I am not for lowering it in France but I don't think it should be increased because if you have excessive you used to have before and Piketty was OK with that you used to have marginal tax rates on capital income of more than 100%. That was crazy. So what Macron did and very much I pushed for that with him was to have a flat tax on capital income of 30%, you see, because it was crazy. It was discouraging innovation. And there's been work by Stantcheva, Akcigit and others showing that indeed excessive capital income taxation discourages innovation, and you don't want to discourage innovation because if you discourage innovation, it's bad for growth but it's also bad for social mobility.

So you shoot yourself in the feet. So you need taxation. I believe in taxation. But you need to have a reasonable tax system. A reasonable tax system.

It's a tax system where we don't overtax capital income and where you don't overtax wealth you tax it but you don't overtax, because you don't want to discourage people becoming rich. In Sweden they used to have also excessive taxation of capital income and wealth. People were leaving the country, and they realised if they wanted innovations to come back, they needed to put taxation at a reasonable level. Still, they have a very developed welfare state in Sweden and in Denmark. So you need to strike the right balance. You need taxation.

You need taxation to finance education, health, labour market policies, so you need to raise the tax. You need to have reasonably progressive tax on labour income. But I think the tax at 30% on capital income, corporate income tax at the reasonable 25% is reasonable, and then you have a tax system that works, and I would be in favour of inheritance tax. In France we have a reasonable inheritance tax, which is fine, and I would not raise tax in France.

That's crazy. But I would have risen tax like Biden did in the US. It all depends on the starting point.

You see what I mean? It all depends where you start from. RICHARD: It certainly does depend on the starting point. I always thought it was you can agree or disagree, but when Ronald Reagan wanted to cut taxes, when they were at a very high point, it's quite another thing to try and say, "I'm always for tax cuts; I'm Republican; I'm always for tax cuts", even if they're already 19%. "I'm for lower taxes" and so on.

And I always remember President Kennedy cut taxes. Marginal tax cuts were 91% in the United States when he did that. That didn't make him a Trumpist either by any stretch. So that starting point is obviously very important. I guess that also connects up with the idea of human capital mobility, and if you're going to have innovation and innovators as a country, you can't be a country like Sweden or Australia or France and have some of your best minds and human capital, basically your innovators, take your education, grow up, get all that human capital and then disappear overseas to pay lower tax rates.

So you have to be internationally competitive in that area as well. I think one of the other things that's so important as an implication of your work is about, if you like, green innovation and you talk about this in the book and environmental innovation. It's obviously one of the most the natural environment is one of the most pressing issues of our time and dealing with it is something where I think many of us economists you can tell me if I'm wrong on this but many of us economists think we've understood a little bit what the solution has been to this for quite a long time, for decades and decades, but there's been a political problem in getting these things done. What's your view on how we need to make progress on dealing with the huge environmental problems the world has but also in doing it in a way where we can foster innovation to actually find the new technologies that can reduce our reliance on fossil fuels and other things that are bad for the natural environment? PHILIPPE: So on the environment, there was a very interesting natural experiment, and the natural experiment is that, you know, with the first lockdown in France, GDP went it was in March/April/May last year GDP went down by 30% but CO2 emissions went down by only 8%.

So that shows that negative growth is not the solution. The solution is green innovation and the question is how can you get green innovation? Then you have a problem. It's what we call path dependence, and we deal with that in chapter 9 of the book. It's that firms that have innovated in dirty technologies in the past will keep will spontaneously prefer to keep innovating in dirty technology today because you want to keep doing what you're good at. That we call path dependence. So it shows that the first solution is to have creative destruction, encourage new firms to come because they don't have that problem.

You see? The new firms, they are not wedded to the past. So they don't have the path dependence problem. So creative destruction is really a way to deal with green innovation, OK? But then you have to also direct redirect innovation of existing firms towards green technologies.

There you have several instruments. You have the carbon tax, the carbon price, which obviously works very well. You have another instrument, which is subsidies to clean R&D, and what I would call smart industrial policy. In France we build nuclear plants and hydroelectric plants that helped to reduce CO2 emission but we subsidise also all kinds of R&D activities towards green technologies.

So that's the second thing. So carbon tax. R&D subsidies and industrial policy is the second one. And the third one is the consumers. When consumers want green, competition is also a new way to make the economy greener because if I don't innovate greener, you will. You see what I mean? So we show and that's in recent work with Roland Bénabou but it's also in chapter 9 that the civic society and in particular consumers are also a big force pushing firms towards green innovation.

You see what I mean? Particularly when consumers are aware of the need for environment, competition combined with the awareness of the importance of our environment, that's a force which is as important as carbon price. You see what I mean? And that comes from civic society. So one thing is the carbon price. One thing is subsidy to green R&D and industrial policy, and the third one is consumers, and the consumers in a more competitive environment.

So it would be competition policy in an environment where consumers are aware of the importance of environment. It's the combination between educating consumers and having competition. This combination is as important as the carbon price to induce greener innovation.

RICHARD: Very good. So we'll see where the Biden Administration goes and other countries. Australia is we're proud of many things and we're world leaders on many things.

Tackling environmental problems is sadly not one of them. We had a carbon tax and then got rid of it and we have some issues with trying to deal with that. But I think the carbon border tax that Europe seems to be likely to put in place and the US may copy, we may get a price on carbon in Australia because everybody else will have a price on our carbon exports. So we'll see how we go on that front.

I guess one of the big debates in the United States and we'll see where the Biden Administration comes out on this has been between a carbon tax, price on carbon, maybe a carbon dividend like the Climate Leadership Council have talked about that's had a lot of support particularly from economists, and then something more like Ocasio Cortez and others have championed, Bernie Sanders, Elizabeth Warren something more like a Green New Deal. Where does that fit? That's a bit more, as I understand it a bit more interventionist than kind of 'smart industrial policy', to use your term. That's more spending trillions of dollars for the government to do a lot more stuff. How do you think that that debate should resolve itself? Where does innovation theory fit into that? PHILIPPE: I think I think that you know, innovation has to be a lot to be bottom up. You see what I mean? Grassroots.

So I believe very much in horizontal policies. Create the environment for innovation and creative destruction to take place, OK. Make entry easy. Have a Small Business Act, you know, so that small businesses can sustain R&D investment over the business cycle. Have education so that many people can become innovators and innovation hubs can flourish.

So I believe a lot in horizontal policies, OK. Have a tax policy which is not discouraging innovation. That I think is crucial.

So innovation first is horizontal. Education, taxation, you know, competition all these things horizontal. They apply to all sectors. But it's true also that I believe in smart industrial policy and in the US they found a DARPA, Defense Advanced Research Project Agency. It was created in the '50s for defence and space. That's a situation where the basic technology, the basic knowledge, has been generated in basic research, but you need to translate it into applications quickly and you have very defined, well defined missions.

So then you have to coordinate a dozen resources, and for that the DARPA was very effective. "I need to put the man in space" when Gagarin went in space. "I need to put the man in space in one year." "I need to develop defence systems in one year or two years." And we saw that recently with the vaccine. BARDA, Biomedical Advanced Research and Development Agency, "We are the ARN messenger technology.

We need to produce within a year mass production of vaccines based on this technology. For that, you need this DARPA. "It was very good with the DARPA. The money the funding comes from the Ministry. Then they have team leaders and the team leaders elicit competitive projects, you see. So there you have the bottom up part.

It's a mixture of top down and bottom up. And the team leaders elicit competitive biddings. Many people come to them and they encourage private public partnerships and that's competitive. You know, BARDA have Pfizer, Moderna; many others that you don't know about and they didn't succeed. And that I think is a good thing to do. So they did that for the vaccines and I think they also have in the US an ARPA energy.

They have an agency for energy. You may want to do more but they have the structure that allows them to do it in the US, which is the ARPA energy, and we need to create the equivalent in Europe. That would be great to do.

But I think that's the right tool. So it's important you can put more money but the governance is very important because you don't want to have the pitfalls of bad industrial policy, which is to stifle competition and to help incumbents at the expense of entrants. So you want the competition policy which is you want an industrial policy which is pro competition and pro entry and the DARPA/BARDA well done can be that, you see, but it has to be well governed. RICHARD: I see. I see.

So this maybe draws a connection to some of your other work in contract theory but it seems to me there's a little bit of an analogy here to the theory of firms versus markets. I think we have learnt over the years that one of the good things about firms is authority, that if you're the boss and you want to make a car that's painted green, you tell people to paint it green, and if they don't like it, you fire them and you find somebody else who'll paint the car green and you'll get a green car. But markets have competition. Markets also, as Hayek famously pointed out, help aggregate and communicate information. It sounds like a little bit what you were saying with DARPA and with some of these developing vaccines, sometimes you have sort of like a space race, a war time production environment, and there you really need coordination and authority and other times you need to kind of let a thousand flowers bloom, where people come up, they try mRNA; it works, it doesn't work; they try something else. Is it that kind of thing where you want an ecosystem that can allow you to be going from a thousand flowers sometimes to we're fighting a war and we're going to do it this way.

PHILIPPE: Yeah. So you have to understand for basic research, you don't have you don't need a DARPA for basic research. You need to have many people be free. You have areas, for example, areas like Silicon Valley is not like DARPA. In software, you don't need that.

You see what I mean? So you need that in particular areas where the basic research has been done and you need to go very quickly into industrial production with clear mission. It's only those activities that are DARPA able. Do you see what I mean? Not everything is DARPA able.

And in those things there, you need the coordination problem. There you have the coordination problem and you need a structure to deal with the coordination problem but you want it not to kill the bottom up, not to kill the grassroots, and that's where DARPA is great. DARPA solves the coordination problem without removing the competition, the free entry, the bottom up part.

You see? So that I think that's where they found something that works with the DARPA model. But you want to be also aware that different parts of the research basic research, for example, needs freedom and openness. Very much actually.

You know, then you have the research within firms but you have sometimes these areas where you need to coordinate actors and resources, and on those segments, then DARPA can be helpful. But it's in these particular instances, otherwise you want to go more as much grassroots as you want and as much competitive as you want, with no need for coordination. So you always have the trade off between initiative and coordination and you need to find the right the right, you know the right compromise between coordination and the need to raise initiative. Too much top down kills initiative and but sometimes if you are just bottom up, your coordination has to occur and then take place.

That's exactly the same trade off. But I want to take advantage of this question that you asked. Going back to the Schumpeter specialism about the future of capitalism because he thought that innovators would turn into conglomerates that would stifle innovation. And what we claim in the book is that the response to Schumpeter's specialism is the triangle between firms, the state and civic society, and you need the three of them.

If you have only firms, then the big eat the small, or the incumbents prevent the entry of the new innovative firms, so you need something else. It could be the state. The state could regulate the incumbents but the state can be captured by incumbent firms, so, of course, you could say, well, but the state you could have separation of powers.

You could have Montesquieu. You could say where the judiciary would control the executive power and limit the extent to which the executive power colludes with incumbent firms. But the problem is that constitutions are incomplete contracts, and we go back to incomplete contracts there. Constitutions are incomplete contracts and they may not be enforced, and that's where civic society is very important. Civic society is there with the media, the union, with the associations, with the voters, to make sure that the contract will be implemented, will be enforced, and that's why you need a contract between firms, state and civic society that's there.

We saw that in the US. It was very important to turn out for voting. Now if we have more competition in the US, it means Biden could be elected, and Biden could be elected because many more people could vote for him. Now you can see that Republicans in the United States, in the US, try to limit again and you work on gerrymandering.

You know very well about that but they are trained by other tricks in addition to gerrymandering to limit the votes of the poor because they don't want to lose again. So they want to limit civic society. Limiting the vote means limiting civic society expression. But civic society is what got Biden there in the US, and because you have Biden, you got more new competition laws.

So you need the triangle between firms, state and civic society. You know, Colombia has the same constitution as France, but in Colombia if you are a union leader, you are very likely to be killed. That's not the case in France because you don't have the triangle as you have in France.

France you have decades and decades of fights to secure the right of the media, to secure the right of the union leaders and all that, which you don't have in Colombia, and you need to secure this third leg, which is civic society. Another example is the Civil War in the US. The Civil War in the US led to the 15th amendment of the US Constitution to give voting rights to everybody, including African Americans.

But, as you know, the southern states in the US for 100 years didn't implement it because they would find poll tax or they would put crazy literacy requirements which would make it impossible for African Americans to vote. And it took the Civil Rights Movement in the US to finally lead to the Voting Act of the Supreme Court in 1965 that made it impossible to have the literacy test and all that and to do anything that would prevent the African Americans to vote. Still there are other tricks which I just mentioned before to make it hard to register without ID or without this. There are other ways, but they don't have the literacy test.

And so again you see how the Civil Rights Movement is what allows you to enforce the Constitutional contract. You may have separation of power. You have a well defined Constitution, but without the civic society, this Constitution remains lettre morte, as we say in French. It remains abstract. It doesn't come into reality.

And that's why the triangle between firms, state with the separation of power, and civic society this triangle is the way to avert Schumpeter's specialism. That's how you can have, you know, true competition policy. That's how you can have things that would prevent conglomerates in common France to become a barrier to new innovation. That would allow you to have green innovation.

We discussed the green. We have discussed the role of firms. Firms are the ones who do the green innovation. But the state does the carbon tax and the industrial policy, and also the consumer and the shareholder and what we call corporate social responsibility. That also is very important in enforcing green innovation.

RICHARD: I think that's very important. We're seeing a kind of lively experiment in the United States about whether its incomplete constitutional contract can kind of adapt to changing circumstances. The contract theorist in both of us thinks about one of the important things as being that you need to be able to adapt to changing circumstances but also have certainty, and I guess we'll see if the United States can adapt to their changing political circumstances and will have a big impact on that limb, that civil society limb, of getting around the Schumpeterian paradox, as you say. One of the big debates in the economics of innovation is around whether technology whether really good innovations are still happening. I guess Robert Gordon is maybe the most notable person who's maybe described as a bit of a techno pessimist and say things like along the lines of, "Computers are kind of a relatively minor innovation in the scheme of things compared to running water and toilets and refrigeration" and things like that.

That's led to a big an interesting, I think, debate about: should we be techno optimists or techno pessimists? Where do you come out on that issue? PHILIPPE: On that issue I believe I believe, you know, that I think what Gordon underestimates is the fact that the IT revolution, for example, not only improved the technology to produce goods and services but it also improved the technology to produce ideas, and that Gordon doesn't take into account. You see what I mean? So there is a colleague of mine, Salomé Baslandze, who did her PhD thesis on that. She wrote that when you take into account the contribution of the IT revolution in the production of ideas, in fact you get much more. You overturn the event. You know, the assessment of Gordon that the IT revolution was less important than the steam engine or electricity. So that's my first comment.

The second one is that I don't believe I think on each particular technology, you eventually run up into decreasing returns but then you have new general purpose technologies that come all the time, and so that's so the whole issue is to make sure that the new general purpose technology will produce the growth. What may prevent them to produce the growth is the competition, is the fact that the institution did not adapt to the general purpose technology. That's another thing. You see what I mean? So it could be that we saw with the digital IT and AI, when without proper competition policy in the US, instead of becoming a boost for growth, it becomes an impediment to growth because, thanks to the IT, these firms became hegemonic and prevent innovation by others.

So you see growth is the result is the combined result of technologies and institutions. If the technologies don't adapt to if the institutions don't adapt to the technology, you won't get as much growth from the technological revolution as you would have hoped, and so that's why you need institutions and policies to adapt to the technological revolution. That's exactly what we experience in the US. Without proper competition policy, US will not be able to take full advantage of the IT and AI revolutions.

RICHARD: Very good. You had a wonderful conference recently honouring, I guess, the 30th anniversary of the publication of your famous Schumpeter paper with Peter. It was written several years before that, as I recall, but I think it's the 30th anniversary recently of the publication.

There were many great economists there speaking on all the implications of your work, as you alluded to earlier, in many, many fields. One person who's not an economist but when I heard him speak, I thought he would have made a very fine economist had he chosen to go into our field, and that's the President of France, Emmanuel Macron, and he said I won't make you blush here on camera but he said some very nice accurate but extremely nice things about you and your contribution. I thought that was wonderful to see.

But there was one particular sentence or two that he said in his he spoke for quite a while, 15 minutes I think, but he said one thing that really stuck with me that I thought was very important, and I'm interested in your view on how we do this he talked about the idea of the Washington Consensus, which I guess is something that's been around for a while and is often associated with, say, the Clinton Administration and people who really delivered on some important policy changes there, but there was, I think, a sense for many years now that maybe the Washington Consensus needs updating, that it's not quite fit for purpose for exactly the challenges that the world faces now. I think a lot of things have changed, technology among them, since the early to mid 1990s. And what President Macron said, and I'm quoting here he said, "We must build a new consensus and I think the Schumpeterian model must be a key part of this new consensus", so that's a pretty nice endorsement from the President of France.

What do you think is what's your take on the Washington Consensus and the virtues or otherwise, or vices, that it has brought us and what do we need in that political sphere in terms of our international institutions the IMF, the World Bank, maybe some of these international tax arrangements that Janet Yellen and Joe Biden are helping to put in place what's your vision, if you like, of President Macron's new consensus? PHILIPPE: So I think the Washington Consensus was very much on fashion. It's a term that John Williamson found because IMF, the World Bank and the US Treasury were thinking alike at the time. It was at the time of the transition of Eastern European countries and Soviet Union. So it was very much the idea but also in Latin America they were advocating. It said, you know: privatise, liberalise, stabilise. Stabilise, liberalise, privatise.

And the view was that you could go everywhere in the world, just advocate that and that would get growth going. So, of course, for innovation, you need of course, if you have an unstable economy with hyperinflation, you won't have innovation because nobody wants to innovate if they believe that hyperinflation will eat up their profits. Liberalise you want to liberalise entry and competition, of course.

Privatise you don't want the fully you don't want a socialist economy. You want a capitalist economy where you have private sector. So that was right. I mean, in a sense those three things, of course, are ingredients but they are not enough. We realise that education is very important.

Why is China why did China do so well? Because they opened up their economy with education. If they had had an uneducated population, it would have led nowhere. So education is very important. We also realise that smart industrial policy is important, you see. In fact, the US did it.

A lot of innovation came from the DARPA and the BARDA that I talked about. So that was not part of the Washington Consensus. Also we realised that, you know, when, in Denmark or Sweden, they put in place an active market level policy that allows you to deal with people who lose their job and look for a new job, that helps creative destruction at the same time as it protects the individual. So the Washington Consensus didn't have anything about inequality, social mobility, education, you know, active level market policy.

They didn't have that at all, so it was very incomplete. They had three things which are important but they needed it to be completed. We know that you can't have a Washington Consensus without education. You go nowhere without any form, you know without education, health and the basic public services, you go nowhere.

Without smart industrial policy, it's also not very helpful. So I think it needed to be completed. And now what we learn from this COVID is two things. We learn that the social model in the US is broken. They need to completely rehaul their social model.

There has been the work of Anne Case and Angus Deaton showing the sharply increasing mortality of the white non Hispanics middle age, because whenever you lose your job in the US, it destabilises your family. It creates drama. And because of the stress created by the fear of unemployment, you get opioids, you get obesity, you get people abusing sleeping pills, and mortality follows, whereas in Denmark, as we explain in chapter 11 of the book, when you lose your job, the state gives you 90% of your salary for two years, helps you find a new job and retrains you. In Denmark, losing your job has no negative effect on your health and has no effect on mortality. So you want a system like this. You would like the capitalism which is as innovative as the US capitalism but as inclusive and protective as the Scandinavian capitalism, and we believe that you can get both.

That's what we tell in the book. Some people believe that the lack of protection was the price to pay for innovation in the US or that the lack of innovation was the price to pay for protection in Europe. I believe that we can have both.

When you have flexicurity system in Denmark, it helps creative destruction work better and that has both growth and protection. When you have more education, you allow more people to become Einsteins, so that's good for more it enhances growth but it makes also growth be more inclusive. When you introduce more competition in the US, it will make it will boost growth in the US because you will put an end to secular stagnation but, at the same time, because it allows new entrants to come in, it will make growth more inclusive.

So it's not the innovation or protection. You can have a model which does better on both grounds, and that's what the book says. You see what I mean? You can have a capitalism that combines, that makes it as innovative as the US and as protective and inclusive as Denmark, and you can do both together, and that's the new agenda, and that goes way beyond the Washington Consensus, you see.

It incorporates, of course, the Washington Consensus but it goes way beyond the Washington Consensus. RICHARD: Well, that's a very important and all encompassing agenda. I can see the sort of perfect circle from your left wing agitating roots at the start to your contributions throughout your career as an incredibly distinguished economist, and putting both of those things back together now, there's an agenda there for politicians and activists and policy makers. There's a rich agenda there for, I think, the economists of the future to work on, people who work on empirical work, people who work on theory, people who work at the intersection of political economy. It's been great to talk to you, Philippe. I've got a lot more questions.

I could keep going on and on but we have a limited amount of time. You've been very generous with yours. I've got more questions and I will save them for once COVID is finally over and we can get you on an innovative plane that doesn't have too many carbon emissions to come down and visit us at UNSW. But, you know, on a personal note, you've been very important to a number of people in the profession. You were very important a very important person in my graduate studies and in my professional development and in my life and I've been very lucky in that regard and I'll always be grateful.

I think this book really translates a career of work, putting together all these incredibly important pieces of rigorous economics that are so connected to what will change the lives of people all around the world, so it's a great contribution. I commend the book to all the people who are watching and to others. As always, it's been a great pleasure. Philippe Aghion, thank you so much for your time. PHILIPPE: And, Richard, it's been great to have you to meet you, to have you as my student and to work with you and to co author with you and to have you in my life.

It's been a huge plus for me. I follow your work and I'm always dazzled by your work, and I know that very much the economic policy of the US depends on you for a big part, but we won't get into that joke! RICHARD: Well, thank you. That's very kind and I guess I'll say bonsoir.

PHILIPPE: All the best. Thank you very much, Richard. Bye.

Bye bye.

2021-09-12 15:38

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