FindingFeb 03, 2020

A Global View of Creative Destruction

Chang-Tai Hsieh, Peter J. Klenow, Ishan B. Nath
Policymakers often focus on short-run trade deficits and surpluses when constructing trade policy. However, the biggest benefit to trade comes from the flow of ideas and the innovations that occur when firms apply those new ideas.

When trade costs are low, creative destruction among firms increases, jobs are reallocated accordingly, and productivity increases. Analyzing trade patterns between the United States and Canada before and after the Canada-US Free Trade Agreement (CUSFTA) of 1988, the authors describe key facts about the flow of jobs across firms, and how these flows are affected by trade policy. These facts can be distilled to two key points:

  1. Large job flows. The average job creation and destruction rate in manufacturing over five-year periods (from 1973-2012) is about 30 percent in Canada. The average job creation rate in US manufacturing is also about 30 percent (1973-2012), and the average job destruction rate in the US is about 5 percentage points higher. The large rates of job creation and destruction suggest that an important part of economics is when firms innovate on products of other firms. Innovating firms then gain jobs, while the firms whose products are taken over lose jobs.
  2. Trade is a big driver of creative destruction. This is particularly evident in Canada, which has a much smaller economy than the US and, likewise, shifts in trade policy have larger aggregate impacts. For example, Table 1 shows job creation and destruction rates in Canada before and after CUSTA. Job losses increased from about 25 percent to 32 percent, but job gains from exports doubled from about 9 percent to 18 percent. In the US, the job destruction rate increased about 6 percentage points after CUSTA (Table 2), but the US was also impacted by increased imports from China during that period, so these results cannot be attributed primarily to CUSTA. Also, all of the US job destruction was driven by large firms. Finally, productivity improves as trade grows and innovations occur.

One important implication of this research is that policymakers should consider the role of innovation—and the flow of cross-border ideas—when conducting trade policy.