Creative destruction

Creative destruction, introduced in 1942 by the economist Joseph Schumpeter, describes the process of transformation that accompanies radical innovation. In Schumpeter's vision of capitalism, innovative entry by entrepreneurs was the force that sustained long-term economic growth, even as it destroyed the value of established companies that enjoyed some degree of monopoly power.

Theory and examples

Companies that once revolutionized and dominated new industries – for example, Xerox in copiers or Polaroid in instant photography have seen their profits fall and their dominance vanish as rivals launched improved designs or cut manufacturing costs (lowering their own costs allows them to charge lower prices to customers, thereby drawing customers away from less efficient competitors who eventually close their doors or move into other products where they are able to find a cost advantage). Wal-Mart is a recent example of a company that has achieved a strong position in many markets, through its use of new inventory-management, marketing, and personnel-management techniques, using its resulting lower prices to eliminate the profitability of older or smaller companies. Just as older behemoths perceived to be juggernauts by their contemporaries (e.g., Montgomery Ward, Kmart, Sears) were eventually undone by nimbler and more innovative competitors, Wal-Mart faces the same threat. Just as the mini-cassette replaced the 8-track, only to be replaced in turn by the compact disc (which is now being undercut by MP3 players), the seemingly dominant Wal-Mart may well find itself an antiquated company of the past. This is the process of creative destruction.

In fact, successful innovation is normally a source of temporary market power, eroding the profits and position of old firms, yet ultimately succumbing to the pressure of new inventions commercialised by competing entrants. Creative destruction is a powerful economic concept because it can explain many of the dynamics of industrial change: the transition from a competitive to a monopolistic market, and back again. It has been the inspiration of endogenous growth theory and also of evolutionary economics.

Creative destruction can hurt. Layoffs of workers with obsolete working skills can be one price of new innovations valued by consumers. Though a continually innovating economy generates new opportunities for workers to participate in more creative and productive enterprises (provided they can acquire the necessary skills), creative destruction can cause severe hardship in the short term.

There are numerous types of innovation-generating creative destruction in an industry:

• New markets or products
• New equipment
• New sources of labor and raw materials
• New methods of organization or management
• New methods of inventory management
• New methods of transportation
• New methods of communication (e.g., the Internet)
• New methods of advertising and marketing
• New financial instruments
• New ways to lobby politicians or new legal strategies (though many economists would argue that this last is not a genuine example of creative destruction, so much as an example of using force of government to prevent more innovative or lower cost competitors from selling to one's customers)

History

The expression "creative destruction" was brought in to the economic discourse via Schumpeter's book, Capitalism, Socialism and Democracy, first published in 1942. The idea as such derives from the philosophy of Friedrich Nietzsche, but scholars today agree that Schumpeter, although he did read Nietzsche himself, took the concept and phrase from the work of fellow economist Werner Sombart.

Schumpeter's contributions are not generally included in most elementary economic textbooks, which focus instead on the theories of perfect competition and static supply and demand, models which Schumpeter claimed had little relevance to the real world.

In 1992, the idea of creative destruction was put into formal mathematical terms by Philippe Aghion and Peter Howitt in their paper "A Model of Growth through Creative Destruction," published in Econometrica.

In 1995, Harvard Business School authors Richard L. Nolan and David C. Croson released Creative Destruction: A Six-Stage Process for Transforming the Organization. The book advocated downsizing to free up slack resources, which could then be reinvested to create competitive advantage.

More recently, the idea of "creative destruction" was utilized by Max Page in his 1999 book, The Creative Destruction of Manhattan, 1900-1940. The book traces Manhattan's constant reinvention, often at the expense of preserving a concrete past. Describing this process as "creative destruction," Page describes the complex historical circumstances, economics, social conditions and personalities that have produced crucial changes in Manhattan's cityscape.

Alternative name

Per the following text, this process is also known as Schumpeter's Gale:

"The opening up of new markets and the organizational development from the craft shop and factory to such concerns as US Steel illustrate the process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one ... [The process] must be seen in its role in the perennial gale of creative destruction; it cannot be understood on the hypothesis that there is a perennial lull." (Quote from "The Process of Creative Destruction" by Joseph A. Schumpeter, 1942)

Antonyms

Destructive creativity is a mental process involving generation of ideas and behavior focused on harmful and destructive goals, such as committing crimes, extortion, organising criminal systems, harming business efficiency to feed socio-economic parasitism, implying that the sustainability of predation is threatened by improved efficiency. Psychology of system and software testing is also based on the knowledge of destructive creativity (try to break, try to falsify, be nasty) in order to understand and prevent possible destructive attacks by malicious software and other internet crime.

See also

• Disruptive technology

References

• Philippe Aghion and Peter Howitt. A Model of growth through Creative Destruction. Econometrica 60:2 (1992), pp. 323-51.
• Philippe Aghion and Peter Howitt. Endogenous Growth Theory. MIT Press. 1997.
• Clayton M. Christensen. "The Innovator's Dilemma". HarperBusiness. 2001.
• Richard Foster and Sarah Kaplan. "Creative Destruction: Why Companies that are Built to Last Underperform the Market - And how to Successfully Transform Them". Currency publisher. 2001.
• J. Stanley Metcalfe. Evolutionary Economics and Creative Destruction (Graz Schumpeter Lectures, 1). Routledge. 1998.
• Richard L. Nolan and David C. Croson, Creative Destruction: A Six-Stage Process for Transforming the Organization. Harvard Business School Press. 1995.
• Max Page. The Creative Destruction of Manhattan, 1900-1940. University of Chicago Press. 1999.
• Hugo Reinert and Erik S. Reinert. "Creative Destruction in Economics: Nietzsche, Sombart, Schumpeter." In J.G. Backhaus and W. Drechsler, eds. Friedrich Nietzsche: Economy, and Society. Springer. 2006.
• Joseph A. Schumpeter. The Process of Creative Destruction. Unwin. 1942.
• James M. Utterback. Mastering the Dynamics of Innovation. Harvard Business School Press. 1996.
• Roger D. Smith. "The Disruptive Potential of Game Technologies: Lessons Learned from its Impact on the Military Simulation Industry". Research Technology Management 50:Sept-Oct (2006), pp. 57-64.
• Thomas Homer-Dixon. Upside of Down: Catastrophe, Creativity, and the Renewal of Civilization. Island Press. 2006.