What drives progress?
The answer is simple. And it probably won’t surprise you.
But it’s hard to focus on progress when all you see is regression.
The Financial Times headlines, “Italy turns to China for help in debt crisis”.
The Age says, “Retailing to go from ‘bad to worse’”.
And Bloomberg News reveals, “BofA [Bank of America] to Slash 30,000 Jobs in Cost-Cutting Plan”.
Every way you look, you see destruction… job cuts, companies going bust and countries borrowing and begging from other countries.
Things look bad. And if we’re honest… it is bad.
But among the gloom, there’s something to look forward to.
Progress needs destruction. We know that may sound weird, but it’s true. Throughout history all improvements to human life have come as a result of destruction.
We’re talking about entrepreneurs coming up with new ideas, products and services that replace existing ways of doing things.
It’s destruction caused by creation.
In this case it’s where the destruction hits an established business. Now, the business isn’t necessarily doing something bad. It’s just that entrepreneurs always look for ways to make a profit.
If there’s no way for new firms to make a profit with an established product, an entrepreneur will find a way with another product.
The technology sector is a perfect example.
When new technology is introduced it will typically have high profit margins. This is because it’s new and the firm has invested a lot of money in it. So, in order to make money the firm charges a high price.
It’s a risk, because there’s no guarantee consumers will pay the high price. But if they do, the technology firm is on a winner… and the profits start racking up.
But there is a downside for technology leaders. High profits act as a signal to competitors. This causes competing firms to enter the market to get a cut of the action.
And because the established and new firms want to gain market share (and profits), the inevitable result is a race to the bottom as they undercut each other… prices and profits are slashed. This is, of course, great news for the consumer.
And it’s good news for progress and creative destruction too.
Because at some point it becomes unattractive for new players to enter the market. Start-up costs and low profit potential means entrepreneurs will look elsewhere. Simply put, the “high profit signal” isn’t flashing anymore.
But that doesn’t mean progress stops. Entrepreneurs will just look for other ways to make money. And so the search for profits leads entrepreneurs to come up with newer ideas… something else that could shake up the same or a different industry.
Take television manufacturing as an example. The last 10 years has seen the industry go through several phases: old style CRT… rear projection… plasma… LCD… LED LCD… 3-D LED LCD… Smart 3-D LED LCD… what comes next?
For all we know, the “next” may have already happened but we haven’t seen it yet!
As each technology appears you see a wave effect in prices. Plasma TV prices were high until LCD TVs came on the scene… then they dropped. But as soon as LED LCD TVs appeared, standard LCD prices fell too… LED had become the new premium product.
We use this example because it’s the most obvious and visible. But this is what happens all the time. And not just in the technology sector. It happens with any industry.
But in order for progress to advance, you need an environment where entrepreneurs can flourish. Without it progress stops.
For years, Western governments have meddled with the free market. Erecting barriers to entry to keep entrepreneurs from destroying established businesses with new innovations.
That doesn’t mean entrepreneurialism is dead. It’s just harder to find.
But maybe it won’t be that way for long.
A positive from the disaster happening in Europe and North America is the experiment of allowing governments to steer national economies is proving more of a failure as each day passes.
The destruction of national economies in Europe is painful. But the upside is it’s purging economies of welfare dependency and that should result in smaller governments.
And that’s why, in the long run we’re positive about the future.
The reversion to smaller governments will allow an altogether more positive type of destruction to take hold – creative destruction.
Old ways of doing things – ways created by the State – will be cast aside and replaced by the next breed of entrepreneur. One who can make profits without fear of government taxing away their gains.
This won’t happen overnight. But ultimately, we’ve greater faith in the abilities of entrepreneurs than we’ll ever have in the abilities of meddling bureaucrats.
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Written by Kris Sayce
Kris Sayce is Editor in Chief of Australia’s biggest circulation daily financial email — Money Morning. (You can subscribe to Money Morning for free here).
Kris is also editor of Australian Small-Cap Investigator, his small-cap stock research service, where he provides detailed analysis on some the brightest, smallest listed companies on the ASX.
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