Wednesday, January 18, 2012

Creative destruction

Lately the term “creative destruction” has gone viral. The concept received its classic formulation in the work of Joseph Alois Schumpeter (1883 –1950), who taught at Harvard University in his later years. in his 1942 book Capitalism, Socialism and Democracy, Schumpeter used the term to describe the disruptive 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 and laborers that enjoyed some degree of monopoly or oligopoly power derived from previous technological, organizational, regulatory, and economic paradigms. Schumpeter’s thinking can be traced back to his 1939 book Business Cycles. Here the Western world first learned about Nikolai Kondratieff and his long-wave concept with its cyclical patterns. Such cycles, Schumpeter believed, were caused by innovations.

Current examples include the decline of the Kodak firm, occasioned by the rise of the digital camera, and the insecure status of print newspapers, threatened by Internet sites such as the Huffington Post and the Daily Beast. Not so long ago, the cassette tape replaced the 8-track, only yield in turn to the compact disc, itself being undercut by MP3 players. These are technological manifestations of the process of creative destruction.

Sometimes the traditional form does not disappear, but becomes marginal. In this way legitimate theaters, once found in virtually every American city and town, were eclipsed by movie theaters, now threatened by Netflix. Still, we can expect to retain some theaters of both kinds for the foreseeable future.

To be sure, creative destruction can cause temporary economic distress. Layoffs of workers with obsolete skills can be one consequence of new innovations valued by consumers. While a continually innovating economy generates new opportunities for workers who can acquire the necessary skills to participate in the newer enterprises, creative destruction can cause severe hardship in the short term--and in the long term for those who cannot acquire the skills and work experience.

This downside must be frankly acknowledged. Yet some analysts have pointed out that in the long run society as a whole enjoys a rise in overall quality of life due to the accumulation of innovation. For example, 90% of Americans were farmers in 1790, while the number had declined to 2.6% in 1990. Over those 200 years farm jobs were destroyed by exponential productivity gains in agricultural technology and replaced by jobs in new industries. Today farmers and non-farmers alike enjoy much more prosperous lifestyles than their counterparts in 1790.

Schumpeter’s concept might be called the Kali Principle, after the Hindu goddess who presides over both destruction and creation. Significantly, Hinduism is imbued with a cyclical concept of history.

Schumpeter’s theory has been compared with Karl Marx's idea of the recurring crises of capitalism. Yet Marx thought that these crises were propelling the present economic system to its its doom, when it would be replaced by socialism. By contrast Schumpeter held that the situation was normal: superannuated things were constantly yielding to newer ones, thus assuring the continuity of the system. In this way the overall picture is homeostatic. Paradoxically, stability is achieved by instability.

Full disclosure requires me to state that Joseph Schumpeter is one of the modern economists I most admire.



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