Capitalism is Creative Destruction

Profit From Innovation

When a recession bites and companies and jobs start to disappear, there is often a demand for government intervention to counteract these effects. The Austrian Economist, Joseph Schumpeter, writing in the depths of Great Depression (1930s), disagreed. He insisted that recessions are how capitalism moves forward, weeding out the inefficient and making new growth, in a process originally described by Karl Marx as 'creative destruction'.

Schumpeter believed that entrepreneurs are at the heart of capitalist progress. Where Adam Smith saw profit arising from the earnings of capital, and Marx from the exploitation of labour, Schumpeter said that the profit comes from innovation – which does not derive from capital or labour.

The New Class - Entrepreneurs

Schumpeter saw the entrepreneurs as a new class of person, an 'upstart' outside the capital owning or working class, who innovates, creating new products and forms of production in uncertain conditions.

The entrepreneurs’ creative response to economic change makes him or her stand out from the owners of existing firms, who only make 'adaptive responses' to minor economic change. Forced to borrow to bring their innovations to market, entrepreneurs take risks and inevitably meet with resistance. They disturb the old system and open up new opportunities for profit. For Schumpeter, innovation creates new armlets far more effectively than Smith’s invisible hand or free market competition.

New products and new methods compete with the old... not on equal terms but at a decisive advantage that may mean death to the latter. - Joseph Schumpeter

Breaking Through

Schumpeter argued that, although a new market may grow after an innovation, others soon imitate and begin to eat into the profits of the original innovator. In time, the market begins to stagnate. Recessions are a vital way of moving forward again, clearing away the dead wood, even if the process is painful.

In recent years, business strategist such as US economist Clayton M Christensen have distinguished between 2 Types of Innovations.
i. Sustaining Innovations - Sustaining innovations maintain an ongoing system and are often technological improvements.
ii. Disruptive Innovations - Disruptive innovations upset the market and really get things moving, changing innovation. For example, although Apple did not invent the technology of the digital music player, it combined a high-design product (iPod) with a music download program (iTunes) to provide a new way of accessing music.

Conclusion

Marx believed that creative destruction gave capitalism huge energy, but also explosive crises would destroy it. Schumpeter on the other hand agreed but argued that it would destroy itself due to its success but not it’s failure.



He saw monopolies as the engine of innovation but said these were doomed to grow into over-large corporations, whose bureaucracy would eventually stifle the entrepreneurial spirit that had given them their life.