 Good afternoon. Welcome to An Idea and Insight, a one-on-one conversation with Professor Clay Christensen. I'm Zanni Minton-Bettos of The Economist. Professor Christensen is the Kim Clark Professor of Business Administration at Harvard Business School. And he is one of the world's foremost experts on growth and innovation. He's the author of nine books and more than 100 articles. And I believe it was your first book, The Innovator's Dilemma, which is widely regarded as one of the best business books of all time. Recently, you've turned your attention away from businesses, from organizations, to the bigger picture of the economy as a whole. And I believe it was November the 4th last year you published a provocative, compelling essay in The New York Times entitled The Capitalist Dilemma. This is the subject that we're going to talk about today, The Capitalist Dilemma. But before we get to what is the Capitalist Dilemma, talk me through what persuaded you to move your attention from organizations, from firms, to the big picture of the whole economy. Well, in my research about innovation, almost always, if you're wrestled with the paradox, two things are going on that just don't make sense to you. Almost always, you've got the categories wrong. And if you get the categories wrong, then they conflict and there's no answer. And so in The Innovator's Dilemma, the paradox is that it's not the way the categories innovation is incremental and radical. They always couldn't explain everything that was going on. And then when I realized that, no, we got the categories wrong and there's sustaining, disruptive, then all of a sudden, things fell into place. And so when you see in our economy, from a financial point of view, it looks like America's economy is just robustly emerging out of the recession. But they're not creating jobs. There's something wrong here. It just doesn't fit. And I realize that they've got the categories wrong. So that's what the fact that the overall economy wasn't doing so well while financial returns were doing well. That was the dilemma you looked at. That's right. That's the capitalist dilemma. Explain to me how you then developed an insight to explain what caused this. So always in developing a theory, you've got to get what are the categories. And it became very clear, very quickly, that innovation is the wrong category. Because there are a lot of different types of innovation. So studying this and figuring out what fits in what categories, we realized that there is one type of innovation that we call disruptive innovation or empowering innovations. And this is a class of innovations that transform complicated, expensive products into things that are so affordable and accessible that many more people now have access to it. And so in our past, Henry Ford's Model T was it enabled many more people now to own a car. The personal computer had the same impact. When it was a mainframe, only a few had it. The personal computer made allowed everybody to have one. And the reason why this was a salient category is that by making it affordable and accessible, lots more people could own it. Therefore, you had to hire people to make it and distribute it and sell it and service it and so on. And if the data were available, I bet that it would show that nearly 100% of all net jobs in America are created by this type of innovation. So that's one, disruptive or empowering innovations. The second set, we called sustaining innovations. And these were also very important for the economy. But by their very nature, they don't create new jobs. And the reason why is that when you sell the customer, sustaining innovations are innovations that make good products better. And when you sell them a better product, they don't buy the old product. So Toyota has a marvelous innovation we call a Prius. But every time they sell a Prius, they don't sell a Camry. So by their very nature, it's important for the economy, but it doesn't create jobs. And then the third type, we called efficiency innovations. And these also are very important innovations, but their purpose is to transform products that people already have access to and make them even more affordable. And as a consequence of trying to make those more efficient, they reduce employment in the economy. So you divided, and this was a brilliant, in some sense, brilliant simplicity of this approach, you divided the economy into these broad categories of innovation. And as I understand it, it used to be that they were more in balance, that we used to have empowering innovations and efficiency innovations and sustaining ones. But now we've shifted more to a world of efficiency innovations. That's right. So even though empowering or disruptive innovations are the ones that create jobs, over the last 20 years, there has been less and less investment in those kinds of innovations. And more and more innovation plowing into efficiency innovations. Now, the reason why that's salient is it's out of balance in terms of jobs, but it's also out of balance in terms of capital. Because capital is like the fuel that the economy needs to keep going. And if you invest in empowering innovations, they use capital because you have to generate more capacity. And when you invest in efficiency innovations, they create or emancipate capital. So for example, it used to take General Motors 60 days to make a car. And during the last 60 days, all of the investment was on the balance sheet supported by capital. Toyota figured out how to make a car in two days. And so they just didn't need that much capital. And efficiency innovations emancipates or frees up capital to be used. And when things were in balance, you use that capital to invest in disruptive or empowering innovations. And now over the last 20 years, you take this capital and pull it right back into efficiency innovations, take more capital, invest it in efficiency innovations. And so we're caught in investing in the things that reduce jobs rather than create growth. So the result is much less job growth. That's right. Now, this obviously begs the question, why did this change happen? Why in your view have we moved from a more balanced environment, where there are all three kinds of innovation to use your topology, to one now where there is this investment and reinvestment in efficiency innovation in this major problem? Well, I'm ashamed to say that the cause of the problem are the business school professors like me. And the reason is it's kind of like in almost everything in my research, we're doing the right thing in the wrong situation. So back in the 1930s, 40s, 50s, and 60s, when new finance was emerging, capital was scarce. And when anything is scarce and it's costly, you've got to be careful about how you use it and your husband its use and deploy it only where that investment will generate the maximum return for the use of that capital. And because it's so scarce, when you put it in, you want to get it out as fast as you can and you want to take more out than you put in. And when capital is scarce, you have to be careful, almost lovingly put your capital in because it's so scarce. If something is abundant and cheap like sand, you don't deal with it in that way. And so at the time that finance emerged, capital was scarce. And therefore, they developed measures of return on capital that caused you to gently deploy that. And one measure is return on net assets. And that was a measure that helped you understand whether or not you're deploying it in the right way. Internal rate of return caused you to invest only in things that paid off quickly. Now, what's happened over the last 20 years is as people who we taught how to measure investments by these measures looked at empowering innovations, they say, man, that takes five to eight years to pay off. And it uses capital. It doesn't generate capital. And so by the very metric by which we taught people to measure things, it caused them not to invest in the very innovations that create growth. And instead, they look at efficiency innovations and said, holy cow guys, if we just put our money in efficiency innovations, it pays off in one year or two. We get a lot more capital out than we put into it. And by following the very measures that we taught, in this situation, it causes this problem. That's an extremely interesting perspective. The idea that it emanates from the way you think about the world, the way you're taught at business school to think about the world. Let me just suggest or let's explore whether there are alternatives or perhaps additional explanations. And one might be that the world is more uncertain, that there is a growing sense of uncertainty over longer term horizons. Is that a plausible explanation too? Well, let me say two things about that. The first one is that actually the economy is awash in capital. It is awash in capital. If you talk to somebody who are the leaders of private equity funds, they just bemoan the fact that there is so much capital going after so few deals, even while entrepreneurs can't raise capital. And it's like cold riches, the rhyme of the ancient mariner, there is water, water everywhere and not a drop to drink. But not water for some of the people who need it. That's right. That's exactly the problem. So that's what we taught our students to do was the right answer in the right situation and now we're in the wrong situation. And measuring profitability that way causes us to invest in things that don't create growth. Well, from this fascinating paradigm, what then are the conclusions, the solutions that come out of that? Well, let me back up just quickly to look at Japan. Because if you want to look into the Christmas of America's future, look at Japan. Because through the 1950s, 60s, and 70s, they invested powerfully in empowering innovations. So Toyota made the car so cheap that graduate students can have a car. And Toyota or Honda made motorcycles so cheap that grandmas could have one. And Sony made radios so cheap that teenagers could have this. And you could just go over and over again. Billions of people around the world were enabled to have these things because the Japanese made them affordable and accessible. And during that era, Japan's economy grew like nothing had ever happened before. And now, through the 1980s, they started to measure profitability in the way that I've described. And from 1990 to the present, Japan's economy has been absolutely dead. There has been no growth. They are awash in capital. The cost of capital is essentially zero, and they can't get going. And rather than this being a cycle in Japan, it's a straight line. There was a beginning, and there's an end. And that's what America is facing if we don't get serious about the answers. But what then are the answers? What does one need to do to address this problem, which has come in your view from applying role models? Yeah. Well, so the answer is, who knows? This is a very complicated problem. And I'm just playing old clay, so I don't know. But there are a few proposals, I think. The first one is, in America, the rate of tax on capital is taxed at the personal rate until you hold it for 366 days. And there's something about 366 that also now it's taxed at 15% as a long-term capital gain. And that needs to be graded downwards so that if you keep the money in the company at work for five years, the tax rate is zero. So you use the tax code to give an incentive to make these longer-term investments. That's right. There is a lot of capital, and they're looking for short-term wins. And we just need to repurpose that as long-term capital. And I think that this tax code can help do that. But to the extent that this is the function of a way of looking at the world in your view that comes from business school models and comes from the way we think about finance, then doesn't part of the solution have to be in that direction, too? Yeah, that's right. So the professors themselves need to teach our students that everything that we teach has to be circumstance contingent. In other words, I'm going to tell you that this is how you do things. But before you use it, you've got to ask yourself, am I in this situation or that situation? So right now, we're in a world where the cost of capital is nearly zero, and it is everywhere. And so when we teach our students that when they go off and they have a project and we teach them historically that they should calculate the net present value of a future stream of growth, if the cost of capital was 10%, 15%, 20%, then you use that to discount it to the present. What happens, though, if the cost of capital is zero? It means an investment that will yield return in five years is just the same as an investment that yields return next week. And so you just have to calculate things totally differently. If the cost of capital is zero, how do you maximize the return on your investment if, in fact, the net present value is zero? It is a totally different set of mindsets that the professors need to cultivate. And as you said earlier, for some people, cost of capital is not zero. But let's pause until it is. Do you think this is a permanent paradigm shift, or is this just a temporary, perhaps rather long, temporary period in the aftermath of a very big asset bust? Yeah, that's a great question. And the answer, by definition, is it's only temporary. And so we need to teach our students always to say, are we in this situation or that situation? But we're now in this situation. And so now is the kind of situation where investments on our people actually might be a better way to measure the robustness of our enterprise. If we invest in our people, and what kind of return in the people do we get as a result, is probably a lot more salient than the return on investment of capital. So firms should be measuring the investment, return on the investment in their people. That's right. In the situation that we're in, the skills that we need and the questions we need to ask to develop tomorrow's innovations, we need to invest in those things, because that's what scares. And we've got to be sure that every time we invest in them that we use that investment to help the company grow. And I think that at least for now, that's a better way to frame what we need to do. You mentioned that solutions are very difficult. One of the things that you've become known for is helping firms, helping to think about how to actually innovate and how to deal with disruptive change. Put yourself, let's try and do this for the business schools and then for the government, because these are now your deposit that they are two new clients. How do you affect change? Let's start with the business schools. What can you actually do to get this change that you're looking for? Well, the Harvard Business School long has wanted to influence the world by teaching students one at a time to be better people. And I think that we've had some impact on helping individual people be better people. But when you're facing a big problem and you want a whole group of people to agree on what needs to happen, we need to take, we need a different business model. And let me tell you an extraordinary experience I had with Andy Grove at Intel and then talk about the business school and our economy. So Andy Grove when he was the chairman of Intel became aware of this theory of disruption, called me up and said, what do we do about this thing? Because when you had that on its lenses, there were two companies at the bottom of the market, Cyrix and AMD that were just killing Intel just like this Toyota did it to General Motors. And so we talked about it. I was interested then that Andy Grove did not stand up in front of the company and announce, ladies and gentlemen, we're gonna go to the bottom of the market and launch what they called the Celeron processor because that was so counter to the profit logic of the employees. So he set up a seminar and he convened it 20 times over the course of the year. It lasted a whole day. And it was, they brought in 100 people at a time. And I ran that for a while and then I turned it over to Andy and his staff. We spent a whole day focusing on what does this theory imply for what could kill us and how could we kill other companies? And I was talking to Andy a couple of years ago about what the result of that was which today Intel ships maybe $20 billion of products that emerged from these seminars. And Grove said, you know, Clay, your theories don't give us any answers, but it gave us a common language and a common way to frame the problem so that we could reach consensus around a counterintuitive course of action. And I thought that's just brilliant because when we have a problem collectively and we sit around a table and the question we pose is, what do we do? We just talk past each other. But instead, if we ask the question, what's the problem? If you get consensus around, you have a common language and a common way to frame the problem, then we too can reach consensus around what otherwise would be a counterintuitive course of action. That's a very interesting idea. And I have no doubt difficulty in imagining that happening in Harvard Business School. I'm now gonna try and transport this to Washington because you are talking about the overall economy and actually by extension in other rich economies too because your perspective could be applied broadly, more broadly than the US. You mentioned to me earlier that this article you wrote in the New York Times where you first coined the idea of the capitalist dilemma was one of, had engendered more interest in the short term than many- Than anything I've written. So what happens? How do you get this kind of a conversation going in an incredibly polarized environment? Boy, it is horrible. I bet if I was a good historian, I bet we would realize that the Republicans and the Democrats have never been able to agree on anything. This is not a new phenomenon. But up until the mid 1980s, there was a group of people in America that we called Southern Democrats. And they had a business card that allowed them to go to the Democrats' meetings. But when they voted, they voted Republican. And that meant that anybody who wanted to get anything done in Washington had to convene in the office of one of the Southern Democrats. And that's how agreement occurred. Well, then Ronald Reagan was so popular and successful. Through the mid and late 1980s, we just lost the Southern Democrats. They either converted to the Republican Party or they retired. And the people who were elected to take their place were Republicans. And all of a sudden, there wasn't anything in the middle or a geographical place where one side or the other could convene to get anything done. And so it's become very polarized. And what I hope, who knows whether I could ever realize this dream, is I think there's a different way to pull them together. And that's not a deal in the office of a Southern Democrat, but rather around a foundation of a common language and a common way to frame the problem. And if we can invite people to just take the time to spend a day with us and let us describe why this is happening and what actions will yield what results and how that changes by the situation that we're in, these are smart people. But because they don't have a common language and a common way to frame the problem, there's not a foundation in which they can intellectually reach a conclusion. And that's what I hope my research will do. That's a wonderful goal. In the two months, I guess, since this was brought to the world's attention, do you have a sense of that being at all possible? Have you had interest from both sides of the political aisle? Could you imagine this happening? Even on both sides, truly, the interest is significant. And from the alumni of the Harvard Business School, these are people who want to change the world, you know? And we just need to bring them to HBS and help them to equip them with this way of thinking about the problem. And there are a lot of people can go out and change the world. And I hope that mine is just a little part of it. What would, to conclude, where if you were to bring them together, presumably you'd have to have a little seminar first to convince your HBS colleagues to also view the world this way. And you'd have everybody around the table. What's your sense of what could happen? What's the power of this idea looking forward? Well, I don't know whether they'll let me call it this or not, but what I'd like to convene then is I'll call it the Congress in exile. The people in Washington are like POWs. They can't get anything done, right? But let's convene a hundred people who aren't part of them, but who listen, who those people listen to and bring them to HBS or to places around the country and teach them how to think their way through this problem. And then have somebody like you publish the result. There's some smart people who are thinking about this thing and it's clear why and what. And in the conversations you've had so far with people, has there been agreement on your analysis of the problem, presumably disagreement on the solutions, but is there a broad, have people brought into the very bold topology that you have of what the problem is? You know, I'm shocked actually that nobody has argued with me about this fundamental way of framing things. And that's just because maybe they haven't thought deeply about it, but I also think that when you have a complicated problem again, if you have the categories wrong, then the solution is gonna be complicated. And I actually really believe that when you get the categories right, complicated things become simple. And when you frame it in a simple way, then simple answers are possible. And when you don't have that, then you get Obamacare or just, there's a lot of good stuff in that, you know, but it is so complicated because they never thought to simplify the problem first. I think we can see from this conversation why you have the reputation that you do as one of the most innovative thinkers about innovation and growth. I'm very glad, very happy for the U.S. that you have turned your sights from the organization to the economy as a whole. Professor Christensen, thank you very much for joining us. Great questions, thanks for letting me do that.