There is increasing empirical evidence that creative destruction, driven by experimentation
and the adoption of new products and processes when investment is sunk, is a core
mechanism of development. Obstacles to this process are likely to be obstacles to
the progress in standards of living. Generically, underdeveloped and politicized
institutions are a major impediment to a well-functioning creative destruction process,
and result in sluggish creation, technological sclerosis,' and spurious reallocation.
Those ills reflect the macroeconomic consequences of contracting failures in the
presence of sunk investments. Recurrent crises are another major obstacle to creative
destruction. The common inference that increased liquidations during crises result
in increased restructuring is unwarranted. Indications are, to the contrary, that
crises freeze the restructuring process and that this is associated with the tight
financial-market conditions that follow. This productivity cost of recessions adds
to the traditional costs of resource under-utilization.