Understanding Creative Destruction: Definition, Examples, And Impacts

Definition of Creative Destruction

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Creative destruction refers to the ongoing process of innovation where new things and new systems replace existing things and the existing systems (Archibugi, Filipptti & Frenz, 2013). This means it refers to the mechanism of continual process and product innovation by which the old and outdated production units are replaced by the new ones. It permeates the major feature of the structural adjustments, macro-economic performances, and the functioning of the markets. With the passage of time, the process of constructive destruction illuminate for over 50% of the total productivity growth (Martin & Scarpetta, 2012). The obstacles in this process may have a strong both short and long run macro-economic outcomes.

Joseph Schumpeter first coined the term ‘Creative Destruction’ in the year 1942 (Sledzik, 2013). He has developed this concept of creative destruction from Karl Marx. He considered it as an essential fact about the capitalism. Schumpeterian creative destruction pervades the major face of the macroeconomic performance (Mitchell, 2013). Joseph Schumpeter has used this term for describing the particular form of the economic growth, which the entrepreneurs especially bring towards the capitalist structure. He further argued that creative destruction was the introduction of entrepreneur of fundamental innovation in the capitalist structure, which was real power that has sustained the continuing growth in economy; even it has ruined the economic significance of the established enterprises that may have relished a level of monopolistic authority earlier.  He has described the creative destruction as a process of total economic growth into the capitalist structure, where the entrepreneur creates economic value through their radical innovations more than it is destroyed when their innovations replace the already established process of doing the things. However, the primary aspect of the belief of Schumpeter was “The essential point to grasp is that in dealing with capitalism, we are dealing with an evolutionary process”.  

According to this theory, the term leads to eventual failure of the capitalism as economic system. The current business uses the term in order to refer it to the unappealing choices, which is considered important for the sustainability. With the same, the corporate executives uses the term ‘creative destruction’ in order to describe the unpopular measures of cost-cutting like outsourcing and downsizing as the creative destruction. It could be used in various different areas including product development, corporate governance, economic, marketing and technology (Mazzucato, 2013). For example, in the field of product development, creative destruction refers to disruptive technology. Smartphone is one of the frequently cited examples that have killed earlier market for not only the day-to-day cell phones but also the MP3 players, PDAs, calculators, wristwatches, voice recorders and cameras as well. On the other hand, in the field of marketing, the ad campaign is one of the examples of creative destruction. Ad campaigns targets the new and lucrative markets by risking the alienation of the existing one.

Origin of the Term ‘Creative Destruction’

Creative destruction not only permeates the long-run development but also the structural modification, operation of factor markets and the economic fluctuations (Ogun, 2014). At the microeconomic level, creative destruction is typified by several decisions in order to create as well as destroy the arrangements of productions. The decisions are very complex and they involve several parties and that too with technological and strategic considerations. Effectiveness of these decisions is not only dependent on the managerial talents but also depends on the presence of the sound institutions, which provides appropriate framework of transactions. The failure among the dimensions could have severe impact on the micro-economic level, once it communicates with the restructuring process. Some of these constraints are natural since they are derived from the utter complication of such transactions. The rest others are human made and their origins are ranged from the eccentric economic ideas for achieving higher human objectives like the inviolability of the human capital. Such institutional limitation gives rise to the business cycle models for example, those that are observed in most flexible and developed economies. In addition to that, they also help in explaining the recurrent macroeconomic challenges like cyclical behavior of the unemployment, wages and investment. At times, by restricting the potential of the economy in order to tap over latest technological openings and reconstruct itself to a shifting environment, failure in institution may result in the impaired factor markets, financial inactivity, subjection to profound crises and resource misallocation.

The factors of reallocation, particularly the job flows, is the most commonly chosen empirical substitutes for intensity of the creative destruction process (Brown, Lambert & Florax, 2013). According to Bogliacino, Lucchese and Pianta (2013), job creation or destruction is the positive or negative total employment change for the institution level from period one to another. They concluded further that over ten percent of the total jobs, which subsist at any point of time did not survive one year prior or would not survive one year later. This means, more than ten percent of the existing jobs destroy every year and with the same, same amount of job is created side by side (Rotman, 2013). Most of the authors have established more or less likely equivalent measures of the job flows for various episodes and countries. However, there is much significant dissimilarity among them but they do possess some common differences as well. Hence, in sum, it can be said that both the job creation as well as job destruction flows are ongoing, large and determined (Haltiwanger, 2012). In addition, most of the job flow takes place within instead of between the narrowly defined economical sectors. Furthermore, Hallward-Driemeier and Rijkers (2013) have stated that reallocation (the industry-level productivity in between the plant) is most intimately linked to the component of creative destruction. It accounts for more than 50 percent of the total efficiency growth of ten years (1977 to 1987) in the United State manufacturing sector. With the same, it was also concluded that the existing plants have comparatively lesser productivity than the continuing plants. In contrast to this, the new plants experience a selection and learning period through which they moderately reach with the incumbents. However, there are some other studies conducted on a bit different methodologies, which have coincide with the closure that, the reapportionment accounts for primary element of within the industry output growth.

Impact of Creative Destruction on Macro-economic Performance

Recent evidences on cyclical features of the creative destruction have found out that rise in job destruction or sharp liquidation constitutes the most eminent affects of contractions on the creative destructions. On the other hand, the job destruction is comparatively less volatile as well as pro-cyclical (Gallipoli & Pelloni, 2013). For every practical purpose, some or the product or innovation of process is taking place at each instant in time. Continuous innovation and absence of obstacles to adjustments would necessitate infinite restructuring rates. However, there are few economists, who have objected to the hypothesis of- Regulation of labor market obstructs the course of the creative destruction and that its pragmatic support is very limited. Furthermore, it is an old concept that the well functioning of markets and financial institutions are very important factors after the economic growth. In modern days, it is considered that the creative destruction process is likely to play a chief role behind this link.

International competition is one of the important sources of creative destruction. Brandt, Van Biesebroeck and Zhang (2012) has concluded that there are notable reallocation and productivity effects from the trade openness. He finds that, in industries, which have experienced deepest reduction in Canadian tariff, shrinkage of less productivity plants have reduced the employment by twelve percent by raising the labor productivity n the industry level by fifteen percent. He further finds that this increase is partially linked with the exit or the contraction of less productivity plants. Lastly, the industries, which have experienced the biggest reductions in US tariff, the labor productivity at the plant level have soared by fourteen percent. The conjugal deregulation of the goods markets may have same effects, such as Dogramaci and Fare (2012), have found that deregulation in the United State’s industry of telecommunications has increased the productivity mostly through the factor of reallocation towards more productive plants instead of productivity gains through intra-plants. The consequences of the creative destruction often referred to as the Schumpeter’s gale.

In today’s world, creative destruction is a throwaway term that is mostly used by the economists in order to describe the free messy way of the markets to deliver progress. In one of the most famous book of Schumpeter namely the Capitalism, Socialism, and Democracy (1942), he has stated that, “This process of Creative Destruction is the essential fact about capitalism” (Schubert, 2013). He in fact, has eexplaind it as- “The perennial gale of creative destruction.” He observed that the creative destruction has provided a strong force in order to make the societies more wealthy as it has made the sparse resources far more productive because they proceed from the slightest to the more effective industries.

Examples of Creative Destruction

With the same, transportation too provides an ongoing and dramatic instance of the creative destruction at the work (Haltiwanger, 2012). Amid the emergence of the steam power in the 19^th century, the railroads have flounced across United States by enlarging the markets, building new industries, reducing the shipping costs and serving thousands of new and productive jobs. The automobiles’ ripples surge into tourism, oil, retailing, entertainment and other industries. Internal ignition engine has covered the means for the automobiles prior in the upcoming century. Similarly, the Americans assisted as the horses and the mules have opened ways for the airplanes and the cars but these innovations too did not entered into the world without destructions. Each of the new modes of transportations has taken a count on the existing industries. Along with that, the emergence of internet has spawned a high need for thousands of web masters, which is an occupation that did not even exist earlier. Similarly, the famous LASIK surgery lets the consumers throw away the glasses and reduces the visit of the opticians and the optometrists but it, on the other hand has increased the need for the ophthalmologists (Anghart, 2012).

One of the latest examples of creative destruction is the manner in which the iPod has destroyed the market of CDs, as it made the experience of listening music far more convenient for the people. The emergence of iPods have completely spurred and destroyed the economic value of the CDs by creating its own economic value (Ng, 2014). However, overall, the societies and the consumers feel better off in the process of satisfying more of their demands by making use of lesser resources. Another best example of creating destruction, which is slowly taking place in front of us, is the emergence of online news. Online news now a day is so in trend that it is slowly declining the use of newspapers (Xiang et al., 2015). The immediacy and easy accessibility of the online news in current days is leading the newspapers towards their declination and, it is predictable that newspapers would lose its importance in the coming days. However, the most ironic part of the Schumpeter’s iconic line is- “The societies, which try to reap the gain of the creative destruction without the pain find themselves enduring the pain but not the gain”.

From the above analysis, it is clear that the creative destruction process is an essential and fundamental part of the economic fluctuations and growth and barriers to this process could have serious short and long-term macro economic impact. Hence, it can be said that people are witnessing the development of the creativity in the form of new industries by watching the destructions of the old ones and this in turn is referred to as creative destruction.

References:

Anghart, L. (2012). Improve Your Eyesight Naturally: See Results Quickly. Crown House Publishing.

Archibugi, D., Filippetti, A., & Frenz, M. (2013). Economic crisis and innovation: Is destruction prevailing over accumulation?. Research Policy, 42(2), 303-314.

Bogliacino, F., Lucchese, M., & Pianta, M. (2013). Job creation in business services: Innovation, demand, and polarisation. Structural Change and Economic Dynamics, 25, 95-109.

Brandt, L., Van Biesebroeck, J., & Zhang, Y. (2012). Creative accounting or creative destruction? Firm-level productivity growth in Chinese manufacturing. Journal of development economics, 97(2), 339-351.

Brown, J. P., Lambert, D. M., & Florax, R. J. (2013). The birth, death, and persistence of firms: Creative destruction and the spatial distribution of US manufacturing establishments, 2000–2006. Economic Geography, 89(3), 203-226.

Creative Destruction’ was first coined by Joseph Schumpeter in the year 1942

Dogramaci, A., & Färe, R. (Eds.). (2012). Applications of modern production theory: efficiency and productivity (Vol. 9). Springer Science & Business Media.

Gallipoli, G., & Pelloni, G. (2013). Macroeconomic effects of job reallocations: A survey.

Hallward-Driemeier, M., & Rijkers, B. (2013). Do crises catalyze creative destruction? Firm-level evidence from Indonesia. Review of Economics and Statistics, 95(1), 1788-1810.

Haltiwanger, J. (2012). Job creation and firm dynamics in the United States. Innovation policy and the economy, 12(1), 17-38.

Haltiwanger, J. (2012). Job creation and firm dynamics in the United States. Innovation policy and the economy, 12(1), 17-38.

Martin, J. P., & Scarpetta, S. (2012). Setting it right: Employment protection, labour reallocation and productivity. De Economist, 160(2), 89-116.

Mazzucato, M. (2013). Financing innovation: creative destruction vs. destructive creation. Industrial and Corporate Change, 22(4), 851-867.

Mitchell, C. J. (2013). Creative destruction or creative enhancement? Understanding the transformation of rural spaces. Journal of rural studies, 32, 375-387.

Ng, I. C. (2014). Creating new markets in the digital economy. Cambridge University Press.

Ogun, O. (2014). Reconstructing Long-Run Economics: Survey and Issues. Journal of Economics and Economic Education Research, 15(3), 147.

Rotman, D. (2013). How technology is destroying jobs. Technology Review, 16(4), 28-35.

Schubert, C. (2013). How to evaluate creative destruction: reconstructing Schumpeter’s approach. Cambridge Journal of Economics, 37(2), 227-250.

Xiang, Z., Wang, D., O’Leary, J. T., & Fesenmaier, D. R. (2015). Adapting to the internet: trends in travelers’ use of the web for trip planning. Journal of Travel Research, 54(4), 511-527.