Creative Destruction: A Brief Introduction

Creative destruction is the dynamic process inherent in a free market economy (or one that is largely so) of existing products (i.e., goods and services), production techniques, professions, companies and even entire industries becoming obsolete and dying out as a result of technological advances (including the development of new or improved products, more efficient production techniques and better distribution methods).

A free market economy is one in which decisions about production (i.e., what to produce, how to produce it and how much of it to produce) and prices are made by competing businesses that are primarily attempting to maximize their profits. This contrasts with a centrally planned economy, such as the former Soviet Union, in which such decisions are made mainly by a centralized government agency.

The definition of a new product or production technique can be quite broad. For example, a new production technique does not necessarily need to be some variation on the traditional model of paid workers making things in a centralized location at a factory, and it could be something as revolutionary as the creation of goods or services by many volunteers at dispersed locations connected by the Internet.

Moving production offshore could also be considered a type of creative destruction, at least if the negative externalities are not greater than the benefits. Externalities occur when an activity results in costs or benefits to individuals or groups other than the person or group engaging in the activity. Negative externalities from offshore production could include air and water pollution from transporting the products long distances via airplane or ship, pollution from lax environmental standards in the newly producing countries, and injuries to workers from minimal safety standards in those countries.

Creative destruction is fostered by advances in technology and the opportunities that entrepreneurs see to profit from such advances. It continues over time even if the entrepreneurs and others who make decisions about their businesses are not fully aware of it, which is often the case. That is, technological progress and the destruction of existing products, production techniques, professions, businesses and industries are inextricably intertwined; this relationship is as inevitable as the boom and bust cycles that are inherent in any industrial economy and as inevitable economic growth itself.

Monopolies and Resistance to Creative Destruction

In an industry (i.e., product category) that is characterized by vigorous competition (i.e., many buyers and sellers), it is relatively easy for a manufacturer to introduce a new or improved product that incorporates some innovation, such as enhanced performance, new features, or a lower cost of production (and hence lower price). However, it can be much more difficult to introduce such a product in an industry that is dominated by a monopoly, which is a company that is the sole (or nearly so) producer and/or supplier of some product or products.

This is because monopolists generally favor the (usually highly profitable) status quo and are usually able to quash any potential competition. Among the non-market techniques that monopolists traditionally use to prevent the emergence and growth of competitors are temporarily undercutting their prices to drive them out of business, starting lengthly legal proceedings that small competitors can rarely afford, collaborating with or threatening their existing or potential customers, influencing the political system to enact legislation that is unfavorable to them, and controlling product standards1.

Of course, many firms in a competitive industry likewise frequently tend to favor the status quo because they have major investments in existing products and production techniques. Monopolists are just in a far stronger position to protect their status quo.

Regardless of the degree of competition or lack thereof, efforts to preserve the status quo and hold back creative destruction will almost invariably eventually fail in a vigorous and growing economy. This is because the pressures that lead to creative destruction will continue to accumulate until the opposing interests are no longer able to restrain them. Interestingly, it is often those who most vociferously claim that they are advocates of a free market economy who are actually the most opposed to creative destruction2.

The analogy can be made to a dam that restrains the water from flowing downstream. The dam is successful until the water behind the it has accumulated to such an extent that the dam can no longer contain it, and the water then bursts out with great force. The larger the dam, the longer it can accumulate water but the greater will be the volume and fury of the rushing water when it finally breaks.

The only type of economy in which large monopolies, other than natural monopolies, might be able to keep their dominance for prolonged periods would be a stagnant economy. A natural monopoly is a company (usually a public utility such as supplier of electricity or water) that becomes the only producer or supplier of a product for a region because the average cost of production of the product is lower if one firm produces it rather than multiple firms. However, even natural monopolies can be vulnerable to technological advance.

In the heyday of each large industry, whether monopoly or not, it was almost inconceivable to the ordinary citizen that the world would ever be dramatically different, i.e., that any of the great industries could lose most of their wealth and power and become largely irrelevant, or even disappear entirely. Yet, history is replete with examples3 and, as difficult as it is to imagine the loss of power and wealth for some of the huge corporations that exist today, there is little reason to expect that their fate will be any different.

Benefits of Creative Destruction

Not only is creative destruction an inherent feature of capitalistic (i.e., relatively free market) societies, but it can also be an extremely beneficial feature, at least with regard to the economy as a whole. This is because allows resources to be transferred out of older, less efficient industries and into newer, more efficient industries which produce improved and/or less expensive products. It thus plays a key role in economic growth, which can, if well managed, lead to higher incomes and therefore higher standards of living.

Moreover, although creative destruction is largely a result of technological advance, it also helps to promote technological advance, which, in turn, further promotes economic growth. For example, the incentive for firms to innovate can be much stronger in an industry in which one or more other firms have introduced a disruptive technology than in a stagnant industry because the alternative becomes losing market share and profits to the innovating firms.

Of course, there are also costs to creative destruction. While they will often be small relative to the economy as a whole, such costs can be extremely large to those who have to bear them directly, such as the entrepreneurs whose businesses and savings are wiped out, the skilled craftsmen who lose their lifetime investment in their craft, and the ordinary workers who may be too old to find new jobs at comparable wages.

Examples of Creative Destruction

Creative destruction has long characterized the economies of the U.S. and other industrialized countries, and there are countless examples of entire manufacturing industries that have been greatly reduced in size or virtually wiped by it. Notable examples include candles, mechanical clocks and watches, phonographs and phonograph records, punched cards, teletype machines, steam locomotives, typewriters, vacuum tubes and whaling.

Among the many professions that have likewise disappeared, or nearly disappeared, in the more industrialized countries as a result of creative destruction are blacksmiths, bus conductors, elevator operators, firemen on locomotives, ice delivery men, keypunch operators, telephone operators, television repairmen, typists and typesetters.

Creative destruction can operate at different speeds in different countries and regions as a result of differences in cost structures, government policies, consumer tastes, etc. For example, coal mining has been almost entirely replaced by other sources of energy in the UK and Japan, whereas it is still a huge industry in the U.S. and China as a result of vast deposits which allow for low cost extraction. Likewise, whaling, once an efficient means of obtaining oil for lamps and other purposes, survives as a major industry in Japan because of a consumer demand for whale meat (and a government that promotes it). Bus conductors are still common in some countries in which labor costs are low relative to the cost of automatic fare collection equipment.

The computer field, despite its relative youth (little more than half a century), and in conjunction with its extremely rapid development, is littered with examples of creative destruction. They include components (e.g., vacuum tubes, magnetic core memories and discrete transistors), storage media (punched cards and five-inch floppy disks), entire hardware systems (mainframes and minicomputers), operating systems (Amiga, MS-DOS, Macintosh 9x) and application programs as well as occupations and entire companies. For example, the development of the personal computer destroyed most of the mainframe computer companies, including the once mighty Digital Equipment Corporation (and with the notable exception of the highly diversified IBM), replacing it with a much larger and more useful industry.

Many industries, products and professions that are now (or were recently) flourishing are likely candidates for demise by creative destruction in the coming years. They include conventional (i.e., non-digital) cameras and photographic film, cassette tapes, tube televisions and tube display monitors, facsimile machines, and some types of commercial computer software (particularly operating systems and general office productivity programs)4.

Creative destruction does not necessarily mean that all new things are always superior and that old things are necessarily inferior. And many victims of creative destruction do not disappear entirely, but instead they continue with a minor, and perhaps different, role. For example, candles are still produced, but in most of the world only as decorative items rather than as a main source of lighting. Likewise, blacksmiths still exist in the industrialized countries, but again mainly just to produce decorative items rather than to make basic household and industrial products.

Among the many examples of old product types, production techniques and situations that might be better than new things, at least in the opinion of some people, are historic buildings, streetcars (i.e., trams), hand-woven Oriental rugs, low pollution levels and crops grown without artificial chemicals (i.e., organic foods). In some cases, older industries, production techniques or product types can rebound, although rarely to their former levels, as is the case with streetcars, organic foods5 and Unix-like computer operating systems6. Such revivals are usually due to technological advances and/or shifts in consumer preferences or awareness.

Schumpeter and Creative Destruction

The term creative destruction was introduced into the economics mainstream by Joseph A. Schumpeter (1883-1950) in his 1942 book Capitalism, Socialism and Democracy. For Schumpeter, who is widely regarded as one of the greatest, but most underrated, economists of the twentieth century, the fundamental principle of capitalism was innovation and the introduction of new technology rather than the perfect competition upon which his colleagues generally focused their attention. He went so far as to state that "the process of creative destruction is the essential fact about capitalism." The main idea of this principle is that innovation (which is a type of creation) encourages economic growth and thus is central to capitalism's functioning. But innovation by one company also leads to destruction of the monopoly market shares of its complacent competitors.

The relative lack of attention that has been devoted to the concept of creative destruction by no means indicates that it is inconsistent with classical economic theory, which emphasizes price competition; rather, it is mainly just a matter of focus. That is, most economists have chosen to follow their peers and center their research and writings on the idealized state of perfect competition (including deviations from it) rather than to emphasize the changes that occur over time in a dynamic economy.

Creative destruction has likewise often been largely ignored in economics education at the university level in favor of emphasis on both the classical model of price competition and macroeconomics. Although understanding them is fundamental to comprehending how an economy works, they can only be a part of the overall picture; that is, something additional is necessary to explain the massive, and often turbulent, transformations that characterize industrial economies.

This situation has resulted in a lack of understanding by the general public and even many politicians and other policy makers of creative destruction and how it fits into the longer term picture of economic growth (even if they are familiar with the term itself). Thus, there is a tendency to think of each currently prospering industry or dominant company as something special that should be preserved rather than as just another example of a flash in the pan that has occurred over and over again throughout history.

False Creative Destruction

At the same time that it is important to be aware of existence of creative destruction and the potential benefits that it can provide, it is also important to be cognizant of situations that superficially appear to be creative destruction but which might not actually be. That is, there is often a strong incentive for businesses to claim that their activities are consistent with creative destruction when they are not (and which thus might more accurately be termed destructive destruction).

Such situations can occur as a result of the use of non-market means to destroy competition and as a result of costs that are not internalized, that is, not borne by the business that creates them but rather by others. For example, reducing its costs by dumping its waste into a river or by eliminating health and other benefits for its workers might help a company capture a large market share for its products and technology, but this would not be true creative destruction. It is certainly destructive (e.g., of competitors, their products and their technologies), but it is difficult to consider it creative if there is no net benefit to society.

The driving of small, independent stores out of business by large chain stores is often cited as an example of more efficient business techniques leading to creative destruction. However, this is not creative destruction if the ability of the large chain stores to sell products at a lower cost than their competitors is a result of not internalizing the full social costs of their cost-cutting actions. Such actions might include eliminating health benefits for their employees, selling products that are made in overseas factories with harsh working conditions and few environmental controls, and shipping products long distances thereby resulting in increased pollution and increased consumption of dwindling petroleum reserves.

Likewise, independent farmers being replaced by large agricultural corporations may appear to be creative destruction. However, it might not be the result of more efficient production techniques and it might not be beneficial for the economy and society as a whole when all of the social costs, externalities and government subsidies are taken into consideration.

One of the most notable examples of what was claimed would be creative destruction but turned out to be far from it is the nuclear power industry. From around the 1950s, its advocates asserted that nuclear power would be so cheap and clean that it would lead to the end of the traditional electric power industries that used fossil fuels and hydroelectric dams. This has not yet happened, and is not likely to, although such claims resulted in massive government subsidies for the nuclear power industry and, consequently, substantial profits for that industry7.

Implications for Public Policy

The very central role of creative destruction in economic growth and the often serious economic and social disruptions that it engenders strongly suggest that it should be taken into consideration when formulating public policy with regard to the economy and society. An enlightened (and minimally corrupted) government that is interested in advancing the economy and simultaneously promoting the quality of life for its constituents would at the very least take a neutral stance with regard to creative destruction while trying to minimize its adverse short term and societal effects (e.g., by retraining of displaced workers), rather than emphasizing the preservation of the status quo for vested interests at the expense of the economy.

Moreover, a strong case could be made for doing more than just taking a neutral stance. That is, it could be beneficial to take steps to actually facilitate, or even promote, creative destruction, again while implementing efficient policies to mitigate the negative effects. This is particularly true when taking into consideration the fact that many governments already often play a substantial role in promoting technological advance (e.g., through grants for research and for science education), a role for which there is usually widespread public support.

Some economists also suggest that as an additional, long-term measure to help influence public policy in a favorable direction, more should be taught about creative destruction (including the difference between true and false creative destruction) in educational institutions as part of the economics and social studies curricula. This would help the general public become more cognizant of the fact that such upheaval is a normal and necessary part of economic growth, rather than an unusual and truly destructive force (and one to be counteracted, as special interests promoting the status quo would want the public to believe).

1For a more complete list of tactics that monopolies use to restrain competition, see Monopoly Predatory Tactics: A Brief Introduction, The Linux Information Project, January 2005.

2This is particularly true of monopolists who, if they will admit that they actually have a monopoly, claim that it is the result of the free market.

3Undoubtedly one of the most notable examples of a dominant corporation that faded away is AT&T (American Telephone and Telegraph), the gigantic telecommunications monopoly that was long a fixture of everyday American life, perhaps more so than any other monopoly. The immediate cause of AT&T's demise, however, was due not so much to creative destruction as to the forced breakup by the U.S. government, perhaps more for political than economic reasons. AT&T was quite unusual for a monopoly in that it was highly innovative; in fact, its legendary research and development subsidiary, Bell Labs, was probably the most innovative organization the world has ever known. Yet, AT&T's demise can still be viewed as being consistent with the concept of creative destruction, particularly when seen in the context of the massive changes that subsequently took place in the telecommunications industry, including large reductions in rates and a speeding up of the introduction of new services (including the Internet).

4These industries or product types are being replaced as follows: conventional photography by digital photography, cassette tapes by compact disks and eventually by electronic memory chips (especially flash memory), tube televisions and displays by LCD (liquid crystal display) and possibly other, newer technologies, fax machines by e-mail, and some types of commercial computer software by free software (and perhaps also by web-based applications). All of these are the result of advances in electronics technology, including free software, which has become a viable replacement for commercial software as a result of the development of the Internet, which, in turn, has been made possible in large part by advances in electronics technology.

5Recent years have seen a surge in the construction of new streetcar systems in the U.S. after nearly all such systems were dismantled by the 1960s in favor of supposedly more flexible and more modern busses and automobiles. Although the term light rail is often used now, the technology is based on the older streetcar technology but with numerous advances (e.g., reduced power consumption, low floors for easy entrance and exit, and less audible noise). This resurgence of streetcars has been the result of these technological advances together with a greater awareness of the adverse environmental effects of the alternatives.

Likewise, organic crops, which is the way almost all crops were grown until a few decades ago, are now one of the most rapidly growing areas of U.S. agriculture. Although the product is essentially the same, there have likewise been technological advances that have been incorporated into the production of such crops (e.g., techniques for maintaining soil fertility and reducing damage from pests). This resurgence of organic crops has been the result of these advances together with a growing awareness of the potential health and environmental consequences of the heavy use of industrial chemicals in agriculture and foodstuffs.

6For many years it was widely assumed that Unix-like operating systems were becoming a victim of creative destruction. They were old, with the original UNIX having been invented in 1969 (which is ancient by computer standards), and they were rapidly being replaced the Microsoft Windows systems, which were cheaper and were easier for new users and for new system administrators because of their almost exclusive use of a GUI (graphical user interface) in place of command line (i.e., all-text mode) interfaces.

However, the situation has recently seen a dramatic reversal, with Unix-like systems (mainly in the form of Linux but also including Mac OS X) becoming the fastest growing of operating systems and, in the opinion of some computer experts, having the potential to become the dominant type of operating system in the future. This is a result of technological and other advances (most notably the open source development model) in combination with the inherently superior stability and security of Unix-like systems. These advances have made them far cheaper than the Microsoft Windows systems (i.e., essentially free), have given them highly intuitive GUIs, and are resulting in a faster pace of technological development than is being attained by commercial software.

7Its proponents claimed that nuclear power plants would be able to generate electricity so cheaply that it would not even be economical to meter usage by individual consumers, and thus this would spell the end for the traditional electric power industry that was based on fossil fuels and hydroelectric dams. They explained that all that was necessary was massive government subsidies to overcome the initial large development and construction costs. It turned out that this was very profitable for the construction and other companies involved, but that nuclear power was actually so expensive that, not only did it have to be metered, but that huge subsidies were required to keep the rates to users competitive with those from other sources. In addition to construction costs, large subsidies are also necessary for the safe dismantling of the plants, after their relatively short life expectancies of just a few decades, as that cost is comparable to, if not greater than, the cost of constructing them. Moreover, this does not take into consideration the still unknown costs of having to store the radioactive waste for thousands of years. It is not inconceivable that the nuclear industry was aware of the true costs from the beginning but instead chose to hide this knowledge in the interests of obtaining public support and, thus, profits. In the meantime, the efficiencies of the traditional power sources have continued to improve and progress has been made on harnessing so-called alternative energy sources such as wind, wave and solar power. Of course, this situation could change in the future, particularly if nuclear fusion power generation becomes practical, rather than the current fission technology, but most scientists believe that any such breakthroughs would be many years in the future.

Created January 30, 2006.
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