Joseph Schumpeter

Free markets are a lot like democracy, wonderful in theory, but often very messy in practice. Case in point: the U.S. economy is looking pretty messy right now, to say the least.

Before heading for the hills-or China-though, it’s important to remember two things: first, that things are not always as bad as they seem; and second, that downs, as well as ups, are as much a part of a free market as currency.

With regard to the state of the economy: for all thestrurm und drangplaguing Detroit, there’s also plenty of good news out there that might not be grabbing headlines, but bodes very well for the future.

Manufacturing exports, for example, are up, thanks in part to a favorable currency situation, in part to continued confidence in American quality and ingenuity. An increasing number of manufacturers are also either setting up shop in the United States or expanding existing production capacity, for these same two reasons.

Caterpillar Inc. (Peoria, IL), for example, recently announced it is going to invest $1 billion to expand production capacity in a number of Midwest plants that assemble mining and construction equipment. Similarly, Cessna Aircraft Co. (Wichita, KS) currently has a backlog of $14.5 billion on its orders books. In both instances, sales are robust thanks to demand in places like Eastern Europe and Asia.

Oh, and although it isn’t getting much mainstream media coverage, sales are actuallyupat Honda North America by nearly 5 percent. In fact, the company is running its U.S. plants as hard as it can to keep up with demand-amazing what happens when you run a smart company that builds the kinds of products people actually want!

With regard to those companies that are being hard hit by the current economic situation, it’s important to bear in mind that the real strength of a free market lies in it ability to continually reinvent itself in response to a changing world. In the words of that champion ofunternehmergeist, or the entrepreneurial spirit, Joseph Schumpeter, a free economy “incessantly revolutionizes from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact of capitalism.”

This point was recently reinforced in a study titled “Turmoil and Growth: Young Businesses, Economic Churning and Productivity Gains,” published by the Ewing Marion Kauffman Foundation (Kansas City, MO). The study reminds us that even in good times millions of jobs are lost as businesses contract or close, and that this is a good thing.

According to the report: “While the churning of businesses and jobs is the subject of much debate among policy makers and the cause of much anxiety among workers, new research indicates that this churning is important to the health of the economy.”

Specifically, the destruction of old businesses is necessary, not just to make room for new business, but to ensure long-term productivity. Turns out new businesses are key drivers not just in terms of the types of products being brought to market. They are also a major driver in terms of the efficiency with which they are manufactured.

Imagine what would happen if our economydidn’tallow inefficient companies to go down the tubes. Imagine what would happen if it didn’t compel companies like the Big Three automakers to radically restructure or face extinction. Granted, there is a lot of very real pain out there right now. But it is important to remember that this short-term pain is far better than the alternative-just look at the former Soviet Union.

In the words of the Kauffman report: “The reallocation of jobs, workers and capital to their best use is a major force behind productivity gains over time, and these gains are the main source of improved living standards…. The turmoil in our economy, it appears, also is one of its greatest strengths.”

Amen to that!