Back in October, the Nobel Prize for economics was shared between three economists for their work on explaining innovation-driven growth. Technically, there isn’t a Nobel Prize in economics. It’s the Sveriges Riksbank prize, and critics like Peter Nobel (a great-grandnephew of Alfred Nobel) have argued that Alfred Nobel would have hated the idea of a prize for economics. But putting that to one side, Joel Mokyr received one half of the prize for his work on the prerequisites for sustained growth through technological progress, while Philippe Aghion and Peter Howitt shared the other half of the prize for their work on the theory of sustained growth through “creative destruction”, Joseph Schumpeter’s theory of economic progress. The “work” was Aghion and Howitt’s 1992 paper, where they “constructed a mathematical model for what is called creative destruction: when a new and better product enters the market, the companies selling the older products lose out. The innovation represents something new and is thus creative. However, it is also destructive, as the company whose technology becomes passé is outcompeted.”
The Royal Swedish Academy of Sciences went on to note that,
“In different ways, the laureates show how creative destruction creates conflicts that must be managed in a constructive manner. Otherwise, innovation will be blocked by established companies and interest groups that risk being put at a disadvantage.”
Given the enormous optimism surrounding the growth potential of (primarily) AI, but also related areas like autonomous driving, quantum computing, or small nuclear reactors, it’s not surprising that the prize committee chose to highlight this area. But while markets are busy discounting our very bright future, with all the focus on the “creative”, you could be forgiven for thinking markets have lost sight of the “destruction”. The notion of winners AND losers is central to the process of creative destruction, and economic growth is the net of that mix.
AI seems likely to result in some very big winners, but who are the losers? Well, one example of a business on the wrong side of the process of creative destruction is advertising. WPP is a particularly poor performer, down 85% from its 2016 highs, but none of the big global agencies have covered themselves in glory. When life hands you lemons, you make lemonade. So WPP has busied itself embracing the strategic threat to its business by developing its own AI tool, “WPP Open”. Still, it doesn’t appear to have done much to arrest the decline so far.
The same “if you can’t beat them, join them” approach is true of software as a service (SAAS) businesses that are often cited as likely victims of AI. Salesforce (Einstein AI), Adobe (Sensei), and Microsoft (Azure AI) have all integrated AI into their platforms for features like predictive analytics, creative workflows, and AI-building tools. In this case, AI might well be additive to their business models, but the rationale for adoption is to limit the threat AI poses to an established franchise. But AI remains a strategic threat to lots of businesses. Online travel agencies like Booking will lose business to AI-driven personal assistants that can plan and book entire trips, bypassing aggregator websites. Media companies are seeing freelance writer contracts and royalty incomes for photographers fall as generative AI produces articles, images, and video clips for pennies. And it’s clear that AI is already eroding demand for professional services: how much can law firms continue to charge for routine document reviews that AI can complete in seconds?
It’s not just AI vs legacy business. There is a “winner takes all” logic to AI, which suggests that not all of the competitors in the space can emerge victorious. Why would anyone use the 3rd or 4th best AI? Of course, this is too simplistic. Claude Sonnet 3.5 has already carved a niche as everyone’s favorite coding AI, so there is scope for specialization. But one might still wonder how many of the AI businesses that are currently slugging it out will still be around in 10 years? Perhaps this doesn’t really matter. The lesson of the previous tech boom is that ultimately, accelerating growth is a tide that lifts most boats, and that kissing a few frogs really won’t matter provided you find a prince or two. But is that also true for credit, where your upside is limited to your coupon and your downside is your entire investment? If we are in an environment of accelerating “creative destruction”, we might expect credit markets to discount a little more destruction. Of course, in bull markets, everyone’s glass is half-full. But things can change, and when they do, credit investors might start to ask more questions.
This risk-return asymmetry might explain Sam Altman’s recent PR misstep in suggesting that his company (and the US) might benefit from a government guarantee. Perhaps Sam knows that in a winner takes all environment, you can’t really afford to come 5th. Unfortunately, his competitors have significant real cash flows and can borrow very cheaply. Perhaps there is a sense in which Sam really could use a government guarantee, and the Trump administration does have its own way of doing industrial policy. No harm in asking, particularly given AI is a strategic imperative for the US.
