Building an Innovative Economy through Managed Creative Destruction: A Theory with Applications to South Korea

This paper presents a somewhat novel theory of innovation in the economy wide setting. The starting point for this theory is the creative destruction process at the firm and industry level. However, an extension to an economy wide setting requires the explicit theorization of the role of the state as well as an interacting nonlinear market process. The direction in which the theory leads is a complex interaction between state policies and market processes that influence the decisions taken by specific firms in particular areas of innovative activities. The key concept that is developed in this context can be called a Managed Creative Destruction(MCD) process. In a national (or regional) MCD, the creative destruction process characterizing innovation is structured more consciously by the state (or the states in a particular region). It can be argued that China is now going through this process. In this paper the particular case studied is South Korea's recent historical experience. Following Schumpeter we assume that innovation in specific firms can have economy-wide effects. Models based on this idea can be shown to have multiple equilibria. The idea of a positive feedback loop innovation system or POLIS is formalized by picking an appropriate sequence of equilibria over time. It is shown that POLIS has empirical relevance by applying the formal model to an actual economy. Recent financial crisis in many Asian countries, most notably South Korea, seems to have reversed the conventional wisdom regarding the East Asian “miracle”. This paper applies the concept of a POLIS to show that neither the current view that the miracle was a mirage nor the earlier contrarian view that the growth was a result of factor accumulation only is correct. Ultimately technological transformation — in particular the creation of a positive feedback loop innovation system is what makes the difference between sustained growth and gradual or sudden decline. Although various problems remain in both the real and the financial sectors, it will be premature to dismiss the impressive achievements and the future possibilities of the South Korean economy