Creative destruction - Economics Help (2023)

Definition of creative destructionThis refers to the process of how capitalism leads to a constantly changing structure of the economy. Old industries and firms, which are no longer profitable, close down enabling the resources (capital and labour) to move into more productive processes.

Creative destruction means that the company closures and job losses are good for the long-term well-being of the economy.

It can be seen from both a negative and positive perspective.

Creative destruction and Marxism

Karl Marx wrote at length about the nature of capitalism causing large-scale loss, which enabled new wealth to be created. Marx saw wars and economic crisis as methods for destroying production and enabling capitalism to start a new round of wealth creation for the owners. Although Marx saw how Capitalism could reinvent itself, he also felt it’s inherent tendency to self-destruction would eventually lead to its end.

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“In these crises, a great part not only of existing production, but also of previously created productive forces, are periodically destroyed.”

– Karl Marx, Communist Manifesto

Creative destruction and Schumpeter

Joseph Schumpeter popularised the concept of creative destruction in ‘Capitalism, Socialism and Democracy‘ (1942). He used the phrase ‘gale of Creative Destruction’ and the concept is sometimes known as Schumpeter’s Gale. He derived his ideas from a close reading of Marx. However, whilst Marx believed capitalists crisis and destruction would lead to its demise, Schumpeter saw creative destruction as a necessary and natural way to enable new markets and new growth.

“Capitalism […] is by nature a form or method of economic change and not only never is but never can be stationary. […] The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.”

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– Joseph Schumpeter, ‘Capitalism, Socialism and Democracy‘ (1942)

Creative destruction and laissez-faire economics.

Ironically, for a concept derived from Marxist thought, free-market economists have seen creative destruction as a necessary and inevitable process of economic development and generally oppose government attempts to hold back this process of decline and renewal. Some economists even go so far as to argue that if banks fail, the government should not intervene as it is better to allow bad banks to fail and avoid the government artificially propping up the financial system.

Free market justification for creative destruction

  • If a firm becomes unprofitable, then it should close down so that resources, (labour and capital) can move into more productive and profitable firms and industries. Without this willingness to change, we might have got stuck with Nineteenth Century living standards.
  • The threat of going out of business is an incentive for firms to move with the changing market and keep costs low. For example, in an electronic age, newspapers are needing to re-invent themselves with an online presence.
  • Although short-term job losses are bad for those involved, people often forget the less visible new jobs created during the economic change. In the long-term, periods of labour market change have enabled rising real wages.
  • In 1920, over 1 million worked in British coal industry, now there are just a few thousand. This shift in labour has enabled the growth of new industries and firms in the service sector, enabling better standards of living.

Examples of creative destruction

Creative destruction - Economics Help (1)

Powered looms. The invention of the steam-powered loom reduced the cost of making clothes. This put the traditional cottage industries out of business. But, it helped a new industry of manufactured cotton and clothes which created new kinds of jobs. (This particular invention led to the Luddites, who saw the new power looms as destroying their livelihoods)

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The large mills which once dominated the towns of northern England have now closed down due to cheaper imports from Asia. As the mills have closed down, the local economy has been more geared towards the service sector and less towards manufacturing.

Music

The music industry has seen numerous technological changes which have led to the rise and fall of several companies.

  • In the early 1980s, the cassette started to overtake vinyl, harming firms which relied on the manufacturer of vinyl. But the early 1990s, the compact disc had started to replace the cassette. For a short period, the compact disc was very profitable for record labels and manufacturers, such as Phillips and Sony.
  • However, from the early 2000s, electronic downloads wiped out the profitability of compact disc manufacturer and sale, creating a very different music industry, dominated by digital downloads and new companies like Napster and Apple taking the place of other more traditional music companies.

The problems of creative destruction

Free-market economics makes a case for allowing any unprofitable firm to go out of business whatever the consequences. However, some argue that the process of creative destruction can lead to long-term damage and needs to be more carefully managed.

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  • Structural unemployment. When some industries close down, there is no guarantee the unemployed workers will be sufficiently skilled to shift employment prospects. At the very least, there may be a need for government intervention to give better skills to the long-term unemployed.
  • The firm industry may provide external benefits which impact on social efficiency. For example, in the 1960s, the Beeching report advocated closure of many UK railways because the car was more efficient. It was a classic example of creative destruction – close railways and invest in roads. However, 40 years later many rail closures are regretted because railways can help reduce road congestion, pollution, plus no-body predicted the increase in rail demand of the past 20 years.
  • Regional unemployment. In a shifting economy, regional immobilities can make the ‘destruction phrase’ last for a long time. A large-scale closure and the loss of many jobs can be difficult for an area to deal with. New jobs may be created in the economy, but not in the area of high unemployment. This can lead to a prolonged period of low growth and high regional unemployment.
  • Winner and losers. In the process of creative destruction, some will benefit a lot, but others may lose out, e.g. long-term unemployed struggling to shift occupation. It is not a Pareto improvement.
  • Closure can lead to inefficiency itself. If a firm with experience and investment in human and labour capital closes down, then it can take a long time for these resources to be efficiently redistributed. For example, the theory of hysteresis, suggests short-term unemployment can lead to a higher natural rate.
  • Unprofitability doesn’t mean the firm always should close down. Market forces may lead to many firms closing down because of lack of profitability. However, this closure may not be an efficient outcome. A firm may become unprofitable from short-term factors, such as
    • High tariffs hitting exports
    • Short-term recession hits output
    • Short-term labour market problems, such as strikes
    • A temporary glut in supply from overseas.
    • See bailout of US car industry

In these cases, the lack of profitability is not a sign the firm is terminally inefficient. In these cases, there may be a strong case for temporary government help to enable the firm to come through the short-term difficulties. It may also be possible for a firm to restructure and diversify – this can be less damaging than wholesale closure.

Similarity with Luddite fallacy

The Luddites protested against the introduction of new machines which took the jobs of skilled artisans. However, although jobs were lost in hand-spinning – new jobs were created in other areas of the economy.

Related

(Video) The Power of Creative Destruction: Economic Upheaval and the Wealth of Nations | LSE Online Event

  • Laissez-faire economics
  • Solutions for declining industries
  • The Luddite fallacy

FAQs

Is creative destruction good for the economy? ›

On the positive side, innovation from creative destruction can be a source of economic expansion resulting in a significant number of new jobs and technologies derived from new industries and even sub-industries. Progress of this nature has the ability to transform entire economies and improve standards of living.

How does creative destruction lead to economic development? ›

Creative destruction is often seen as the primary engine of growth in the modern economy. Upstart businesses generate profits and jobs, the theory suggests, by introducing new goods that displace existing products or by devising innovative ways to improve on the products of competing firms.

What is an example of creative destruction in economics? ›

Examples of creative destruction in history include Henry Ford's assembly line and how it revolutionized the automobile manufacturing industry. However, it also displaced older markets and forced many laborers out of work.

Who benefits from creative destruction? ›

Creative destruction saves time and money. These two elements effectively make workers more productive, increase their wealth, and improve their standard of living. Although critics mostly focus on creative destruction's losers, it is essential to examine the direct and indirect winners of this economic process.

How does creative destruction affect the unemployment rate? ›

The counteracting effect is a “creative destruction” effect whereby more growth implies a higher rate of job destruction which in turn tends to increase the equilibrium level of unemployment.

What are the cons of creative destruction? ›

The problems of creative destruction
  • Structural unemployment. ...
  • The firm industry may provide external benefits which impact on social efficiency. ...
  • Regional unemployment. ...
  • Winner and losers. ...
  • Closure can lead to inefficiency itself. ...
  • Unprofitability doesn't mean the firm always should close down.
Jan 21, 2018

Who benefits the most from globalization? ›

Developed industrialized countries continue to benefit most from globalisation because increasing globalization generates the largest GDP per capita gains for them in absolute terms.

What do you understand by the theory of creative destruction? ›

He is perhaps most known for coining the phrase “creative destruction," which describes the process that sees new innovations replacing existing ones that are rendered obsolete over time.

Why is the phenomenon of innovation so important for economists? ›

One of the major benefits of innovation is its contribution to economic growth. Simply put, innovation can lead to higher productivity, meaning that the same input generates a greater output. As productivity rises, more goods and services are produced – in other words, the economy grows.

Why is creative destruction shutting down? ›

The decision to shut down the games is likely based on their dwindling player bases and profits from in-game purchases. I've added the date to the Watch List calendar and will have pages up on the site later.

Why is creative destruction Bad? ›

While creative destruction is good for the economy in many ways, it can also be bad for the economy because it creates winners and losers over time. As old industries are destroyed, people who rely on those industries and who fail to adapt lose out while those who capitalize on new industries reap the rewards.

What best explains the theory of creative destruction quizlet? ›

What best explains the theory of creative​ destruction? Firms will try to come up with new products and more efficient ways to produce products to earn monopoly profits.

What are some examples of creative destruction? ›

Creative Destruction Examples

Traditional watches increasingly becoming replaced by smartwatches; Tablets and kindles replacing conventional printed books; Music streaming services (spotify, apple…) replacing digital shopping of music songs or albums; Video streaming services replacing DVDs.

Which of the following is an example of creative destruction? ›

Which of the following is an example of creative destruction? Automobile production causes the wagon industry to shut down.

What does creative destruction mean in economics? ›

Creative destruction refers to the incessant product and process innovation mechanism by which new production units replace outdated ones. It was coined by Joseph Schumpeter (1942), who considered it 'the essential fact about capitalism'.

Why is creative destruction shutting down? ›

The decision to shut down the games is likely based on their dwindling player bases and profits from in-game purchases. I've added the date to the Watch List calendar and will have pages up on the site later.

Is creative destruction good game? ›

Make no mistake, Creative Destruction is a blatant rip-off ... sorry, "homage" ... to the hit battle royale game. What's most surprising, though, is that this particular clone is actually pretty good. In fact, if you squint hard enough, you might even mistake one game for the other.

What does the American Rose industry reveal about creative destruction? ›

that creative destruction can cause an economic recession. What does the American rose industry reveal about creative destruction? that even trade can cause creative destruction. that creative destruction cannot be applied to all products.

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