Thursday, 26 January 2017

The Process of Creative Destruction

Capitalism, Socialism and Democracy
Joseph A Shumpeter

In Capitalism, Socialism and Democracy, Joseph A Shumpeter uses the term “Creative Destruction” to refer to the endless cycle of product and process innovation through which new production units replace the outdated ones.

According to Shumpeter, the entrepreneurs have a disruptive effect on the economy—when they establish new production units they take the marketshare away from the businesses with outdated production units. A vibrant capitalist economy is characterized by new systems being created and the obsolete production arrangements being destroyed.

I think that Shumpeter selected a bad name for his concept. The oxymoron “Creative Destruction” creates a negative impression, even though it refers to a critical virtue of the free market system. The closure of obsolete businesses and the coming into existence of businesses with innovative systems is not destruction; it is rejuvenation—such creative destruction leads to economic growth and prosperity in the capitalist countries.

Perhaps Shumpeter could have used the term “Creative Rejuvenation.”

In Part I of Capitalism, Socialism and Democracy, Shumpeter explains in some detail how he originated the concept of Creative Destruction from his reading of Karl Marx. He was inspired by Karl Marx, even though he was inclined towards free market ideas. Shumpeter asserts that in dealing with capitalism we are dealing with an evolutionary market process which Karl Marx has dealt with in detail in his works.

Here's an excerpt from Capitalism, Socialism and Democracy in which Shumpeter explains the process of Creative Destruction (Chapter: "The Process of Creative Destruction”):
Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action; this fact is important and these changes (wars, revolutions and so on) often condition industrial change, but they are not its prime movers. Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries of monetary systems of which exactly the same thing holds true. 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.  
As we have seen in the preceding chapter, the contents of the laborer’s budget, say from 1760 to 1940, did not simply grow on unchanging lines but they underwent a process of qualitative change. Similarly, the history of the productive apparatus of a typical farm, from the beginnings of the rationalization of crop rotation, plowing and fattening to the mechanized thing of today—linking up with elevators and railroads—is a history of revolutions. So is the history of the productive apparatus of the iron and steel industry from the charcoal furnace to our own type of furnace, or the history of the apparatus of power production from the overshot water wheel to the modern power plant, or the history of transportation from the mailcoach to the airplane. The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation—if I may use that biological term—that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in.

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