One of the challenges in life is to know the difference between a cyclical slump and a transformation that will permanently change a business, industry, economy, lifestyle, living standard, a family's prospects or the future of a nation-state.
Harvard Professor Clay Christensen explained the difference in the business world, with his 1997 breakout book The Innovator's Dilemma. I interviewed him at Harvard in 2005 about his theory of disruptive innovation and how the failure to recognize the dangers and opportunities in changing circumstances have devastated many industries from steel to retail, telecoms, the media and others.
All these sectors failed to recognize the signs or patterns that revealed the fact that changes were permanent and required recalibration and re-framing of the industry, business and mentalities of all involved.
Last week in Davos, Professor Christensen elaborate his theory to include macro-economics and markets. As with the invention of the PC or Internet or mini steel mill, the current economic conditions are transformative and require recalibration and re-framing of strategies, policies and political judgment.
He calls it the "capitalist's dilemma" and said that the relatively jobless economic recovery in the U.S. and elsewhere is the new normal, and presents serious political and social consequences. Some 204 million people remain unemployed, in large measure due to the 2008 meltdown, but there are other reasons, he pointed out.
"Whatever happens on Election Day," wrote Christensen in the New York Times just before the voting "Americans will keep asking the same question: When will this economy get better?"
Christensen is not an ideologue. He analyses facts, not opinions, and has figured out why low or no interest rates on capital has caused a timid recovery with mediocre job growth. The old paradigm was that by giving away cheap money, the enterprising and enterprises will innovate and create jobs and gobs of economic activity.
Perhaps the sluggishness is due to the fact that trillions in debt are still being paid down after America's spending binge. But that's only a small part of the story, he said. Trillions remain on the sidelines earning low interest, or invested in stock markets with hedge funds.
"Even if there is robust growth there won't be job creation," he said.
This is because the challenge is not framed properly. Policymakers must differentiate -- by providing tax or other incentives -- between three categories of innovation in order to "unlock the type of innovation capital" that creates real wealth for an economy or industry or business.
"There are different types," he said. "Disruptive or empowering innovations are transformative, such as the railway, Model T, the invention of the Personal Computer, the Internet are in the salient category and create lots of new jobs and wealth."
The invention of the railway steam engine gave an enormous boost to the world economy in the 19th century and thousands of companies in this technology were listed in London and New York exchanges. The car followed and by the 1920s, there were 2,000 listed automakers on the NYSE.
"The second category is sustaining innovations and these don't create new jobs, they make good products better," he said.
The problem is that this cannibalizes the market. For instance, the customer who buys Toyota's Prius does not buy a Camry at the same time.
"The third type is what I call efficiency innovations that transform products that exist and make them more affordable," he said. "The consequence of that is the reduction of employment."
In past eras, the three types of innovation investments were in balance, but now there is huge investment in "efficiencies" and little investment in the "first category or empowering innovations."
Paradoxically, he said the lack of balance is due to the fact that money is so cheap so businesses are investing in efficiencies that eliminate jobs.
"Efficiency innovations emancipate capital: It used to take 60 days for General Motors to make a car, and now Toyota can make one in two days. That means less capital is used, and fewer people, and the extra capital is re-invested in more efficiency, not in disruptive or empowering innovation," he said.
So why, given the abundance of cheap capital asked a participant, aren't businesses earmarking money to find and develop those game-changing innovations?
"Because of business professors like me," he responded. "We teach students about internal rates of return which encourages quick payback investments."
Without attempting to explain the arcane world of accounting, Christensen said the fact that the cost of capital is virtually zero the net present value of a future stream of growth in five years is identical to one that yields a return in one week.
Until accounting attitudes changed after the 1980s, the United States and Japan invested in disruptive innovations in technology and products and their economies grew like crazy. "Since we measure profitability the way I've described, their economies have flat-lined," he said.
Empowering innovation takes time -- five to eight years, he estimated -- uses capital and does not generate it. "What we taught them caused them not to invest in anything other than efficiency innovations. They are awash in capital and not innovating because we taught them to measure profitability that way."
The prescription, said the professor, is to change the accounting metrics measuring business investments and to provide tax incentives to keep capital working for at least five years. There must be "soft" accounting too.
"We also need new measurements such as measuring the return on investments in people in order to get out of the situation we're in," he said.
Politicians should also stop giving students loans and grants to learn skills or take subjects that are not in demand or that employers cannot use. This means that universities or colleges must change the subjects they offer and align them with the needs of the economy.
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