Behavioral Finance

Economic Evolution

"If you want to make enemies, try to change something.

"If you want to make enemies, try to change something."
-Woodrow Wilson

Most of the modern world accepts the theory of evolution as the most probable and logical explanation for human existence. Darwin's theories explain very well the reasons for the appearance of animate creatures and critters on the earth.

One of the central elements of evolutionary theory is natural selection, first introduced in Darwin's 1859 book The Origin of Species. Wikipedia defines natural selection as "the evolutionary process by which favorable traits that are heritable become more common in successive generations of a population of reproducing organisms, and unfavorable traits that are heritable become less common." Or, more simply, the stronger survive.

You probably learned all about evolution and natural selection years ago—most likely in your 8th grade biology class. The concept is as fundamental to biology as supply and demand is to economics. Pop culture even spawned the tongue-in-cheek Darwin Awards, given to those who perish from comically foolish deaths. The idea being, of course, that the elimination of the awards winners from the population actually improves the human race. One of last year's award winners tethered himself to a several hundred pound grouper fish without a knife to cut himself loose. After the fish was speared, it dropped dead and sank 17 feet below the surface, the fisherman in-tow. More chlorine in the gene pool!

If all this is so, why do so many have difficulty applying the concept of natural selection to the economy?

Let's take a look at some "extinct" businesses and their evolutionary replacement.

• The candlestick maker ---- electric light bulbs
• The wheelsmith ---- tires for automobiles
• Poloroid pictures ---- digital cameras
• The Teledex machine ---- email
• VHS ---- DVD
• Breaking up face to face ---- the 10pm text message

Most people I know don't pine for the olden days of horse and buggies or subsistence farming, yet every day people of the developed world struggle to cope with the evolving global economy. Economies, just like Galapagos finch, evolve constantly. More efficient businesses push out the stodgy ones. More developed economic structures push out old methods. This concept is called creative destruction.

The godfather of creative destruction is Austrian born Joseph Schumpeter. The Harvard economist coined the phrase in his 1942 book Capitalism, Socialism and Democracy, declaring that antiquated methods are endogenously replaced by new methods. Innovators and entrepreneurs destroy the status quo and drive economic expansion over time.

(Ironically, Schumpeter wrote the book with a tone sympathetic to Marxists in order for them to digest his ideas without rejecting them. He hoped his readers would experience an epiphany as to the pitfalls of socialism.)

Fast forward 65 years and the masses still struggle to accept economic survival of the fittest (namely the media and politicians). It's a bit of a paradox, but we tend to applaud our entrepreneurs for their genius and forward thinking only to later vilify them once their destructive wake is felt. As an example, tech junkies eagerly await each new product launch by Apple's CEO Steve Jobs. Apple products are forward thinking, sleek, user friendly, and can change the marketplace. Conversely, Apple manufactures nothing within the United States. It's just so darn cheap for them to assemble iPods overseas! Luddite politicians and media outlets never let an opportunity pass to bemoan the loss of domestic manufacturing jobs. Apple must hate America, right?

When we look around, the economic structure of the developing world is evolving. In less than 150 years the United States has evolved from an agrarian economy to a manufacturing-based system to the service-heavy environment it is today. GaveKal Research labels the latest economic evolution of the developed world the ‘Platform Economy," an economy based on high value-add roles such as design, engineering, finance, education, and health care. These new roles are destroying the occupations of our grandparents and our parents. Yet the economic benefit is tremendous.

The frantic pace of economic expansion is driven by creative destruction. Outdated industries or businesses must evolve or perish in the event of a more "fit" competitor, whether that be domestically or abroad. The Sword of Damocles currently hangs above the head of US automakers. These outdated monstrosities, ridden with costly pension plans and cumbersome manufacturing processes, struggle to compete with the leaner, more innovative Japanese producers. Toyota now ranks as the largest automaker in the world. Yet the American public and legislators protect this darling industry (and plenty of others) at a huge cost to consumers and tax payers.

As it happens, government intervention is what Schumpeter predicted would eventually crumble capitalism from within. Schumpeter surmised that democratically elected governments would legislate to restrict entrepreneurship and create a massive welfare state. The burdens created by parliaments will become so great that capitalism eventually collapses.

Some governments today are attempting to stall economic evolution with protectionist measures. But those very measures threaten the most natural and successful economic system in the history of the world: free market trade. I, for one, won't let that happen. So in protest, I'm slapping the following bumper sticker on the back of my ride for all to see:


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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.