Cowen, Schumpeter, and employment fluctuations

Tyler Cowen writes,

I take a finance perspective on the output gap. If you are at what others call “full employment,” you can indeed do better, or at least try to do better. Start 300 companies that aim to be the next Stripe, Facebook, SpaceX — whatever. In the short run, you will create jobs, people at jobs will work harder, and so on. Employment, output, and also tax revenue will rise. You can pat yourself on the back and say you were not at full employment.

The thing is, you have accepted a higher level of risk. Many of those companies are likely to fail. And since they were started by humans consuming a broadly common set of cultural and media inputs, those risks will to some extent be correlated as well. Of course it might pay off big time as well.

Schumpeter’s phrase “creative destruction” makes it sound as though those processes are synchronous. A new business is created and destroys an old one.

But the creation cycle and the destruction cycle are out of phase. A new business created today will not destroy an old business for several years. And an old business dying today will release resources that may not be redeployed in new businesses for several years.

We can be in a phase in which new businesses are being created, old businesses are hanging around, and lots of resources are being used Think of the Internet boom of the late 1990s. And Tyler is right that there was a lot of risk-taking going on at that time. Or we can be in a phase, like 2008-2014, where old businesses have died but not enough new businesses are being created. And there was plenty of risk aversion, some of it dictated by financial regulators.